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

                                    FORM 10-K


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

                   For the fiscal year ended December 31, 2006

                                       or

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

                For the transition period from ______ to _______

                         Commission File Number: 0-26006

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

           CALIFORNIA                                         95-4181026
  (State or other jurisdiction                             (I.R.S. Employer
of incorporation or organization)                       Identification Number)

                         3151 EAST WASHINGTON BOULEVARD
                          LOS ANGELES, CALIFORNIA 90023
               (Address of principal executive offices) (Zip code)

       Registrant's telephone number, including area code: (323) 780-8250

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

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

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

                                      NONE

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

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

         Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
Registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

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

         Indicate by check mark whether the  registrant  is a large  accelerated
filer,  an  accelerated  filer or a  non-accelerated  filer.  See  definition of
"accelerated  filer and large  accelerated  filer" in Rule 12b-2 of the Exchange
Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]

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

         The aggregate  market value of the Common Stock held by  non-affiliates
of the Registrant is approximately  $34,264,994  based upon the closing price of
the Common Stock on June 30, 2006.

         Number of shares of Common Stock of the  Registrant  outstanding  as of
March 23, 2007: 30,543,763.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the  Registrant's  definitive  Proxy  Statement to be filed
with the  Securities  and  Exchange  Commission  pursuant to  Regulation  14A in
connection  with the 2007 Annual Meeting of  Shareholders  are  incorporated  by
reference into Part III of this Report.


<PAGE>


                              TARRANT APPAREL GROUP
                               INDEX TO FORM 10-K

PART I                                                                      PAGE

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

Item 1A.      Risk Factors.................................................   10

Item 1B.      Unresolved Staff Comments....................................   16

Item 2.       Properties...................................................   17

Item 3.       Legal Proceedings............................................   17

Item 4.       Submission of Matters to a Vote of Security Holders..........   18

PART II

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

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

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

Item 7A.      Quantitative and Qualitative Disclosures about Market Risk ..   45

Item 8.       Financial Statements and Supplementary Data..................   46

Item 9.       Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure.......................   46

Item 9A.      Controls and Procedures......................................   46

Item 9B.      Other Information............................................   46

PART III

Item 10.      Directors and Executive Officers of the Registrant...........   46

Item 11.      Executive Compensation.......................................   46

Item 12.      Security Ownership of Certain Beneficial Owners and
                 Management and Related Stockholder Matters................   47

Item 13.      Certain Relationships and Related Transactions...............   47

Item 14.      Principal Accounting Fees and Services.......................   47

PART IV

Item 15.      Exhibits and Financial Statement Schedules...................   47


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                                     PART I

            CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

         This  2006  Annual  Report  on  Form  10-K  contains  statements  which
constitute  forward-looking  statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,
both as amended.  Those  statements  include  statements  regarding  our intent,
belief or current  expectations.  Prospective  investors are cautioned  that any
such  forward-looking  statements are not guarantees of future  performance  and
involve risks and  uncertainties,  and that actual results may differ materially
from  those  projected  in  the  forward-looking   statements.  Such  risks  and
uncertainties   include,   among  other  things,   our  ability  to  face  stiff
competition,  profitably  manage  a  sourcing  and  distribution  business,  the
financial  strength of our major  customers,  the  continued  acceptance  of our
existing and new products by our existing and new  customers,  dependence on key
customers, the risks of foreign manufacturing,  competitive and economic factors
in the textile and apparel  markets,  the  availability  of raw  materials,  the
ability to manage growth,  weather-related delays,  dependence on key personnel,
general economic conditions,  global  manufacturing costs and restrictions,  and
other risks and  uncertainties  that may be detailed herein.  See "Item 1A. Risk
Factors."

ITEM 1.  BUSINESS

OVERVIEW

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

         In 2004 and 2005,  our net sales were $155  million  and $215  million,
respectively. In 2006, our net sales increased by 8.3% to $232 million. In 2004,
we experienced a net loss of $104.7 million,  which included non-cash charges of
$22.8 million of foreign  currency  translation  loss and $78.0 million of asset
impairments.  In 2005, we  experienced  net income of $1.0 million.  In 2006, we
experienced a net loss of $22.2  million,  which  included a non-cash  charge of
$27.1  million of a loss on notes  receivable  - related  parties.  See "Item 7.
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations."

         We launched our private brands  initiative in 2003, in which we acquire
ownership of or license  rights to a brand name and sell apparel  products under
the brand,  generally to a single retail company within a geographic  region. At
March 27, 2007, we are selling  apparel  products under the following  brands at
the following retailers:

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

         American Rag CIE                   Macy's Merchandising Group
         Alain Weiz                         Specialty stores, department stores

         During 2005 we sold Gear 7 branded apparel to K-Mart. During the fourth
quarter of 2005,  K-Mart decided to  discontinue  this line, and we did not have
sales of Gear 7 products in 2006. Additionally, in March 2006, we terminated our
license agreement for the brand House of Dereon by Tina Knowles,


                                       1
<PAGE>


and sold our remaining inventory to the licensor. As a result, we will no longer
sell  apparel  products  under this  private  brand.  In March  2006,  we became
involved in a dispute with the licensor of the Jessica  Simpson  brands over our
continued rights to these brands.  Accordingly, we did not have sales of Jessica
Simpson branded apparel after the first quarter of 2006, and will not have sales
in the future  unless and until we  successfully  resolve our  dispute  with the
licensor.

RECENT DEVELOPMENTS - THE BUFFALO GROUP

         On  December  6, 2006,  we entered  into a  definitive  stock and asset
purchase agreement to acquire certain assets and entities comprising The Buffalo
Group. The Buffalo Group designs, imports and sells contemporary branded apparel
and  accessories,  primarily  in  Canada  and the  United  States.  For  further
description  of The  Buffalo  Group and a summary of the  material  terms of the
definitive purchase agreement, see "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operation".

         The proposed  acquisition  of The Buffalo Group is part of our strategy
to grow and diversify our business. We believe its benefits to us will include:

         o        Expanding  our  operations  by adding  additional  proprietary
                  brands and products to compete more effectively;

         o        Expanding the scope,  scale and strength of our  operations by
                  expanding its marketing, sales and distribution capabilities;

         o        Enhancing our  capabilities  to compete in Canada,  the United
                  States and other  markets;  and utilize  The  Buffalo  Group's
                  existing sales and marketing  infrastructure as a platform for
                  expanding sales of our apparel products; and

         o        Providing  opportunities  for us to penetrate  new markets and
                  expand our share in existing markets.

         The  Buffalo  Group was started in 1985 as the  distributor  of Buffalo
branded products in Canada.  Initially,  the Buffalo brand was a denim line, but
it has been expanded over time. In 1993,  The Buffalo Group widened its customer
base by adding U.S.  retailers.  In 2000,  The Buffalo  Group  started a private
label business for retailers in Canada and the U.S. In 1996,  Buffalo opened its
first  retail  store in Canada and it  currently  operates  45 retail  stores in
Canada.  Over this time Buffalo has added additional brand names to its line. It
has also  developed  a licensing  program for the Buffalo  brand for the sale of
apparel-related  products in Canada, and the sale of apparel products in foreign
countries.

         We will be filing a  definitive  proxy  statement  and other  documents
concerning the proposed  transaction with the Securities and Exchange Commission
("SEC").  Shareholders  are urged to read the proxy  statement  when it  becomes
available and any other relevant  documents filed with the SEC because they will
contain important information on the proposed transaction.

BUSINESS STRATEGY

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

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


                                       2
<PAGE>


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

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

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

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

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

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

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

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

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

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

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

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


                                       3
<PAGE>


PRODUCTS

         Women's jeans historically have been, and continue to be, our principal
product.  Our products also include moderately priced women's apparel to include
casual,  non-denim,  fabrications  including  twill and other  cotton and cotton
blends,  in woven tops and  bottoms.  Our  women's  apparel  products  currently
include jeans wear, casual pants, shorts, skirts,  dresses,  t-shirts,  blouses,
shirts,  other tops and  jackets.  These  products are  manufactured  in petite,
standard and large sizes and are sold at a variety of wholesale prices generally
ranging from less than $5 to over $30 per garment.  We have  produced  men's and
children's apparel in varying significance for the last several years.

         Over the past three years,  approximately 64% of net sales were derived
from the sales of pants and  jeans,  approximately  6% from the sale of  shorts,
approximately 13% from the sale of shirts, blouses and tops and approximately 6%
from the sale of skirts and  skort-alls.  The balance of net sales  consisted of
sales of dresses, jackets and other products.

CUSTOMERS

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

         The  following  table shows the  percentage  of our net sales in fiscal
year 2006  attributable to each customer that accounted for more than 10% of net
sales.

                                                     PERCENTAGE OF NET SALES
                                                     -----------------------
         CUSTOMER                                             2006
         -----------------------------------         -----------------------
         Macy's Merchandising Group.........                  18.9
         Kohl's.............................                  14.1
         Mervyn's...........................                  11.9


         We  currently  serve  over 15  customers,  which in  addition  to those
identified above,  include,  Mothers Work,  Chico's,  New York & Co.,  Wal-Mart,
Charlotte Russe, the Avenue,  Lane Bryant,  Sears and J.C. Penney. In 2004, 2005
and 2006, net sales of private  brands  represented  approximately  14%, 26% and
22%,  respectively,  of our total net sales.  We  launched  our  private  brands
initiative  in 2003,  in which we acquire  ownership  of or license  rights to a
brand name and sell  apparel  products  under this brand,  generally to a single
retail  company  within a  geographic  region.  We sell  products  in our brands
"American Rag Cie" exclusively to Macy's  Merchandising  Group. We sold products
in our licensed  brand "Alain Weiz" to Dillard's in 2005 and 2006.  From January
1, 2007,  we may sell our licensed  brand  "Alain Weiz" to specialty  stores and
department stores.

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


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<PAGE>


DESIGN, MERCHANDISING AND SALES

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

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

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

         From  time to time  and at  scheduled  seasonal  meetings,  we  present
samples to the  customer's  buyers who determine  which,  if any, of the samples
will be produced on a test run or a bulk order.  Samples are often  presented in
coordinated groupings or as part of a product line. Some customers, particularly
specialty  retail stores,  may require that a product be tested before placing a
bulk order.  Testing involves the production of as few as several hundred copies
of a given sample in different size, fabric and color combinations. The customer
pays for these test items, which are placed in selected stores to gauge consumer
response.  The  production  of test items  enables  our  customers  to  identify
garments  that may  appeal to  consumers  and also  provides  us with  important
information  regarding the cost and  feasibility  of the bulk  production of the
tested garment. If the test is determined to be successful, we generally receive
a significant  percentage of the customer's total bulk order of the tested item.
In  addition,  as is typical in the  private  label  business,  we receive  bulk
production  orders to produce  merchandise  designed by our competitors or other
designers,  since  most  customers  allocate  bulk  orders  among  a  number  of
suppliers.

SOURCING

GENERAL

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


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<PAGE>


Egypt and Mexico.  Our sourcing  strategy is based on a strong  presence in Hong
Kong, China and Southeast Asia.

 DEPENDENCE ON CONTRACT MANUFACTURERS

         The use of  contract  manufacturers  and the  resulting  lack of direct
control  over the  production  of our  products  could  result in our failure to
receive timely delivery of products of acceptable  quality.  Although we believe
that alternative  sources of cutting,  sewing and finishing services are readily
available,  the  loss  of  one  or  more  contract  manufacturers  could  have a
materially  adverse  effect on our results of  operations  until an  alternative
source can be located and commence producing our products.

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

         Except for a  commitment  to  purchase  $5  million of fabric  annually
manufactured  at  facilities  in  Mexico  that we  previously  owned and sold to
affiliates of Mr. Nacif, a shareholder at the time of transaction in 2004, we do
not have any long-term contracts with independent fabric suppliers.  The loss of
any of our major fabric  suppliers  could have a material  adverse effect on our
financial condition and results of operations until alternative arrangements are
secured.

DIVERSIFIED PRODUCTION NETWORK

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

         By allocating an order among different  manufacturers,  we seek to fill
the  high-volume   orders  of  our  customers,   while  meeting  their  delivery
requirements.  Upon receiving an order,  we determine which of our suppliers and
manufacturers can best fill the order and meet the customer's price, quality and
delivery  requirements.  We consider,  among other things,  the price charged by
each  manufacturer  and the  manufacturer's  available  production  capacity  to
complete the order, as well as the availability of quota, if


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<PAGE>


applicable,  for the  product  from  various  countries  and the  manufacturer's
ability to produce  goods on a timely basis  subject to the  customer's  quality
specifications.  Our  personnel  also  consider  the  transportation  lead times
required  to deliver  an order from a given  manufacturer  to the  customer.  In
addition,  some  customers  prefer not to carry excess  inventory  and therefore
require that we stagger the delivery of products over several weeks.

INTERNATIONAL SOURCING

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

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

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

THE IMPORT SOURCING PROCESS

         As is customary in the apparel  industry,  we do not have any long-term
contracts with our manufacturers.  During the manufacturing process, our quality
control personnel visit each factory to inspect garments when the fabric is cut,
as it is being sewn and as the garment is being finished.  Daily  information on
the  status  of  each  order  is  transmitted  from  the  various  manufacturing
facilities  to our offices in Hong Kong and Los Angeles.  We, in turn,  keep our
customers  apprised,  often through daily telephone  calls and frequent  written
reports. These calls and reports include candid assessments of the progress of a
customer's order, including a discussion of the difficulties,  if any, that have
been encountered and our plans to rectify them.

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

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


                                       7
<PAGE>


DISTRIBUTION

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

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

BACKLOG

         As of March 22, 2007, we had unfilled  customer orders of approximately
$85 million as compared to  approximately  $74 million as of March 22, 2006.  We
believe  that all of our  backlog of orders as of March 22,  2007 will be filled
before the end of fiscal year 2007.  Backlog is based on our  estimates  derived
from internal management reports.  The amount of unfilled orders at a particular
time  is  affected  by  a  number  of  factors,   including  the  scheduling  of
manufacturing and shipping of the product,  which in some instances,  depends on
the customer's requirements.  Accordingly,  a comparison of unfilled orders from
period to period is not  necessarily  meaningful  and may not be  indicative  of
eventual annual bookings or actual  shipments.  Our experience has been that the
cancellations,  rejections or returns of orders have not materially  reduced the
amount of sales realized from our backlog.

SEGMENT INFORMATION

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

IMPORT RESTRICTIONS

QUOTAS

         We  imported   substantially   all  of  our  products   sold  in  2006.
Approximately 1% of this merchandise was imported from Mexico,  which is subject
to special  rules under  NAFTA.  NAFTA  allows for the duty and quota free entry
into the United States of certain qualifying merchandise.

         A  majority of the merchandise  imported by us in 2006 was manufactured
in  various  countries  (e.g.,  China)  with  which the U.S.  had  entered  into
bilateral trade agreements.


                                       8
<PAGE>


         As of  January  1,  2005,  quota on  apparel  from  all WTO  countries,
including  China  (except that certain  commodities  still  require  quotas as a
result of "safeguard measures"), was eliminated. As China is now a member of the
WTO,  its  exports of textiles  and  apparel to the U.S.  are covered by the WTO
Agreement on Textiles and Clothing.  In 2006,  quota was temporarily  reinstated
for China until 2008 for certain import merchandise categories.  Quota is traded
on the open market  through  quota  holders who possess the quota  holdings.  We
purchase quota from the open market. Quota gives us the right within the year to
ship our goods to the U.S. Quota is non-dutiable.

DUTIES AND TARIFFS

         As with all goods imported into the U.S.,  our imported  merchandise is
subject to duty (unless  statutorily  exempt from duty) at rates  established by
U.S.  law.  These  rates  range,   depending  on  the  type  of  product,   from
approximately 2% to 30% of the FOB value of the product.  In addition to duties,
in the ordinary course of our business, we are occasionally subject to claims by
the U.S.  Bureau of Customs  and Border  Protection  for  penalties,  liquidated
damages and other charges relating to import  activities.  Similarly,  we are at
times  entitled to refunds  from  Customs,  resulting  from the  overpayment  of
duties.

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

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

COMPETITION

         There is intense  competition in the sectors of the apparel industry in
which we participate.  We compete with many other  manufacturers,  many of which
are larger and have greater resources than us. We also face competition from our
own customers and potential  customers,  many of which have established,  or may
establish, their own internal product development and sourcing capabilities.  We
believe   that  we  compete   favorably  on  the  basis  of  design  and  sample
capabilities,  the quality and value of our products,  price, and the production
flexibility that we enjoy as a result of our sourcing network.

TRADEMARKS

         As part of our private  brands  strategy,  we acquire  ownership  of or
rights to a brand  name and sell  apparel  products  under this  brand.  We have
ownership  rights to the registered  trademarks  "American Rag Cie," "Gear7" and
"NO! Jeans". In addition,  we have acquired license rights to design, market and
distribute  certain  apparel  products under the Alain Weiz and Jessica  Simpson
brands. We are currently involved in litigation with the licensor of the Jessica
Simpson brands over our continued rights to these brands.

SEASONALITY

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


                                       9
<PAGE>


EMPLOYEES

         At December 31, 2006, we had approximately  145 full-time  employees in
the United States and 141 in Hong Kong. None of our employees are unionized.  We
consider our relations with our employees to be satisfactory in all areas of our
operations.

ITEM 1A. RISK FACTORS

         This Annual  Report on Form 10-K contains  forward-looking  statements,
which are subject to a variety of risks and  uncertainties.  Our actual  results
could  differ  materially  from  those  anticipated  in  these   forward-looking
statements as a result of various factors, including those set forth below.

RISKS RELATED TO OUR BUSINESS

WE DEPEND ON A GROUP OF KEY CUSTOMERS FOR A SIGNIFICANT  PORTION OF OUR SALES. A
SIGNIFICANT  ADVERSE  CHANGE  IN A  CUSTOMER  RELATIONSHIP  OR  IN A  CUSTOMER'S
FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.

         Three  customers  accounted for  approximately  45% of our net sales in
fiscal year 2006.  We believe  that  consolidation  in the retail  industry  has
centralized  purchasing  decisions  and given  customers  greater  leverage over
suppliers,  like us, and we expect this trend to continue. If this consolidation
continues, our net sales and results of operations may be increasingly sensitive
to  deterioration in the financial  condition of, or other adverse  developments
with, one or more of our customers.

         While we have long-standing customer relationships, we generally do not
have  long-term  contracts with them except for Macy's  Merchandising  Group for
American Rag Cie.  Purchases  generally occur on an  order-by-order  basis,  and
relationships  exist as long as there is a perceived benefit to both parties.  A
decision by a major customer,  whether motivated by competitive  considerations,
financial  difficulties,  and economic conditions or otherwise,  to decrease its
purchases  from us or to change  its  manner of doing  business  with us,  could
adversely  affect our  business and  financial  condition.  In addition,  during
recent  years,  various  retailers,   including  some  of  our  customers,  have
experienced  significant  changes and difficulties,  including  consolidation of
ownership,  increased  centralization of purchasing  decisions,  restructurings,
bankruptcies and liquidations.

         These and other financial problems of some of our retailers, as well as
general  weakness  in the retail  environment,  increase  the risk of  extending
credit  to  these  retailers.   A  significant  adverse  change  in  a  customer
relationship  or in a customer's  financial  position could cause us to limit or
discontinue  business with that customer,  require us to assume more credit risk
relating to that  customer's  receivables,  limit our ability to collect amounts
related to previous purchases by that customer, or result in required prepayment
of our  receivables  securitization  arrangements,  all of which  could harm our
business and financial condition.

FAILURE TO COMPLETE THE PROPOSED  ACQUISITION  OF THE BUFFALO  GROUP COULD CAUSE
OUR STOCK PRICE TO DECLINE.

         We have  entered into a stock and asset  purchase  agreement to acquire
certain assets and entities  comprising The Buffalo Group, as discussed  further
in "Item 7 -  Management's  Discussion  and Analysis of Financial  Condition and
Results of  Operation."  The  completion  of the  transaction  is subject to the
satisfaction  of a number of conditions as set forth in the purchase  agreement,
including among others, the approval of the acquisition and related transactions
by our shareholders, our obtaining the necessary


                                       10
<PAGE>


financing to complete the acquisition,  obtaining  certain third party consents,
and  other  customary  closing  conditions.  There can be no  guaranty  that the
acquisition will be completed in a timely manner, if at all.

          If the proposed  acquisition is not  consummated  for certain  reasons
specified in the purchase agreement, our stock price may decline because we will
incur  significant  costs  relating  to the  acquisition  that must be paid even
though the acquisition is not completed.  Most  importantly,  the sellers may be
entitled  to  retain  the  $5  million  deposit.  In  addition,  we  will  incur
significant  legal,  accounting and other  expenses,  and may be required to pay
Buffalo's  out-of-pocket  expenses.  If the acquisition is not completed for any
reason,  our stock price may decline to the extent that the current market price
reflects a market assumption that the acquisition will be completed.

THE PROPOSED  ACQUISITION OF THE BUFFALO GROUP WILL RESULT IN SIGNIFICANT  COSTS
TO US, WHETHER OR NOT IT IS COMPLETED,  WHICH COULD RESULT IN A REDUCTION IN OUR
INCOME AND CASH FLOWS.

         The  proposed   acquisition   of  The  Buffalo  Group  will  result  in
significant  costs to us.  Transaction  costs are  estimated to be at least $2.1
million.  These costs are expected to consist  primarily of fees for  attorneys,
accountants,  filing fees and financial printers. We will also incur substantial
fees and costs  associated  with the amended credit facility that we are putting
in place in connection with the proposed acquisition. All of these costs will be
incurred whether or not the transaction is completed.  In addition, if the stock
and asset purchase agreement is terminated under specified circumstances, the $5
million deposit we made upon signing the purchase  agreement will be retained by
the sellers and will not be returned  to us.  Under most  circumstances,  we are
also required to pay  out-of-pocket  expenses  incurred by Buffalo in connection
with the  transaction.  Incurring  these  expenses will cause a reduction in our
income and cash flows, and harm our business.

FAILURE OF THE  TRANSPORTATION  INFRASTRUCTURE TO MOVE SEA FREIGHT IN ACCEPTABLE
TIME FRAMES COULD ADVERSELY AFFECT OUR BUSINESS.

         Because the bulk of our  freight is  designed to move  through the West
Coast ports in  predictable  time frames,  we are at risk of  cancellations  and
penalties when those ports operate inefficiently creating delays in delivery. We
experienced  such  delays  from  June  2004  until  November  2004,  and  we may
experience  similar  delays  in  the  future  especially  during  peak  seasons.
Unpredictable  timing for  shipping  may cause us to utilize  air freight or may
result in customer  penalties for late  delivery,  any of which could reduce our
operating margins and adversely affect our results of operations.

UNPREDICTABLE  DELAYS  AS  THE  RESULT  OF  INCREASED  AND  INTENSIFIED  CUSTOMS
ACTIVITY.

         U.S.  Customs has stepped up efforts to  scrutinize  imports  from Hong
Kong in order to verify all details of  shipments  under the OPA rules  allowing
certain  processes to be performed in China without shipping under China country
of origin  documentation.  Such "detentions" are unpredictable and cause serious
interruption of normally expected freight movement timetables.

THE  OUTCOME OF  LITIGATION  IN WHICH WE ARE  INVOLVED IS  UNPREDICTABLE  AND AN
ADVERSE  DECISION IN ANY SUCH MATTER COULD HAVE A MATERIAL ADVERSE AFFECT ON OUR
FINANCIAL POSITION AND RESULTS OF OPERATIONS.

         We are  currently  in  litigation  with the  licensors  of the  Jessica
Simpson brands regarding our rights to sell apparel under these brands. See Item
3 "Legal Proceedings" for a detailed  description of this lawsuit.  The licensor
has filed a  counterclaim  against us seeking  damages.  These claims may divert
financial and management  resources that would  otherwise be used to benefit our
operations.  Although we believe that we have meritorious claims and defenses to
the counter-claims made against us, and intend to pursue the lawsuit vigorously,
no assurances can be given that the results of these matters will be


                                       11
<PAGE>


favorable to us. An adverse  resolution  of any of these  lawsuits  could have a
material  adverse  affect on our financial  position and results of  operations.
Additionally,  we have incurred  significant legal fees in this litigation,  and
unless the case is settled,  we will continue to incur  additional legal fees in
increasing amounts as the case accelerates to trial.

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

         Since our inception,  we have experienced  periods of rapid growth.  No
assurance can be given that we will be successful in  maintaining  or increasing
our sales in the  future.  Any future  growth in sales will  require  additional
working capital and may place a significant strain on our management, management
information systems,  inventory  management,  sourcing capability,  distribution
facilities and receivables  management.  Any disruption in our order processing,
sourcing or  distribution  systems  could cause orders to be shipped  late,  and
under  industry  practices,  retailers  generally can cancel orders or refuse to
accept goods due to late shipment.  Such  cancellations and returns would result
in a reduction in revenue,  increased  administrative  and shipping  costs and a
further burden on our distribution facilities.

OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.

         We have experienced, and expect to continue to experience,  substantial
variations  in our net sales and operating  results from quarter to quarter.  We
believe that the factors which influence this  variability of quarterly  results
include  the  timing of our  introduction  of new  product  lines,  the level of
consumer  acceptance  of each new product  line,  general  economic and industry
conditions  that  affect  consumer   spending  and  retailer   purchasing,   the
availability of manufacturing  capacity, the seasonality of the markets in which
we participate,  the timing of trade shows,  the product mix of customer orders,
the timing of the placement or  cancellation  of customer  orders,  the weather,
transportation  delays, the occurrence of charge backs in excess of reserves and
the timing of  expenditures  in  anticipation  of increased sales and actions of
competitors.  Due to  fluctuations  in our revenue and  operating  expenses,  we
believe that period-to-period comparisons of our results of operations are not a
good  indication of our future  performance.  It is possible that in some future
quarter or quarters,  our operating  results will be below the  expectations  of
securities analysts or investors.  In that case, our stock price could fluctuate
significantly or decline.

WE DEPEND ON OUR COMPUTER AND COMMUNICATIONS SYSTEMS.

         As  a  multi-national   corporation,   we  rely  on  our  computer  and
communication  network to operate efficiently.  Any interruption of this service
from power loss,  telecommunications  failure, weather, natural disasters or any
similar  event  could  have  a  material  adverse  affect  on our  business  and
operations. Additionally, hackers and computer viruses have disrupted operations
at many major companies. We may be vulnerable to similar acts of sabotage, which
could have a material adverse effect on our business and operations.

WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE.

         We may not be able to fund our  future  growth or react to  competitive
pressures if we lack sufficient funds.  Currently, we believe we have sufficient
cash on hand and cash available through our bank credit facilities,  issuance of
long-term  debt and equity  securities,  and proceeds from the exercise of stock
options to fund existing operations for the foreseeable future.  However, in the
future we may need to raise  additional  funds through equity or debt financings
or collaborative relationships. This additional funding may not be available or,
if  available,  it may not be available on  economically  reasonable  terms.  In
addition,  any additional funding may result in significant dilution to existing
shareholders. If adequate


                                       12
<PAGE>


funds are not available,  we may be required to curtail our operations or obtain
funds through  collaborative  partners  that may require us to release  material
rights to our products.

OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.

         Substantially  all of our  import  operations  are  subject  to tariffs
imposed on imported  products,  safeguards and growth  targets  imposed by trade
agreements. In addition, the countries in which our products are manufactured or
imported may from time to time impose  additional  new duties,  tariffs or other
restrictions on our imports or adversely modify existing  restrictions.  Adverse
changes in these import costs and  restrictions,  or our  suppliers'  failure to
comply with customs or similar laws,  could harm our business.  We cannot assure
that future trade  agreements will not provide our competitors with an advantage
over us, or increase our costs,  either of which could have an adverse effect on
our business and financial condition.

         Our operations are also subject to the effects of  international  trade
agreements and regulations such as the North American Free Trade Agreement,  and
the activities and regulations of the World Trade Organization. Generally, these
trade  agreements  benefit our  business by reducing or  eliminating  the duties
assessed  on products  manufactured  in a  particular  country.  However,  trade
agreements can also impose requirements that adversely affect our business, such
as limiting the  countries  from which we can purchase raw materials and setting
duties or  restrictions  on products that may be imported into the United States
from a  particular  country.  In  addition,  the World  Trade  Organization  may
commence a new round of trade  negotiations  that  liberalize  textile  trade by
further  eliminating  or reducing  tariffs.  The  elimination of quotas on World
Trade Organization  member countries in 2005 has resulted in explosive growth in
textile imports from China, and subsequent  safeguard measures including embargo
of  certain  China  country of origin  products.  Actions  taken to avoid  these
measures caused disruption, and a negative impact on margins. In 2006, quota was
temporarily  reinstated  for China  until 2008 for  certain  import  merchandise
categories.  Such disruptions and the temporary  measures may continue to affect
us to some extent in the future.

OUR DEPENDENCE ON INDEPENDENT  MANUFACTURERS  REDUCES OUR ABILITY TO CONTROL THE
MANUFACTURING  PROCESS,  WHICH  COULD HARM OUR  SALES,  REPUTATION  AND  OVERALL
PROFITABILITY.

