UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                   FORM 10-K/A
                                 AMENDMENT NO. 2


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

                   For the fiscal year ended December 31, 2005

                                       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:

                                      NONE

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

                                  COMMON STOCK

         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  $51,515,376  based upon the closing price of
the Common Stock on June 30, 2005.

         Number of shares of Common Stock of the  Registrant  outstanding  as of
March 30, 2006: 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 2006 Annual Meeting of  Shareholders  are  incorporated  by
reference into Part III of this Report.


<PAGE>


                                EXPLANATORY NOTE

         We are filing this  Amendment No. 2 to Annual Report on Form 10-K/A for
the year ended  December 31, 2005 (the "Amended  Annual  Report"),  to amend our
Annual Report on Form 10-K for the year ended December 31, 2005 originally filed
with the  Securities and Exchange  Commission  (the "SEC") on March 31, 2006 and
previously  amended by our Annual  Report on Form  10-K/A  filed with the SEC on
January 31, 2007 (as amended,  the  "Original  Annual  Report").  The Company is
filing this Amended Annual Report in response to comments received from the SEC.
The following Items amend the Original Annual Report,  as permitted by the rules
and regulations of the SEC. Unless otherwise stated,  all information  contained
in this Amended  Annual Report is as of March 31, 2006.  All  capitalized  terms
used herein but not otherwise  defined shall have the meanings  ascribed to them
in the Original Annual Report.



                                     PART II

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.



                                     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.

EXHIBIT
NUMBER                                 DESCRIPTION
------------ -------------------------------------------------------------------
23.1         Consent of Singer Lewak Greenbaum & Goldstein LLP.

23.2         Consent of Grant Thornton LLP.

23.3         Consent of Singer Lewak Greenbaum & Goldstein LLP.

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

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

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

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


<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, 2004 and 2005..................F-4

    Consolidated Statements of Operations and Comprehensive Loss--
    Three year period ended December 31, 2005................................F-5

    Consolidated Statements of Shareholders' Equity--Three year
    period ended December 31, 2005...........................................F-6

    Consolidated Statements of Cash Flows--Three year period ended
    December 31, 2005........................................................F-7

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

Financial Statement Schedules

    Schedule II--Valuation and Qualifying Accounts..........................F-41

    American Rag Combined Financial Statements for Year Ended
    December 31, 2005.......................................................F-42


                                       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  sheet of Tarrant  Apparel  Group and
subsidiaries  (collectively,  the  "Company")  as of December 31, 2005,  and the
related  consolidated  statement of  operations,  stockholders'  equity and cash
flows for the year then ended.  Our audit 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 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.  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  audit  provides  a
reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the  financial  position of Tarrant  Apparel  Group and
subsidiaries  as of December 31, 2005, and the results of its operations and its
cash flows for the year then ended 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 15, 2006, except for Note 6,
as to which the date is October 3, 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  balance sheet of Tarrant Apparel
Group (a California  corporation)  and  subsidiaries as of December 31, 2004 and
the related  consolidated  statements  of  operations  and  comprehensive  loss,
shareholders'  equity,  and cash  flows for each of the two years in the  period
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 audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements  are free of material  misstatement.  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  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 as of December  31, 2004 and the  results of its  operations  and its cash
flows  for each of the two  years  in the  period  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 each of the two
years in the period  ending  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, except for Note 19,
as to which the date is March 30, 2005, and
Note 13, as to which the date is May 31, 2005


                                      F-3
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                           CONSOLIDATED BALANCE SHEETS

<CAPTION>
                                                                                DECEMBER 31,
                                                                       ------------------------------
                                                                            2004             2005
                                                                       -------------    -------------
<S>                                                                    <C>              <C>
                                ASSETS
Current assets:
  Cash and cash equivalents ........................................   $   1,214,944    $   1,641,768
  Accounts receivable, net .........................................      37,759,343       54,598,443
  Due from related parties .........................................      10,651,914        3,100,928
  Inventory ........................................................      19,144,105       31,628,960
  Current portion of note receivable from related party ............       5,323,733        5,139,387
  Prepaid expenses .................................................       1,251,684        1,292,441
  Prepaid royalties ................................................       2,257,985        1,123,531
  Income taxes receivable ..........................................         144,796           25,468
                                                                       -------------    -------------