         We depend on independent contract  manufacturers to secure a sufficient
supply of raw  materials  and  maintain  sufficient  manufacturing  and shipping
capacity in an environment  characterized by declining  prices,  labor shortage,
continuing  cost  pressure  and  increased  demands for product  innovation  and
speed-to-market.  This  dependence  could  subject us to difficulty in obtaining
timely delivery of products of acceptable quality.  In addition,  a contractor's
failure  to ship  products  to us in a timely  manner  or to meet  the  required
quality  standards could cause us to miss the delivery date  requirements of our
customers.  The failure to make timely  deliveries  may cause our  customers  to
cancel  orders,  refuse  to accept  deliveries,  impose  non-compliance  charges
through  invoice  deductions or other  charge-backs,  demand  reduced  prices or
reduce future orders, any of which could harm our sales,  reputation and overall
profitability.  We do not  have  material  long-term  contracts  with any of our
independent  contractors and any of these contractors may unilaterally terminate
their  relationship with us at any time. To the extent we are not able to secure
or maintain relationships with independent  contractors that are able to fulfill
our requirements, our business would be harmed.

         We have implemented a factory compliance  agreement with our suppliers,
and monitor our independent  contractors' compliance with applicable labor laws,
but we do not control our contractors or their labor practices. The violation of
federal,  state or foreign labor laws by one of the our contractors could result
in our being subject to fines and our goods that are  manufactured  in violation
of such laws being seized or their sale in interstate commerce being prohibited.
From time to time, we have been


                                       13
<PAGE>


notified  by  federal,   state  or  foreign  authorities  that  certain  of  our
contractors  are the  subject  of  investigations  or have  been  found  to have
violated  applicable  labor  laws.  To date,  we have not  been  subject  to any
sanctions that,  individually or in the aggregate,  have had a material  adverse
effect  on our  business,  and we are not  aware of any  facts on which any such
sanctions could be based. There can be no assurance, however, that in the future
we will not be subject to  sanctions  as a result of  violations  of  applicable
labor laws by our  contractors,  or that such sanctions will not have a material
adverse effect on our business and results of operations.  In addition,  certain
of our  customers,  require  strict  compliance by their apparel  manufacturers,
including us, with applicable labor laws and visit our facilities  often.  There
can be no assurance  that the violation of  applicable  labor laws by one of our
contractors will not have a material adverse effect on our relationship with our
customers.

OUR  BUSINESS IS SUBJECT TO RISKS OF  OPERATING  IN A FOREIGN  COUNTRY AND TRADE
RESTRICTIONS.

         We are subject to the risks  associated  with doing business in foreign
countries,   including,   but  not   limited  to,   transportation   delays  and
interruptions,  political instability,  expropriation, currency fluctuations and
the imposition of tariffs, import and export controls, other non-tariff barriers
and cultural  issues.  Any changes in those countries' labor laws and government
regulations may have a negative effect on our profitability.

RISK ASSOCIATED WITH OUR INDUSTRY

OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES.

         Apparel  is a cyclical  industry  that is  heavily  dependent  upon the
overall level of consumer spending.  Purchases of apparel and related goods tend
to be highly  correlated with cycles in the disposable  income of our consumers.
Our customers  anticipate and respond to adverse changes in economic  conditions
and uncertainty by reducing  inventories and canceling orders. As a result,  any
substantial deterioration in general economic conditions,  increases in interest
rates,  acts of war,  terrorist  or  political  events  that  diminish  consumer
spending and confidence in any of the regions in which we compete,  could reduce
our sales and adversely affect our business and financial condition.

OUR BUSINESS IS HIGHLY COMPETITIVE AND DEPENDS ON CONSUMER SPENDING PATTERNS.

         The  apparel  industry  is highly  competitive.  We face a  variety  of
competitive challenges including:

         o        anticipating  and  quickly  responding  to  changing  consumer
                  demands;

         o        developing innovative,  high-quality products in sizes, colors
                  and styles that appeal to  consumers of varying age groups and
                  tastes;

         o        competitively  pricing our  products  and  achieving  customer
                  perception of value; and

         o        the need to provide strong and effective marketing support.

WE MUST SUCCESSFULLY  GAUGE FASHION TRENDS AND CHANGING CONSUMER  PREFERENCES TO
SUCCEED.

         Our success is largely  dependent upon our ability to gauge the fashion
tastes of our customers and to provide  merchandise  that  satisfies  retail and
customer demand in a timely manner. The apparel business fluctuates according to
changes in consumer  preferences  dictated in part by fashion and season. To the
extent we misjudge  the market for our  merchandise  our sales may be  adversely
affected.  Our ability to anticipate and effectively respond to changing fashion
trends depends in part on our ability to attract and retain key personnel in our
design, merchandising and marketing staff. Competition for these


                                       14
<PAGE>


personnel is intense,  and we cannot be sure that we will be able to attract and
retain a sufficient number of qualified personnel in future periods.

OUR BUSINESS IS SUBJECT TO SEASONAL TRENDS.

         Historically,  our  operating  results  have been  subject to  seasonal
trends when measured on a quarterly  basis.  This trend is dependent on numerous
factors,  including the markets in which we operate,  holiday seasons,  consumer
demand,  climate,  economic  conditions  and numerous  other factors  beyond our
control.  There can be no assurance  that our historic  operating  patterns will
continue in future  periods as we cannot  influence  or  forecast  many of these
factors.

OTHER RISKS RELATED TO AN INVESTMENT IN OUR COMMON STOCK

THE ULTIMATE RESOLUTION OF THE INTERNAL REVENUE SERVICE'S EXAMINATION OF OUR TAX
RETURNS MAY REQUIRE US TO INCUR AN EXPENSE  BEYOND WHAT HAS BEEN RESERVED FOR ON
OUR BALANCE SHEET OR MAKE CASH PAYMENTS BEYOND WHAT WE ARE THEN ABLE TO PAY.

         In January 2004, the Internal Revenue Service  proposed  adjustments to
increase  our federal  income tax payable for the years ended  December 31, 1996
through 2001. In addition, in July 2004, the IRS initiated an examination of our
Federal  income tax return for the year ended  December 31, 2002. In March 2005,
the IRS proposed an adjustment to our taxable income of approximately $9 million
related to similar  issues  identified  in their audit of the 1996  through 2001
federal  income tax returns.  This  adjustment  would also result in  additional
state  taxes,  penalties  and  interest.  We  believe  that we have  meritorious
defenses to and intend to vigorously  contest the proposed  adjustments  made to
our federal  income tax returns for the years ended 1996  through  2002.  If the
proposed  adjustments are upheld through the  administrative  and legal process,
they could have a material  impact on our earnings and cash flow.  We believe we
have provided adequate reserves for any reasonably  foreseeable  outcome related
to these matters on the  consolidated  balance sheets under the caption  "Income
Taxes".  The  maximum  amount  of loss in excess of the  amount  accrued  in the
financial  statements  is $8.3 million.  If the amount of any actual  liability,
however, exceeds our reserves, we would experience an immediate adverse earnings
impact in the amount of such  additional  liability,  which  could be  material.
Additionally,  we anticipate that the ultimate  resolution of these matters will
require  that we make  significant  cash  payments  to the  taxing  authorities.
Presently we do not have sufficient cash to make any future payments that may be
required.  No assurance can be given that we will have  sufficient  surplus cash
from operations to make the required payments.  Additionally,  any cash used for
these purposes will not be available for other corporate  purposes,  which could
have a  material  adverse  effect on our  financial  condition  and  results  of
operations.

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

         As of March 23, 2007,  our  executive  officers and directors and their
affiliates  owned  approximately  43% of our  common  stock.  Gerard  Guez,  our
Chairman and Interim Chief Executive  Officer,  and Todd Kay, our Vice Chairman,
alone own approximately 33% and 8%,  respectively,  of our common stock at March
23, 2007. Accordingly,  our executive officers and directors have the ability to
affect  the  outcome  of, or exert  considerable  influence  over,  all  matters
requiring shareholder approval,  including the election and removal of directors
and any change in control. If the proposed Buffalo acquisition is completed, the
shares  our stock to be issued to the  sellers  in the stock and asset  purchase
transaction will  collectively  comprise  approximately  30% of the total voting
power of our shares  immediately after the closing of these  transactions.  As a
result, the Buffalo sellers and our existing significant shareholders would have
the ability, if voting together, to control the outcome over most


                                       15
<PAGE>


matters requiring shareholder  approval.  This concentration of ownership of our
common stock could have the effect of delaying or preventing a change of control
of  us or  otherwise  discouraging  or  preventing  a  potential  acquirer  from
attempting to obtain control of us. This, in turn,  could have a negative effect
on the market price of our common stock. It could also prevent our  shareholders
from  realizing  a premium  over the market  prices  for their  shares of common
stock.

WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF
OUR COMMON STOCK.

         Our shareholders rights plan, our ability to issue additional shares of
preferred stock and some provisions of our articles of incorporation  and bylaws
could make it more difficult for a third party to make an  unsolicited  takeover
attempt of us. These anti-takeover  measures may depress the price of our common
stock by making it more difficult for third parties to acquire us by offering to
purchase  shares of our stock at a premium to its market price without  approval
of our board of directors.

OUR STOCK PRICE HAS BEEN VOLATILE.

         Our common stock is quoted on the NASDAQ Global  Market,  and there can
be  substantial  volatility in the market price of our common stock.  The market
price of our common stock has been,  and is likely to continue to be, subject to
significant  fluctuations  due to a  variety  of  factors,  including  quarterly
variations  in  operating  results,   operating  results  which  vary  from  the
expectations  of  securities  analysts  and  investors,   changes  in  financial
estimates,  changes in market valuations of competitors,  announcements by us or
our competitors of a material nature,  loss of one or more customers,  additions
or  departures of key  personnel,  future sales of common stock and stock market
price and volume  fluctuations.  In  addition,  general  political  and economic
conditions such as a recession,  or interest rate or currency rate  fluctuations
may adversely affect the market price of our common stock.

         In addition,  the stock market in general has experienced extreme price
and volume fluctuations that have affected the market price of our common stock.
Often, price fluctuations are unrelated to operating performance of the specific
companies whose stock is affected.  In the past, following periods of volatility
in the market price of a company's stock, securities class action litigation has
occurred  against  the  issuing  company.  If we were  subject  to this  type of
litigation in the future,  we could incur  substantial  costs and a diversion of
our  management's  attention and resources,  each of which could have a material
adverse effect on our revenue and earnings.  Any adverse  determination  in this
type of litigation could also subject us to significant liabilities.

ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO YOU.

         Some investors  favor  companies that pay  dividends,  particularly  in
general  downturns  in the stock  market.  We have not declared or paid any cash
dividends on our common stock. We currently intend to retain any future earnings
for funding growth, and we do not currently  anticipate paying cash dividends on
our  common  stock  in the  foreseeable  future.  Additionally,  we  cannot  pay
dividends on our common stock unless the terms of our bank credit facilities and
outstanding  preferred  stock,  if any,  permit the payment of  dividends on our
common stock.  Because we may not pay dividends,  your return on this investment
likely depends on your selling our stock at a profit.

ITEM 1B. UNRESOLVED STAFF COMMENTS

         Not applicable.


                                       16
<PAGE>


ITEM 2.  PROPERTIES

         At March 23, 2007, we conducted our operations from 9 facilities,  7 of
which were leased. The following table sets forth our facilities, and for leased
facilities the annual rental amount of, expiration of the current lease:

                                                  Annual
Location                     Purpose           Rental Amount      Expiration
------------------    ---------------------    -------------    --------------

Los Angeles, CA       Executive offices and    $656,000         July 2011
(Washington Blvd.)    warehouse

New York, NY          Showroom                 $150,000         August 2007

New York, NY          Showroom                 $559,000         June 2015

Ruleville, MS         Office and warehouse     Own
(2 facilities)

Hong Kong             Office and warehouse     $480,000         January 2008

Hong Kong             Warehouse                $17,000          July 2007

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

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


         We lease our executive offices and warehouse in Los Angeles, California
from GET, a corporation  which is owned by Gerard Guez, our Chairman and Interim
Chief Executive Officer, and Todd Kay, our Vice Chairman. Additionally, we lease
our warehouse and office space in Hong Kong from Lynx  International  Limited, a
Hong Kong corporation that is owned by Messrs.  Guez and Kay. On August 1, 2006,
we  entered  into a lease  agreement  with  GET for our  executive  offices  and
warehouse in Los Angeles, which lease has a term of five years with an option to
renew for an  additional  five year term. On February 1, 2007, we entered into a
one year lease  agreement with Lynx  International  Limited for our office space
and warehouse in Hong Kong.

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

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

         We renewed our lease  agreement  in March 2007 in Mexico for our office
and storage through March 2008.

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

ITEM 3.  LEGAL PROCEEDINGS

         On or about April 6, 2006, we commenced an action  against the licensor
of the  Jessica  Simpson  brands  (captioned  Tarrant  Apparel  Group v.  Camuto
Consulting  Group,  Inc.,  VCJS LLC, With You, Inc. and Jessica  Simpson) in the
Supreme  Court of the State of New York,  County  of New  York.  The suit  named
Camuto Consulting  Group,  Inc., VCJS LLC, With You, Inc. and Jessica Simpson as
defendants,  and asserts that the defendants  failed to provide promised support
in connection with our sublicense agreement for the Jessica


                                       17
<PAGE>


Simpson  brands.  Our complaint  includes eight causes of action,  including two
seeking a declaration that the sublicense  agreement is exclusive and remains in
full  force and  effect,  as well as claims  for  breach of  contract  by Camuto
Consulting,  breach of the duty of good faith and fair  dealing  and  fraudulent
inducement against Camuto Consulting, and a claim against With You, Inc. and Ms.
Simpson that we are an intended third party  beneficiary of the licenses between
those  defendants  and Camuto  Consulting.  On or about April 26,  2006,  Camuto
Consulting  served  its answer to our  complaint  and  included  a  counterclaim
against us for breach of the  sublicense  agreement  and alleging  damages of no
less than $100 million.  With You, Inc. has also filed counterclaims against us,
alleging  trademark  infringement,  unfair  competition and business  practices,
violation  of the right of privacy  and other  claims,  and  seeking  injunctive
relief and damages in an amount to be  determined  but no less than $100 million
plus treble and  punitive  damages.  Discovery  in the matter has been  underway
since May 2006.  Oral  argument on the appeal of the trial  court's  ruling with
respect  to one  motion  was held on March 21,  2007,  and the  parties  await a
decision.  We intend to continue to vigorously pursue this action and defend the
counterclaims.

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

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

         There were no matters  submitted to a vote of our  shareholders  during
the fourth quarter of 2006.


                                     PART II

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

NASDAQ GLOBAL MARKET

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

                                                          Low          High
                                                       ----------    ----------
2005
----
First Quarter...............................             1.50          2.62
Second Quarter..............................             1.35          3.88
Third Quarter...............................             2.76          4.12
Fourth Quarter..............................             1.02          3.15

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

         On March 23, 2007,  the last reported sale price of our common stock as
reported by NASDAQ was $1.55.  As of March 23, 2007, we had 25  shareholders  of
record.


                                       18
<PAGE>


DIVIDEND POLICY

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

PERFORMANCE GRAPH

         The  following  graph sets forth the  percentage  change in  cumulative
total  shareholder  return of our common stock during the five-year  period from
December 31, 2001 to December 31, 2006,  compared with the cumulative returns of
the NASDAQ Composite Index and a peer group of companies. The component entities
of the peer group consist of Accesstel Inc., GS Energy Corp.,  Maidenform Brands
Inc.  and Nitches  Inc.  and were  generated  by Research  Data Group,  Inc. The
comparison  assumes  $100 was  invested on December 31, 2001 in our common stock
and in each  of the  foregoing  indices.  The  stock  price  performance  on the
following graph is not necessarily indicative of future stock price performance.

                          [PERFORMANCE GRAPH OMITTED]

<TABLE>
<CAPTION>
                                             Cumulative Total Return
                       ----------- ----------- ----------- ----------- ----------- ----------
                            12/01       12/02       12/03       12/04       12/05      12/06
---------------------  ----------- ----------- ----------- ----------- ----------- ----------
<S>                        <C>          <C>        <C>         <C>         <C>        <C>
TARRANT APPAREL GROUP      100.00       74.64       65.51       44.53       19.34      26.82
NASDAQ COMPOSITE           100.00       71.97      107.18      117.07      120.50     137.02
PEER GROUP                 100.00      103.65        3.89        2.02        0.36       0.52
</TABLE>


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


                                       19
<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,
                                         -------------------------------------------------------------
                                            2002         2003         2004         2005         2006
                                         ---------    ---------    ---------    ---------    ---------
                                                     (In thousands, except per share data)
<S>                                      <C>          <C>          <C>          <C>          <C>
INCOME STATEMENT DATA:
Net sales ............................   $ 347,391    $ 320,423    $ 155,453    $ 214,648    $ 232,402
Cost of sales ........................     302,082      288,445      134,492      169,767      181,760
                                         ---------    ---------    ---------    ---------    ---------
   Gross profit ......................      45,309       31,978       20,961       44,881       50,642
Selling and distribution expenses ....      10,757       11,329        9,291       10,726       11,016
General and administrative
   expenses ..........................      30,082       31,767       32,084       26,865       26,879
Royalty expense ......................         656          242          605        3,665        2,815
Loss on notes receivable-
   related parties (5) ...............        --           --           --           --         27,137
Impairment charges (3) ...............        --         22,277       77,982         --           --
Cumulative translation loss (4) ......        --           --         22,786         --           --
                                         ---------    ---------    ---------    ---------    ---------
Income (loss) from operations ........   $   3,814      (33,637)    (121,787)       3,625      (17,205)
Interest expense .....................      (5,444)      (5,603)      (2,857)      (4,625)      (6,060)
Interest income ......................       4,748          425          377        2,081        1,181
Minority interest ....................      (4,581)       3,461       15,331          (75)          21
Interest in income of equity
   method investee ...................        --           --            770          560           80
Other income (1) .....................       2,648        4,784        6,366          354          336
Adjustment to fair value of
   derivative ........................        --           --           --           --            315
Other expense (1) ....................      (1,348)      (1,183)        (529)        --           (436)
                                         ---------    ---------    ---------    ---------    ---------
Income (loss) before provision for
   income taxes and cumulative
   effect of accounting change .......        (163)     (31,753)    (102,329)       1,920      (21,768)
Provision for income taxes ...........      (1,051)      (4,132)      (2,348)        (927)        (453)
                                                      ---------    ---------    ---------    ---------
Income (loss) before cumulative
   effect of accounting change .......   $  (1,214)   $ (35,885)   $(104,677)   $     993    $ (22,221)
Cumulative effect of
   accounting change (2) .............      (4,871)        --           --           --           --
                                         ---------    ---------    ---------    ---------    ---------
Net income (loss) ....................   $  (6,085)   $ (35,885)   $(104,677)   $     993    $ (22,221)
Dividend to preferred stockholders ...        --         (7,494)        --           --           --
                                         ---------    ---------    ---------    ---------    ---------
Net income (loss) available to
   common stockholders (as
   restated) .........................   $  (6,085)   $ (43,379)   $(104,677)   $     993    $ (22,221)
                                         =========    =========    =========    =========    =========

Net income (loss) per share - Basic:
   Before cumulative effect of
     accounting change (as
       restated) .....................   $   (0.08)   $   (2.38)   $   (3.64)   $    0.03    $   (0.73)
Cumulative effect of
     accounting change ...............       (0.30)        --           --           --           --
   After cumulative effect of
     accounting change (as
       restated) .....................   $   (0.38)   $   (2.38)   $   (3.64)   $    0.03    $   (0.73)
Net income (loss) per share - Diluted:
   Before cumulative effect of
     accounting change (as
       restated) .....................   $   (0.08)   $   (2.38)   $   (3.64)   $    0.03    $   (0.73)
   Cumulative effect of
     accounting change ...............       (0.30)        --           --           --           --

   After cumulative effect of
     accounting change (as
       restated) .....................   $   (0.38)   $   (2.38)   $   (3.64)   $    0.03    $   (0.73)

Weighted average shares
   outstanding (000)
   Basic .............................      15,834       18,215       28,733       29,729       30,546
   Diluted ...........................      15,834       18,215       28,733       29,734       30,546
</TABLE>


                                       20
<PAGE>


<TABLE>
<CAPTION>
                                                               AS OF DECEMBER 31,
                                         -------------------------------------------------------------
                                            2002         2003         2004         2005         2006
                                         ---------    ---------    ---------    ---------    ---------
                                                                (In thousands)
<S>                                      <C>          <C>          <C>          <C>          <C>
BALANCE SHEET DATA:
Working capital ......................   $  11,731    $ (18,018)   $ (12,295)   $ (11,004)   $  (9,794)
Total assets .........................     316,444      253,105      131,811      151,242      111,132
Bank borrowings, convertible
   debenture and long-term
   obligations .......................     106,937       68,587       48,455       56,148       44,501
Shareholders' equity .................     121,161      107,709       30,678       35,360       17,922
</TABLE>

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

(2)  Effective  January 1, 2002,  we adopted  Statement of Financial  Accounting
     Standards No. 142,  "Goodwill and Other  Intangible  Assets."  According to
     this statement,  goodwill and other intangible assets with indefinite lives
     are no longer subject to amortization,  but rather an annual  assessment of
     impairment applied on a  fair-value-based  test. We adopted SFAS No. 142 in
     fiscal 2002 and performed our first annual assessment of impairment,  which
     resulted in an impairment loss of $4.9 million.
(3)  The expense in 2004 was the  impairment of long-lived  assets of our Mexico
     operations  due to our  decision to sell the  manufacturing  operations  in
     Mexico.  The  expense  in  2003  was the  impairment  of our  goodwill  and
     intangible  assets and write-off of prepaid expenses due to our decision to
     cease directly operating a substantial  majority of our equipment and fixed
     assets in Mexico commencing in the third quarter of 2003.
     See Note 5 of the "Notes to Consolidated Financial Statements."
(4)  Cumulative translation loss attributable to liquidated Mexico operations in
     2004 was due to our decision to cease our Mexico operations.  See Note 5 of
     the "Notes to Consolidated Financial Statements."
(5)  In the third quarter of 2006, we evaluated the  recoverability of the notes
     receivable - related parties and recorded a reserve on the notes receivable
     in an  amount  equal  to the  outstanding  balance  less  the  value of the
     underlying  assets  securing  the  notes.  The  loss  was  estimated  to be
     approximately  $27.1 million,  resulting in a notes  receivable  balance at
     September 30, 2006 of  approximately  $14 million.  We believe there was no
     significant  change  subsequently  on the  value of the  underlying  assets
     securing the notes;  therefore,  we did not have additional  reserve in the
     fourth  quarter of 2006. We will continue to pursue  payment of all amounts
     under the notes receivable and believe the remaining $14 million balance at
     December 31, 2006 is  realizable.See  Note 5 of the "Notes to  Consolidated
     Financial Statements."


                                       21
<PAGE>


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

         The following  discussion and analysis should be read together with the
Consolidated  Financial  Statements  of Tarrant  Apparel Group and the "Notes to
Consolidated  Financial  Statements"  included elsewhere in this Form 10-K. This
discussion   summarizes  the  significant  factors  affecting  the  consolidated
operating results,  financial  condition and liquidity and cash flows of Tarrant
Apparel  Group for the fiscal  years ended  December  31,  2004,  2005 and 2006.
Except for historical  information,  the matters  discussed in this Management's
Discussion  and Analysis of Financial  Condition and Results of  Operations  are
forward looking  statements that involve risks and  uncertainties  and are based
upon  judgments  concerning  various  factors that are beyond our  control.  See
"Cautionary Statement Regarding  Forward-Looking  Statements" and "Item 1A. Risk
Factors."

OVERVIEW

         Tarrant  Apparel  Group is a design and  sourcing  company  for private
label and private brand casual apparel  serving mass  merchandisers,  department
stores, branded wholesalers and specialty chains located primarily in the United
States. Our private brands include American Rag Cie and Alain Weiz.

         We  generate  revenues  from the  sale of  apparel  merchandise  to our
customers  that we have  manufactured  by  third  party  contract  manufacturers
located  outside of the United  States.  Revenues and net income  (loss) for the
years  ended  December  31,  2004,  2005 and 2006 were as  follows  (dollars  in
thousands):

REVENUES AND NET INCOME (LOSS):         2004             2005            2006
                                     ---------        ---------       ---------

Net sales ....................       $ 155,453        $ 214,648       $ 232,402
Net income (loss) ............       $(104,677)       $     993       $ (22,221)


         Cash flows for the years ended December 31, 2004, 2005 and 2006 were as
follows (dollars in thousands):

<TABLE>
<CAPTION>
CASH FLOWS:                                             2004        2005        2006
                                                      --------    --------    --------
<S>                                                   <C>         <C>         <C>
Net cash provided by (used in) operating activities   $ 12,168    $(12,900)   $ 15,047
Net cash provided by (used in) investing activities   $  1,250    $  3,555    $ (5,071)
Net cash provided by (used in) financing activities   $(15,552)   $  9,772    $(10,713)
</TABLE>


SIGNIFICANT DEVELOPMENTS IN 2006

THE BUFFALO GROUP

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

         Pursuant to the Purchase  Agreement,  we and our subsidiaries agreed to
acquire  (1) all the  outstanding  capital  stock  of four  principal  operating
subsidiaries of The Buffalo Group - Buffalo Inc.,  3163946 Canada Inc.,  3681441
Canada  Inc.  and  Buffalo  Corporation,  and  (2)  certain  assets,  consisting


                                       22
<PAGE>


primarily of intellectual property rights and licenses,  from The Buffalo Trust.
The  consideration  for the stock and  assets  to be  purchased  by us under the
Purchase Agreement will consist of:

         o        $40,000,000 in cash, subject to reduction prior to closing;

         o        $15,000,000  in  promissory  notes that are due and payable in
                  five  equal  annual  installments   beginning  on  the  second
                  anniversary of the closing date;

         o        The issuance to the sellers of 13,000,000  exchangeable shares
                  of our Canadian subsidiary,  which shares will be exchangeable
                  by the  holders  into  shares of our common  stock on a 1-to-1
                  basis;

         o        The  issuance  by us to a trustee  of  shares of our  Series A
                  Special Voting  Preferred  Stock that will entitle the sellers
                  to direct the trustee to vote a number of shares  equal to the
                  number of exchangeable  shares of our Canadian subsidiary that
                  remain  outstanding  from time to time on all matters on which
                  our shareholders are entitled to vote;

         o        Assumption of debt of the entities being acquired by us; and

         o        Earn-out payments of up to $12,000,000 in the aggregate over a
                  four year period,  contingent upon achievement by the acquired
                  business of specified  earnings  targets in years 2007 through
                  2010.

         In  addition,  we may be required  to make a  contingent  cash  payment
following  the fifth  anniversary  of the  closing if the  average  price of our
common stock does not equal or exceed  $3.076  within any 10 trading days during
the five year period following the closing of the purchase transaction.

         At signing of the Purchase  Agreement,  we delivered  $5,000,000 to the
sellers as a deposit  against the purchase  price payable  under the  agreement.
Upon  closing,  this deposit will be used to pay a portion of the  consideration
payment and will reduce the amount of cash  delivered at closing.  Under certain
conditions  specified under the agreement,  if we or the Buffalo Group terminate
the  agreement  prior to  closing,  the $5.0  million  deposit may or may not be
refundable to us.

         Pursuant to the Purchase  Agreement,  at the closing we will enter into
employment agreements with each of Gabriel Bitton, Gilbert Bitton, David Bitton,
Charles  Bitton and Michel  Bitton  pursuant  to which they will serve as senior
executives  of the  acquired  business,  and we have agreed to issue  options to
purchase an aggregate  of  2,000,000  shares of our common stock to the Bittons.
Gabriel Bitton will continue to serve as Chief Executive Officer of the acquired
business  following  closing and will be appointed to our Board of Directors.  A
second nominee of the sellers reasonably acceptable to us will also be nominated
to serve on our Board of Directors upon completion of the transaction.

         The completion of the  transaction is subject to the  satisfaction of a
number of conditions  as set forth in the Purchase  Agreement,  including  among
others,  the  approval  of  the  acquisition  and  related  transactions  by our
shareholders, our obtaining the necessary financing to complete the acquisition,
obtaining certain third party consents,  and other customary closing conditions.
Dates for closing the acquisition and for our  shareholders'  meeting to vote on
the  acquisition  have not yet been  determined.  The Purchase  Agreement may be
terminated under certain conditions,  including by mutual written consent of the
parties,  by either party in the event of a material  breach by the other party,
or by either party if the closing does not occur by April 30, 2007.

         There are no material  relationships  between us and The Buffalo Group,
other than in respect of the Purchase Agreement.

         The  Buffalo  Group  transaction  is part of our  strategy  to grow and
diversify our business. We believe its benefits to us will include:


                                       23
<PAGE>


         o        Expanding  our  operations  by adding  additional  proprietary
                  brands and products to compete more effectively;

         o        Expanding the scope,  scale and strength of our  operations by
                  expanding its marketing, sales and distribution capabilities;

         o        Enhancing our  capabilities  to compete in Canada,  the United
                  States and other  markets;  and utilize  The  Buffalo  Group's
                  existing sales and marketing  infrastructure as a platform for
                  expanding sales of our apparel products; and

         o        Providing  opportunities  for us to penetrate  new markets and
                  expand our share in existing markets.

         The  Buffalo  Group was started in 1985 as the  distributor  of Buffalo
branded products in Canada.  Initially,  the Buffalo brand was a denim line, but
it has been expanded over time. In 1993,  The Buffalo Group widened its customer
base by adding U.S.  retailers.  In 2000,  The Buffalo  Group  started a private
label business for retailers in Canada and the U.S. In 1996,  Buffalo opened its
first retail store in Canada.  Currently it operates 45 retail stores in Canada.
Over this time Buffalo has added additional brand names to its line. It has also
developed  a  licensing   program  for  the  Buffalo   brand  for  the  sale  of
apparel-related  products in Canada, and the sale of apparel products in foreign
countries.

PRIVATE LABEL

         Private  label  business has been our core  competency  for over twenty
years, and involves a one to one relationship with a large, centrally controlled
retailer   with  whom  we  can   develop   product   lines  that  fit  with  the
characteristics of their particular  customer.  Private label sales in 2006 were
$181.2 million compared to $159.6 million in 2005.

PRIVATE BRANDS

         We launched our private brands initiative in 2003, pursuant to which we
acquire ownership of or license rights to a brand name and sell apparel products
under this brand,  generally  to a single  retail  company  within a  geographic
region.  Private  brands  sales in 2006 were  $51.2  million  compared  to $55.0
million in 2005.  During  2006,  we owned or  licensed  rights to the  following
private brands:

         o        AMERICAN  RAG CIE:  During  the  first  quarter  of  2005,  we
                  extended our agreement with Macy's Merchandising Group through
                  2014, pursuant to which we exclusively distribute our American
                  Rag Cie brand through Macy's  Merchandising  Group's  national
                  Department  Store  organization  of more than 600 stores.  Net
                  sales  of  American  Rag Cie  branded  apparel  totaled  $34.4
                  million in 2006 compared to $21.8 million in 2005.

         o        ALAIN  WEIZ:  We  have   previously  sold  Alan  Weiz  apparel
                  exclusively to Dillard's Department Stores. Net sales of Alain
                  Weiz branded  apparel totaled $5.5 million in 2006 compared to
                  $5.3 million in 2005.  From  January 1, 2007,  we may sell our
                  licensed brand "Alain Weiz" to specialty stores and department
                  stores.

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

         o        GEAR 7: During the fourth quarter of 2005, K-Mart discontinued
                  sales of Gear 7 products, which resulted in a decline in sales
                  for this  brand in the fourth  quarter  of 2005.  Net sales


                                       24
<PAGE>


                  of Gear 7 branded  apparel  totaled  $14.4 million in 2005. We
                  did not have any sales of Gear 7 branded apparel in 2006.

         o        JESSICA  SIMPSON  brands:  The JS by Jessica Simpson brand was
                  originally launched as a denim line with Charming Shoppes. Net
                  sales of JS by Jessica Simpson and Princy by Jessica  Simpson,
                  which is the  department  store  and  better  specialty  store
                  brand,  totaled $8.9 million in 2006 compared to $12.6 million
                  in 2005. In March 2006,  we became  involved in a dispute with
                  the licensor of the Jessica  Simpson brands over our continued
                  rights to these  brands,  and we are  presently in  litigation
                  with this licensor.  Accordingly, we did not have any sales of
                  Jessica  Simpson  branded  apparel  after the first quarter of
                  2006 and do not  anticipate  any sales unless and until we are
                  able to successfully resolve our dispute and retain our rights
                  to these brands.

         o        HOUSE OF DEREON BY TINA KNOWLES:  We began  shipping  products
                  for the House of Dereon by Tina  Knowles  brand in the  fourth
                  quarter of 2005,  resulting  in net sales of $309,000 in 2005.
                  In March 2006,  we terminated  our license  agreement for this
                  brand, and sold our remaining inventory to the licensor or its
                  designee.  Prior to December 31, 2005,  we had written off the
                  capitalized  balance of $1.2 million  related to the agreement
                  and  recognized  a  corresponding  loss in 2005.  Net sales of
                  House of Dereon by Tina Knowles  branded  apparel totaled $2.2
                  million  in 2006  which  included  $1.5  million  of  sales of
                  inventory to a designee of the licensor.

NOTES RECEIVABLE - RELATED PARTY RESERVE

         In connection  with the sale in 2004 of our assets and real property in
Mexico, the purchasers of the Mexico assets issued us unsecured promissory notes
of $3,910,000 that mature on November 30, 2007 and secured  promissory  notes of
$40,204,000 that mature on December 31, 2014 and are payable in partial or total
amounts  anytime  prior to the  maturity  of each note.  The  secured  notes are
secured  by the  real  and  personal  property  in  Mexico  that  we sold to the
purchasers.  As of September 30, 2006, the outstanding  balance of the notes and
interest receivables were $41.1 million prior to the reserve.  Historically,  we
have placed orders for purchases of fabric from the  purchasers  pursuant to the
purchase  commitment  agreement  we entered  into at the time of the sale of the
Mexico assets,  and we have satisfied our payment  obligations for the fabric by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  during  2006,  the  purchasers  ceased  providing  fabric  and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable  in the third  quarter of 2006 in an amount equal to the  outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be approximately $27.1 million, resulting in a net notes receivable
balance at September 30, 2006 of approximately $14 million. We believe there was
no  significant  change  subsequently  on the  value  of the  underlying  assets
securing the notes;  therefore, we did not have additional reserve in the fourth
quarter of 2006.  We will  continue to pursue  payment of all amounts  under the
notes  receivable and believe the remaining $14 million  balance at December 31,
2006 is realizable. The entire reserve was recorded in the Luxembourg geographic
reporting segment.

CREDIT FACILITY REFINANCING

         In June 2006,  we entered into a new $65 million  credit  facility with
Guggenheim  Corporate  Funding,  LLC (as agent for certain lenders) and expanded
our existing  facilities with GMAC Commercial  Finance Credit,  LLC and DBS Bank
(Hong Kong) Limited.  The credit facility with Guggenheim consists of an initial
term loan of $25  million,  of which $15.5  million was  advanced at the initial
closing.  The initial  term loan was or will be used to repay  certain  existing
indebtedness and fund general operating and


                                       25
<PAGE>


working capital needs. A second term loan of up to $40 million will be available
to finance acquisitions  acceptable to Guggenheim as agent. In addition, in June
2006, our credit  facility with GMAC Commercial  Finance  Credit,  LLC and other
lenders was increased from $45 million to $55 million,  and our credit  facility
with DBS Bank  (Hong  Kong)  Limited  was  increased  from $4.5  million  to $25
million.  These  financings  significantly  expand  our  borrowing  base,  which
provides us with enhanced financial flexibility.

INTERNAL REVENUE SERVICE AUDIT

         In January 2004, the Internal Revenue Service completed its examination
of our Federal  income tax returns for the years ended December 31, 1996 through
2001.  The IRS has proposed  adjustments  to increase our income tax payable for
the six years under examination. In addition, in July 2004, the IRS initiated an
examination  of our Federal  income tax return for the year ended  December  31,
2002. In March 2005,  the IRS proposed an  adjustment  to our taxable  income of
approximately $9 million related to similar issues  identified in their audit of
the 1996 through 2001 federal  income tax returns.  The proposed  adjustments to
our 2002 federal  income tax return would not result in  additional  tax due for
that year due to the tax loss reported in the 2002 federal return.  However,  it
could reduce the amount of net  operating  losses  available to offset taxes due
from the preceding tax years.  This  adjustment  would also result in additional
state  taxes,  penalties  and  interest.  We  believe  that we have  meritorious
defenses to and intend to vigorously  contest the proposed  adjustments  made to
our federal  income tax returns for the years ended 1996  through  2002.  If the
proposed  adjustments are upheld through the  administrative  and legal process,
they could have a material  impact on our earnings and cash flow.  We believe we
have provided adequate reserves for any reasonably  foreseeable  outcome related
to these matters on the  consolidated  balance sheets under the caption  "Income
Taxes".  The  maximum  amount  of loss in excess of the  amount  accrued  in the
financial statements is $8.3 million. We do not believe that the adjustments, if
any, arising from the IRS examination,  will result in an additional  income tax
liability  beyond  what is  recorded in the  accompanying  consolidated  balance
sheets.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

         Our discussion  and analysis of our financial  condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance  with  accounting  principles  generally  accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities.  We are required to make assumptions  about matters,  which are
highly  uncertain  at the time of the  estimate.  Different  estimates  we could
reasonably  have used or changes in the estimates that are reasonably  likely to
occur  could  have a material  effect on our  financial  condition  or result of
operations.  Estimates  and  assumptions  about future  events and their effects
cannot be determined with certainty. On an ongoing basis, we evaluate estimates,
including  those  related to returns,  discounts,  bad debts,  inventory,  notes
receivable - related parties reserve,  intangible  assets,  income taxes,  stock
options  valuation,  contingencies  and  litigation.  We base our  estimates  on
historical  experience and on various assumptions  believed to be applicable and
reasonable  under the  circumstances.  These  estimates may change as new events
occur,  as additional  information is obtained and as our operating  environment
changes. In addition,  management is periodically faced with uncertainties,  the
outcomes of which are not within its control and will not be known for prolonged
period of time.

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


                                       26
<PAGE>


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

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

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

         As of December  31,  2006,  the balance in the  allowance  for returns,
discounts and bad debts  reserves was $2.1 million,  compared to $3.0 million at
December 31, 2005.

INVENTORY

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

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

         We assess the impairment of identifiable intangibles, long-lived assets
and  goodwill  whenever  events or changes in  circumstances  indicate  that the
carrying value may not be recoverable.  Factors considered  important that could
trigger an impairment review include, but are not limited to, the following:

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

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

         o        a significant negative industry or economic trend.

         Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." According to
this statement,  goodwill and other intangible  assets with indefinite lives are
no longer subject to amortization, but rather an annual assessment of impairment
applied on a  fair-value-based  test on an annual basis or more frequently if an
event occurs or circumstances  change that would more likely than not reduce the
fair value of a reporting unit below its carrying amount.

         We utilized  the  discounted  cash flow  methodology  to estimate  fair
value. At December 31, 2006, we have a goodwill  balance of $8.6 million,  and a
net property and equipment  balance of $1.4  million,  as compared to a goodwill
balance of $8.6 million and a net property and equipment balance of $1.7 million


                                       27
<PAGE>


at December 31, 2005.  During the years ended December 31, 2005 and 2006, we did
not recognize any impairment related to goodwill and property and equipment.

         We assess the carrying  value of long-lived  assets in accordance  with
SFAS No. 144,  "Accounting for the Impairment or Disposal of Long-Lived Assets."
In 2004, we evaluated the  long-lived  assets in Mexico for  recoverability  and
concluded that the book value of the asset group was  significantly  higher than
the expected future cash flows and that impairment had occurred. Accordingly, we
recognized a non-cash impairment loss of approximately $78 million in the second
quarter of 2004. The impairment  charge was the difference  between the carrying
value and fair value of the impaired assets. Our determination of fair value was
determined  based  on  independent  appraisals  of the  property  and  equipment
obtained in June 2004.

FOREIGN CURRENCY TRANSLATION

         Assets and  liabilities  of our Mexico and Hong Kong  subsidiaries  are
translated at the rate of exchange in effect on the balance  sheet date;  income
and expenses are translated at the average rates of exchange  prevailing  during
the respective periods. The functional currency in which we transact business in
Hong Kong is the Hong Kong dollar and in Mexico is the peso.

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

REVENUE RECOGNITION

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

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

STOCK-BASED COMPENSATION

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

         We adopted SFAS No.  123(R) using the modified  prospective  transition
method,  which requires the application of the accounting standard as of January
1, 2006, the first day of our fiscal year 2006.  Our financial  statements as of
and for year ended  December  31,  2006  reflect the impact of SFAS  123(R).  In
accordance  with the  modified  prospective  transition  method,  our  financial
statements  for prior  periods  have not been  restated to  reflect,  and do not
include, the impact of SFAS No. 123(R). Stock-based


                                       28
<PAGE>


compensation  expense  recognized  under SFAS No.  123(R)  during the year ended
December 31, 2006 was  $187,000.  Basic and dilutive  earnings per share for the
year ended  December 31, 2006 were decreased by $0.01 from $(0.72) to $(0.73) by
the additional stock-based compensation recognized.

         The fair value of each option  granted to  employees  and  directors is
estimated  on the date of grant  using the  Black-Scholes  option-pricing  model
("Black-Scholes model") with the following weighted average assumptions used for
grants  in 2004,  2005 and  2006:  weighted-average  volatility  factors  of the
expected  market  price of our common  stock of 0.51 to 0.55 for 2004,  0.55 for
2005 and 0.7 for 2006, weighted-average risk-free interest rates of 3% to 4% for
2004, 4% for 2005 and 5.075% for 2006,  dividend yield of 0% for 2004,  2005 and
2006,  and  weighted-average  expected  life of the options of 4 years for 2004,
2005 and 6.25 years for 2006.

INCOME TAXES

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

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

DEBT COVENANTS

         Our debt agreements require certain covenants including a minimum level
of EBITDA and specified tangible net worth; and required interest coverage ratio
and  leverage  ratio  as  discussed  in  Note 9 of the  "Notes  to  Consolidated
Financial Statements." If our results of operations erode and we are not able to
obtain  waivers from the  lenders,  the debt would be in default and callable by
our  lenders.  In  addition,  due  to  cross-default   provisions  in  our  debt
agreements,  substantially all of our long-term debt would become due in full if
any of the debt is in default.  In anticipation of us not being able to meet the
required  covenants due to various  reasons,  we either negotiate for changes in
the relative  covenants or an advance  waiver or reclassify the relevant debt as
current.  We also believe that our lenders would  provide  waivers if necessary.
However,  our expectations of future operating results and continued  compliance
with other debt  covenants  cannot be assured and our  lenders'  actions are not
controllable by us. If projections of future operating  results are not achieved
and the debt is placed in default,  we would be required to reduce our expenses,
including by curtailing  operations,  and to raise  capital  through the sale of
assets,  issuance  of equity or  otherwise,  any of which  could have a material
adverse  effect on our  financial  condition  and results of  operations.  As of
December  31, 2006,  we were in violation of the EBITDA,  tangible net worth and
leverage ratio covenants and waivers of the defaults were obtained in March 2007
from our lenders.


                                       29
<PAGE>


DERIVATIVE ACTIVITIES

WARRANT DERIVATIVES

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

FOREIGN CURRENCY FORWARD CONTRACT

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

          SFAS No. 133 requires measurement of certain derivative instruments at
their  fair  value for  accounting  purposes.  All  derivative  instruments  are
recorded on our balance sheet at fair value; as a result,  we mark to market all
derivative  instruments.  Derivative  liabilities  are  adjusted to reflect fair
value at each period end,  with any increase or decrease in the fair value being
recorded in  consolidated  statements of operations as adjustments to fair value
of derivatives.  There were no exchange  contracts at December 31, 2005.  During
the year ended  December 31, 2006,  we entered  into  foreign  currency  forward
contracts  to hedge  against the effect of exchange  rate  fluctuations  on cash
flows  denominated  in foreign  currencies and certain  inter-company  financing
transactions. This transaction is undesignated and as such an ineffective hedge.
At December  31,  2006,  we had one open foreign  exchange  forward  which has a
maturity of less than one year. Hedge  ineffectiveness  resulted in an impact of
$196,000 in our consolidated statements of operations as of December 31, 2006

NEW ACCOUNTING PRONOUNCEMENTS

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


                                       30
<PAGE>


RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                       2004         2005         2006
                                                     --------     --------     --------
<S>                                                     <C>          <C>          <C>
Net sales ........................................      100.0%       100.0%       100.0%
Cost of sales ....................................       86.5         79.1         78.2
                                                     --------     --------     --------
Gross profit .....................................       13.5         20.9         21.8
Selling and distribution expenses ................        6.0          5.0          4.7
General and administration expenses ..............       20.6         12.5         11.6
Royalty expenses .................................        0.4          1.7          1.2
Loss on notes receivable-related parties .........       --           --           11.7
Impairment charges ...............................       50.2         --           --
Cumulative translation loss ......................       14.7         --           --
                                                     --------     --------     --------

Income (loss) from operations ....................      (78.4)         1.7         (7.4)
Interest expense .................................       (1.8)        (2.2)        (2.6)
Interest income ..................................        0.2          1.0          0.5
Minority interest ................................        9.9          0.0          0.0
Interest in income of equity method investee .....        0.5          0.3          0.0
Other income .....................................        4.1          0.1          0.2
Adjustment to fair value of derivative ...........        0.0          0.0          0.1
Other expense ....................................       (0.3)        (0.0)        (0.2)
                                                     --------     --------     --------

Income (loss) before provision for income taxes ..      (65.8)         0.9         (9.4)
Provision for income taxes .......................       (1.5)        (0.4)        (0.2)
                                                     --------     --------     --------

Net Income (loss) ................................      (67.3)%        0.5%        (9.6)%
                                                     ========     ========     ========
</TABLE>


COMPARISON OF 2006 TO 2005

         Net sales  increased by $17.8 million,  or 8.3%, from $214.6 million in
2005 to $232.4  million in 2006.  The increase in net sales was primarily due to
increased sales of the private label business,  which was $181.2 million in 2006
compared  to  $159.6  million  in 2005,  with  the  increase  in 2006  resulting
primarily  from higher sales to Mothers Work and Charlotte  Russe which is a new
customer.  Private  brands  sales in 2006 was $51.2  million  compared  to $55.0
million in 2005 with the decrease resulting primarily from no sales of Gear 7 in
2006,  compared to $14.4 million in 2005,  and offset by an increase in sales to
Macy's  Merchandising  Group of $11.6  million  which  included  $1.5 million of
sublicensing royalty income in 2006.

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


                                       31
<PAGE>


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

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

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

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

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

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

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

         Interest in income of equity method  investee  decreased by $480,000 or
85.8%,  from  $560,000 in 2005 to $80,000 in 2006. As a percentage of net sales,
this interest in income of equity method  decreased to 0.0% in 2006 from 0.3% in
2005. Interest in income of equity method investee  represented our 45% share of
equity  interest  in the  owner  of the  trademark  "American  Rag  CIE" and the
operator of American Rag retail stores.

         Income (loss) before  provision for income taxes was $(21.8) million in
2006 and  $1.9  million  in 2005,  representing  (9.4)%  and 0.9% of net  sales,
respectively. The increase in loss before provision for


                                       32
<PAGE>


income taxes was primarily due to the loss on notes receivable - related parties
of $27.1 million recorded in 2006 and the other factors discussed above.

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

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

COMPARISON OF 2005 TO 2004

         Net sales increased by $59.2 million,  or 38.1%, from $155.5 million in
2004 to $214.6  million in 2005.  The increase in net sales was primarily due to
increased sales of private  brands,  which was $55.0 million in 2005 compared to
$21.7  million  in 2004.  Gear 7, JS by  Jessica  Simpson  and Princy by Jessica
Simpson recorded  significant sales  contributions in 2005, as compared to sales
of $1.2  million for these  brands in 2004.  We expect  sales of these brands to
decline  significantly in 2006 due to the  discontinuance  of the Gear 7 line by
K-Mart,  the dispute over our continued  rights to the Jessica  Simpson line and
the discontinuation of House of Dereon.  Private label sales in 2005 were $159.6
million  compared  to  $133.8  million  in  2004,  with the  increase  resulting
primarily from increased  sales in 2005 to Wal-Mart,  Chico's,  Mothers Work and
Macy's Merchandising Group.

         Gross  profit  for  2005 was  $44.9  million,  or  20.9% of net  sales,
compared to $21.0 million,  or 13.5 % of net sales,  for 2004,  representing  an
increase  of $23.9  million or 114.1%.  The  increase  in gross  profit for 2005
occurred  primarily because of an increase in sales volume and gross margin. The
improvement in gross margin is primarily  attributable to the change of relative
product mix in favor of the higher margin private brands business as compared to
private label as well as improved  margins in the private label  business due to
expansion  of our  business to include  more  knitwear  and woven tops at better
margins using private brand product developments.

         Selling and distribution  expenses increased by $1.4 million, or 15.5%,
from $9.3  million in 2004 to $10.7  million  in 2005.  As a  percentage  of net
sales,  these variable expenses  decreased from 6.0% in 2004 to 5.0% in 2005 due
to the significant increase in sales volume during 2005.

         General and  administrative  expenses  decreased  by $5.2  million,  or
16.3%,  from $32.1  million in 2004 to $26.9  million in 2005.  The decrease was
primarily due to the  depreciation and amortization of our Mexico assets of $6.8
million and $1.1  million of  severance  paid to the Mexican  workers in 2004 as
compared to no such  expense in 2005 after  disposition  of our fixed  assets in
Mexico in late 2004. As a percentage of net sales, these expenses decreased from
20.6% in 2004 to 12.5% in 2005.

         Royalty and marketing  allowance expenses increased by $3.1 million, or
505.8%,  to $3.7  million  in 2005  from  $605,000  in 2004.  The  increase  was
primarily  due to  increased  sales  under the  licensed  Alain Weiz and Jessica
Simpson  brands and a  write-off  of the  remaining  balance of $1.2  million of
prepaid  royalty  on House of Dereon in 2005 as a result of  termination  of our
agreement  to design,  market and sell House of Dereon by Tina  Knowles  branded
apparel  in March  2006.  See Note 13 of the  "Notes to  Consolidated  Financial
Statements." As a percentage of net sales,  these expenses  increased to 1.7% in
2005 from 0.4% in 2004.

         Impairment  charges  were $78.0  million in 2004 or 50.2% of net sales,
compared to no such expense in 2005.  The expense in 2004 was the  impairment of
long-lived assets of our Mexico operations


                                       33
<PAGE>


due to our decision to sell the manufacturing  operations in Mexico.  See Note 5
of the "Notes to Consolidated Financial Statements."

         Cumulative   translation   loss   attributable  to  liquidated   Mexico
operations was $22.8 million in 2004, or 14.7% of net sales, compared to no such
expense in 2005.  We incurred  this charge upon the sale of our fixed  assets in
Mexico in the fourth quarter of 2004.

         Income from  operations was $3.6 million in 2005, or 1.7% of net sales,
compared  to loss from  operation  of $121.8  million  in 2004,  or 78.4% of net
sales, due to the factors described above.

         Interest expense increased by $1.7 million, or 61.9%, from $2.9 million
in 2004 to $4.6  million in 2005.  As a  percentage  of net sales,  this expense
increased to 2.2% in 2005 from 1.8% in 2004.  The increase was  primarily due to
an interest  expense of $1.3  million in 2005  related to  interest  payments to
holders of convertible debentures and amortization of debt discount arising from
issuing  convertible  debentures,  compared to no such expense in 2004. Interest
income  increased  by $1.7  million,  or 451.3%,  from  $378,000 in 2004 to $2.1
million in 2005. The increase was primarily due to the interest  earned from the
notes  receivable  related  to the sale of our  fixed  assets  in Mexico of $1.9
million in 2005,  compared to no such income in 2004.  Other income decreased by
$6.0  million,  or 94.4%,  from $6.4  million in 2004 to $354,000  in 2005,  due
primarily  to $5.5  million  of  lease  income  received  for the  lease  of our
facilities  and equipment in Mexico in 2004,  compared to no such income in 2005
due to the sale of our Mexico  operations in the fourth  quarter of 2004.  Other
expenses were $529,000 in 2004 compared to $1,000 in 2005.

         In 2005,  we allocated  $75,000 of profit to minority  interest,  which
consisted of profit  shared with the  minority  partner in the PBG7,  LLC.  Loss
allocated to minority interests in 2004 was $15.3 million, representing $471,000
attributed to the minority shareholder in United Apparel Ventures,  LLC, for its
49.9% share in the loss and $14.8 million attributed to the minority shareholder
in Tarrant Mexico for its 25% share in the loss.

         Income  before  provision for income taxes was $1.9 million in 2005 and
loss before provision for income taxes was $102.3 million in 2004,  representing
0.9% and  (65.8)% of net sales,  respectively.  The  increase  in income  before
provision for income taxes was due to the factors discussed above.

         Provision  for  income  taxes was  $927,000  in 2005  compared  to $2.3
million in 2004, representing 0.4% and 1.5% of net sales, respectively.

         Net income was $1.0  million in 2005 as  compared to net loss of $104.7
million in 2004,  representing  0.5% and  (67.3)%  of net  sales,  respectively.
Included in the $104.7  million loss in 2004 were  charges of $78.0  million for
the impairment of long-lived assets and $22.8 million of cumulative  translation
loss attributable to liquidated Mexico operations. There were no such charges in
2005.

QUARTERLY RESULTS OF OPERATIONS

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


                                       34
<PAGE>


<TABLE>
<CAPTION>
                                                            QUARTER ENDED

                     MAR. 31     JUN. 30    SEP. 30    DEC. 31     MAR. 31    JUN. 30    SEP. 30     DEC. 31
                       2005        2005       2005       2005        2006       2006       2006        2006
                     -------     -------    -------    -------     -------    -------    -------     -------
<S>                  <C>         <C>        <C>        <C>         <C>        <C>        <C>         <C>
Net Sales .......    $  44.8     $  50.5    $  69.6    $  49.7     $  61.3    $  59.1    $  54.6     $  57.4
Gross profit ....        8.9        11.5       14.5       10.0        12.5       12.7       11.8        13.6
Operating income
 (loss) .........        0.2         1.5        3.0       (1.1)        1.6        2.6      (24.7)        3.3
Net income (loss)       (0.1)        0.9        1.7       (1.5)        0.8        0.6      (25.3)        1.7
</TABLE>


<TABLE>
<CAPTION>
                                                           QUARTER ENDED

                     MAR. 31     JUN. 30    SEP. 30    DEC. 31     MAR. 31    JUN. 30    SEP. 30     DEC. 31
                       2005        2005       2005       2005        2006       2006       2006        2006
                     -------     -------    -------    -------     -------    -------    -------     -------
<S>                   <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%
Gross profit ....      20.0        22.7       20.9       20.0        20.4       21.4       21.6        23.8
Operating income
 (loss) .........       0.5         2.8        4.3       (2.1)        2.7        4.4      (45.3)        5.7
Net income (loss)      (0.2)        1.7        2.5       (3.0)        1.4        1.0      (46.4)        2.9
</TABLE>


         As is typical  for us,  quarterly  net sales  fluctuated  significantly
because  our  customers  typically  place bulk orders with us, and 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

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

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

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

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

         o        decreases in market prices for our products;

         o        increases in costs of raw materials; and


                                       35
<PAGE>


         o        changes in our working capital requirements.

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

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

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

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

         Cash flows for the years ended December 31, 2004, 2005 and 2006 were as
follows (dollars in thousands):

<TABLE>
<CAPTION>
CASH FLOWS:                                             2004        2005        2006
                                                      --------    --------    --------
<S>                                                   <C>         <C>         <C>
Net cash provided by (used in) operating activities   $ 12,168    $(12,900)   $ 15,047
Net cash provided by (used in) investing activities   $  1,250    $  3,555    $ (5,071)
Net cash provided by (used in) financing activities   $(15,552)   $  9,772    $(10,713)
</TABLE>

         Net cash provided by operating activities was $15.0 million in 2006, as
compared to net cash used in operating  activities  in 2005 of $12.9 million and
net cash  provided by operating  activities in 2004 of $12.2  million.  Net cash
provided by operating  activities in 2006 resulted  primarily from a net loss of
$22.2  million and a decrease of $10.6  million in accounts  payable,  offset by
$27.1  million of loss on notes  receivable - related  parties,  $3.0 million of
depreciation  and  amortization  of fixed assets and deferred  financing cost, a
decrease of $13.3 million in inventory and $6.5 million in accounts  receivable.
The decrease in inventory  was  primarily  due to the increase in sales in 2006,
the decrease in accounts  payable resulted from the pay down of payables and the
decrease in accounts receivable was due to increased collections.

         During 2006, net cash used in investing activities was $5.1 million, as
compared to net cash  provided by investing  activities  of $3.6 million in 2005
and $1.3 million in 2004.  Cash used in investing  activities  in 2006  included
approximately  $5.0 million in a deposit and $1.1 million in due diligence  fees
incurred in connection with our pending acquisition of the Buffalo Group, offset
by $1.1 million of collection on notes receivable.

         During 2006, net cash used in financing activities was $10.7 million as
compared to net cash  provided by financing  activities  of $9.8 million in 2005
and net cash used in financing  activities  of $15.6  million in 2004.  Net cash
used in financing  activities in 2006 resulted  primarily from net repayments of
our long-term obligations and financing cost of $19.2 million, and repayments of
borrowings from convertible  debentures of $6.9 million,  offset by financing of
$15.5 million under our credit facility with Guggenheim Corporate Funding LLC.


                                       36
<PAGE>


CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

         Following is a summary of our  contractual  obligations  and commercial
commitments available to us as of December 31, 2006 (in millions):

<TABLE>
<CAPTION>
                                                       PAYMENTS DUE BY PERIOD
                                     ---------------------------------------------------------
CONTRACTUAL OBLIGATIONS                Total     Less than    Between     Between      After
                                                   1 year    2-3 years   4-5 years    5 years
----------------------------------   ---------   ---------   ---------   ---------   ---------
<S>                                  <C>         <C>         <C>         <C>         <C>
Long-term debt(1) ................   $    44.4   $    23.2   $     3.8   $    17.4   $    --
Operating leases .................   $     9.2   $     1.8   $     2.6   $     2.3   $     2.5
Minimum royalties(2) .............   $    14.5   $     6.0   $     2.7   $     2.5   $     3.3
Purchase commitment ..............   $    45.4   $    10.4   $    10.0   $    10.0   $    15.0
                                     ---------   ---------   ---------   ---------   ---------
Total Contractual Cash Obligations   $   113.5   $    41.4   $    19.1   $    32.2   $    20.8
</TABLE>

----------
(1)      Includes interest on long-term debt  obligations.  Based on outstanding
         borrowings as of December 31, 2006, and assuming all such  indebtedness
         remained  outstanding  during  2006  and the  interest  rates  remained
         unchanged,  we estimate that our interest cost on long-term  debt would
         be approximately $9.3 million.
(2)      Includes minimum royalties of $6.1 million under the agreement with the
         licensor of the Jessica Simpson brands.