    Total current assets ...........................................      77,748,504       98,550,926

  Property and equipment, net ......................................       1,874,893        1,702,840
  Notes receivable - related party, net of current portion .........      40,107,337       36,268,446
  Due from related parties .........................................            --          2,994,945
  Equity method investment .........................................       1,880,281        2,138,865
  Deferred financing cost, net .....................................       1,203,259          838,786
  Other assets .....................................................         414,161          164,564
  Goodwill, net ....................................................       8,582,845        8,582,845
                                                                       -------------    -------------

    Total assets ...................................................   $ 131,811,280    $ 151,242,217
                                                                       =============    =============

                 LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Short-term bank borrowings .......................................   $  17,951,157    $  13,833,532
  Accounts payable .................................................      24,394,553       33,278,959
  Accrued expenses .................................................      11,243,179        9,503,806
  Income taxes .....................................................      16,826,383       16,828,538
  Current portion of long-term obligations and factoring arrangement      19,628,701       36,109,699
                                                                       -------------    -------------

    Total current liabilities ......................................      90,043,973      109,554,534

Long-term obligations ..............................................       2,544,546          239,935
Convertible debentures, net ........................................       8,330,483        5,965,098
Deferred tax liabilities ...........................................         213,784           47,098

Minority interest in PBG7 ..........................................            --             75,241

Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized;
   no shares (2004) and no shares (2005) issued and outstanding ....            --               --
Common stock, no par value, 100,000,000 shares authorized;
   28,814,763 shares (2004) and 30,553,763 shares (2005) issued and
   outstanding .....................................................     111,515,091      114,977,465
Warrant to purchase common stock ...................................       2,846,833        2,846,833
Contributed capital ................................................       9,965,591       10,004,331
Accumulated deficit ................................................     (91,182,959)     (90,189,615)
Notes receivable from officer/shareholder ..........................      (2,466,062)      (2,278,703)
                                                                       -------------    -------------

    Total shareholders' equity .....................................      30,678,494       35,360,311
                                                                       -------------    -------------

    Total liabilities and shareholders' equity .....................   $ 131,811,280    $ 151,242,217
                                                                       =============    =============
</TABLE>


                             See accompanying notes.


                                      F-4
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

          CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                 -----------------------------------------------
                                                      2003              2004            2005
                                                 -------------    --------------   -------------
<S>                                              <C>              <C>              <C>
Net sales ....................................   $ 320,422,850    $ 155,452,663    $ 214,648,218
Cost of sales ................................     288,445,173      134,492,460      169,767,051
                                                 -------------    -------------    -------------

Gross profit .................................      31,977,677       20,960,203       44,881,167
Selling and distribution expenses ............      11,329,414        9,290,819       10,726,425
General and administrative expenses ..........      31,767,122       32,083,637       26,864,789
Write-off of prepaid expenses ................       2,771,989             --               --
Royalty expense ..............................         242,426          604,888        3,664,454
Impairment charges ...........................      19,504,521       77,982,034             --
Cumulative translation loss attributable to
   liquidated Mexico operations ..............            --         22,786,125             --
                                                 -------------    -------------    -------------

Income (loss) from operations ................     (33,637,795)    (121,787,300)       3,625,499
Interest expense .............................      (5,602,556)      (2,857,096)      (4,624,590)
Interest income ..............................         424,518          377,587        2,081,456
Minority interest ............................       3,461,243       15,331,171          (75,241)
Interest in income of equity method investee..            --            769,706          559,634
Other income .................................       4,784,479        6,366,637          354,347
Other expense ................................      (1,182,920)        (529,257)            (580)
                                                 -------------    -------------    -------------
Income (loss) before provision for income
  taxes ......................................     (31,753,031)    (102,328,552)       1,920,525
Provision for income taxes ...................       4,131,629        2,348,119          927,181
                                                 -------------    -------------    -------------

Net income (loss) ............................   $ (35,884,660)   $(104,676,671)   $     993,344
                                                 =============    =============    =============

Net income (loss) per share - Basic (as
  restated, see Note 13): ....................   $       (2.38)   $       (3.64)   $        0.03
                                                 =============    =============    =============

Net income (loss) per share - Diluted (as
  restated, see Note 13) .....................   $       (2.38)   $       (3.64)   $        0.03
                                                 =============    =============    =============

Weighted average common and common equivalent
  shares outstanding:
  Basic ......................................      18,215,071       28,732,796       29,728,997
                                                 =============    =============    =============

  Diluted ....................................      18,215,071       28,732,796       29,734,291
                                                 =============    =============    =============

Net income (loss) ............................   $ (35,884,660)   $(104,676,671)   $     993,344
Foreign currency translation adjustment ......      (9,945,727)            --               --
                                                 -------------    -------------    -------------
Total comprehensive income (loss) ............   $ (45,830,387)   $(104,676,671)   $     993,344
                                                 =============    =============    =============
</TABLE>


                             See accompanying notes.


                                      F-5
<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005

<CAPTION>


                                                   PREFERRED         NUMBER           COMMON           NUMBER
                                                     STOCK          OF SHARES          STOCK         OF SHARES         WARRANTS
                                                 -------------    -------------    -------------    -------------    -------------
<S>                                              <C>                    <C>        <C>                 <C>           <C>
Balance at January 1, 2003 ...................   $   8,820,573          100,000    $  69,368,239       15,846,315    $        --
   Net loss ..................................            --               --               --               --               --
   Currency translation ......................            --               --               --               --               --
   Comprehensive loss ........................            --               --               --               --               --
   Conversion of preferred stock to
      common stock ...........................      (8,820,573)        (100,000)       8,820,573        3,000,000             --
   Issuance of preferred stock and
      warrant, net ...........................      29,226,041          881,732             --               --          1,798,733
   Conversion of preferred stock to
      common stock ...........................     (29,226,041)        (881,732)      29,226,041        8,817,320             --
   Intrinsic value of beneficial conversion
      associated with convertible preferred
      stock ..................................            --               --               --               --               --
   Issuance of common stock ..................            --               --            788,000          200,000             --
   Retirement of stock .......................            --               --           (311,427)        (248,872)            --
   Compensation expense ......................            --               --               --               --               --
   Repayment from shareholders ...............            --               --               --               --               --
                                                 -------------    -------------    -------------    -------------    -------------

Balance at December 31, 2003 (as restated,
see Note 13) .................................            --               --        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 shareholders ...............            --               --               --               --               --
   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 shareholders ...............            --               --               --               --               --
                                                 -------------    -------------    -------------    -------------    -------------
Balance at December 31, 2005 .................   $        --               --      $ 114,977,465       30,553,763    $   2,846,833
                                                 =============    =============    =============    =============    =============


<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, 2003 ...................       1,434,259      56,873,094       (9,733,458)      (5,601,804)     121,160,903
   Net loss ..................................            --       (35,884,660)            --               --        (35,884,660)
   Currency translation ......................            --              --         (9,945,727)            --         (9,945,727)
                                                                                                                    -------------
   Comprehensive loss ........................            --              --               --               --        (45,830,387)
   Conversion of preferred stock to
      common stock ...........................            --              --               --               --               --
   Issuance of preferred stock and
      warrant, net ...........................            --              --               --               --         31,024,774
   Conversion of preferred stock to
      common stock ...........................            --              --               --               --               --
   Intrinsic value of beneficial conversion
      associated with convertible preferred
      stock ..................................       7,494,722      (7,494,722)            --               --               --
   Issuance of common stock ..................            --              --               --               --            788,000
   Retirement of stock .......................            --              --               --               --           (311,427)
   Compensation expense ......................          71,572            --               --               --             71,572
   Repayment from shareholders ...............            --              --               --            805,376          805,376
                                                 -------------   -------------    -------------    -------------    -------------

Balance at December 31, 2003 (as restated,
see Note 13) .................................       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 shareholders ...............            --              --               --             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 shareholders ...............            --              --               --            187,359          187,359
                                                 -------------   -------------    -------------    -------------    -------------
Balance at December 31, 2005 .................   $  10,004,331   $ (90,189,615)   $        --      $  (2,278,703)   $  35,360,311
                                                 =============   =============    =============    =============    =============
</TABLE>