<TABLE>
<CAPTION>
                                                                     AMOUNT OF COMMITMENT
                                               TOTAL                EXPIRATION PER PERIOD
                                              AMOUNTS    ---------------------------------------------
OTHER COMMERCIAL                             COMMITTED   Less than    Between     Between      After
COMMITMENTS AVAILABLE TO US                    TO US      1 year     2-3 years   4-5 years    5 years
------------------------------------------   ---------   ---------   ---------   ---------   ---------
<S>                                          <C>         <C>         <C>         <C>         <C>
Lines of credit ..........................   $    80.0   $    80.0   $    --     $    --     $    --
Letters of credit (within lines of credit)   $    25.0   $    25.0   $    --     $    --     $    --
Total Commercial Commitments .............   $    80.0   $    80.0   $    --     $    --     $    --
</TABLE>


         On June 13, 2002,  we entered  into a letter of credit  facility of $25
million with UPS Capital Global Trade Finance  Corporation  ("UPS").  Under this
facility,   we  could  arrange  for  the  issuance  of  letters  of  credit  and
acceptances. The facility was collateralized by the shares and debentures of all
of our  subsidiaries in Hong Kong. In addition to the guarantees  provided by us
and our subsidiaries,  Fashion Resource (TCL) Inc. and Tarrant  Luxembourg Sarl,
Gerard Guez,  our Chairman and Interim Chief  Executive  Officer,  also signed a
guarantee of $5 million in favor of UPS to secure this  facility.  Additionally,
Gerard Guez  pledged to UPS 4.6 million  shares of our common  stock held by Mr.
Guez to secure the obligations  under the credit  facility.  On June 9, 2006, we
completed  the pay-off of all  remaining  amounts due under the letter of credit
facility with UPS. As a result of the payment of these  obligations,  the letter
of credit  facility was  terminated and all  collateral  released.  There was no
prepayment  penalty  under this  arrangement.  As of December 31,  2006,  $0 was
outstanding under this facility with UPS.

         On December 31, 2004,  our Hong Kong  subsidiaries  entered into a loan
agreement  with UPS  pursuant  to which UPS made a $5  million  term  loan,  the
proceeds  of which  were used to repay $5 million  of  indebtedness  owed to UPS
under the letter of credit of facility.  The  principal  amount of this loan was
due and payable in 24 equal monthly installments of approximately $208,333 each,
plus  interest  equivalent to the "prime rate" plus 2% commencing on February 1,
2005. The obligations  under the loan agreement were  collateralized by the same
security  interests and guarantees  provided under our letter of credit facility
with  UPS.  Additionally,  the term loan was  secured  by two  promissory  notes
payable to Tarrant  Luxembourg  Sarl in the amounts of $2,550,000 and $1,360,000
and a pledge by Gerard Guez, of 4.6 million shares of our common stock.  On June
9, 2006, we completed the pay-off of all remaining amounts due under the


                                       37
<PAGE>


term loan agreement  with UPS. As a result of the payment of these  obligations,
the term loan agreement was terminated and all collateral released. There was no
prepayment  penalty  under this  arrangement.  As of December 31,  2006,  $0 was
outstanding under this loan arrangement with UPS.

         Since  March  2003,  DBS Bank  (Hong  Kong)  Limited  ("DBS")  had made
available a letter of credit facility of up to HKD 20 million  (equivalent to US
$2.6 million) to our  subsidiaries  in Hong Kong. This was a demand facility and
was secured by the pledge of our office property, which is owned by Gerard Guez,
our  Chairman  and  Interim  Chief  Executive  Officer,  and Todd Kay,  our Vice
Chairman,  and by our guarantee.  The letter of credit facility was increased to
HKD 30 million  (equivalent to US $3.9 million) in June 2004. In September 2006,
a tax loan for HKD 8.438 million  (equivalent  to US $1.1 million) was also made
available to our Hong Kong  subsidiaries and bears interest at the rate equal to
the Hong Kong prime rate plus 1% and are subject to the same  security.  It bore
interest at 9% per annum at December  31, 2006.  As of December  31, 2006,  $1.0
million was outstanding under this tax loan.

         In June 2006, our  subsidiaries in Hong Kong,  Tarrant Company Limited,
Marble  Limited  and Trade  Link  Holdings  Limited,  entered  into a new credit
facility with DBS. Under this facility, we may arrange for letters of credit and
acceptances. The maximum amount our Hong Kong subsidiaries may borrow under this
facility at any time is US $25 million.  The  interest  rate under the letter of
credit  facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if
paid in Hong  Kong  Dollars,  which  the  interest  rate was  8.5% per  annum at
December 31, 2006, or the Standard Bills Rate quoted by DBS plus 0.5% if paid in
any other  currency,  which the interest rate was 8.6% per annum at December 31,
2006. This is a demand facility and is secured by a security interest in all the
assets of the Hong Kong  subsidiaries,  by a pledge of our office property where
our Hong Kong office is located,  which is owned by Gerard Guez and Todd Kay and
by our guarantee.  The DBS facility includes  customary default  provisions.  In
addition,  we are subject to certain  restrictive  covenants,  including that we
maintain  a  specified  tangible  net  worth,  and a minimum  level of EBITDA at
December 31, 2006,  interest  coverage ratio,  leverage ratio and limitations on
additional indebtedness.  As of December 31, 2006, we were in violation with the
EBITDA,  tangible  net worth  and  leverage  ratio  covenants  and a waiver  was
obtained  on March  19,  2007.  As of  December  31,  2006,  $12.5  million  was
outstanding  under this facility.  In addition,  $4.1 million of open letters of
credit was outstanding  and $7.4 million was available for future  borrowings as
of December 31, 2006.

         On October 1, 2004,  we amended and  restated our  previously  existing
credit facility with GMAC Commercial Finance Credit, LLC ("GMAC CF") by entering
into a new factoring  agreement with GMAC CF. The amended and restated agreement
(the  factoring  agreement)  extended  the  expiration  date of the  facility to
September 30, 2007 and added as parties our subsidiaries Private Brands, Inc and
No! Jeans,  Inc. In addition,  in connection with the factoring  agreement,  our
indirect  majority-owned  subsidiary PBG7, LLC entered into a separate factoring
agreement with GMAC CF. Pursuant to the terms of the factoring agreement, we and
our  subsidiaries  agree to assign and sell to GMAC CF, as factor,  all accounts
which arise from our sale of  merchandise  or rendition of service  created on a
going  forward  basis.  At our  request,  GMAC CF, in its  discretion,  may make
advances  to us up to the lesser of (a) up to 90% of our  accounts on which GMAC
CF has the risk of loss or (b) $40 million,  minus in each case, any amount owed
by us to GMAC CF. In May 2005, we amended our factoring  agreement  with GMAC CF
to permit our  subsidiaries  party thereto and us, to borrow up to the lesser of
$3 million or 50% of the value of eligible  inventory.  In connection  with this
amendment,  we granted GMAC CF a lien on certain of our inventory located in the
United States.  On January 23, 2006, we further amended our factoring  agreement
with GMAC CF to increase  the amount we might  borrow  against  inventory to the
lesser of $5 million or 50% of the value of eligible  inventory.  The $5 million
limit was reduced to $4 million on April 1, 2006.

         On June 16,  2006,  we  expanded  our credit  facility  with GMAC CF by
entering  into a new Loan and Security  Agreement and amending and restating our
previously existing Factoring Agreement with GMAC CF. UPS Capital Corporation is
also a lender under the Loan and Security Agreement. This is a


                                       38
<PAGE>


revolving  credit  facility and has a term of 3 years.  The amount we may borrow
under this credit  facility is determined  by a percentage of eligible  accounts
receivable and inventory,  up to a maximum of $55 million, and includes a letter
of credit  facility of up to $4 million.  Interest on outstanding  amounts under
this credit  facility  is payable  monthly and accrues at the rate of the "prime
rate" plus 0.5%. Our  obligations  under the GMAC CF credit facility are secured
by a lien on substantially  all our domestic assets,  including a first priority
lien on our accounts  receivable and inventory.  This credit  facility  contains
customary  financial  covenants,  including  covenants that we maintain  minimum
levels of EBITDA and interest  coverage  ratios and  limitations  on  additional
indebtedness.  This facility  includes  customary  default  provisions,  and all
outstanding obligations may become immediately due and payable in the event of a
default.  The facility bore interest at 8.75% per annum at December 31, 2006. As
of December 31, 2006, we were in violation with the EBITDA covenant and a waiver
was obtained on March 23, 2007. A total of $19.6  million was  outstanding  with
respect to receivables factored under the GMAC CF facility at December 31, 2006.

          The amount we can borrow  under the  factoring  facility  with GMAC is
determined  based on a  defined  borrowing  base  formula  related  to  eligible
accounts receivable.  A significant decrease in eligible accounts receivable due
to the  aging  of  receivables,  can have an  adverse  effect  on our  borrowing
capabilities under our credit facility,  which may adversely affect the adequacy
of our working  capital.  In addition,  we have typically  experienced  seasonal
fluctuations in sales volume. These seasonal fluctuations result in sales volume
decreases  in the first and  fourth  quarters  of each year due to the  seasonal
fluctuations  experienced  by  the  majority  of  our  customers.  During  these
quarters,  borrowing  availability  under our credit  facility may decrease as a
result of decrease in eligible accounts receivables generated from our sales.

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

         In connection with  Guggenheim  credit  facility,  on June 16, 2006, we
issued the lenders under this  facility  warrants to purchase up to an aggregate
of 3,857,143 shares of our common stock. These warrants have a term of 10 years.
These warrants are exercisable at a price of $1.88 per share with respect to 20%
of the  shares,  $2.00 per share with  respect to 20% of the  shares,  $3.00 per
share with respect to 20% of the shares,  $3.75 per share with respect to 20% of
the shares and $4.50 per share with  respect to 20% of the shares.  The exercise
prices are subject to adjustment for certain dilutive  issuances pursuant to the
terms  of  the  warrants.  357,143  shares  of  the  warrants  will  not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and Emerging  Issues Task Force  ("EITF") No. 00-19  "Accounting  for Derivative
Financial  Instruments  Indexed to, and Potentially  Settled in, a Company's Own
Stock" and determined to be a derivative  instrument due to certain registration
rights. As such, the warrants  excluding the ones not exercisable were valued at
$4.9  million  using the  Black-Scholes  model with the  following  assumptions:


                                       39
<PAGE>


risk-free  interest rate of 5.1%;  dividend yields of 0%; volatility  factors of
the expected market price of our common stock of 0.70; and  contractual  term of
ten years. We also paid to Guggenheim 2.25% of the committed principal amount of
the  loans  which  was  $563,000  on June 16,  2006.  The  $563,000  fee paid to
Guggenheim  is included in the  deferred  financing  cost,  and the value of the
warrants to purchase  3.5 million  shares of our common stock of $4.9 million is
recorded as debt discount, both of them are amortized over the life of the loan.
As of December 31, 2006, $654,000 was amortized.

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

         The  Guggenheim  facility bore interest at 12.36% per annum at December
31, 2006. As of December 31, 2006, we were in violation with the EBITDA covenant
and a waiver was obtained on March 23, 2007.  A total of $11.2  million,  net of
$4.3 million of debt discount,  was outstanding  under this facility at December
31, 2006.

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

         The credit facilities with GMAC CF and Guggenheim include cross-default
clauses  subject to certain  conditions.  An event of default  under the GMAC CF
facility  would  constitute  an event of default under the  Guggenheim  facility
entitling  Guggenheim to demand payment in full of all outstanding amounts under
its


                                       40
<PAGE>


facility. An event of default under the Guggenheim facility, under circumstances
where  Guggenheim  has  accelerated  the debt or has  exercised any other remedy
available to Guggenheim which  constitutes a Lien  Enforcement  Action under its
Intercreditor Agreement with GMAC CF, would entitle GMAC CF to demand payment in
full of all outstanding amounts under its debt facilities.

         On December 14, 2004, we completed a $10 million  financing through the
issuance  of (i) 6%  Secured  Convertible  Debentures  ("Debentures")  and  (ii)
warrants  to  purchase  up to  1,250,000  shares of our common  stock.  Prior to
maturity,  the investors  could convert the Debentures into shares of our common
stock at a price of $2.00 per share.  The warrants have a term of five years and
an exercise price of $2.50 per share. The warrants were valued at $866,000 using
the Black-Scholes model with the following assumptions:  risk-free interest rate
of 4%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.55;  and an expected  life of four years.  The  Debentures
bore interest at a rate of 6% per annum and have a term of three years. We could
elect to pay interest on the Debentures in shares of our common stock if certain
conditions are met,  including a minimum market price and trading volume for our
common stock.  The Debentures  contained  customary events of default and permit
the holder  thereof to  accelerate  the  maturity if the full  principal  amount
together  with  interest and other  amounts  owing upon the  occurrence  of such
events of default. The Debentures were secured by a subordinated lien on certain
of our accounts  receivable and related assets.  The closing market price of our
common stock on the closing date of the financing was $1.96. The Debentures were
thus valued at $8,996,000,  resulting in an effective conversion price of $1.799
per share.  The intrinsic  value of the conversion  option of $804,000 was being
amortized  over the life of the loan.  The value of the warrants of $866,000 and
the intrinsic  value of the  conversion  option of $804,000 were netted from the
$10 million  presented as the convertible  debentures,  net on our  accompanying
balance sheets at December 31, 2004.

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

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

         On January 19, 2006, we borrowed  $4.0 million from Max Azria  pursuant
to the terms of a promissory  note,  which  amount bore  interest at the rate of
5.5% per annum and was payable in weekly  installments of $200,000  beginning on
March 1, 2006. This was an unsecured loan. We paid off the remaining  balance of
this loan in July 2006. As of December 31, 2006, $0 was  outstanding  under this
loan.


                                       41
<PAGE>


         We had three  equipment  loans  outstanding  during 2006.  One of these
equipment loans bore interest at 6% payable in installments  through 2009, which
we paid off in January 2006.  The second loan bears interest at 15.8% payable in
installment  through 2007 and the third loan bears  interest at 6.15% payable in
installment  through  2007. In August 2006, we entered into a new auto loan that
bears interest at 4.75% payable in installment  through 2008. As of December 31,
2006, $38,000 was outstanding under the three remaining loans.

         From time to time, we open letters of credit under an uncommitted  line
of credit from Aurora Capital  Associates  which issues these letters of credits
out of Israeli Discount Bank. As of December 31, 2006,  $190,000 was outstanding
under this  facility  (classified  above under import  trade bills  payable) and
$532,000  of  letters  of  credit  was open  under  this  arrangement.  We pay a
commission fee of 2.25% on all letters of credits issued under this arrangement.

         The  effective  interest  rates  on  short-term  bank  borrowing  as of
December 31, 2005 and 2006 were 7.8% and 10.9%, respectively.

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

         From time to time in the past,  we borrowed  funds from,  and  advanced
funds to, certain officers and principal shareholders, including Gerard Guez and
Todd Kay. See disclosure under "-Related Party Transactions" below.

         The Internal  Revenue  Service has proposed  adjustments to our Federal
income tax  returns to  increase  our income  tax  payable  for the years  ended
December 31, 1996 through 2001. In addition,  in July 2004, the IRS initiated an
examination  of our Federal  income tax return for the year ended  December  31,
2002. In March 2005,  the IRS proposed an  adjustment  to our taxable  income of
approximately $9 million related to similar issues  identified in their audit of
the 1996  through  2001  federal  income tax  returns.  We believe  that we have
meritorious   defenses  to  and  intend  to  vigorously   contest  the  proposed
adjustments  made to our  federal  income tax  returns  for the years ended 1996
through  2002.  This  adjustment  would also result in  additional  state taxes,
penalties  and  interest.  We believe that we have  meritorious  defenses to and
intend  to  vigorously  contest  the  proposed  adjustments.   If  the  proposed
adjustments are upheld through the administrative and legal process,  they could
have a material impact on our earnings and, in particular, cash flow. We may not
have an adequate cash reserve to pay the final  adjustments  resulting  from the
IRS  examination.  As a result,  we may be required to arrange for payments over
time or raise additional capital in order to meet these obligations.  We believe
we have  provided  adequate  reserves  for any  reasonably  foreseeable  outcome
related to these matters on the  consolidated  balance  sheets under the caption
"Income  Taxes." The maximum  amount of loss in excess of the amount  accrued in
the  financial   statements  is  $8.3  million.  We  do  not  believe  that  the
adjustments,  if any,  arising  from  the IRS  examination,  will  result  in an
additional  income tax  liability  beyond what is  recorded in the  accompanying
consolidated balance sheets.

         We may seek to  finance  future  capital  investment  programs  through
various methods, including, but not limited to, borrowings under our bank credit
facilities,  issuance of long-term debt, sales of equity securities,  leases and
long-term  financing  provided by the sellers of  facilities or the suppliers of
certain equipment used in such facilities. As described above, in December 2006,
we entered into a definitive  stock and asset purchase  agreement to acquire The
Buffalo.  If the acquisition is approved by our  shareholders and is consummated
pursuant to the terms of the agreement, we will be required to issue 13


                                       42
<PAGE>


million exchangeable shares of our Canadian subsidiary to the sellers (which are
exchangeable  in shares  of our  common  stock on a  one-for-one  basis),  incur
additional  long-term and medium-term debt of  approximately  $40 million to pay
the cash portion of the purchase price, issue promissory notes of $15 million to
sellers, and assume certain debt of The Buffalo Group. In addition,  we may have
to pay  additional  $12 million in cash earn-out  payments to the sellers over a
four year  period,  contingent  upon  achievement  of the  acquired  business of
specified earnings targets. We believe we have sufficient internal resources and
borrowing capability to cover all the related expenses.

         We do not believe that the  moderate  levels of inflation in the United
States in the last  three  years have had a  significant  effect on net sales or
profitability.

RELATED PARTY TRANSACTIONS

         We lease our principal  offices and  warehouse  located in Los Angeles,
California  from GET and  office  space in Hong  Kong  from  Lynx  International
Limited.  GET and Lynx International  Limited are each owned by Gerard Guez, our
Chairman and Interim Chief Executive  Officer,  and Todd Kay, our Vice Chairman.
We  believe,  at the time the  leases  were  entered  into,  the  rents on these
properties  were comparable to then  prevailing  market rents.  During the first
seven months of 2006,  our Los Angeles  offices and  warehouse  were leased on a
month to month basis.  On August 1, 2006, we entered into a lease agreement with
GET for the Los Angeles  offices and  warehouse,  which lease has a term of five
years with an option to renew for an  additional  five year term. On February 1,
2007, we entered into a one year lease agreement with Lynx International Limited
for our office space and warehouse in Hong Kong. We paid $1,330,000,  $1,019,000
and  $1,076,000,  respectively,  in 2004,  2005 and 2006 in rent for  office and
warehouse facilities at these locations.  On May 1, 2006, we sublet a portion of
our executive office in Los Angeles, California and our sales office in New York
to Seven  Licensing  Company,  LLC ("Seven  Licensing") for a monthly payment of
$25,000 on a month to month  basis.  Seven  Licensing is  beneficially  owned by
Gerard Guez.  We received  $200,000 in rental  income from this  sublease in the
year ended December 31, 2006.

         On October 16, 2003,  we leased to  affiliates  of Mr.  Kamel Nacif,  a
shareholder  at the time of the  transaction,  for a substantial  portion of our
manufacturing  facilities  and  operations in Mexico  including  real estate and
equipment. We leased our twill mill in Tlaxcala, Mexico, and our sewing plant in
Ajalpan,  Mexico,  for a period of 6 years and for an annual  rental  fee of $11
million.  In  connection  with this lease  transaction,  we also  entered into a
management services agreement pursuant to which Mr. Nacif's affiliates agreed to
manage the operation of our  remaining  facilities in Mexico in exchange for the
use of such facilities.  The term of the management  services agreement was also
for a period of 6 years.  In 2004,  $5.5 million of lease income was recorded in
other  income.  We agreed to  purchase  annually,  six  million  yards of fabric
manufactured at the facilities leased and/or operated by Mr. Nacif's  affiliates
at market  prices to be  negotiated.  We purchased  $5.3 million of fabric under
this agreement in 2004.

         In August 2004,  we entered  into an  Agreement  for Purchase of Assets
with  affiliates  of  Mr.  Kamel  Nacif,  a  shareholder  at  the  time  of  the
transaction,  which  agreement  was  amended in October  2004.  Pursuant  to the
agreement,  as  amended,  on  November  30,  2004,  we  sold  to the  purchasers
substantially  all of our assets and real  property  in  Mexico,  including  the
equipment  and  facilities  we previously  leased to Mr.  Nacif's  affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and  $3,910,000 by delivery of unsecured  promissory  notes bearing  interest at
5.5% per annum;  and b)  $40,204,000,  by delivery of secured  promissory  notes
bearing  interest at 4.5% per annum,  with payments due on December 31, 2005 and
every year thereafter until December 31, 2014. The secured  promissory notes are
payable in partial or total amounts  anytime prior to the maturity of each note.
As of September  30,  2006,  the  outstanding  balance of the notes and interest
receivables  were $41.1  million  prior to the  reserve.  Historically,  we have
placed  orders for  purchases  of fabric  from the  purchasers  pursuant  to the
purchase


                                       43
<PAGE>


commitment  agreement  we  entered  into at the time of the  sale of the  Mexico
assets,  and we  have  satisfied  our  payment  obligations  for the  fabric  by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  during  2006,  the  purchasers  ceased  providing  fabric  and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable  in the third  quarter of 2006 in an amount equal to the  outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be  approximately  $27.1 million,  resulting in a notes  receivable
balance at September 30, 2006 of approximately $14 million.  We will continue to
pursue  payments on the notes  receivable  and believe the remaining $14 million
balance at December 31, 2006 is realizable.

         Upon  consummation of the sale of our Mexico assets,  we entered into a
purchase commitment  agreement with the purchasers,  pursuant to which we agreed
to purchase  annually  over the ten-year  term of the  agreement,  $5 million of
fabric  manufactured  at our former  facilities  acquired by the  purchasers  at
negotiated market prices. This agreement replaced a previously existing purchase
commitment  agreement with Mr. Nacif's affiliates.  We purchased $6.4 million of
fabric,  of which  $2.4  million  was paid in cash and $4.0  million  was offset
against  the  notes  receivable  principal  and  accrued  interest  on the  note
receivable  from the  affiliates of Mr. Kamel Nacif in 2005. We did not purchase
any fabric in 2006.  Net amount due from Mr. Kamel Nacif and his  affiliates was
$236,000 and $116,000 as of December 31, 2005 and 2006, respectively.

         From time to time in the past, we had advanced funds to Mr. Guez. These
were  net  advances  to Mr.  Guez or  payments  paid on his  behalf  before  the
enactment of the  Sarbanes-Oxley  Act in 2002. The promissory  note  documenting
these advances contains a provision that the entire amount together with accrued
interest is immediately  due and payable upon our written  demand.  The greatest
outstanding  balance of such advances to Mr. Guez during 2006 was  approximately
$2,279,000.  At December 31, 2006, the entire balance due from Mr. Guez totaling
$2.2 million was reflected as a reduction of shareholders'  equity.  All amounts
due from Mr. Guez bore  interest at the rate of 7.75%  during the period.  Total
interest  paid by Mr. Guez was  $370,000,  $209,000  and  $171,000 for the years
ended December 31, 2004, 2005 and 2006, respectively.  Mr. Guez paid expenses on
our behalf of approximately $400,000,  $397,000 and $299,000 for the years ended
December 31, 2004,  2005 and 2006,  respectively,  which amounts were applied to
reduce accrued interest and principal on Mr. Guez's loan. These amounts included
fuel and related expenses incurred by 477 Aviation,  LLC, a company owned by Mr.
Guez,  when our executives used this company's  aircraft for business  purposes.
Since the enactment of the Sarbanes-Oxley Act in 2002, no further personal loans
(or  amendments  to  existing  loans)  have been or will be made to  officers or
directors of Tarrant.

         On July 1, 2001, we formed an entity to jointly  market,  share certain
risks and achieve economies of scale with Azteca Production International,  Inc.
("Azteca"),  called United Apparel Ventures, LLC ("UAV"). Azteca is owned by the
brothers of Gerard Guez. This entity was created to coordinate the production of
apparel for a single customer of our branded business. UAV is owned 50.1% by Tag
Mex,  Inc.,  our wholly owned  subsidiary,  and 49.9% by Azteca.  Results of the
operation of UAV have been  consolidated  into our results  since July 2001 with
the  minority  partner's  share of all gains and loses  eliminated  through  the
minority interest line in our financial statements.  Due to the restructuring of
our Mexico  operations,  we discontinued  manufacturing for UAV customers in the
second  quarter of 2004. We have been  consolidating  100% of the results of the
operation of UAV into our results since 2005.  Two and one half percent of gross
sales as  management  fees were paid in 2004 to each of the members of UAV,  per
the  operating  agreement.  The  management  fees  paid to  Azteca  in 2004  was
$179,000.  We  purchased  $11.5  million,  $135,000 and $1.1 million of finished
goods,  fabric and service  from Azteca and its  affiliates  for the years ended
December 31, 2004,  2005 and 2006,  respectively.  Our total sales of fabric and
service to Azteca in 2004, 2005 and 2006 were $1.0 million,  $88,000 and $9,000,
respectively.


                                       44
<PAGE>


         Since June 2003,  UAV had been selling to Seven  Licensing,  jeans wear
bearing the brand "Seven7",  which was ultimately  purchased by Express.  In the
third quarter of 2004, in order to strengthen our own private brand business, we
decided to discontinue  sourcing for Seven7.  Total sales to Seven  Licensing in
the year ended  December 31, 2004 were $2.6 million.  On September 1, 2006,  our
subsidiary in Hong Kong, Tarrant Company Limited, entered into an agreement with
Seven  Licensing  to  be  its  buying  agent  to  source  and  purchase  apparel
merchandise.  Total sales to Seven Licensing  during the year ended December 31,
2006 were $4.4 million.

         At December 31, 2006,  Messrs.  Guez and Kay beneficially owned 488,400
and 1,003,500  shares,  respectively,  of common stock of Tag-It  Pacific,  Inc.
("Tag-It"), collectively representing 8.1% of Tag-It's common stock. Tag-It is a
provider of brand identity  programs to  manufacturers  and retailers of apparel
and accessories. Tag-It assumed the responsibility for managing and sourcing all
trim and packaging used in connection  with products  manufactured  by or on our
behalf in Mexico. Due to the restructuring of our Mexico  operations,  Tag-It no
longer manages our trim and packaging  requirements.  We purchased $1.0 million,
$450,000  and $205,000 of trim from Tag-It  during the years ended  December 31,
2004,  2005 and 2006.  Our sales of garment  accessories  to Tag-It for the year
ended December 31, 2006 were $39,000.

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         FOREIGN CURRENCY RISK. Our earnings are affected by fluctuations in the
value of the U.S. dollar as compared to foreign  currencies as a result of doing
business  in foreign  jurisdictions.  As a result,  we bear the risk of exchange
rate gains and losses  that may result in the  future.  At times we use  forward
exchange contracts to reduce the effect of fluctuations of foreign currencies on
purchases  and  commitments.   These  short-term   assets  and  commitments  are
principally  related to trade payables  positions.  At December 31, 2006, we had
one open foreign exchange forward which has a maturity of less than one year. We
do not utilize derivative financial instruments for trading or other speculative
purposes.   We  actively   evaluate  the   creditworthiness   of  the  financial
institutions that are counter parties to derivative financial  instruments,  and
we do not expect any counter parties to fail to meet their obligations.

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

         Our interest  expense is  sensitive to changes in the general  level of
U.S.  interest  rates.  In this regard,  changes in U.S.  interest  rates affect
interest paid on our debt. A majority of our credit  facilities  are at variable
rates.  As of December 31, 2006,  we had $228,000 of fixed-rate  borrowings  and
$48.6 million of variable-rate  borrowings  outstanding.  A one percentage point
increase in interest  rates would result in an  annualized  increase to interest
expense of approximately $0.5 million on our variable-rate borrowings.


                                       45
<PAGE>


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

         None.

ITEM 9A. CONTROLS AND PROCEDURES

         EVALUATION OF CONTROLS AND PROCEDURES

         Members of the  company's  management,  including  our Chief  Executive
Officer and Chief Financial  Officer,  have evaluated the  effectiveness  of our
disclosure controls and procedures,  as defined by paragraph (e) of Exchange Act
Rules 13a-15 or 15d-15,  as of December 31, 2006,  the end of the period covered
by this  report.  Members  of the  Company's  management,  including  our  Chief
Executive Officer and Chief Financial  Officer,  also conducted an evaluation of
our internal control over financial  reporting to determine  whether any changes
occurred during the further quarter of 2006 that have  materially  affected,  or
are reasonably likely to materially  affect, our internal control over financial
reporting.  Based upon that  evaluation,  the Chief Executive  Officer and Chief
Financial  Officer  concluded  that our  disclosure  controls and procedures are
effective.

         CHANGES IN CONTROLS AND PROCEDURES

         During  the fourth  quarter  ended  December  31,  2006,  there were no
changes in our internal  control over financial  accounting  that has materially
affected,  or is reasonably  likely to materially  affect,  our internal control
over financial reporting.

ITEM 9B. OTHER INFORMATION

         None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

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

ITEM 11. EXECUTIVE COMPENSATION

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


                                       46
<PAGE>


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

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

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

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

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

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

                                     PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

         (a)      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)      Exhibits.  See the  Exhibit  Index  attached to this Form 10-K
annual report.