                             See accompanying notes


                                      F-6




<PAGE>


<TABLE>
                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>
                                                                              YEAR ENDED DECEMBER 31,
                                                                      2003             2004              2005
                                                                  ------------      -----------      ------------
<S>                                                             <C>              <C>              <C>
Operating activities:
Net Income (loss) ...........................................   $ (35,884,660)   $(104,676,671)   $     993,344
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
   Deferred taxes ...........................................        (132,622)         (61,345)        (166,686)
   Depreciation and amortization ............................      16,097,595        8,337,946        2,126,585
   Receipt of merchandise in lieu of interest on notes
     receivable, related party ..............................            --               --         (1,742,540)
   Impairment charges .......................................      22,276,510       77,982,034             --
   Cumulative transaction loss attributable to the liquidated
     Mexico operations ......................................            --         22,786,125             --
   Inventory write-down .....................................      10,986,153             --               --
   Prepaid royalties write-off ..............................            --               --          1,165,970
   Income from equity method investment .....................            --           (769,706)        (559,634)
   Loss (gain) on sale of fixed assets ......................         593,626          (15,272)        (124,041)
   Unrealized (gain) loss on foreign currency ...............         560,602         (367,262)            --
   Minority interest ........................................      (3,218,069)     (15,331,171)          75,241
   Gain on legal settlement .................................        (235,785)            --               --
   Compensation expense related to stock options ............          71,572          161,038           38,740
   Change in the provision for returns and discounts ........        (324,387)      (1,747,060)         (78,060)
   Changes in operating assets and liabilities:
      Restricted cash .......................................      (2,759,742)       2,759,742             --
      Accounts receivable ...................................       7,856,700       21,224,454      (16,761,040)
      Due to/from related parties ...........................     (14,801,324)        (122,389)       2,702,047
      Inventory .............................................       9,626,509        4,162,158       (8,503,086)
      Prepaid expenses ......................................         590,046       (1,860,955)          47,055
      Other assets ..........................................         450,782             --               --
      Accounts payable ......................................      (4,207,552)         687,758        9,248,667
      Accrued expenses and income tax payable ...............       2,388,976         (981,196)      (1,362,218)
                                                                -------------    -------------    -------------

   Net cash (used in) provided by operating activities ......       9,934,930       12,168,228      (12,899,656)

Investing activities:
Purchase of fixed assets ....................................        (368,113)        (111,836)        (559,081)
Proceeds from sale of fixed assets ..........................         209,788        1,219,904          130,552
Investment in equity investment method ......................      (1,434,375)        (137,000)            --
Distribution from equity investment method ..................            --            460,800          301,050
Collection on notes receivable, related party ...............            --               --          1,194,722
Investment in joint venture .................................            --           (211,963)            --
Collection of advances from shareholders/officers ...........          88,723           30,366        2,487,360
                                                                -------------    -------------    -------------

   Net cash provided by (used in) investing activities ......      (1,503,977)       1,250,271        3,554,603

Financing activities:
Short-term bank borrowings, net .............................        (161,194)     (11,342,166)      (4,117,625)
Proceeds from long-term obligations .........................     239,280,109      129,667,084      218,367,495
Payment of financing costs ..................................            --         (1,124,668)            --
Payment of long-term obligations and bank borrowings ........    (275,640,677)    (146,375,987)    (204,477,993)
Repayments of borrowings from shareholders/officers .........        (486,379)            --               --
Proceeds from issuance of preferred stock and warrant .......      31,024,774        3,623,665             --
Proceeds from convertible debentures, net ...................            --         10,000,000             --
Repurchase of shares ........................................        (311,427)            --               --
                                                                -------------    -------------    -------------

   Net cash provided by (used in) financing activities ......      (6,294,794)     (15,552,072)       9,771,877

Effect of exchange rate on cash .............................        (204,677)          28,553             --
                                                                -------------    -------------    -------------

Increase (decrease) in cash and cash equivalents ............       1,931,482       (2,105,020)         426,824
Cash and cash equivalents at beginning of year ..............       1,388,482        3,319,964        1,214,944
                                                                -------------    -------------    -------------

Cash and cash equivalents at end of year ....................   $   3,319,964    $   1,214,944    $   1,641,768
                                                                =============    =============    =============
</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.,  Mexico,  and Asia. At December 31, 2005, 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,  Gerard Guez. The 25% minority interest in PBG7
is owned by BH7, LLC, an unrelated party.