                                       47
<PAGE>


                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULE



                                                                            PAGE
                                                                            ----

Financial Statements

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

    Report of Independent Registered Public Accounting Firm, Grant
       Thornton LLP..........................................................F-3

    Consolidated Balance Sheets--December 31, 2005 and 2006..................F-4

    Consolidated Statements of Operations and Comprehensive Loss--
       Three year period ended December 31, 2006.............................F-5

    Consolidated Statements of Shareholders' Equity--Three year
       period ended December 31, 2006........................................F-6

    Consolidated Statements of Cash Flows--Three year period ended
       December 31, 2006.....................................................F-7

    Notes to Consolidated Financial Statements...............................F-8

Financial Statement Schedule

    Schedule II--Valuation and Qualifying Accounts..........................F-43


                                      F-1
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


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


We have audited the  consolidated  balance  sheets of Tarrant  Apparel Group and
subsidiaries (collectively, the "Company") as of December 31, 2006 and 2005, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the two years in the  period  ended  December  31,  2006.  Our
audits also included the financial  statement  schedule of Tarrant Apparel Group
listed  in Item  15(a).  These  financial  statements  and  financial  statement
schedule are the responsibility of the Company's management.  Our responsibility
is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the financial  position of Tarrant  Apparel
Group and  subsidiaries  as of December  31,  2006 and 2005,  and the results of
their  operations  and their  cash flows for each of the two years in the period
ended December 31, 2006, in conformity with U.S. generally  accepted  accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole,  presents  fairly in all  material  respects  the  information  set forth
therein.

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

Los Angeles, California
March 22, 2007


                                      F-2
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors and
Shareholders of Tarrant Apparel Group

We have audited the  accompanying  consolidated  statements  of  operations  and
comprehensive loss, shareholders' equity and cash flows of Tarrant Apparel Group
(a California  corporation)  and  subsidiaries  for the year ended  December 31,
2004.  These  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audit.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements  are free of material  misstatement.  The Company is not  required to
have,  nor were we  engaged to perform  an audit of its  internal  control  over
financial reporting.  Our audit included  consideration of internal control over
financial  reporting  as  a  basis  for  designing  audit  procedures  that  are
appropriate  in the  circumstances,  but not for the  purpose of  expressing  an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting.  Accordingly,  we express  no such  opinion.  An audit also  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial   statements,   assessing  the  accounting  principles  used  and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audit  provides  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the consolidated  results of operations and
cash flows of Tarrant  Apparel  Group for the year ended  December  31,  2004 in
conformity with accounting principles generally accepted in the United States of
America.

We have also  audited  Schedule II of Tarrant  Apparel  Group for the year ended
December 31,  2004.  In our  opinion,  this  schedule  presents  fairly,  in all
material respects, the information required to be set forth therein.


/s/ Grant Thornton, LLP
-----------------------
GRANT THORNTON, LLP

Los Angeles, California
March 24, 2005


                                      F-3
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                           CONSOLIDATED BALANCE SHEETS
<CAPTION>
                                                                          DECEMBER 31,
                                                                ------------------------------
                                                                     2005             2006
                                                                -------------    -------------
<S>                                                             <C>              <C>
                            ASSETS
Current assets:
  Cash and cash equivalents .................................   $   1,641,768    $     904,553
  Accounts receivable, net of $3.0 million and $2.1 million
    allowance for returns, discounts and bad debts at
    December 31, 2005 and 2006, respectively ................      54,598,443       48,079,527
  Due from related parties ..................................       3,100,928        3,688,355
  Inventory .................................................      31,628,960       17,774,103
  Temporary quota rights ....................................            --             32,217
  Current portion of notes receivable - related parties .....       5,139,387             --
  Prepaid expenses ..........................................       1,292,441        1,515,087
  Prepaid royalties .........................................       1,123,531             --
  Deferred tax assets .......................................            --            123,607
  Income taxes receivable ...................................          25,468           25,468
                                                                -------------    -------------
    Total current assets ....................................      98,550,926       72,142,917

Property and equipment, net of $10.8 million and $9.4 million
  accumulated depreciation at December 31, 2005 and 2006,
  respectively ..............................................       1,702,840        1,414,354
Notes receivable - related parties, net of current portion,
  and net of $27.1 million reserve at December 31, 2006 .....      36,268,446       14,000,000
Due from related parties ....................................       2,994,945        4,168,205
Equity method investment ....................................       2,138,865        2,151,061
Deferred financing cost, net of $711,250 and $1.7 million
  accumulated amortization at December 31, 2005 and 2006,
  respectively ..............................................         838,786        2,448,526
Other assets ................................................         164,564        6,223,816
Goodwill, net ...............................................       8,582,845        8,582,845
                                                                -------------    -------------

    Total assets ............................................   $ 151,242,217    $ 111,131,724
                                                                =============    =============

           LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Short-term bank borrowings ................................   $  13,833,532    $  13,696,182
  Accounts payable ..........................................      33,278,959       22,685,674
  Accrued expenses ..........................................       9,503,806        8,907,658
  Derivative liability ......................................            --            195,953
  Income taxes ..............................................      16,828,538       16,865,125
  Current portion of long-term obligations and factoring
    arrangement .............................................      36,109,699       19,586,565
                                                                -------------    -------------
    Total current liabilities ...............................     109,554,534       81,937,157

Term loan, net of $0 and $4.3 million debt discount at
  December 31, 2005 and 2006, respectively ..................            --         11,212,724
Other long-term obligations .................................         239,935            5,338
Convertible debentures, net of $948,000 and $0 debt discount
  at December 31, 2005 and 2006, respectively ...............       5,965,098             --
Deferred tax liabilities ....................................          47,098             --
                                                                -------------    -------------
    Total liabilities .......................................     115,806,665       93,155,219

Minority interest in PBG7 ...................................          75,241           54,338
Commitments and contingencies

Shareholders' equity:
Preferred stock, 2,000,000 shares authorized;
    no shares at December 31, 2005 and 2006 issued and
    outstanding .............................................            --               --
Common stock, no par value, 100,000,000 shares authorized;
    30,553,763 shares and 30,543,763 shares at December 31,
    2005 and 2006 issued and outstanding, respectively ......     114,977,465      114,977,465
Warrants to purchase common stock ...........................       2,846,833        7,314,239
Contributed capital .........................................      10,004,331       10,191,511
Accumulated deficit .........................................     (90,189,615)    (112,410,363)
Notes receivable from officer/shareholder ...................      (2,278,703)      (2,150,685)
                                                                -------------    -------------

    Total shareholders' equity ..............................      35,360,311       17,922,167
                                                                -------------    -------------

    Total liabilities and shareholders' equity ..............   $ 151,242,217    $ 111,131,724
                                                                =============    =============
</TABLE>


                             See accompanying notes.


                                      F-4
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                 -----------------------------------------------
                                                      2004             2005             2006
                                                 -------------    -------------    -------------
<S>                                              <C>              <C>              <C>
Net sales ....................................   $ 155,452,663    $ 214,648,218    $ 232,401,689
Cost of sales ................................     134,492,460      169,767,051      181,759,585
                                                 -------------    -------------    -------------

Gross profit .................................      20,960,203       44,881,167       50,642,104
Selling and distribution expenses ............       9,290,819       10,726,425       11,016,352
General and administrative expenses ..........      32,083,637       26,864,789       26,878,871
Royalty expenses .............................         604,888        3,664,454        2,814,929
Impairment charges ...........................      77,982,034             --               --
Cumulative translation loss attributable to
   liquidated Mexico operations ..............      22,786,125             --               --
Loss on notes receivable - related parties ...            --               --         27,137,297
                                                 -------------    -------------    -------------

Income (loss) from operations ................    (121,787,300)       3,625,499      (17,205,345)
Interest expense .............................      (2,857,096)      (4,624,590)      (6,059,628)
Interest income ..............................         377,587        2,081,456        1,181,437
Minority interest ............................      15,331,171          (75,241)          20,903
Interest in income of equity method investee .         769,706          559,634           79,696
Other income .................................       6,366,637          354,347          335,731
Adjustment to fair value of derivative .......            --               --            315,134
Other expense ................................        (529,257)            (580)        (435,586)
                                                 -------------    -------------    -------------

Income (loss) before provision for income
   taxes .....................................    (102,328,552)       1,920,525      (21,767,658)
Provision for income taxes ...................       2,348,119          927,181          453,090
                                                 -------------    -------------    -------------

Net income (loss) ............................   $(104,676,671)   $     993,344    $ (22,220,748)
                                                 =============    =============    =============

Net income (loss) per share - Basic: .........   $       (3.64)   $        0.03    $       (0.73)
                                                 =============    =============    =============

Net income (loss) per share - Diluted ........   $       (3.64)   $        0.03    $       (0.73)
                                                 =============    =============    =============

Weighted average common and common equivalent
   shares outstanding:
   Basic .....................................      28,732,796       29,728,997       30,545,599
                                                 =============    =============    =============

   Diluted ...................................      28,732,796       29,734,291       30,545,814
                                                 =============    =============    =============
</TABLE>


                             See accompanying notes.


                                      F-5
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006

<CAPTION>


                                                 PREFERRED        NUMBER          COMMON          NUMBER
                                                   STOCK         OF SHARES         STOCK         OF SHARES         WARRANTS
                                               -------------   -------------   -------------   -------------    -------------
<S>                                            <C>                      <C>    <C>                <C>           <C>
Balance at January 1, 2004 .................   $        --              --     $ 107,891,426      27,614,763    $   1,798,733
   Currency translation ....................            --              --              --              --               --
   Net loss ................................            --              --              --              --               --
   Cumulative translation loss attributable
      to liquidated Mexico operations ......            --              --              --              --               --
   Compensation expense ....................            --              --              --              --               --
   Issuance of common stock ................            --              --         3,623,665       1,200,000           44,100
   Issuance of warrants with debentures ....            --              --              --              --          1,004,000
   Intrinsic value of beneficial conversion
      associated with convertible debentures            --              --              --              --               --
   Repayment from shareholder ..............            --              --              --              --               --
   Reclassification of shareholders'
      receivable to current asset ..........            --              --              --              --               --
                                               -------------   -------------   -------------   -------------    -------------

Balance at December 31, 2004 ...............   $        --              --     $ 111,515,091      28,814,763    $   2,846,833
   Net income ..............................            --              --              --              --               --
   Compensation expense ....................            --              --              --              --               --
   Issuance of common stock ................            --              --           375,000         195,313             --
   Conversion of debentures ................            --              --         3,087,374       1,543,687             --
   Repayment from shareholder ..............            --              --              --              --               --
                                               -------------   -------------   -------------   -------------    -------------

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

Balance at December 31, 2006 ...............   $        --              --     $ 114,977,465      30,543,763    $   7,314,239
                                               =============   =============   =============   =============    =============


<CAPTION>
                                                                   RETAINED       ACCUMULATED
                                                                   EARNINGS          OTHER                              TOTAL
                                                 CONTRIBUTED    (ACCUMULATED     COMPREHENSIVE     NOTES FROM       SHAREHOLDERS'
                                                   CAPITAL         DEFICIT)      INCOME (LOSS)    SHAREHOLDERS         EQUITY
                                                -------------   -------------    -------------    -------------    -------------
<S>                                             <C>             <C>              <C>              <C>              <C>
Balance at January 1, 2004 .................    $   9,000,553   $  13,493,712    $ (19,679,185)   $  (4,796,428)   $ 107,708,811
   Currency translation ....................             --              --         (3,106,940)            --         (3,106,940)
   Net loss ................................             --      (104,676,671)            --               --       (104,676,671)
   Cumulative translation loss attributable
      to liquidated Mexico operations ......             --              --         22,786,125             --         22,786,125
   Compensation expense ....................          161,038            --               --               --            161,038
   Issuance of common stock ................             --              --               --               --          3,667,765
   Issuance of warrants with debentures ....             --              --               --               --          1,004,000
   Intrinsic value of beneficial conversion
      associated with convertible debentures          804,000            --               --               --            804,000
   Repayment from shareholder ..............             --              --               --             30,366           30,366
   Reclassification of shareholders'
      receivable to current asset ..........             --              --               --          2,300,000        2,300,000
                                                -------------   -------------    -------------    -------------    -------------

Balance at December 31, 2004 ...............    $   9,965,591   $ (91,182,959)   $        --      $  (2,466,062)   $  30,678,494
   Net income ..............................             --           993,344             --               --            993,344
   Compensation expense ....................           38,740            --               --               --             38,740
   Issuance of common stock ................             --              --               --               --            375,000
   Conversion of debentures ................             --              --               --               --          3,087,374
   Repayment from shareholder ..............             --              --               --            187,359          187,359
                                                -------------   -------------    -------------    -------------    -------------

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

Balance at December 31, 2006 ...............    $  10,191,511   $(112,410,363)   $        --      $  (2,150,685)   $  17,922,167
                                                =============   =============    =============    =============    =============
</TABLE>


                             See accompanying notes.


                                      F-6
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>
                                                                      YEAR ENDED DECEMBER 31,
                                                         -----------------------------------------------
                                                              2004             2005             2006
                                                         -------------    -------------    -------------
<S>                                                      <C>              <C>              <C>
Operating activities:
Net Income (loss) ....................................   $(104,676,671)   $     993,344    $ (22,220,748)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
   Deferred taxes ....................................         (61,345)        (166,686)         237,045
   Depreciation and amortization of fixed assets .....       7,852,625          727,233          455,124
   Amortization of deferred financing cost ...........         485,321        1,399,352        2,525,210
   Receipt of merchandise in lieu of interest on notes
      receivable, related party ......................            --         (1,742,540)            --
   Impairment charges ................................      77,982,034             --               --
   Cumulative transaction loss attributable to the
      liquidated Mexico operations ...................      22,786,125             --               --
   Adjustment to fair value of derivative ............            --               --           (315,134)
   Loss on notes receivable - related parties ........            --               --         27,137,297
   Prepaid royalties write-off .......................            --          1,165,970             --
   Income from equity method investment ..............        (769,706)        (559,634)         (79,696)
   Loss (gain) on sale of fixed assets ...............         (15,272)        (124,041)          35,587
   Unrealized gain on foreign currency ...............        (367,262)            --               --
   Minority interest .................................     (15,331,171)          75,241          (20,903)
   Compensation expense related to stock options .....         161,038           38,740             --
   Stock-based compensation ..........................            --               --            187,180
   Change in the provision for returns and discounts .      (1,747,060)         (78,060)         292,356
   Change in the provision for bad debts .............         (41,458)         591,945       (1,167,248)
   Changes in operating assets and liabilities:
      Restricted cash ................................       2,759,742             --               --
      Accounts receivable ............................      21,265,912      (17,352,985)       6,528,104
      Due to/from related parties ....................        (122,389)       2,702,047       (1,160,821)
      Inventory ......................................       4,162,158       (8,503,086)      13,305,121
      Temporary quota rights .........................            --               --            (32,217)
      Prepaid expenses ...............................      (1,860,955)          47,055          900,886
      Accounts payable ...............................         687,758        9,248,667      (10,593,284)
      Accrued expenses and income tax payable ........        (981,196)      (1,362,218)        (967,312)
                                                         -------------    -------------    -------------
   Net cash provided by (used in) operating activities      12,168,228      (12,899,656)      15,046,547

Investing activities:
Purchase of fixed assets .............................        (111,836)        (559,081)        (208,571)
Proceeds from sale of fixed assets ...................       1,219,904          130,552            6,346
Investment in equity investment method ...............        (137,000)            --               --
Distribution from equity method investee .............         460,800          301,050           67,500
Deposit in acquisition ...............................            --               --         (5,000,000)
Due diligence fees in acquisition ....................            --               --         (1,050,256)
Collection on notes receivable - related parties .....            --          1,194,722        1,086,110
Trademark ............................................            --               --           (100,000)
Investment in joint venture ..........................        (211,963)            --               --
Collection of advances from shareholders/officers ....          30,366        2,487,360          128,018
                                                         -------------    -------------    -------------
   Net cash provided by (used in) investing activities       1,250,271        3,554,603       (5,070,853)

Financing activities:
Short-term bank borrowings, net ......................     (11,342,166)      (4,117,625)        (137,351)
Proceeds from long-term obligations ..................     129,667,084      218,367,495      235,101,785
Payment of financing costs ...........................      (1,124,668)            --         (2,405,201)
Payment of long-term obligations and bank borrowings .    (146,375,987)    (204,477,993)    (236,359,516)
Proceeds from issuance of preferred stock and warrant        3,623,665             --               --
Proceeds (repayments) from convertible debentures ....      10,000,000             --         (6,912,626)
                                                         -------------    -------------    -------------
   Net cash provided by (used in) financing activities     (15,552,072)       9,771,877      (10,712,909)

Effect of exchange rate on cash ......................          28,553             --               --
                                                         -------------    -------------    -------------

Increase (decrease) in cash and cash equivalents .....      (2,105,020)         426,824         (737,215)
Cash and cash equivalents at beginning of year .......       3,319,964        1,214,944        1,641,768
                                                         -------------    -------------    -------------

Cash and cash equivalents at end of year .............   $   1,214,944    $   1,641,768    $     904,553
                                                         =============    =============    =============
</TABLE>


                             See accompanying notes


                                      F-7
<PAGE>


                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BASIS OF CONSOLIDATION

The accompanying  financial  statements  consist of the consolidation of Tarrant
Apparel Group,  a California  corporation,  and its majority owned  subsidiaries
located  primarily in the U.S., Asia,  Mexico,  and Luxembourg.  At December 31,
2006,  we own 50.1% of United  Apparel  Ventures  ("UAV")  and 75% of PBG7,  LLC
("PBG7").  We consolidate  these entities and reflect the minority  interests in
earnings (losses) of the ventures in the accompanying financial statements.  All
inter-company  amounts  are  eliminated  in  consolidation.  The 49.9%  minority
interest in UAV is owned by Azteca Production International, a corporation owned
by the brothers of our  Chairman and Interim  Chief  Executive  Officer,  Gerard
Guez.  The 25%  minority  interest in PBG7 is owned by BH7,  LLC,  an  unrelated
party.

We serve  specialty  retail,  mass  merchandisers,  department  store chains and
branded wholesalers by designing, merchandising, contracting for the manufacture
of, and selling casual  apparel for women,  men and children under private label
and private brand.  Commencing in 1999, we expanded our operations from sourcing
apparel to sourcing and operating our own  vertically  integrated  manufacturing
facilities.  In August 2003, we determined to abandon our strategy of being both
a  trading  and  vertically  integrated  manufacturing  company,  and  effective
September  1, 2003,  we leased and  outsourced  operation  of our  manufacturing
facilities in Mexico to affiliates of Mr. Kamel Nacif, a shareholder at the time
of the  transaction.  In  August  2004,  we  entered  into a  purchase  and sale
agreement to sell these facilities to affiliates of Mr. Nacif, which transaction
consummated  in the fourth quarter of 2004. See Note 5 and Note 17 of the "Notes
to Consolidated Financial Statements."

Historically,  our operating  results have been subject to seasonal  trends when
measured on a quarterly  basis.  This trend is  dependent  on numerous  factors,
including the markets in which we operate,  holiday  seasons,  consumer  demand,
climate,  economic  conditions  and numerous  other factors  beyond our control.
Generally,  the second and third quarters are stronger than the first and fourth
quarters.  There can be no assurance that the historic  operating  patterns will
continue in future periods.

RISK AND UNCERTAINTIES - IRS EXAMINATION

As discussed in Note 12 of the "Notes to Consolidated Financial Statements," our
federal  income tax returns for the years ended  December  31, 1996 through 2002
were under  examination by the Internal  Revenue  Service  ("IRS").  The IRS has
proposed adjustments to increase our federal income tax payable for these years.
This  adjustment  would also result in  additional  state taxes,  penalties  and
interest.  We  believe  that we  have  meritorious  defenses  to and  intend  to
vigorously  contest the  proposed  adjustments  made to our  federal  income tax
returns for the years ended 1996 through 2002. If the proposed  adjustments  are
upheld through the administrative and legal process,  they could have a material
impact on our  earnings and cash flow.  The maximum  amount of loss in excess of
the amount accrued in the financial statements is $8.3 million. If the amount of
any actual  liability,  however,  exceeds our reserves,  we would  experience an
immediate  adverse  earnings impact in the amount of such additional  liability,
which  could  be  material.   Additionally,  we  anticipate  that  the  ultimate
resolution of these matters will require that we make  significant cash payments
to the taxing authorities.  Presently we do not have sufficient cash to make any
future  payments  that may be required.  No assurance  can be given that we will
have  sufficient  surplus cash from  operations  to make the required  payments.
Additionally,  any cash used for these  purposes will not be available for other
corporate purposes,  which could have a material adverse effect on our financial
condition and results of operations.  See Note 12 of the "Notes to  Consolidated
Financial Statements" for a further discussion on the IRS examination.

 RISK AND UNCERTAINTIES - DEBT COVENANTS

As discussed in Note 9 of the "Notes to Consolidated  Financial Statements," our
debt agreements  require certain  covenants  including a minimum level of EBITDA
and specified tangible net worth; and required interest coverage


                                      F-8
<PAGE>


ratio and leverage ratio. If our results of operations erode and we are not able
to obtain waivers from the lenders, the debt would be in default and callable by
our  lenders.  In  addition,  due  to  cross-default   provisions  in  our  debt
agreements,  substantially all of our long-term debt would become due in full if
any of the debt is in default.  In anticipation of us not being able to meet the
required  covenants due to various  reasons,  we either negotiate for changes in
the relative  covenants or an advance  waiver or reclassify the relevant debt as
current.  We also believe that our lenders would  provide  waivers if necessary.
However,  our expectations of future operating results and continued  compliance
with other debt  covenants  cannot be assured and our  lenders'  actions are not
controllable by us. If projections of future operating  results are not achieved
and the debt is placed in default,  we would be required to reduce our expenses,
including by curtailing  operations,  and to raise  capital  through the sale of
assets,  issuance  of equity or  otherwise,  any of which  could have a material
adverse effect on our financial condition and results of operations.  See Note 9
of the "Notes to Consolidated  Financial Statements" for a further discussion of
the credit  facilities and related debt  covenants.  As of December 31, 2006, we
were in violation of the EBITDA, tangible net worth and leverage ratio covenants
and waivers of the defaults were obtained in March 2007 from our lenders.

REVENUE RECOGNITION

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

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

SHIPPING AND HANDLING COSTS

Freight  charges  are  included  in selling  and  distribution  expenses  in the
statements of operations and amounted to $783,000, $667,000 and $781,000 for the
years ended  December 31,  2004,  2005 and 2006,  respectively.  We did not bill
customers  for shipping and handling  costs for the year 2004. In 2005 and 2006,
we did some  billing for freight to  specialty  stores  although  the amount was
insignificant.

CASH AND CASH EQUIVALENTS

Cash equivalents  consist of cash and highly liquid investments with an original
maturity of three months or less when purchased.  Cash and cash equivalents held
in foreign financial institutions totaled $1,062,000 and $260,000 as of December
31,  2005 and 2006,  respectively.  Cash is  deposited  with what we believe are
highly  credited  quality  financial  institutions  and may exceed FDIC  insured
limits.  As  of  December  31,  2005  and  2006,  cash  deposited  in  financial
institutions  that  exceeded  FDIC  insured  limits  was $1.1  million  and $1.4
million, respectively.

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

We evaluate the collectibility of accounts receivable and chargebacks  (disputes
from the customer) based upon a combination of factors.  In circumstances  where
we  are  aware  of  a  specific  customer's  inability  to  meet  its  financial
obligations  (such  as  in  the  case  of  bankruptcy   filings  or  substantial
downgrading  of  credit  sources),  a  specific  reserve  for bad debts is taken
against  amounts  due to reduce  the net  recognized  receivable  to the  amount
reasonably  expected to be  collected.  For all other  customers,  we  recognize
reserves for bad debts and  uncollectible  chargebacks  based on our  historical
collection experience.  If collection experience  deteriorates (for example, due
to an unexpected  material adverse change in a major customer's  ability to meet
its financial obligations to us), the estimates of the recoverability of amounts
due to us could be reduced by a material  amount.  As of  December  31, 2005 and
2006, the balance of the allowance for returns, discounts and bad debts was $3.0
million and $2.1 million, respectively.


                                      F-9
<PAGE>


INVENTORIES

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

COST OF SALES

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

SELLING AND DISTRIBUTION EXPENSES

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

GENERAL AND ADMINISTRATIVE EXPENSES

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

LICENSE AGREEMENTS AND ROYALTY EXPENSES

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

Royalty expense for each of the three fiscal years ended December 31, 2004, 2005
and 2006 were $605,000, $3.7 million and $2.8 million, respectively.

DEFERRED RENT PROVISION

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

DERIVATIVE ACTIVITIES

WARRANT DERIVATIVES

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


                                      F-10
<PAGE>


derivative  on our  consolidated  statements  of  operations.  See Note 9 of the
"Notes to Consolidated Financial Statements"

FOREIGN CURRENCY FORWARD CONTRACT

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

SFAS No. 133 requires  measurement  of certain  derivative  instruments at their
fair value for accounting purposes.  All derivative  instruments are recorded on
our balance sheet at fair value;  as a result,  we mark to market all derivative
instruments.  Derivative  liabilities are adjusted to reflect fair value at each
period end,  with any  increase or decrease in the fair value being  recorded in
consolidated   statements  of  operations  as   adjustments  to  fair  value  of
derivatives.  There were no exchange  contracts at December 31, 2005. During the
year ended December 31, 2006, we entered into foreign currency forward contracts
to hedge  against  the  effect  of  exchange  rate  fluctuations  on cash  flows
denominated   in  foreign   currencies  and  certain   inter-company   financing
transactions. This transaction is undesignated and as such an ineffective hedge.
At December  31,  2006,  we had one open foreign  exchange  forward  which has a
maturity of less than one year. Hedge  ineffectiveness  resulted in an impact of
$196,000 in our consolidated statements of operations as of December 31, 2006

PRODUCT DESIGN, ADVERTISING AND SALES PROMOTION COSTS

Product design,  advertising and sales promotion costs are expensed as incurred.
Product  design,  advertising  and sales  promotion  costs  included in selling,
general and administrative expenses in the accompanying statements of operations
(excluding  the  costs  of  manufacturing   production   samples)   amounted  to
approximately  $2,106,000,  $3,009,000  and  $2,731,000 in 2004,  2005 and 2006,
respectively.

PROPERTY AND EQUIPMENT

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

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

IMPAIRMENT OF LONG-LIVED ASSETS

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


                                      F-11
<PAGE>


VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

Effective  January  1,  2002,  we  adopted  SFAS No.  142,  "Goodwill  and Other
Intangible  Assets." According to this statement,  goodwill and other intangible
assets with indefinite lives are no longer subject to  amortization,  but rather
an  assessment  of impairment  applied on a  fair-value-based  test on an annual
basis or more frequently if an event occurs or  circumstances  change that would
more  likely  than not  reduce  the fair  value of a  reporting  unit  below its
carrying amount.

We utilized the  discounted  cash flow  methodology  to estimate fair value.  At
December 31, 2006, we had a goodwill balance of $8.6 million, and a net property
and equipment balance of $1.4 million, as compared to a goodwill balance of $8.6
million and a net property and equipment balance of $1.7 million at December 31,
2005. See Note 5 and Note 8 of the "Notes to Consolidated Financial Statements."

Factors  considered  important that could trigger an impairment  review include,
but are not limited to, the following:

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

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

         o        a significant negative industry or economic trend.

During the years ended  December  31, 2005 and 2006,  we did not  recognize  any
impairment related to goodwill and property and equipment.

DEFERRED FINANCING COST

Deferred financing costs were $839,000 and $2.4 million at December 31, 2005 and
2006,  respectively.   These  costs  of  obtaining  financing  and  issuance  of
convertible debt  instruments are being amortized on a straight-line  basis over
the term of the related debt.  Amortization  expenses for deferred  charges were
$387,000,  $1,399,000 and $2,525,000 for the years ended December 31, 2004, 2005
and 2006, respectively.

INCOME TAXES

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

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


                                      F-12
<PAGE>


NET INCOME (LOSS) PER SHARE

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

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                               ----------------------------------------------
                                                    2004             2005            2006
                                               -------------    -------------   -------------
<S>                                            <C>              <C>             <C>
Basic EPS Computation:
Numerator:
Reported net income (loss) .................   $(104,676,671)   $     993,344   $ (22,220,748)

Denominator:
Weighted average common shares outstanding .      28,732,796       29,728,997      30,545,599

Basic EPS ..................................   $       (3.64)   $        0.03   $       (0.73)
                                               =============    =============   =============

Diluted EPS Computation:
Numerator:
Reported net income (loss) .................   $(104,676,671)   $     993,344   $ (22,220,748)

Denominator:
Weighted average common shares outstanding .      28,732,796       29,728,997      30,545,599
Incremental shares from assumed exercise of
warrants ...................................            --               --              --
convertible debentures .....................            --               --              --
options ....................................            --              5,294             215
                                               -------------    -------------   -------------
Total shares ...............................      28,732,796       29,734,291      30,545,814

Diluted EPS ................................   $       (3.64)   $        0.03   $       (0.73)
                                               =============    =============   =============
</TABLE>


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

                                         2004            2005            2006
                                      ----------      ----------      ----------

Options ........................       8,331,962       6,727,756       7,673,444
Warrants .......................       2,361,732       2,361,732       5,931,732
Convertible debentures .........       5,000,000       3,456,313            --
                                      ----------      ----------      ----------
   Total .......................      15,693,694      12,545,801      13,605,176


DIVIDENDS

We did not declare or pay any cash dividends in 2004, 2005 or 2006. We intend to
retain  any future  earnings  for use in our  business  and,  therefore,  do not
anticipate declaring or paying any cash dividends in the foreseeable future. The
declaration and payment of any cash dividends in the future will depend upon our
earnings,  financial condition,  capital needs and other factors deemed relevant
by the Board of  Directors.  In  addition,  our credit  agreements  prohibit the
payment of dividends during the term of the agreements.


                                      F-13
<PAGE>


FOREIGN CURRENCY TRANSLATION

Assets and liabilities of the Mexico and Hong Kong  subsidiaries  are translated
at the rate of exchange in effect on the balance sheet date; income and expenses
are translated at the average rates of exchange  prevailing during the year. The
functional currencies in which we transact business are the Hong Kong dollar and
the peso in Mexico.

Foreign  currency  gains and losses  resulting  from  translation  of assets and
liabilities are included in other comprehensive income (loss). Transaction gains
or losses, other than inter-company debt deemed to be of a long-term nature, are
included  in net income  (loss) in the period in which they occur.  In 2004,  we
substantially liquidated our Mexico subsidiaries following the sale of the fixed
assets in  Mexico.  The  accumulated  foreign  currency  translation  adjustment
related to the Mexico subsidiaries of $22.8 million of loss was reclassified and
charged to income.  The  adjustment  occurred in the fourth quarter of 2004. See
Note 5 of the "Notes to Consolidated  Financial  Statements."  Foreign  currency
gains and losses  resulting  from  translation  of assets and  liabilities  were
insignificant in 2005 and 2006.

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

CONCENTRATION OF CREDIT RISK

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

Our products are  primarily  sold to mass  merchandisers  and  specialty  retail
stores.  These customers can be  significantly  affected by changes in economic,
competitive or other factors.  We make  substantial  sales to a relatively  few,
large customers. In order to minimize the risk of loss, we assign certain of our
domestic accounts receivable to a factor without recourse or requires letters of
credit  from our  customers  prior to the  shipment of goods.  For  non-factored
receivables,  account-monitoring procedures are utilized to minimize the risk of
loss.  Collateral  is  generally  not  required.  At December 31, 2005 and 2006,
approximately  22% and 23% of accounts  receivable  were due from two customers,
respectively.   The  following  table  presents  the  percentage  of  net  sales
concentrated with certain customers.

                                                        PERCENTAGE OF NET SALES
                                                       -------------------------
                CUSTOMER                                2004      2005      2006
--------------------------------------------------      ----      ----      ----
Macy's Merchandising Group .......................      10.3      13.4      18.9
Kohl's ...........................................      16.4      13.5      14.1
Mervyn's .........................................      15.4      11.2      11.9
Wal-Mart .........................................       5.9      11.1       4.5
New York & Co. ...................................      15.0       8.6       4.5

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

USE OF ESTIMATES

The preparation of financial  statements in conformity  with generally  accepted
accounting  principles  in the United States of America  requires  management to
make estimates and assumptions that affect the amounts reported in the financial
statements  and  accompanying  notes.   Significant  estimates  used  by  us  in
preparation of the financial statements include allowance for returns, discounts
and bad debts, inventory, notes receivable - related parties


                                      F-14
<PAGE>


reserve,  valuation of long-lived  and  intangible  assets and goodwill,  income
taxes,  stock options  valuation,  contingencies and litigation.  Actual results
could differ from those estimates.

STOCK-BASED COMPENSATION

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

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

The following table illustrates the effect on net loss and net loss per share if
we had  applied  the  fair  value  recognition  provisions  of SFAS  No.  123 to
stock-based  payment  awards  granted  under our stock option plans for the year
ended December 31, 2004 and 2005:

                                                    2004               2005
                                               -------------      -------------

Net income (loss) as reported ..............   $(104,676,671)     $     993,344
Add stock-based employee compensation
   charges reported in net income (loss) ...   $     161,038      $      38,740
Pro forma compensation expense, net of tax .   $  (3,852,990)     $  (4,298,193)
                                               -------------      -------------
Pro forma net loss .........................   $(108,368,623)     $  (3,266,109)
                                               =============      =============

Net income (loss) per share
Basic ......................................   $       (3.64)     $        0.03
Add stock-based employee compensation
   charges reported in net income (loss)
Basic ......................................   $        0.01      $        0.00
Pro forma compensation expense per share
Basic ......................................   $       (0.14)     $       (0.14)
                                               -------------      -------------
Pro forma loss per share
Basic ......................................   $       (3.77)     $       (0.11)
                                               =============      =============

Net income (loss) per share
Diluted ....................................   $       (3.64)     $        0.03
Add stock-based employee compensation
   charges reported in net income (loss)
Diluted ....................................   $        0.01      $        0.00
Pro forma compensation expense per share
Diluted ....................................   $       (0.14)     $       (0.14)
                                               -------------      -------------
Pro forma loss per share
Diluted ....................................   $       (3.77)     $       (0.11)
                                               =============      =============


SFAS No.  123(R)  requires  companies to estimate the fair value of  share-based
payment  awards  to  employees  and  directors  on the  date of  grant  using an
option-pricing  model.  The value of the portion of the award that is ultimately


                                      F-15
<PAGE>


expected to vest is recognized as expense over the requisite  service periods in
our  consolidated  statements of  operations.  Prior to the adoption of SFAS No.
123(R),  we accounted for stock-based  payment awards to employees and directors
using the intrinsic  value method in accordance with APB No. 25 as allowed under
SFAS No. 123,  "Accounting  for Stock-Based  Compensation".  Under the intrinsic
value method,  no stock-based  compensation  expense had been  recognized in our
consolidated  statements  of  operations  for awards to employees  and directors
because the exercise price of our stock options equaled the fair market value of
the underlying stock at the date of grant.

On September  23,  2005,  the Board of Directors  approved the  acceleration  of
vesting of all our unvested stock options,  including those not issued under the
plan; see Note 14 of the "Notes to Consolidated Financial Statements." In total,
1.7 million stock options with an average exercise price of $3.69 and an average
remaining  contractual life of 7.9 years were subject to this acceleration.  The
exercise  prices and number of shares  subject to the  accelerated  options were
unchanged. The acceleration was effective as of September 23, 2005. As a result,
there were no stock  options  granted prior to, but not yet vested as of January
1, 2006.

IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In March  2006,  the FASB  issued SFAS No. 156,  "Accounting  for  Servicing  of
Financial  Assets",  which  provides an  approach to simplify  efforts to obtain
hedge-like  (offset)  accounting.  This Statement amends FASB Statement No. 140,
"Accounting for Transfers and Servicing of Financial Assets and  Extinguishments
of  Liabilities",  with  respect to the  accounting  for  separately  recognized
servicing assets and servicing liabilities. The Statement (1) requires an entity
to recognize a servicing asset or servicing liability each time it undertakes an
obligation to service a financial asset by entering into a servicing contract in
certain situations; (2) requires that a separately recognized servicing asset or
servicing  liability be initially  measured at fair value, if  practicable;  (3)
permits  an entity to choose  either the  amortization  method or the fair value
method  for  subsequent  measurement  for each  class of  separately  recognized
servicing  assets or servicing  liabilities;  (4) permits at initial  adoption a
one-time reclassification of available-for-sale securities to trading securities
by  an  entity  with  recognized  servicing  rights,   provided  the  securities
reclassified  offset the  entity's  exposure to changes in the fair value of the
servicing  assets or  liabilities;  and (5) requires  separate  presentation  of
servicing assets and servicing  liabilities  subsequently measured at fair value
in the balance sheet and additional  disclosures  for all separately  recognized
servicing  assets and servicing  liabilities.  SFAS No. 156 is effective for all
separately recognized servicing assets and liabilities as of the beginning of an
entity's fiscal year that begins after September 15, 2006, with earlier adoption
permitted in certain  circumstances.  The Statement also describes the manner in
which it should be initially applied. We are currently  evaluating the impact of
this Statement.

In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes - An  Interpretation of FASB Statement No. 109," ("FIN 48"). FIN
48 clarifies the  accounting for  uncertainty  in income taxes  recognized in an
enterprise's  financial  statements in accordance  with FASB  Statement No. 109,
"Accounting  for Income Taxes." FIN 48 also  prescribes a recognition  threshold
and  measurement   attribute  for  the  financial   statement   recognition  and
measurement of a tax position taken or expected to be taken in a tax return that
results  in  a  tax  benefit.   Additionally,   FIN  48  provides   guidance  on
de-recognition,  income  statement  classification  of interest  and  penalties,
accounting in interim periods,  disclosure, and transition.  This interpretation
is  effective  for fiscal  years  beginning  after  December  15,  2006.  We are
currently  evaluating the effect that the application of FIN 48 will have on our
results of operations and financial condition.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". SFAS
No. 157  establishes a framework for measuring fair value in generally  accepted
accounting  principles,  and expands  disclosures about fair value measurements.
SFAS No. 157 is  effective  for  financial  statements  issued for fiscal  years
beginning  after  November 15, 2007.  We are required to adopt the  provision of
SFAS No. 157, as  applicable,  beginning in fiscal year 2008.  We do not believe
the  adoption  of SFAS No.  157 will have a  material  impact  on our  financial
position or results of operations.

In September  2006,  the FASB issued SFAS No. 158,  "Employer's  Accounting  for
Defined  Benefit  Pension and Other  Postretirement  Plans-an  amendment of FASB
Statements  No.  87,  88,  106 and  132(R)".  SFAS No.  158  requires  us to (a)
recognize a plan's  funded status in the  statement of financial  position,  (b)
measure a plan's assets and its obligations  that determine its funded status as
of the end of the employer's fiscal year and (c) recognize changes in the funded
status of a


                                      F-16
<PAGE>


defined postretirement plan in the year in which the changes occur through other
comprehensive  income.  SFAS No. 158 is effective  for fiscal years ending after
December  15,  2006.  We do not  believe  that SFAS No. 158 will have a material
impact on our results of operations and financial condition.

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

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

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current year
presentation.

2.       ACCOUNTS RECEIVABLE

Accounts receivable consists of the following:
                                                            DECEMBER 31
                                                   ----------------------------
                                                       2005            2006
                                                   ------------    ------------

U.S. trade accounts receivable .................   $  2,893,217    $  2,975,840
Foreign trade accounts receivable ..............     19,619,172      16,986,357
Factored accounts receivable ...................     33,222,354      29,697,935
Other receivables ..............................      1,815,450         496,253
Allowance for returns, discounts and bad debts .     (2,951,750)     (2,076,858)
                                                   ------------    ------------
                                                   $ 54,598,443    $ 48,079,527
                                                   ============    ============

Under the asset-based  lending arrangement we had with GMAC before September 29,
2004, we factored trade  receivables from clients with credit ratings below BBB.
GMAC did not  advance any funds to us and only  afforded  us a credit  insurance
coverage.  We received funds from GMAC only after such funds were collected from
customers at their respective due dates. Effective as of September 29, 2004, the
asset  based  lending  arrangement  was  amended  and  converted  to a factoring
arrangement.   At  December  31,  2006,  substantially  all  trade  receivables,
irrespective of their debt ratings, were factored and GMAC advances up to 90% of
the invoice value to us immediately upon the submission of invoices.  See Note 9
of "Notes to Consolidated Financial Statements."

3.       INVENTORY

Inventory consists of the following:
                                                             DECEMBER 31,
                                                     ---------------------------
                                                         2005            2006
                                                     -----------     -----------

Raw materials, fabric and trim accessories .....     $ 5,079,428     $ 3,271,610
Finished goods shipments-in-transit ............       8,800,014       7,331,422
Finished goods .................................      17,749,518       7,171,071
                                                     -----------     -----------
                                                     $31,628,960     $17,774,103
                                                     ===========     ===========


                                      F-17
<PAGE>


4.       PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

                                                           DECEMBER 31,
                                                   ----------------------------
                                                       2005            2006
                                                   ------------    ------------

Land ...........................................   $     85,000    $     85,000
Buildings ......................................        819,372         819,372
Equipment ......................................      6,249,487       4,621,339
Furniture and fixtures .........................      2,308,537       2,197,648
Leasehold improvements .........................      2,684,720       2,727,243
Vehicles .......................................        322,487         333,311
                                                   ------------    ------------
                                                     12,469,603      10,783,913

Less accumulated depreciation and amortization .    (10,766,763)     (9,369,559)
                                                   ------------    ------------

                                                   $  1,702,840    $  1,414,354
                                                   ============    ============

Depreciation  expense,  including  amortization of assets recorded under capital
leases,  totaled $7,853,000,  $727,000 and $455,000 for the years ended December
31, 2004, 2005 and 2006, respectively.

5. RESTRUCTURING AND SALE OF MEXICO OPERATIONS

Following our restructuring of our Mexican operations in 2003, and the resulting
reduction  in our Mexican  work force,  we became the target of workers'  rights
activists  who  picketed  our  customers,   stuffed  electronic  mailboxes  with
inaccurate,  protest  e-mails,  and threatened  customers with  retaliation  for
continuing  business  with  us.  While  we  had  defended  our  position  to our
customers,  some of our larger customers for Mexico-produced jeans wear had been
reluctant to place orders with us in response to actions taken and  contemplated
by these activist groups. As a consequence, we experienced a significant decline
in revenue from sales of Mexico-produced merchandise during 2004. As a result of
this  reduction in revenue  from the sale of  Mexico-produced  merchandise,  the
Board of Directors approved a resolution in July 2004 authorizing  management to
sell the manufacturing operations in Mexico.

In accordance  with SFAS No. 144,  "Accounting for the Impairment or Disposal of
Long-Lived   Assets,"  we  evaluated  the   long-lived   assets  in  Mexico  for
recoverability  and  concluded  that  the  book  value of the  asset  group  was
significantly higher than the expected future cash flows and that impairment had
occurred. Accordingly, we recognized a non-cash impairment loss of approximately
$78  million  in the  second  quarter  of 2004.  The  impairment  charge was the
difference  between the carrying  value and fair value of the  impaired  assets.
Fair value was determined  based on  independent  appraisals of the property and
equipment  obtained  in June 2004.  There was no tax benefit  recorded  with the
impairment loss due to a full valuation  allowance  recorded  against the future
tax benefit as of June 30, 2004.  The entire  impairment  charge was recorded in
the Mexico geographic reporting segment.

In connection with our restructuring of our Mexico operations,  we incurred $1.1
million of severance costs in 2004 in the Mexico reportable  segment. We did not
relocate any employees in connection with this  restructuring  and therefore did
not incur any  relocation  costs.  In  addition,  we did not incur any  contract
termination costs. There was no ending liability balance for the severance costs
incurred  in 2004  since such  amounts  were all paid in 2004.  Severance  costs
incurred in 2004 were  included in general  and  administrative  expenses in the
accompanying consolidated statements of operations.

In August 2004,  through Tarrant Mexico,  S. de R.L. de C.V., our majority owned
and controlled  subsidiary in Mexico,  we entered into an Agreement for Purchase
of Assets with  affiliates of Mr. Kamel Nacif,  a shareholder at the time of the
transaction,  which  agreement  was  amended in October  2004.  Pursuant  to the
agreement,  as  amended,  on  November  30,  2004,  we  sold  to the  purchasers
substantially  all of our  assets  and real  property  in Mexico  which  include
equipment and facilities  previously leased to Mr. Nacif's affiliates in October
2003,  for an aggregate  purchase  price  consisting  of a) $105,400 in cash and
$3,910,000 by delivery of unsecured promissory


                                      F-18
<PAGE>


notes that mature on November 30, 2007,  bearing interest at 5.5% per annum; and
b) $40,204,000, by delivery of secured promissory notes bearing interest at 4.5%
per annum,  with  payments  due on December  31, 2005 and every year  thereafter
until December 31, 2014. The secured  promissory notes are payable in partial or
total amounts  anytime prior to the maturity of each note. The secured notes are
secured  by the  real  and  personal  property  in  Mexico  that  we sold to the
purchasers.

Upon  consummation of the sale of our Mexico assets,  we entered into a purchase
commitment  agreement  with the  purchasers,  pursuant  to which  we  agreed  to
purchase annually over the ten-year term of the agreement,  $5 million of fabric
manufactured at our former  facilities  acquired by the purchasers at negotiated
market prices. This agreement replaced a previously existing purchase commitment
agreement  whereby we were  obligated  to  purchase  annually  from Mr.  Nacif's
affiliates,  6 million yards of fabric (or approximately $19.2 million of fabric
at today's market prices)  manufactured at these same facilities through October
2009. The annual future purchase  commitments  approximate the annual maturities
of the notes  receivable  from the  related  party and are  allowed to be offset
against annual principal and interest requirements.

Included  in the  $41.4  million  notes  receivable  -  related  parties  on the
accompanying  balance  sheet as of December  31, 2005 was  $1,317,000  of Mexico
valued added taxes on the real  property  component of this  transaction.  As of
September  30,  2006,  the  outstanding   balance  of  the  notes  and  interest
receivables  were $41.1  million  prior to the  reserve.  Historically,  we have
placed  orders for  purchases  of fabric  from the  purchasers  pursuant  to the
purchase  commitment  agreement  we entered  into at the time of the sale of the
Mexico assets,  and we have satisfied our payment  obligations for the fabric by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  during  2006,  the  purchasers  ceased  providing  fabric  and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable  in the third  quarter of 2006 in an amount equal to the  outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be approximately $27.1 million, resulting in a net notes receivable
balance at September 30, 2006 of approximately $14 million. We believe there was
no  significant  change  subsequently  on the  value  of the  underlying  assets
securing the notes;  therefore, we did not have additional reserve in the fourth
quarter of 2006.  We will  continue to pursue  payment of all amounts  under the
notes  receivable and believe the remaining $14 million  balance at December 31,
2006 is realizable. The entire reserve was recorded in the Luxembourg geographic
reporting segment.

6.       EQUITY METHOD INVESTMENT - AMERICAN RAG

In the second quarter of 2003, we acquired a 45% equity interest in the owner of
the trademark  "American Rag CIE" and the operator of American Rag retail stores
for $1.4 million,  and our subsidiary,  Private Brands, Inc., acquired a license
to certain exclusive rights to this trademark. We have guaranteed the payment to
the licensor of minimum royalties of $10.4 million over the initial 10-year term
of the  agreement.  The guaranteed  annual  minimum  royalty is payable in equal
monthly  installments during the term of the agreement.  The royalty owed to the
licensor in excess of the guaranteed  minimum,  if any, is payable no later than
30 days after the end of the  preceding  full  quarter  with the amount for last
quarter  adjusted  based on actual  royalties  owed for the year. The guaranteed
annual  minimum  royalty for 2006 is $661,000.  At December 31, 2006,  the total
commitment on royalties  remaining on the term was $8.4 million.  Private Brands
also entered  into a multi-year  exclusive  distribution  agreement  with Macy's
Merchandising Group ("MMG"), the sourcing arm of Federated Department Stores, to
supply MMG with American Rag CIE, a casual sportswear collection for juniors and
young men.  Under this  arrangement,  Private  Brands  designs and  manufactures
American Rag  apparel,  which is  distributed  by MMG  exclusively  to Federated
stores across the country. Beginning in August 2003, the American Rag collection
was  available in  approximately  100 select  Macy's  locations and is currently
available in  approximately  600 Macy's  stores  nationally.  The  investment in
American  Rag CIE,  LLC  totaling  $2.1 million and $2.2 million at December 31,
2005 and 2006,  respectively,  is  accounted  for under the  equity  method  and
included in equity method  investment on the accompanying  consolidated  balance
sheets.  Income  from the equity  method  investment  is  recorded in the United
States geographical  segment.  The change in investment in American Rag for 2005
and 2006 was as follows:


                                      F-19
<PAGE>


         Balance as of December 31, 2004 ...........       $ 1,880,281
         Share of income ...........................           559,634
         Distribution ..............................          (301,050)
                                                           -----------
         Balance as of December 31, 2005 ...........       $ 2,138,865
         Share of income ...........................            79,696
         Distribution ..............................           (67,500)
                                                           -----------
         Balance as of December 31, 2006 ...........       $ 2,151,061
                                                           ===========


We hold a 45% member  interest in American  Rag. The remaining 55% owners are an
unrelated  third party who  contributed  the  American Rag  trademark  and other
assets and liabilities relating to two retail stores operating under the name of
"American  Rag".  The entity is generating  positive cash flow and net operating
profit from its retail stores.  The royalty income paid by us to American Rag is
considered  other income and is ancillary  to the primary  operations.  Reported
revenue from the retail business in fiscal 2004, 2005 and 2006 was approximately
$9 million,  $10 million and $10  million,  respectively.  The amount of royalty
income to American Rag in 2004,  2005 and 2006 was  $500,000,  $575,000 and $1.1
million,  respectively.  We do not have sole decision-making ability. Day to day
management of American Rag is effectively controlled by one of the 55% owners.

We do not expect to receive a guaranteed return on its investment. We determined
that we were not the primary  beneficiary  of American Rag under FIN 46. In June
2006,  we signed a  guarantee  of certain  liabilities  of  American  Rag CIE to
California  United Bank to the aggregate amount equal at all times to the lesser
of (A)  45% of the  aggregate  amount  of  the  outstanding  liabilities  or (B)
$675,000.  Upon execution of the guarantee, we re-evaluated our investment under
the  provisions of FIN 46. In our analysis,  we  determined  that  consolidation
under FIN 46 is still not appropriate.  Our variable  interest will not absorb a
majority of the VIE's  expected  losses.  We record its  proportionate  share of
income and losses but are not obligated nor do we intend to absorb losses beyond
its 45%  investment  interest.  Additionally,  we do not  expect  to  receive  a
majority  of the  entity's  expected  residual  returns,  other  than  their 45%
ownership interest.

7.       OTHER ASSETS

THE BUFFALO GROUP

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

Pursuant to the Purchase  Agreement,  we and our subsidiaries  agreed to acquire
(1) all the outstanding capital stock of four principal  operating  subsidiaries
of The Buffalo Group - Buffalo Inc.,  3163946  Canada Inc.,  3681441 Canada Inc.
and  Buffalo  Corporation,  and (2)  certain  assets,  consisting  primarily  of
intellectual  property  rights  and  licenses,   from  The  Buffalo  Trust.  The
consideration  for the stock and assets to be purchased by us under the Purchase
Agreement will consist of:

         o        $40 million in cash, subject to reduction prior to closing;

         o        $15  million in  promissory  notes that are due and payable in
                  five  equal  annual  installments   beginning  on  the  second
                  anniversary of the closing date;

         o        The issuance to the sellers of 13 million  exchangeable shares
                  of our Canadian subsidiary,  which shares will be exchangeable
                  by the  holders  into  shares of our common  stock on a 1-to-1
                  basis;

         o        The  issuance  by us to a trustee  of  shares of our  Series A
                  Special Voting  Preferred  Stock that will entitle the sellers
                  to direct the trustee to vote a number of shares  equal to the
                  number of exchangeable  shares of our Canadian subsidiary that
                  remain  outstanding  from time to time on all matters on which
                  our shareholders are entitled to vote;

         o        Assumption of debt of the entities being acquired by us; and

         o        Earn-out payments of up to $12 million in the aggregate over a
                  four year period,  contingent upon achievement by the acquired
                  business of specified  earnings  targets in years 2007 through
                  2010.


                                      F-20
<PAGE>


In addition,  we may be required to make a contingent cash payment following the
fifth  anniversary  of the closing if the average price of our common stock does
not equal or exceed  $3.076  within  any 10  trading  days  during the five year
period following the closing of the purchase transaction.

At signing of the Purchase  Agreement,  we delivered $5.0 million to the sellers
as a deposit  against the  purchase  price  payable  under the  agreement.  Upon
closing, this deposit will be used to pay a portion of the consideration payment
and  will  reduce  the  amount  of cash  delivered  at  closing.  Under  certain
conditions  specified under the agreement,  if we or The Buffalo Group terminate
the  agreement  prior to  closing,  the $5.0  million  deposit may or may not be
refundable to us. This $5.0 million  deposit and $1.1 million due diligence fees
paid were included in other assets in our consolidated balance sheets.

The completion of the transaction is subject to the  satisfaction of a number of
conditions as set forth in the Purchase  Agreement,  including among others, the
approval of the acquisition and related  transactions by our  shareholders,  our
obtaining the necessary financing to complete the acquisition, obtaining certain
third party consents, and other customary closing conditions.  Dates for closing
the  acquisition  and for our  shareholders'  meeting to vote on the acquisition
have not yet been  determined.  The Purchase  Agreement may be terminated  under
certain  conditions,  including by mutual  written  consent of the  parties,  by
either party in the event of a material  breach by the other party, or by either
party if the closing does not occur by April 30, 2007.

8.       IMPAIRMENT OF ASSETS

IMPAIRMENT OF GOODWILL

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

The following table displays the change in the gross carrying amount of goodwill
by reporting units for the years ended December 31, 2005 and 2006. The reporting
unit  below is one level  below the  reportable  segments  included  in Note 18,
"Operations  by  Geographic  Areas".  The  reporting  unit FR TCL. - Chazz & MGI
Division was included within the United States  geographical  segment of Note 18
of the "Notes to the Consolidated Financial Statements."

                                 REPORTING UNITS
                         FR TCL - CHAZZZ & MGI DIVISION

         Balance as of January 1, 2005 ...............       $8,582,845
         Activities for the year .....................             --
                                                             ----------
         Balance as of December 31, 2005 .............       $8,582,845
         Activities for the year .....................             --
                                                             ----------
         Balance as of December 31, 2006 .............       $8,582,845
                                                             ==========


                                      F-21
<PAGE>


9.       DEBT

Debt consists of the following:

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                         ----------------------------
                                                             2005            2006
                                                         ------------    ------------
<S>                                                      <C>             <C>
Short-term bank borrowings:
  Import trade bills payable - UPS, DBS Bank and
     Aurora Capital ..................................   $  4,165,306    $  5,844,887
  Bank direct acceptances - UPS and DBS Bank .........      1,471,476       3,368,054
  Other Hong Kong credit facilities - UPS and DBS Bank      8,196,750       4,483,241
                                                         ------------    ------------
                                                         $ 13,833,532    $ 13,696,182
                                                         ============    ============
Long-term debt:
  Equipment financing ................................   $     83,206    $     38,148
  Term loan - UPS ....................................      2,708,333            --
  Credit facility - Guggenheim, net ..................           --        11,212,724
  Debt facility and factoring agreement - GMAC .......     33,558,095      19,553,755
                                                         ------------    ------------
                                                           36,349,634      30,804,627
  Less current portion ...............................    (36,109,699)    (19,586,565)
                                                         ------------    ------------
                                                         $    239,935    $ 11,218,062
                                                         ============    ============
</TABLE>


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

On June 13,  2002,  we entered  into a letter of credit  facility of $25 million
with UPS Capital Global Trade Finance Corporation ("UPS").  Under this facility,
we could  arrange  for the  issuance of letters of credit and  acceptances.  The
facility  was  collateralized  by  the  shares  and  debentures  of  all  of our
subsidiaries in Hong Kong. In addition to the guarantees  provided by us and our
subsidiaries,  Fashion Resource (TCL) Inc. and Tarrant  Luxembourg Sarl,  Gerard
Guez, our Chairman and Interim Chief Executive Officer,  also signed a guarantee
of $5 million in favor of UPS to secure this facility. Additionally, Gerard Guez
pledged to UPS 4.6 million shares of our common stock held by Mr. Guez to secure
the  obligations  under the credit  facility.  On June 9, 2006, we completed the
pay-off of all  remaining  amounts due under the letter of credit  facility with
UPS.  As a result of the  payment  of these  obligations,  the  letter of credit
facility was  terminated and all  collateral  released.  There was no prepayment
penalty  under this  arrangement.  As of December 31, 2006,  $0 was  outstanding
under this facility with UPS.

Since March  2003,  DBS Bank (Hong Kong)  Limited  ("DBS") had made  available a
letter  of  credit  facility  of up to HKD 20  million  (equivalent  to US  $2.6
million) to our  subsidiaries  in Hong Kong.  This was a demand facility and was
secured by the pledge of our office property, which is owned by Gerard Guez, our
Chairman and Interim Chief Executive  Officer,  and Todd Kay, our Vice Chairman,
and by our  guarantee.  The letter of credit  facility  was  increased to HKD 30
million  (equivalent to US $3.9 million) in June 2004. In September  2006, a tax
loan for HKD  8.438  million  (equivalent  to US $1.1  million)  was  also  made
available to our Hong Kong  subsidiaries and bears interest at the rate equal to
the Hong Kong prime rate plus 1% and are subject to the same  security.  It bore
interest at 9% per annum at December  31, 2006.  As of December  31, 2006,  $1.0
million was outstanding under this tax loan.

In June 2006, our  subsidiaries in Hong Kong,  Tarrant Company  Limited,  Marble
Limited and Trade Link Holdings Limited, entered into a new credit facility with
DBS. Under this facility,  we may arrange for letters of credit and acceptances.
The maximum amount our Hong Kong  subsidiaries may borrow under this facility at
any time is US $25  million.  The  interest  rate  under  the  letter  of credit
facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if paid in
Hong Kong  Dollars,  which the interest  rate was 8.5% per annum at December 31,
2006,  or the  Standard  Bills Rate quoted by DBS plus 0.5% if paid in any other
currency,  which the interest rate was 8.6% per annum at December 31, 2006. This
is a demand facility and is secured by a security  interest in all the assets of
the Hong Kong  subsidiaries,  by a pledge of our office  property where our Hong
Kong  office is  located,  which is owned by Gerard Guez and Todd Kay and by our
guarantee. The DBS facility includes customary default provisions.  In addition,
we are subject to certain  restrictive  covenants,  including that we maintain a
specified  tangible  net worth,  and a minimum  level of EBITDA at December  31,
2006, interest coverage ratio, leverage ratio and limitations on


                                      F-22
<PAGE>


additional indebtedness.  As of December 31, 2006, we were in violation with the
EBITDA,  tangible  net worth  and  leverage  ratio  covenants  and a waiver  was
obtained  on March  19,  2007.  As of  December  31,  2006,  $12.5  million  was
outstanding  under this facility.  In addition,  $4.1 million of open letters of
credit was outstanding  and $7.4 million was available for future  borrowings as
of December 31, 2006.