We serve specialty  retail,  mass  merchandise  and department  store chains and
major  international  brands by designing,  merchandising,  contracting  for the
manufacture  of, and selling  casual  apparel for women,  men and children under
private  label.  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.  See  Note 7 and  Note  15 of the  "Notes  to  Consolidated
Financial  Statements."  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 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 10 of the "Notes to Consolidated Financial Statements," our
federal  income tax returns for the years ended  December  31, 1996 through 2002
are 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 $7.7 million. If the amount of
any actual  liability,  however,  exceeds our reserves,  we would  experience an
immediate  adverse  earnings impact in the amount of such additional  liability,
which  could  be  material.   Additionally,  we  anticipate  that  the  ultimate
resolution of these matters will require that we make  significant cash payments
to the taxing authorities. Presently we do not have sufficient cash or borrowing
ability to make any future  payments  that may be required.  No assurance can be
given that we will have  sufficient  surplus  cash from  operations  to make the
required  payments.  Additionally,  any cash used for these purposes will not be
available  for other  corporate  purposes,  which could have a material  adverse
effect on our financial condition and results of operations.  See Note 10 of the
"Notes to Consolidated Financial Statements" for a further discussion on the IRS
examination.


                                      F-8
<PAGE>


RISK AND UNCERTAINTIES - DEBT COVENANTS

As discussed in Note 8 of the "Notes to Consolidated  Financial Statements," our
debt  agreements  require  certain  covenants  including a minimum  level of net
worth. 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 8 of the "Notes to  Consolidated
Financial  Statements"  for a further  discussion of the credit  facilities  and
related debt covenants.

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
statement of operations  and amounted to  $1,817,000,  $783,000 and $667,000 for
the years ended December 31, 2003, 2004 and 2005, respectively.  We did not bill
customers for shipping and handling  costs for the years 2003 and 2004. In 2005,
we did some billing for freight to specialty  stores although the amount was not
material.

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  $1,206,000  and  $1,062,000  as of
December 31, 2004 and 2005, respectively. Cash is deposited with what we believe
are highly credited quality  financial  institutions and may exceed FDIC insured
limits.

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, 2004 and
2005, the balance of the allowance for returns, discounts and bad debts was $2.4
million and $3.0 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,
manufacturing overhead, duty, quota, freight in, and brokerage.

SELLING AND DISTRIBUTION EXPENSES

Selling and distribution  expenses  include expenses related to samples,  travel
and entertainment, salaries, rent, warehouse handling and 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 and other office
expenses, depreciation and amortization, professional fees and bank charges.

ROYALTY EXPENSES

Royalty  expenses consist of the royalty payments and marketing fund commitments
according to the various  licensing  agreements  we have entered  into.  Royalty
expenses are calculated based on a certain percentage of net sales. All of these
agreements include minimum royalties.  See Note 11 of the "Notes to Consolidated
Financial Statements" regarding various agreements we have entered into.

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  $1,306,000,  $2,106,000  and  $3,009,000 in 2003,  2004 and 2005,
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                                               7 to 15 years
         Furniture and Fixtures                                   5 to 7 years
         Vehicles                                                      5 years
         Leasehold Improvements         Term of lease or Estimated useful life


                                      F-10
<PAGE>




IMPAIRMENT OF LONG-LIVED ASSETS

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

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

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 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,  2005,  we have a  goodwill  balance  of $8.6  million,  and a net
property  and  equipment  balance of $1.7  million,  as  compared  to a goodwill
balance of $8.6 million and a net property and equipment balance of $1.9 million
at December 31, 2004.  Our net  property and  equipment  balance at December 31,
2004  reflects the disposal of our Mexico fixed assets of $123.3  million in the
fourth  quarter  of 2004.  See Note 5 and Note 7 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 year ended  December 31, 2005, we did not  recognize  any  impairment
related to goodwill and property and equipment.