As of December 31, 2006, the total balance outstanding under the DBS Bank credit
facilities  was $13.5  million  (classified  above as follows:  $5.6  million in
import trade bills  payable,  $3.4 million in bank direct  acceptances  and $4.5
million in other Hong Kong credit facilities).

From time to time, we open letters of credit under an uncommitted line of credit
from Aurora  Capital  Associates  which issues  these  letters of credits out of
Israeli Discount Bank. As of December 31, 2006,  $190,000 was outstanding  under
this facility  (classified  above under import trade bills payable) and $532,000
of letters of credit was open under this arrangement. We pay a commission fee of
2.25% on all letters of credits issued under this arrangement.

LOAN FROM MAX AZRIA

On January 19, 2006,  we borrowed  $4.0  million from Max Azria  pursuant to the
terms of a promissory  note,  which amount bore interest at the rate of 5.5% per
annum and was payable in weekly  installments of $200,000  beginning on March 1,
2006. This was an unsecured loan. We paid off the remaining balance of this loan
in July 2006. As of December 31, 2006, $0 was outstanding under this loan.

EQUIPMENT FINANCING

We had three  equipment  loans  outstanding  during 2006. One of these equipment
loans bore interest at 6% payable in  installments  through 2009,  which we paid
off in  January  2006.  The  second  loan  bears  interest  at 15.8%  payable in
installment  through 2007 and the third loan bears  interest at 6.15% payable in
installment  through  2007. In August 2006, we entered into a new auto loan that
bears interest at 4.75% payable in installment  through 2008. As of December 31,
2006, $38,000 was outstanding under the three remaining loans.

TERM LOAN - UPS

On December 31, 2004, our Hong Kong  subsidiaries  entered into a loan agreement
with UPS  pursuant  to which UPS made a $5 million  term loan,  the  proceeds of
which were used to repay $5 million of indebtedness owed to UPS under the letter
of credit of facility.  The principal amount of this loan was due and payable in
24 equal monthly  installments  of  approximately  $208,333 each,  plus interest
equivalent  to the "prime  rate" plus 2%  commencing  on February  1, 2005.  The
obligations  under the loan agreement were  collateralized  by the same security
interests and guarantees  provided under our letter of credit facility with UPS.
Additionally,  the term loan was  secured  by two  promissory  notes  payable to
Tarrant Luxembourg Sarl in the amounts of $2,550,000 and $1,360,000 and a pledge
by Gerard Guez of 4.6 million  shares of our common  stock.  On June 9, 2006, we
completed the pay-off of all remaining amounts due under the term loan agreement
with  UPS.  As a result  of the  payment  of these  obligations,  the term  loan
agreement was terminated and all  collateral  released.  There was no prepayment
penalty  under this  arrangement.  As of December 31, 2006,  $0 was  outstanding
under this loan arrangement with UPS.

DEBT FACILITY AND FACTORING AGREEMENT - GMAC CF

On October 1, 2004,  we amended and  restated  our  previously  existing  credit
facility with GMAC Commercial Finance Credit, LLC ("GMAC CF") by entering into a
new factoring  agreement  with GMAC CF. The amended and restated  agreement (the
factoring  agreement)  extended the expiration date of the facility to September
30,  2007 and added as parties  our  subsidiaries  Private  Brands,  Inc and No!
Jeans,  Inc. In  addition,  in  connection  with the  factoring  agreement,  our
indirect  majority-owned  subsidiary PBG7, LLC entered into a separate factoring
agreement with GMAC CF. Pursuant to the terms of the factoring agreement, we and
our  subsidiaries  agree to assign and sell to GMAC CF, as factor,  all accounts
which arise from our sale of  merchandise  or rendition of service  created on a
going  forward  basis.  At our  request,  GMAC CF, in its  discretion,  may make
advances  to us up to the lesser of (a) up to 90% of our  accounts on which GMAC
CF has the risk of loss or (b) $40 million,  minus in each case, any amount owed
by us to GMAC CF. In May 2005, we amended our factoring  agreement  with GMAC CF
to permit our


                                      F-23
<PAGE>


subsidiaries  party  thereto and us, to borrow up to the lesser of $3 million or
50% of the value of eligible  inventory.  In connection with this amendment,  we
granted GMAC CF a lien on certain of our inventory located in the United States.
On January 23, 2006, we further amended our factoring  agreement with GMAC CF to
increase  the  amount we might  borrow  against  inventory  to the  lesser of $5
million or 50% of the value of  eligible  inventory.  The $5  million  limit was
reduced to $4 million on April 1, 2006.

On June 16, 2006, we expanded our credit  facility with GMAC CF by entering into
a new Loan and Security  Agreement  and amending and  restating  our  previously
existing  Factoring  Agreement  with GMAC CF. UPS Capital  Corporation is also a
lender  under  the Loan  and  Security  Agreement.  This is a  revolving  credit
facility  and has a term of 3 years.  The amount we may borrow under this credit
facility is  determined  by a percentage  of eligible  accounts  receivable  and
inventory,  up to a maximum  of $55  million,  and  includes  a letter of credit
facility of up to $4 million.  Interest on outstanding amounts under this credit
facility is payable  monthly  and  accrues at the rate of the "prime  rate" plus
0.5%. Our obligations under the GMAC CF credit facility are secured by a lien on
substantially  all our domestic  assets,  including a first priority lien on our
accounts  receivable  and inventory.  This credit  facility  contains  customary
financial  covenants,  including  covenants  that we maintain  minimum levels of
EBITDA and interest coverage ratios and limitations on additional  indebtedness.
This  facility  includes  customary  default  provisions,  and  all  outstanding
obligations  may become  immediately  due and payable in the event of a default.
The  facility  bore  interest at 8.75% per annum at  December  31,  2006.  As of
December 31, 2006,  we were in violation  with the EBITDA  covenant and a waiver
was obtained on March 23, 2007. A total of $19.6  million was  outstanding  with
respect to receivables factored under the GMAC CF facility at December 31, 2006.

CREDIT FACILITY FROM GUGGENHEIM CORPORATE FUNDING LLC AND WARRANTS

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

In connection with Guggenheim  credit facility,  on June 16, 2006, we issued the
lenders under this facility warrants to purchase up to an aggregate of 3,857,143
shares of our  common  stock.  These  warrants  have a term of 10  years.  These
warrants  are  exercisable  at a price of $1.88 per share with respect to 20% of
the shares,  $2.00 per share with respect to 20% of the shares,  $3.00 per share
with  respect to 20% of the shares,  $3.75 per share with  respect to 20% of the
shares  and $4.50 per share  with  respect to 20% of the  shares.  The  exercise
prices are subject to adjustment for certain dilutive  issuances pursuant to the
terms  of  the  warrants.  357,143  shares  of  the  warrants  will  not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and Emerging  Issues Task Force ("EITF") No. 00-19,  "Accounting  for Derivative
Financial  Instruments  Indexed to, and Potentially  Settled in, a Company's Own
Stock" and determined to be a derivative  instrument due to certain registration
rights. As such, the warrants  excluding the ones not exercisable were valued at
$4.9  million  using the  Black-Scholes  model with the  following  assumptions:
risk-free  interest rate of 5.1%;  dividend yields of 0%; volatility  factors of
the expected market price of our common stock of 0.70; and  contractual  term of
ten years. We also paid to Guggenheim 2.25% of the committed principal amount of
the  loans  which  was  $563,000  on June 16,  2006.  The  $563,000  fee paid to
Guggenheim  is included in the  deferred  financing  cost,  and the value of the
warrants to purchase  3.5 million  shares of our common stock of $4.9 million is
recorded as debt discount, both of them are amortized over the life of the loan.
As of December 31, 2006, $654,000 was amortized.

Durham Capital  Corporation  ("Durham")  acted as our advisor in connection with
the Guggenheim credit facility.  As compensation for its services,  we agreed to
pay Durham a cash fee in an amount equal to 1% of the committed


                                      F-24
<PAGE>


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

The Guggenheim  facility bore interest at 12.36% per annum at December 31, 2006.
As of December 31, 2006,  we were in  violation  with the EBITDA  covenant and a
waiver was  obtained on March 23, 2007.  A total of $11.2  million,  net of $4.3
million of debt discount,  was  outstanding  under this facility at December 31,
2006.

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

The credit facilities with GMAC CF and Guggenheim include  cross-default clauses
subject to certain  conditions.  An event of default  under the GMAC CF facility
would  constitute an event of default under the  Guggenheim  facility  entitling
Guggenheim  to  demand  payment  in full of all  outstanding  amounts  under its
facility. An event of default under the Guggenheim facility, under circumstances
where  Guggenheim  has  accelerated  the debt or has  exercised any other remedy
available to Guggenheim which  constitutes a Lien  Enforcement  Action under its
Intercreditor Agreement with GMAC CF, would entitle GMAC CF to demand payment in
full of all outstanding amounts under its debt facilities.

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

GUARANTEES

Guarantees had been issued since 2001 in favor of YKK, Universal Fasteners,  and
RVL Inc. for $750,000, $500,000 and unspecified amount,  respectively,  to cover
trim  purchased  by Tag-It  Pacific  Inc. on our behalf.  We had not  reported a
liability for these guarantees. We issued the guarantees to cover trim purchased
by Tag-It in order to ensure our production in a timely  manner.  If Tag-It ever
defaults, we would have to pay the outstanding liability due to these vendors by
Tag-It for purchases  made on our behalf.  We had not had to perform under these
guarantees


                                      F-25
<PAGE>


since  inception.  In April 2005, we terminated these guarantees with respect to
Tag-It's obligations arising after the date of termination.

In June 2006, we signed a guarantee of certain  liabilities  of American Rag CIE
to  California  United Bank to the  aggregate  amount  equal at all times to the
lesser of (A) 45% of the aggregate amount of the outstanding  liabilities or (B)
$675,000.

10.      CONVERTIBLE DEBENTURES AND WARRANTS

On December 14, 2004, we completed a $10 million  financing through the issuance
of (i) 6% Secured  Convertible  Debentures  ("Debentures")  and (ii) warrants to
purchase up to 1,250,000  shares of our common  stock.  Prior to  maturity,  the
investors  could  convert the  Debentures  into shares of our common  stock at a
price of $2.00 per share. The warrants have a term of five years and an exercise
price of $2.50  per  share.  The  warrants  were  valued at  $866,000  using the
Black-Scholes model with the following  assumptions:  risk-free interest rate of
4%;  dividend yields of 0%;  volatility  factors of the expected market price of
our common stock of 0.55;  and an expected  life of four years.  The  Debentures
bore interest at a rate of 6% per annum and have a term of three years. We could
elect to pay interest on the Debentures in shares of our common stock if certain
conditions are met,  including a minimum market price and trading volume for our
common stock.  The Debentures  contained  customary events of default and permit
the holder  thereof to  accelerate  the  maturity if the full  principal  amount
together  with  interest and other  amounts  owing upon the  occurrence  of such
events of default. The Debentures were secured by a subordinated lien on certain
of our accounts  receivable and related assets.  The closing market price of our
common stock on the closing date of the financing was $1.96. The Debentures were
thus valued at $8,996,000,  resulting in an effective conversion price of $1.799
per share.  The intrinsic  value of the conversion  option of $804,000 was being
amortized  over the life of the loan.  The value of the warrants of $866,000 and
the intrinsic  value of the  conversion  option of $804,000 were netted from the
$10 million  presented as the convertible  debentures,  net on our  accompanying
balance sheets at December 31, 2004.

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

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

11.      DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS

We use forward  currency  contracts to manage risks  generally  associated  with
foreign exchange rate.  During the year ended December 31, 2006, we entered into
foreign currency forward  contracts to hedge against the effect of exchange rate
fluctuations  on cash  flows  denominated  in  foreign  currencies  and  certain
inter-company financing transactions.


                                      F-26
<PAGE>


This transaction is undesignated  and as such an ineffective  hedge. At December
31, 2006, we had one open foreign  exchange forward which has a maturity of less
than one year.  Hedge  ineffectiveness  resulted in an impact of $196,000 in our
consolidated statements of operations as of December 31, 2006.

12.      INCOME TAXES

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

                                             YEAR ENDED DECEMBER 31,
                               -------------------------------------------------
                                   2004               2005               2006
                               -----------        -----------        -----------
Current:
  Federal ..............       $ 1,000,000        $      --          $     6,968
  State ................             8,511              2,425              6,400
  Foreign ..............         1,400,953          1,091,442            202,677
                               -----------        -----------        -----------
                                 2,409,464          1,093,867            216,045
Deferred:
  Federal ..............              --                 --                 --
  State ................              --                 --                 --
  Foreign ..............           (61,345)          (166,686)           237,045
                               -----------        -----------        -----------
                                   (61,345)          (166,686)           237,045
                               -----------        -----------        -----------

    Total ..............       $ 2,348,119        $   927,181        $   453,090
                               ===========        ===========        ===========


The source of income (loss) before the provision for taxes and cumulative effect
of accounting change is as follows:

                                           YEAR ENDED DECEMBER 31,
                            ---------------------------------------------------
                                 2004               2005               2006
                            -------------      -------------      -------------

Federal ...............     $ (14,271,441)     $  (4,481,879)     $   1,436,555
Foreign ...............       (88,057,111)         6,402,404        (23,204,213)
                            -------------      -------------      -------------

         Total ........     $(102,328,552)     $   1,920,525      $ (21,767,658)
                            =============      =============      =============


Our effective tax rate differs from the statutory  rate  principally  due to the
following reasons:  (1) a substantial  valuation allowance has been provided for
deferred tax assets as a result of the operating losses in the United States and
Mexico,  since  recoverability  of those  assets has not been  assessed  as more
likely than not; (2) although we have taxable losses in Mexico, it is subject to
a minimum tax; and (3) the earnings of our Hong Kong  subsidiary  are taxed at a
rate of 17.5% versus the 35% U.S. federal rate. The impairment  charge in Mexico
did not result in a tax benefit due to an  increase in the  valuation  allowance
against the future tax  benefit.  We believe it is more likely than not that the
tax benefit will not be realized based on our future business plans in Mexico.


                                      F-27
<PAGE>


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

<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                                                --------------------------------------------
                                                    2004            2005            2006
                                                ------------    ------------    ------------
<S>                                             <C>             <C>             <C>
Income tax (benefit) based on federal
   statutory rate ...........................   $(35,814,993)   $    672,184    $ (7,618,680)
State income taxes, net of federal benefit ..          5,532        (246,978)        190,152
Effect of foreign income taxes ..............      2,749,376      (1,316,085)      8,561,197
Nondeductible impairment of long-lived assets     30,463,663            --              --
Increase in tax reserve .....................      1,000,000            --              --
Increase in valuation allowance
   and other ................................      3,944,541       1,818,060        (679,579)
                                                ------------    ------------    ------------
                                                $  2,348,119    $    927,181    $    453,090
                                                ============    ============    ============
</TABLE>


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

<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                                     ----------------------------

                                                                          2005            2006
                                                                      ------------    ------------
<S>                                                                   <C>             <C>
Deferred tax assets:
   Provision for doubtful accounts and unissued credits ...........   $    117,979    $    501,546
   Provision for other reserves ...................................      2,874,377       1,808,092
   Domestic and foreign loss carry forwards and foreign tax credits     11,162,380      13,867,841
      Goodwill ....................................................      2,138,984       4,240,274
                                                                      ------------    ------------
      Total deferred tax assets ...................................     16,293,720      20,417,753

Deferred tax liabilities:
   Other ..........................................................        (47,098)           --
                                                                      ------------    ------------
                                                                           (47,098)           --
Valuation allowance for deferred tax assets .......................    (16,293,720)    (20,294,146)
                                                                      ------------    ------------

Net deferred tax assets (liabilities) .............................   $    (47,098)   $    123,607
                                                                      ============    ============
</TABLE>


At December 31, 2006, we have $37.3 million of federal net operating  loss carry
forwards  that expire  beginning in 2023. We also have foreign tax credits carry
forwards totaling $1.9 million that expire beginning in 2009.

In January 2004, the Internal Revenue Service ("IRS")  completed its examination
of our Federal  income tax returns for the years ended December 31, 1996 through
2001.  The IRS has proposed  adjustments  to increase our income tax payable for
the six years under examination. In addition, in July 2004, the IRS initiated an
examination  of our Federal  income tax return for the year ended  December  31,
2002. In March 2005,  the IRS proposed an  adjustment  to our taxable  income of
approximately $9 million related to similar issues  identified in their audit of
the 1996 through 2001 federal  income tax returns.  The proposed  adjustments to
our 2002 federal  income tax return would not result in  additional  tax due for
that year due to the tax loss reported in the 2002 federal return.  However,  it
could reduce the amount of net  operating  losses  available to offset taxes due
from the preceding tax years.  This  adjustment  would also result in additional
state  taxes,  penalties  and  interest.  We  believe  that we have  meritorious
defenses to and intend to vigorously  contest the proposed  adjustments  made to
our federal  income tax returns for the years ended 1996  through  2002.  If the
proposed  adjustments are upheld through the  administrative  and legal process,
they could have a material  impact on our earnings and cash flow.  We believe we
have provided adequate reserves for any reasonably  foreseeable  outcome related
to these matters on the  consolidated  balance sheets under the caption  "Income
Taxes".  The  maximum  amount  of loss in excess of the  amount  accrued  in the
financial statements is $8.3


                                      F-28
<PAGE>


million.  We do not believe that the  adjustments,  if any, arising from the IRS
examination,  will result in an additional  income tax liability  beyond what is
recorded in the accompanying consolidated balance sheets.

13.      COMMITMENTS AND CONTINGENCIES

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

2007 ........................................................         $1,805,000
2008 ........................................................          1,290,000
2009 ........................................................          1,263,000
2010 ........................................................          1,291,000
2011 ........................................................          1,044,000
Thereafter ..................................................          2,467,000
                                                                      ----------

      Total future minimum lease payments ...................         $9,160,000
                                                                      ==========

Included in the future  minimum  lease  payments are,  $480,000  payable to Lynx
International Limited, a Hong Kong corporation that is owned by Messrs. Guez and
Kay for leasing our office  space and  warehouse  in Hong Kong,  and  $3,008,000
payable to GET a corporation which is owned by Messrs.  Gerard Guez and Todd Kay
for leasing the Los Angeles offices and warehouse.  See Note 17 of the "Notes to
Consolidated Financial Statements."

Several of the operating  leases contain  provisions  for additional  rent based
upon increases in the operating costs, as defined, per the agreement. Total rent
expense  under  the  operating  leases  amounted  to  approximately  $2,128,000,
$1,295,000 and $1,890,000 for 2004, 2005 and 2006, respectively.

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

We  renewed  the lease  agreement  in March  2007 in Mexico  for our  office and
storage through March 2008.

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

We had open letters of credit of  $9,987,000,  $9,519,000  and  $4,583,000 as of
December 31, 2004, 2005 and 2006, respectively.

We had two employment contracts dated January 1, 1998, and subsequently amended,
with two executives  providing for base  compensation and other  incentives.  On
April 1, 2004,  we amended  each of these  contracts  to extend the term through
March 31,  2006,  and to  provide  one  contract  for base  salary  per annum of
$500,000  for the  period  from April 1, 2003 to March 31,  2006,  and the other
contract  for base  salary per annum of $50,000  from April 1, 2003 to March 31,
2006.  Additionally,  we agreed to pay each of these  executives an annual bonus
(the "Annual  Bonus") for fiscal years ended December 31, 2003, 2004 and 2005 in
an amount,  if any, equal to ten percent (10%) of the amount by which our actual
pre-tax  income for such fiscal year  exceeds  the amount of  projected  pre-tax
income set forth in our annual  budget for the same  fiscal  year as approved by
our Board of Directors.  No bonuses were paid to these executives for the fiscal
year ended December 31, 2004 and 2005.  Bonus of $150,000 was paid to one of the
executives in 2006.

In the second quarter of 2003, we acquired a 45% equity interest in the owner of
the trademark  "American Rag CIE" and the operator of American Rag retail stores
for $1.4 million,  and our subsidiary,  Private Brands, Inc., acquired a license
to certain exclusive rights to this trademark. We have guaranteed the payment to
the licensor of minimum


                                      F-29
<PAGE>


royalties of $10.4 million over the initial  10-year term of the  agreement.  At
December 31, 2006, the total  commitment on royalties  remaining on the term was
$8.4 million.

On October 17, 2004,  Private  Brands,  Inc entered into an agreement with J. S.
Brand Management to design,  manufacture and distribute  Jessica Simpson branded
jeans and casual  apparel.  This agreement has an initial  three-year  term, and
provided we are in compliance with the terms of the agreement,  is renewable for
one additional  two-year term.  Minimum net sales are $20 million in year 1, $25
million in year 2 and $30 million in year 3. The agreement  provides for payment
of a  sales  royalty  and  advertising  commitment  at the  rate  of 8% and  3%,
respectively,  of net sales,  for a total  minimum  payment  obligation  of $8.3
million  over  the  initial  term of the  agreement.  On July 19,  2005,  Camuto
Consulting  Group  replaced J.S.  Brand  Management as the master  licensor.  In
December  2004, we advanced $2.2 million as payment for the first year's minimum
royalties.  We applied $1.1 million from the above  advance  against the royalty
and  marketing  expenses in 2005 and $884,000 in the first three months of 2006.
In March  2006,  we had  written off the  capitalized  balance of  $192,000  and
recognized a  corresponding  loss. The loss was classified as royalty expense on
our consolidated statements of operations.  In March 2006, we became involved in
a dispute with the  licensor of the Jessica  Simpson  brands over our  continued
rights to these brands.  We are presently in litigation  with the licensor.  See
Note 21 of the "Notes to Consolidated  Financial  Statements".  The licensor has
refused to accept payments and maintains that the agreement has been terminated.
There have been no sales of new products since the licensor  started refusing to
approve  products for  manufacture and sale. If we are successful in the lawsuit
against the  licensor,  then we expect to be able to reduce or  eliminate  these
payment  obligations  as an  offset  to  damages  sustained  by us. If we do not
succeed in our  claims,  we believe we will  likely not be  required to make the
entire guaranteed  payments  contemplated  under the agreement.  As a result, in
2006, we did not accrue for the payments of minimum  royalty,  sales royalty and
advertising commitment of $2.1 million pursuant to the agreement.

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

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

In August  2004,  we entered  into an  Agreement  for  Purchase  of Assets  with
affiliates  of Mr. Kamel Nacif;  a shareholder  at the time of the  transaction,
with  agreement  was  amended in October  2004.  Pursuant to the  agreement,  as
amended,  on November 30, 2004, we sold to the purchasers  substantially  all of
our assets and real property in Mexico,  including the equipment and  facilities
we previously leased to Mr. Nacif's  affiliates.  Upon consummation of the sale,
we entered into a purchase commitment agreement with the purchasers, pursuant to
which we agreed to purchase annually over the ten-year term of the agreement, $5
million  of  fabric  manufactured  at  our  former  facilities  acquired  by the
purchasers at negotiated  market prices. We purchased $6.4 million of fabric, of
which $2.4  million  was paid in cash and $4.0  million  was offset  against the
notes receivable  principal and accrued interest on the note receivable from the
affiliates  of Mr. Kamel Nacif in 2005.  We did not purchase any fabric in 2006.
See Note 17 of the "Notes to Consolidated Financial Statements."

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

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


                                      F-30
<PAGE>


14.      STOCK-BASED COMPENSATION

Our  Employee  Incentive  Plan,  formerly  the 1995 Stock Option Plan (the "1995
Plan"),  authorized the grant of both incentive and non-qualified  stock options
to our officers,  employees,  directors and consultants for shares of our common
stock.  As of December 31, 2006,  there were  outstanding  options to purchase a
total of  1,045,000  shares of common  stock  granted  under the 1995  Plan.  No
further grants may be made under the 1995 Plan. On May 25, 2006, we adopted 2006
Stock Incentive Plan (the "2006 Plan"),  which  authorizes the issuance of up to
5,100,000 shares of our common stock pursuant to options or awards granted under
the 2006 Plan.  As of  December  31,  2006,  there were  outstanding  options to
purchase a total of  1,228,000  shares of common  stock,  and  3,872,000  shares
remained  available for issuance  pursuant to award granted under the 2006 Plan.
The  exercise  price of  options  under  the plan  must be equal to 100% of fair
market  value of common  stock on the date of grant.  The 2006 Plan also permits
other types of awards, including stock appreciation rights, restricted stock and
other performance-based benefits.

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

A summary of our stock  option  activity  and related  information  for the year
ended December 31, 2004, 2005 and 2006 is as follows:

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

Options outstanding at December 31, 2003 ......        8,926,087    $1.39-$45.50
Granted .......................................           83,000     $1.39-$3.68
Exercised .....................................             --              --
Forfeited .....................................         (677,125)   $1.39-$18.50
Expired .......................................             --              --
                                                    ------------    ------------
Options outstanding at December 31, 2004 ......        8,331,962    $1.39-$45.50
Granted .......................................           42,000     $1.95-$3.68
Exercised .....................................             --              --
Forfeited .....................................       (1,573,300)   $1.95-$25.00
Expired .......................................          (67,612)          $4.50
                                                    ------------    ------------
Options outstanding at December 31, 2005 ......        6,733,050    $1.39-$45.50
Granted .......................................        1,233,259     $1.84-$1.94
Exercised .....................................             --              --
Forfeited .....................................          (19,650)   $1.94-$33.13
Expired .......................................         (273,000)    $6.75-$7.38
                                                    ------------    ------------
Options outstanding at December 31, 2006 ......        7,673,659    $1.39-$45.50
                                                    ============    ============

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


                                      F-31
<PAGE>


The following  table  summarizes  information  about stock options  outstanding,
expected to vest and exercisable at December 31, 2005 and 2006:

                                                            WEIGHTED
                                                            AVERAGE
                                                WEIGHTED   REMAINING
                                                AVERAGE   CONTRACTUAL
                                    NUMBER OF   EXERCISE     LIFE      INTRINSIC
                                     SHARES      PRICE      (YEARS)      VALUE
                                   ---------   ---------   ---------   ---------
As of December 31, 2005:
Employees - Outstanding ........   6,733,050   $    6.25         6.0   $  12,440
Employees - Expected to vest ...   6,733,050   $    6.25         6.0   $  12,440
Employees - Exercisable ........   6,733,050   $    6.25         6.0   $  12,440

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


The following  table  summarizes our non-vested  options as of December 31, 2006
and changes during the year ended December 31, 2006.

                                                                       WEIGHTED
                                                                        AVERAGE
                                                        NUMBER OF     GRANT-DATE
                NON-VESTED OPTIONS                       SHARES       FAIR VALUE
---------------------------------------------------    ----------     ----------
Non-vested at January 1, 2006 .....................          --              n/a
  Granted .........................................     1,233,259     $     1.26
  Vested ..........................................          --              n/a
  Forfeited .......................................        (5,000)          1.31
                                                       ----------     ----------
Non-vested at December 31, 2006 ...................     1,228,259     $     1.26
                                                       ==========     ==========

The following table shows the fair value of each option granted to employees and
directors  estimated on the date of grant using the Black-Scholes model with the
 following weighted average assumptions used for grants in 2004, 2005 and 2006.

                                                 YEARS ENDED DECEMBER 31,
                                          ------------------------------------
                                             2004         2005         2006
                                          ----------   ----------   ----------
         Expected dividend ............      0.0%         0.0%         0.0%
         Risk free interest rate ......    3% to 4%        4%         5.075%
         Expected volatility ..........   51% to 55%      55%           70%
         Expected term (in years) .....       4            4           6.25

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

Our  determination of fair value of share-based  payment awards to employees and
directors on the date of grant using the Black-Scholes  model, which is affected
by our stock price as well as  assumptions  regarding a number of highly complex
and subjective  variables.  These variables include,  but are not limited to our
expected stock price volatility


                                      F-32
<PAGE>


over the term of the awards. When valuing awards, we estimate its expected terms
using the "safe harbor"  provisions  provided in SAB No. 107 and its  volatility
using historical data. We granted options to purchase 1,233,259 shares of common
stock during 2006. The options granted were fair valued in the aggregate at $1.6
million  or the  weighted-average  exercise  price of  $1.86  during  2006.  The
stock-based  compensation expense related to employees or director stock options
recognized during 2006 was $187,000.

The total intrinsic value of options exercised during 2005 and 2006 was $0. Cash
received  from stock  options  exercised  during 2005 and 2006 was $0. The total
fair value of shares vested during the years ended  December 31, 2004,  2005 and
2006, were approximately $4.3 million, $5.7 million, and $0, respectively.

As  of  December  31,  2006,  there  was  $1.3  million  of  total  unrecognized
compensation cost related to non-vested  share-based  compensation  arrangements
granted  under  the  plans.  That cost is  expected  to be  recognized  over the
weighted-average period of 3.5 years.

When options are exercised,  our policy is to issue previously  un-issued shares
of common stock to satisfy share option  exercises.  As of December 31, 2006, we
had 69.5 million shares of un-issued shares of common stock.

15.      EQUITY TRANSACTIONS

In January 2004, we sold an aggregate of 1,200,000 shares of our common stock at
a price of $3.35 per share, for aggregate  proceeds to us of approximately  $3.7
million after payment of placement  agent fees and other offering  expenses.  We
used the proceeds of this offering for working capital purposes.  The securities
sold in the  offering  were  registered  under the  Securities  Act of 1933,  as
amended,  pursuant to our effective shelf registration statement. In conjunction
with this public offering,  we issued a warrant to purchase 30,000 shares of our
common stock to the placement agent. This warrant has an exercise price of $3.35
per share,  is fully vested and  exercisable  and has a term of five years.  The
warrant was valued using the Black-Scholes model with the following assumptions:
risk-free  interest rate of 3%; dividend yields of 0%; volatility factors of the
expected market price of warrants of 0.51; and an expected life of four years.

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

In June 2005,  holders of our Debentures  converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures  converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. See Note 10 of the "Notes to Consolidated  Financial
Statements."

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

In November  2003, our board of directors  adopted a  shareholders  rights plan.
Pursuant  to the plan,  we issued a dividend  of one right for each share of our
common stock held by shareholders of record as of the close of business


                                      F-33
<PAGE>


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

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

16.      SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION

                                                 YEAR ENDED DECEMBER 31,
                                        ----------------------------------------
                                           2004           2005           2006
                                        ----------     ----------     ----------

Cash paid for interest ............     $1,796,000     $3,335,000     $4,246,000
                                        ==========     ==========     ==========

Cash paid for income taxes ........     $1,196,000     $  875,000     $1,153,000
                                        ==========     ==========     ==========

In 2004,  as  consideration  for the sale of our  assets  and real  property  in
Mexico, we received $45.4 million of notes  receivable.  See Note 5 of "Notes to
Consolidated Financial Statements."

On December 14, 2004, we completed a $10 million  financing through the issuance
of 6% Secured  Convertible  Debentures  ("Debentures"),  we issued  warrants  to
purchase up to 1,250,000 shares of our common stock. The warrants were valued at
$866,000 using the  Black-Scholes  model.  The placement agent in the financing,
for its  services  were paid  $620,000 in cash and issued five year  warrants to
purchase up to 200,000  shares of our common stock at an exercise price of $2.50
per share. The 200,000 warrants were valued at $138,000 using the  Black-Scholes
model.

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

In June 2005,  holders of our Debentures  converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures  converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. On June 26, 2006, we paid off the remaining  balance
of the  outstanding  Debentures  of $6.9  million  plus all  accrued  and unpaid
interest and a prepayment penalty of $171,000. As a result of the repayment, the
Debentures  were  terminated  effective  June  26,  2006.  Upon  paying  off the
Debentures,  debt  discount of $278,000  related to the  intrinsic  value of the
conversion option of $804,000 was expensed,  and of the $620,000  financing cost
paid to the placement agent,  $214,000 was expensed.  The remaining value of the
warrants to holders of our  Debentures of $433,000 and warrants to the placement
agent of $69,000 was also  expensed.  See Note 10 of the "Notes to  Consolidated
Financial Statements."

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

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

On June 16, 2006, we entered into a Credit  Agreement  with certain  lenders and
Guggenheim,  as administrative agent and collateral agent for the lenders.  This
credit facility provides for borrowings of up to $65 million. This


                                      F-34
<PAGE>


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

17.      RELATED-PARTY TRANSACTIONS

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

                                                 YEAR ENDED DECEMBER 31,
                                       -----------------------------------------
                                           2004           2005           2006
                                       -----------    -----------    -----------

Sales to related parties ..........    $ 3,598,000    $    88,000    $ 4,417,000
Purchases from related parties ....    $17,875,000    $ 6,987,000    $ 1,305,000


As of December 31, 2005 and 2006,  related party  affiliates were indebted to us
in the amounts of $8.4 million and $10.0  million,  respectively.  These include
amounts due from Gerard Guez, our Chairman and Interim Chief Executive  Officer,
of $2.3 million and $2.2  million at December  31, 2005 and 2006,  respectively,
which have been shown as reductions to shareholders'  equity in the accompanying
financial statements.

From time to time in the past, we had advanced funds to Mr. Guez. These were net
advances to Mr. Guez or payments  paid on his behalf before the enactment of the
Sarbanes-Oxley  Act in 2002.  The  promissory  note  documenting  these advances
contains a provision  that the entire amount  together with accrued  interest is
immediately  due and payable upon our written demand.  The greatest  outstanding
balance of such advances to Mr. Guez during 2006 was  approximately  $2,279,000.
At December 31, 2006, the entire balance due from Mr. Guez totaling $2.2 million
was reflected as a reduction of shareholders'  equity.  All amounts due from Mr.
Guez bore interest at the rate of 7.75% during the period.  Total  interest paid
by Mr. Guez was $370,000, $209,000 and $171,000 for the years ended December 31,
2004,  2005 and 2006,  respectively.  Mr.  Guez paid  expenses  on our behalf of
approximately  $400,000,  $397,000 and $299,000 for the years ended December 31,
2004, 2005 and 2006, respectively,  which amounts were applied to reduce accrued
interest and  principal on Mr.  Guez's loan.  These  amounts  included  fuel and
related  expenses  incurred by 477  Aviation,  LLC, a company owned by Mr. Guez,
when our executives used this company's  aircraft for business  purposes.  Since
the enactment of the  Sarbanes-Oxley  Act in 2002, no further personal loans (or
amendments to existing loans) have been or will be made to officers or directors
of Tarrant.

On July 1, 2001, we formed an entity to jointly market,  share certain risks and
achieve  economics of scale with Azteca, , called United Apparel  Ventures,  LLC
("UAV").  This entity was created to coordinate  the production of apparel for a
single  customer of our branded  business.  UAV made  purchases from two related
parties in Mexico, an affiliate of Azteca and Tag-It Pacific,  Inc. UAV is owned
50.1% by Tag Mex,  Inc.,  our  wholly  owned  subsidiary,  and 49.9% by  Azteca.
Results of the  operation of UAV have been  consolidated  into our results since
July  2001  with the  minority  partner's  share of gain and  losses  eliminated
through the minority  interest line in our financial  statements until 2004. Due
to the restructuring of our Mexico operations, we discontinued manufacturing for
UAV customers in the second quarter of 2004. We have been  consolidating 100% of
the results of the operation of UAV into our results since 2005.


                                      F-35
<PAGE>


Since June 2003, United Apparel Venture, LLC had been selling to Seven Licensing
Company, LLC ("Seven Licensing"),  jeans wear bearing the brand "Seven7",  which
is ultimately  purchased by Express.  Seven Licensing is  beneficially  owned by
Gerard  Guez.  In the third  quarter  of 2004,  in order to  strengthen  our own
private brand  business,  we decided to discontinue  sourcing for Seven7.  Total
sales to Seven  Licensing  during the year  ended  December  31,  2004 were $2.6
million.  On September 1, 2006,  our  subsidiary in Hong Kong,  Tarrant  Company
Limited,  entered into an agreement with Seven  Licensing to be its buying agent
to source and  purchase  apparel  merchandise.  Total  sales to Seven  Licensing
during the year ended December 31, 2006 were $4.4 million. At December 31, 2006,
Messrs.   Guez  and  Kay  beneficially   owned  488,400  and  1,003,500  shares,
respectively,  of common stock of Tag-It Pacific, Inc. ("Tag-It"),  collectively
representing  approximately 8.1% of Tag-It's common stock.  Tag-It is a provider
of brand  identity  programs  to  manufacturers  and  retailers  of apparel  and
accessories.  Starting from 1998, Tag-It assumed the responsibility for managing
and  sourcing  all  trim  and  packaging   used  in  connection   with  products
manufactured by or on behalf of us in Mexico.  Due to the  restructuring  of our
Mexico operations, Tag-It no longer manages our trim and packaging requirements.
We purchased  $1.0 million,  $450,000 and $205,000 of trim inventory from Tag-It
for the years ended December 31, 2004, 2005 and 2006, respectively. Our sales of
garment accessories to Tag-It were $39,000 for the year ended December 31, 2006.
We purchased $11.5 million,  $135,000 and $1.1 million of finished goods, fabric
and service  from Azteca and its  affiliates  for the years ended  December  31,
2004,  2005 and 2006,  respectively.  Our total  sales of fabric and  service to
Azteca  in  2004,  2005  and  2006  were  $1.0  million,   $88,000  and  $9,000,
respectively.  Two and one half percent of gross sales as  management  fees were
paid in 2004 to each of the members of UAV,  per the  operating  agreement.  The
amount paid to Azteca, the minority member of UAV, totaled $179,000 in 2004. Net
amounts due from these  related  parties as of  December  31, 2005 and 2006 were
$5.5 million and $7.5 million, respectively.

On October 16, 2003, we entered into a lease with affiliates of Mr. Kamel Nacif,
a substantial  portion of our manufacturing  facilities and operations in Mexico
including real estate and equipment.  The lease was effective as of September 1,
2003.  We leased our twill mill in  Tlaxcala,  Mexico,  and our sewing  plant in
Ajalpan,  Mexico,  for a period of 6 years and for an annual  rental  fee of $11
million.  Mr.  Nacif  was a  shareholder  at the  time  of the  transaction.  In
connection  with this  transaction,  we also entered into a management  services
agreement  pursuant to which Mr. Nacif's affiliates managed the operation of our
remaining  facilities in Mexico.  The term of the management  services agreement
was also for a period of 6 years.  In 2004,  $5.5  million  of lease  income was
recorded in other income.  Additionally,  we entered into a purchase  commitment
agreement with Mr. Nacif's affiliates to purchase annually, six million yards of
fabric  manufactured  at the  facilities  leased and/or  operated by Mr. Nacif's
affiliates  at market  prices to be  negotiated.  We  purchased  $5.3 million of
fabric from Acabados y Terminados under this agreement in 2004.

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


                                      F-36
<PAGE>


Upon  consummation of the sale of our Mexico assets,  we entered into a purchase
commitment  agreement  with the  purchasers,  pursuant  to which  we  agreed  to
purchase annually over the ten-year term of the agreement,  $5 million of fabric
manufactured at our former  facilities  acquired by the purchasers at negotiated
market prices. This agreement replaced a previously existing purchase commitment
agreement with Mr. Nacif's  affiliates.  We purchased $6.4 million of fabric, of
which $2.4  million  was paid in cash and $4.0  million  was offset  against the
notes receivable  principal and accrued interest on the note receivable from the
affiliates  of Mr. Kamel Nacif in 2005.  We did not purchase any fabric in 2006.
Net amount due from these  related  parties as of December 31, 2005 and 2006 was
$236,000 and $116,000, respectively.

We lease our  executive  offices and warehouse in Los Angeles,  California  from
GET, a corporation which is owned by Gerard Guez, our Chairman and Interim Chief
Executive Officer, and Todd Kay, our Vice Chairman.  Additionally,  we lease our
office space and warehouse in Hong Kong from Lynx International  Limited, a Hong
Kong  corporation  that is owned by Messrs.  Guez and Kay.  We paid  $1,330,000,
$1,019,000 and $1,076,000, respectively, in rent annually in 2004, 2005 and 2006
for office and warehouse facilities.  During the first seven months of 2006, our
Los Angeles  offices and  warehouse  were leased on a month to month  basis.  On
August 1, 2006, we entered into a lease  agreement  with GET for the Los Angeles
offices  and  warehouse,  which lease has a term of five years with an option to
renew for an  additional  five year term. On February 1, 2007, we entered into a
one year lease agreement with Lynx International Limited for our office space in
Hong Kong. On May 1, 2006,  we sublet a portion of our  executive  office in Los
Angeles,  California  and our sales office in New York to Seven  Licensing for a
monthly  payment  of  $25,000  on a month to month  basis.  Seven  Licensing  is
beneficially  owned by Gerard Guez.  We received  $200,000 in rental income from
this sublease in the year ended December 31, 2006.

At December  31, 2005 and 2006,  we had various  employees  receivable  totaling
$370,000 and $250,000, respectively, included in due from related parties.

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


                                      F-37
<PAGE>


18.      OPERATIONS BY GEOGRAPHIC AREAS

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

<TABLE>
<CAPTION>
                                                                                          ADJUSTMENTS
                                                                                              AND
                       UNITED STATES         ASIA          MEXICO        LUXEMBOURG      ELIMINATIONS        TOTAL
                       -------------    -------------   -------------   -------------   -------------    -------------
<S>                    <C>              <C>             <C>             <C>             <C>              <C>
2004
Sales ..............   $ 149,568,000    $   1,838,000   $   4,047,000   $        --     $        --      $ 155,453,000
Inter-company sales             --         80,420,000       7,453,000            --       (87,873,000)            --
                       -------------    -------------   -------------   -------------   -------------    -------------
Total revenue ......   $ 149,568,000    $  82,258,000   $  11,500,000   $        --     $ (87,873,000)   $ 155,453,000
                       =============    =============   =============   =============   =============    =============

Income (loss) from
 operations ........   $ (13,231,000)   $   3,663,000   $ (89,400,000)  $     (33,000)  $ (22,786,000)   $(121,787,000)
                       =============    =============   =============   =============   =============    =============
Interest income ....   $     378,000    $     856,000   $        --     $        --     $    (856,000)   $     378,000
                       =============    =============   =============   =============   =============    =============
Interest expense ...   $   2,766,000    $      55,000   $      38,000   $     854,000   $    (856,000)   $   2,857,000
                       =============    =============   =============   =============   =============    =============
Provision for
 depreciation and
 amortization ......   $   1,283,000    $     219,000   $   6,836,000   $        --     $        --      $   8,338,000
                       =============    =============   =============   =============   =============    =============
Capital expenditures   $      48,000    $      64,000   $        --     $        --     $        --      $     112,000
                       =============    =============   =============   =============   =============    =============

Total assets .......   $ 113,046,000    $ 121,007,000   $  31,603,000   $ 212,165,000   $(346,010,000)   $ 131,811,000
                       =============    =============   =============   =============   =============    =============

2005
Sales ..............   $ 213,205,000    $   1,282,000   $     161,000   $        --     $        --      $ 214,648,000
Inter-company sales             --        135,531,000            --              --      (135,531,000)            --
                       -------------    -------------   -------------   -------------   -------------    -------------
Total revenue ......   $ 213,205,000    $ 136,813,000   $     161,000   $        --     $(135,531,000)   $ 214,648,000
                       =============    =============   =============   =============   =============    =============

Income (loss) from
 operations ........   $    (928,000)   $   5,071,000   $    (470,000)  $     (48,000)  $        --      $   3,625,000
                       =============    =============   =============   =============   =============    =============
Interest income ....   $     223,000    $   1,955,000   $        --     $   1,856,000   $  (1,953,000)   $   2,081,000
                       =============    =============   =============   =============   =============    =============
Interest expense ...   $   4,219,000    $     403,000   $       2,000   $   1,954,000   $  (1,953,000)   $   4,625,000
                       =============    =============   =============   =============   =============    =============
Provision for
 depreciation and
 amortization ......   $   2,025,000    $     102,000   $        --     $        --     $        --      $   2,127,000
                       =============    =============   =============   =============   =============    =============
Capital expenditures   $     335,000    $     224,000   $        --     $        --     $        --      $     559,000
                       =============    =============   =============   =============   =============    =============

Total assets .......   $ 115,327,000    $ 129,737,000   $  15,782,000   $ 212,019,000   $(321,623,000)   $ 151,242,000
                       =============    =============   =============   =============   =============    =============

2006
Sales ..............   $ 226,913,000    $   5,551,000   $     (62,000)  $        --     $        --      $ 232,402,000
Inter-company sales             --        112,393,000            --              --      (112,393,000)            --
                       -------------    -------------   -------------   -------------   -------------    -------------
Total revenue ......   $ 226,913,000    $ 117,944,000   $     (62,000)  $        --     $(112,393,000)   $ 232,402,000
                       =============    =============   =============   =============   =============    =============

Income (loss) from
 operations ........   $   6,587,000    $   4,005,000   $    (641,000)  $ (27,156,000)  $        --      $ (17,205,000)
                       =============    =============   =============   =============   =============    =============
Interest income ....   $     277,000    $   2,985,000   $        --     $     901,000   $  (2,982,000)   $   1,181,000
                       =============    =============   =============   =============   =============    =============
Interest expense ...   $   5,833,000    $     212,000   $      15,000   $   2,982,000   $  (2,982,000)   $   6,060,000
                       =============    =============   =============   =============   =============    =============
Provision for
 depreciation and
 amortization ......   $   2,872,000    $     108,000   $        --     $        --     $        --      $   2,980,000
                       =============    =============   =============   =============   =============    =============
Capital expenditures   $     134,000    $      75,000   $        --     $        --     $        --      $     209,000
                       =============    =============   =============   =============   =============    =============

Total assets .......   $ 107,595,000    $ 119,531,000   $  13,589,000   $ 188,572,000   $(318,155,000)   $ 111,132,000
                       =============    =============   =============   =============   =============    =============
</TABLE>


                                      F-38
<PAGE>


19.      EMPLOYEE BENEFIT PLANS

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

Tarrant Hong Kong has adopted a Mandatory Provident Fund Scheme - AIA-JF Premium
MPF Scheme under the Mandatory  Provident Fund Schemes  Ordinance,  in which the
employees who have joined  Tarrant Hong Kong since December 1, 2000 are eligible
to enroll. Monthly contributions are made based on 5% of the employees' relevant
income. Costs of the plan charged to operations for 2004, 2005 and 2006 amounted
to approximately $131,000, $160,000 and $178,000, respectively.

On July 1, 1994, we established a defined contribution  retirement plan covering
all of our U.S. employees whose period of service exceeds 12 months. Plan assets
are monitored by a third-party  investment manager and are segregated from those
of  ours.   Participants  may  contribute  from  1%  to  15%  of  their  pre-tax
compensation  up to effective  limitations  specified  by the  Internal  Revenue
Service.  Our  contributions to the plan are based on a 50% (100% effective July
1, 1995) matching of participants' contributions, not to exceed 6% (5% effective
July 1, 1995) of the participants' annual compensation. In addition, we may also
make a discretionary  annual contribution to the plan. Costs of the plan charged
to  operations  for 2004,  2005 and 2006  amounted  to  approximately  $226,000,
$199,000 and $251,000, respectively.

20.      OTHER INCOME AND EXPENSE

Other income and expense consists of the following:

                                                   YEAR ENDED DECEMBER 31,
                                            ------------------------------------
                                               2004         2005         2006
                                            ----------   ----------   ----------

Rental income ...........................   $5,855,000   $  193,000   $  298,000
Gain on sale of fixed assets ............         --        124,000         --
Unrealized gain on foreign currency .....      367,000         --           --
Other items .............................      145,000       37,000       38,000
                                            ----------   ----------   ----------
Total other income ......................   $6,367,000   $  354,000   $  336,000
                                            ==========   ==========   ==========

Realized loss on foreign currency .......      511,000         --           --
Loss on sale of fixed assets ............         --           --         36,000
Termination of license agreement ........         --           --        400,000
Other items .............................       18,000        1,000         --
                                            ----------   ----------   ----------
Total other expense .....................   $  529,000   $    1,000   $  436,000
                                            ==========   ==========   ==========


21.      LEGAL PROCEEDINGS

1. JESSICA SIMPSON & CAMUTO CONSULTING GROUP

On or about April 6, 2006,  we commenced  an action  against the licensor of the
Jessica Simpson brands  (captioned  Tarrant  Apparel Group v. Camuto  Consulting
Group,  Inc., VCJS LLC, With You, Inc. and Jessica Simpson) in the Supreme Court
of the State of New York,  County of New York. The suit named Camuto  Consulting
Group, Inc.,


                                      F-39
<PAGE>


VCJS LLC, With You, Inc. and Jessica Simpson as defendants, and asserts that the
defendants  failed to provide promised support in connection with our sublicense
agreement for the Jessica Simpson brands. Our complaint includes eight causes of
action,  including two seeking a declaration  that the  sublicense  agreement is
exclusive and remains in full force and effect,  as well as claims for breach of
contract by Camuto Consulting, breach of the duty of good faith and fair dealing
and fraudulent  inducement against Camuto  Consulting,  and a claim against With
You, Inc. and Ms. Simpson that we are an intended third party beneficiary of the
licenses between those defendants and Camuto  Consulting.  On or about April 26,
2006,  Camuto  Consulting  served its  answer to our  complaint  and  included a
counterclaim  against us for breach of the  sublicense  agreement  and  alleging
damages  of  no  less  than  $100  million.   With  You,  Inc.  has  also  filed
counterclaims  against us, alleging trademark  infringement,  unfair competition
and business practices,  violation of the right of privacy and other claims, and
seeking  injunctive relief and damages in an amount to be determined but no less
than $100 million plus treble and punitive damages.  Discovery in the matter has
been underway  since May 2006.  Oral argument on the appeal of the trial court's
ruling with  respect to one motion was held on March 21,  2007,  and the parties
await a decision.  We intend to continue  to  vigorously  pursue this action and
defend the counterclaims.

2. BAZAK INTERNATIONAL CORPORATION

Shortly before May 2004, Bazak International  Corp.  commenced an action against
us in the New York  County  Supreme  Court  claiming  that we  breached  an oral
contract to sell a quantity of close-out  goods, as a consequence of which Bazak
was damaged to the extent of $1.3 million.  Bazak  International  Corp.  claimed
that our  liability  exists  under a theory  of  breach  of  contract  or unjust
enrichment.  A non-jury  trial was held in the United States  District Court for
the Southern  District of New York  beginning on November 27, 2006 and ending on
February 1, 2007. The Court's decision currently is pending. We will continue to
vigorously defend against the breach of contract and unjust enrichment claim.

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


                                      F-40
<PAGE>


22.      QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>
                                                       QUARTER ENDED
                                       -------------------------------------------
                                        MAR. 31     JUN. 30    SEP. 30     DEC. 31
                                       --------    --------   --------    --------
                                          (In thousands, except per share data)
<S>                                    <C>         <C>        <C>         <C>
2005
Net sales ..........................   $ 44,830    $ 50,538   $ 69,566    $ 49,714
Gross profit .......................      8,946      11,454     14,545       9,936
Operating income (loss) ............        233       1,437      3,011      (1,056)
Net income (loss) ..................   $   (106)   $    871   $  1,702    $ (1,474)
Net income (loss) per common share:
   Basic ...........................   $  (0.00)   $   0.03   $   0.05    $  (0.05)
   Diluted .........................   $  (0.00)   $   0.03   $   0.05    $  (0.05)
Weighted average shares outstanding:
   Basic ...........................     28,815      29,156     30,366      30,554
   Diluted .........................     28,815      29,163     30,786      30,554

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


                                      F-41
<PAGE>


23.      SUBSEQUENT EVENTS

LETTER AGREEMENT WITH TAVEX ALGODONERA

On March 21, 2007, our wholly-owned  subsidiary,  Tarrant  Luxembourg  S.a.r.l.,
entered  into a letter  agreement  with  Solticio,  S.A.  de C.V.  ("Solticio"),
Inmobiliaria  Cuadros,  S.A.  de C.V.  ("Inmobiliaria"),  and  Acabados y Cortes
Textiles,  S.A. de C.V.  ("Acotex" and together with Solticio and  Inmobiliaria,
the "Sellers"), and Tavex Algodonera, S.A. ("Tavex").

Solticio  and  Acotex  are  indebted  to  Tarrant  Luxembourg  in the  amount of
approximately $41 million (the "Seller Indebtedness"), which Seller Indebtedness
was incurred by the Sellers upon their  purchase from certain of our  affiliates
of our  manufacturing  facilities  and equipment in Mexico in November 2004. The
Seller  Indebtedness  is evidenced by a series of promissory  notes (the "Seller
Notes") and is secured by a lien on the real property and equipment  sold to the
Sellers (the  "Collateral").  During the third quarter of 2006, we evaluated the
recoverability  of the Seller Notes and recorded a reserve  against the notes in
an amount  equal to the  outstanding  balance  less the value of the  Collateral
securing the notes. The reserve was estimated to be approximately $27.1 million,
resulting  in  a  net  notes   receivable   balance  at  December  31,  2006  of
approximately $14 million.

Pursuant  to the  agreement,  Tavex  has  the  right  and  option  (but  not the
obligation),  for a period of 120 days following the date of the  agreement,  to
pay to  Tarrant  Luxembourg  an  aggregate  of U.S.  $20  million  in  cash  and
promissory notes, whereupon, among other things:

                  (a) Tarrant  Luxembourg  will  terminate  the Seller Notes and
         release  the  Sellers  from any  further  obligations  thereunder,  and
         terminate and release all liens on the Collateral;

                  (b) Tarrant  Luxembourg  and the Sellers  will  terminate  all
         other executory obligations among the parties, including any obligation
         of ours to purchase fabric from the Sellers; and

                  (c) Tarrant  Luxembourg  would agree to purchase from Tavex at
         least U.S.  $2.5 million of fabric  during each of the first and second
         years following Tavex's exercise of the option.

The U.S.  $20  million  payment by Tavex upon  exercise  of the option  would be
comprised of the following:

                  (a) U.S.  $2.5  million  in cash,  payable  concurrently  upon
         exercise of the option;

                  (b) U.S. $8.5 million of unsecured  promissory notes delivered
         concurrently  upon exercise of the option,  of which $2.5 million would
         be payable six months  following  closing,  $3 million would be payable
         twelve  months  following  closing,  and $3  million  would be  payable
         eighteen months following closing; and

                  (c)  U.S.   $9.0  million  of   promissory   notes   delivered
         concurrently  upon exercise of the option and guaranteed by a financial
         institution  acceptable  to us, of which $4.5 million  would be payable
         twenty-four  months following closing and $4.5 million would be payable
         thirty months following closing.

Tavex is not  obligated to exercise the option and the terms and  conditions  of
the letter  could  change  prior to the 120-day  expiration  period.  During the
120-day  option  period,  we agreed that we would not seek to enforce the Seller
Notes,  including by taking action with respect to the Collateral,  nor would we
enter into any agreement with a third party that would adversely  affect Tavex's
rights under the agreement.

The Sellers also agreed during the 120-day  option period,  to work  exclusively
with Tavex in respect of the  payment of the Seller  Indebtedness  and the other
transactions  contemplated by the Agreement, and not to enter into any agreement
with any person other than Tavex with respect to the payment  and/or  assignment
of the Seller Indebtedness and the transactions contemplated by the agreement.


                                      F-42
<PAGE>


<TABLE>
                                   SCHEDULE II

                              TARRANT APPAREL GROUP

                        VALUATION AND QUALIFYING ACCOUNTS


<CAPTION>
                                                           ADDITIONS    ADDITIONS
                                            BALANCE AT    CHARGED TO     CHARGED                      BALANCE
                                            BEGINNING     COSTS AND      TO OTHER                     AT END
                                             OF YEAR       EXPENSES      ACCOUNTS     DEDUCTIONS      OF YEAR
                                           -----------   -----------   -----------   -----------    -----------
<S>                                        <C>           <C>           <C>           <C>            <C>
For the year ended December 31, 2004
  Allowance for returns and discounts ..   $ 2,810,381   $   738,326   $      --     $(2,485,386)   $ 1,063,321
  Allowance for bad debt ...............   $ 1,416,002   $   476,016   $      --     $  (517,474)   $ 1,374,544
    Inventory reserve ..................   $10,986,153   $      --     $      --     $(9,869,491)   $ 1,116,662
                                           ===========   ===========   ===========   ===========    ===========

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

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



                                      F-43
<PAGE>


                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                    TARRANT APPAREL GROUP

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

                                POWER OF ATTORNEY

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

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

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

     /S/ GERARD GUEZ       Chairman of the Board of Directors     March 27, 2007
------------------------   and Interim Chief Executive Officer
       Gerard Guez         (Principal Executive Officer)

      /S/ TODD KAY         Vice Chairman of the Board of          March 27, 2007
------------------------   Directors
        Todd Kay

    /S/ CORAZON REYES      Chief Financial Officer, Treasurer     March 27, 2007
------------------------   and Director (Principal Financial
      Corazon Reyes        and Accounting Officer)

   /S/ MILTON KOFFMAN      Director                               March 27, 2007
------------------------
     Milton Koffman

  /S/ STEPHANE FAROUZE     Director                               March 27, 2007
------------------------
    Stephane Farouze

   /S/ MITCHELL SIMBAL     Director                               March 27, 2007
------------------------
     Mitchell Simbal

   /S/ JOSEPH MIZRACHI     Director                               March 27, 2007
------------------------
     Joseph Mizrachi

     /S/ SIMON MANI        Director                               March 27, 2007
------------------------
       Simon Mani


                                      S-1
<PAGE>


                              TARRANT APPAREL GROUP

                                  EXHIBIT INDEX


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

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

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

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

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

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

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

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

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

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

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

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

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

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


                                      EX-1
<PAGE>


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

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

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

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

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

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

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

10.8         Registration  Rights Agreement dated October 17, 2003, by and among
             Tarrant  Apparel Group and Sanders  Morris Harris Inc. as agent and
             attorney-in-fact    for   the   Purchasers    identified   therein.
             (Incorporated by reference to the Company's  Current Report on Form
             8-K dated October 16, 2003.)

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

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

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

10.12        Registration Rights Agreement dated December 14, 2004, by and among
             Tarrant  Apparel  Group and the  investors  listed on the signature
             pages thereto.  (Incorporated by reference to the Company's Current
             Report on Form 8-K dated December 14, 2004.)

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

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

10.15        Tenancy  Agreement,  dated July 1, 2005,  between  Tarrant  Company
             Limited and Lynx International Limited.  (Incorporated by reference
             to the  Company's  Quarterly  Report on Form  10-Q for the  quarter
             ending September 30, 2005.)


                                      EX-2
<PAGE>


10.16        Promissory Note in the principal  amount of $4,000,000  dated as of
             January 19, 2006,  issued by Tarrant  Apparel Group in favor of Max
             Azria. (Incorporated by reference to the Company's Quarterly Report
             on Form 10-Q for the quarter ending March 31, 2006.)

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

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

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

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

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

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

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

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

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

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

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


                                      EX-3
<PAGE>


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

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

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

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

10.30        Tenancy Agreement,  dated February 1, 2007, between Tarrant Company
             Limited and Lynx International Limited.

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

21.1         Subsidiaries.

23.1         Consent of Singer Lewak Greenbaum & Goldstein LLP.

23.2         Consent of Grant Thornton LLP.

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

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

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

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

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

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


                                      EX-4