DEFERRED FINANCING COST

Deferred  financing  costs were $1,203,000 and $839,000 at December 31, 2004 and
2005,  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
$408,000,  $387,000 and $1,399,000  for the years ended December 31, 2003,  2004
and 2005, 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 Hong Kong  corporate  affiliates are taxed at an effective Hong Kong rate of
17.5%.  As of December 31, 2005, no domestic tax provision has been provided for
$41.9 million of un-remitted  retained earnings of these Hong Kong corporations,
as we intend to maintain these amounts outside of the U.S. on a permanent basis.


                                      F-11
<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 loss per share and diluted loss per share is as follows:

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                               -----------------------------------------------
                                                    2003             2004             2005
                                               -------------    -------------    -------------
<S>                                            <C>              <C>              <C>
Basic EPS Computation:
Numerator:
Reported net income (loss) .................   $ (35,884,660)   $(104,676,671)   $     993,344
Dividend to the preferred stockholders .....      (7,494,722)            --               --
                                               -------------    -------------    -------------
Net income (loss) available to common
  stockholders .............................   $ (43,379,382)   $(104,676,671)   $     993,344

Denominator:
Weighted average common shares outstanding..      18,215,071       28,732,796       29,728,997

Basic EPS ..................................   $       (2.38)   $       (3.64)   $        0.03
                                               =============    =============    =============

Diluted EPS Computation:
Numerator:
Reported net income (loss) .................   $ (35,884,660)   $(104,676,671)   $     993,344
Dividend to the preferred stockholders .....      (7,494,722)            --               --
                                               -------------    -------------    -------------
Net income (loss) available to common
  stockholders .............................   $ (43,379,382)   $(104,676,671)   $     993,344

Denominator:
Weighted average common shares outstanding..      18,215,071       28,732,796       29,728,997
Incremental shares from assumed exercise of
warrants ...................................            --               --               --
convertible debentures .....................            --               --               --
options ....................................            --               --              5,294
                                               -------------    -------------    -------------
Total shares ...............................      18,215,071       28,732,796       29,734,291

Diluted EPS ................................   $       (2.38)   $       (3.64)   $        0.03
                                               =============    =============    =============
</TABLE>


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

                                         2003            2004            2005
                                      ----------      ----------      ----------

Options ........................       8,926,087       8,331,962       6,727,756
Warrants .......................         881,732       2,361,732       2,361,732
Convertible debentures .........            --         5,000,000       3,456,313
                                      ----------      ----------      ----------
   Total .......................       9,807,819      15,693,694      12,545,801


DIVIDENDS

We did not declare or pay any cash dividends in 2003, 2004 or 2005. 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


                                      F-12
<PAGE>


declaration and payment of any cash dividends in the future will depend upon our
earnings,  financial condition,  capital needs and other factors deemed relevant
by the Board of  Directors.  In  addition,  our credit  agreements  prohibit the
payment of dividends during the term of the agreements.

FOREIGN CURRENCY TRANSLATION

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."

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  and accounts
payable  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, 2004 and 2005,
approximately  19.6%  and  22.5%  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                                                 2003     2004     2005
-----------------------------------------------------   ------   ------   ------
Kohl's ..............................................      6.6     16.4     13.5
Macy's Merchandising Group ..........................      5.2     10.3     13.4
Mervyn's ............................................      5.9     15.4     11.2
Wal-Mart ............................................      8.7      5.9     11.1
Lerner New York .....................................      8.3     15.0      8.6
Lane Bryant .........................................     12.1      2.0      4.9
The Limited (1) .....................................     15.3      4.6      0.0
----------
(1) Includes Express and Limited stores.

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


                                      F-13
<PAGE>


USE OF ESTIMATES

The preparation of financial  statements in conformity  with generally  accepted
accounting principles in the United States 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,  valuation of long-lived and intangible assets and goodwill,  and tax
provision. Actual results could differ from those estimates.

EMPLOYEE STOCK OPTIONS

We account for employee  stock options  using the intrinsic  value method rather
than the alternative  fair-value  accounting method.  Under the  intrinsic-value
method,  if the exercise price of the employee's stock options equals the market
price of the underlying stock on the date of the grant, no compensation  expense
is recognized.  For the years ended December 31, 2003,  2004 and 2005,  $72,000,
$161,000 and $39,000 were recorded as an expense  related to our stock  options,
respectively.

Pro forma information regarding net income and earnings per share is required by
SFAS 148, and has been  determined as if we had accounted for our employee stock
options under the fair value method of that Statement.  The fair value for these
options was estimated at the date of grant using a Black-Scholes  option pricing
model  with  the  following   weighted-average   assumptions:   weighted-average
risk-free interest rate of 4% for 2003, 3% to 4% for 2004, 4% for 2005; dividend
yields of 0% for 2003, 2004 and 2005; weighted-average volatility factors of the
expected  market  price of our common  stock of 0.65 for 2003,  0.51 to 0.55 for
2004 and 0.55 for 2005;  and a  weighted-average  expected life of the option of
four years for 2003, 2004 and 2005.

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 adoption of SFAS No.
123 (revised 2004) "Share-Based Payment" effective in January 2006.

For purposes of pro forma  disclosures,  the estimated fair value of the options
is  amortized  to  expense  over the  options'  vesting  period.  Our pro  forma
information follows:


                                      F-14
<PAGE>


<TABLE>
<CAPTION>
                                                      2003             2004              2005
                                                --------------    --------------    --------------
<S>                                             <C>               <C>               <C>
Net income (loss) as reported ...............   $  (35,884,660)   $ (104,676,671)   $      993,344
Add stock-based employee compensation charges
reported in net loss ........................   $       71,572    $      161,038    $       38,740
Pro forma compensation expense, net of tax ..   $   (4,115,263)   $   (3,852,990)   $   (4,298,193)
                                                --------------    --------------    --------------
Pro forma net loss ..........................   $  (39,928,351)   $ (108,368,623)   $   (3,266,109)

Net income (loss) per share
Basic (as restated, see Note 13) ............   $        (2.38)   $        (3.64)   $         0.03
Add stock-based employee compensation charges
   reported in net loss
Basic .......................................   $         0.00    $         0.01    $         0.00
Pro forma compensation expense per share
Basic .......................................   $        (0.22)   $        (0.14)   $        (0.14)
                                                --------------    --------------    --------------
Pro forma loss per share
Basic (as restated, see Note 13) ............   $        (2.60)   $        (3.77)   $        (0.11)

Net income (loss) per share
Diluted (as restated, see Note 13) ..........   $        (2.38)   $        (3.64)   $         0.03
Add stock-based employee compensation charges
   reported in net loss
Diluted .....................................   $         0.00    $         0.01    $         0.00
Pro forma compensation expense per share
Diluted .....................................   $        (0.22)   $        (0.14)   $        (0.14)
                                                --------------    --------------    --------------
Pro forma loss per share
Diluted (as restated, see Note 13) ..........   $        (2.60)   $        (3.77)   $        (0.11)
</TABLE>


OTHER COMPREHENSIVE INCOME (LOSS)

Other  comprehensive  income (loss)  includes all changes in equity (net assets)
from non-owner  sources such as foreign  currency  translation  adjustments.  We
account  for other  comprehensive  income  (loss) in  accordance  with SFAS 130,
"Reporting Comprehensive Income."

IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December  2004,  the FASB issued SFAS No. 123  (revised  2004),  "Share-Based
Payment,"  which  addresses the accounting for employee stock options.  SFAS No.
123R eliminates the ability to account for share-based compensation transactions
using  APB  Opinion  No.  25 and  generally  would  require  instead  that  such
transactions  be accounted for using a fair  value-based  method.  SFAS No. 123R
also requires that tax benefits  associated with these  share-based  payments be
classified  as financing  activities  in the  statement of cash flow rather than
operating  activities as currently  permitted.  SFAS No. 123R is effective as of
the beginning of our first annual or interim  reporting period that begins after
June 15, 2005. On April 14, 2005, the Securities and Exchange Commission adopted
a new rule amending the effective date for Statement 123R for public  companies.
Under the effective  date  provisions  included in Statement  123R,  registrants
would have been required to implement  the  Statement's  requirements  as of the
beginning of the first interim or annual period  beginning  after June 15, 2005,
or after  December  15,  2005 for small  business  issuers.  The new rule allows
registrants  to implement  Statement  123R at the beginning of their next fiscal
year, instead of the next interim period,  that begins after June 15, 2005. SFAS
No. 123R offers alternative methods of adopting this final rule. We have not yet
determined  which  alternative  method we will use.  We have not  completed  the
process of  evaluating  the impact that will result from adopting SFAS No. 123R,
but  believe  the impact  upon  adoption  will be an  increase  to  compensation
expense.

In May 2005,  the FASB issued SFAS No.  154,  "Accounting  for Changes and Error
Corrections."  SFAS 154  establishes  standards for the accounting and reporting
for changes in  accounting  principles.  SFAS 154  replaces  APB 20  "Accounting
Changes"  and FASB  Interpretation  No.  20 ("FIN  20"),  "Reporting  Accounting


                                      F-15
<PAGE>


Changes   under  AICPA   Statements  of   Position."   The  Statement   requires
retrospective  application  for changes in  accounting  principle,  unless it is
impracticable to determine either the cumulative  effect or the  period-specific
effects of the change. When it is impracticable to determine the period-specific
effects  of an  accounting  change  on  one or  more  individual  prior  periods
presented,  this  Statement  would  require  that the new  accounting  policy be
applied to the  balances of assets and  liabilities  as of the  beginning of the
earliest  period for which  retrospective  application is practicable and that a
corresponding adjustment be made to the opening balance of retained earnings for
the period.  When it is impracticable  for an entity to determine the cumulative
effect of applying a change in accounting  principle to all prior periods,  this
Statement would require the new accounting principle to be applied as if it were
made prospectively from the earliest date practicable.  SFAS 154 is effective as
of the beginning of our first annual reporting period that begins after December
15, 2005. The adoption of this new accounting  pronouncement  is not expected to
have a material impact on our consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155,  "Accounting  for Certain Hybrid
Financial  Instruments",  which amends SFAS No. 133, "Accounting for Derivatives
Instruments and Hedging Activities" and SFAS No. 140,  "Accounting for Transfers
and Servicing of Financial Assets and  Extinguishment of Liabilities."  SFAS 155
amends  SFAS  133  to  narrow  the  scope   exception  for   interest-only   and
principal-only   strips  on  debt   instruments  to  include  only  such  strips
representing  rights to receive a specified portion of the contractual  interest
or  principle  cash flows.  SFAS 155 also  amends  SFAS 140 to allow  qualifying
special-purpose  entities  to hold a  passive  derivative  financial  instrument
pertaining to beneficial  interests that itself is a derivative  instrument.  We
are currently evaluating the impact this new Standard,  but believe that it will
not have a material impact on our financial  position,  results of operations or
cash flows.

CURRENCY RATE HEDGING

We  manufacture in a number of countries  throughout  the world,  including Hong
Kong, and, as a result,  are exposed to movements in foreign  currency  exchange
rates. Periodically we will enter into various currency rate hedges. The primary
purpose of our foreign currency  hedging  activities is to manage the volatility
associated  with foreign  currency  purchases of materials  and equipment in the
normal course of business. We utilize forward exchange contracts with maturities
of one to three months.  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. As a result,
we mark to market all derivative  instruments  with the gain or loss included in
other income and expense.  See Note 18 of the "Notes to  Consolidated  Financial
Statements."  These instruments are intended to protect against exposure related
to financing transactions (equipment) and income from international  operations.
There were no exchange contracts at December 31, 2004 and December 31, 2005.

RECLASSIFICATIONS

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

2.       ACCOUNTS RECEIVABLE

Accounts receivable consists of the following:

<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                   ----------------------------
                                                       2004            2005
                                                   ------------    ------------
<S>                                                <C>             <C>
U.S. trade accounts receivable .................   $  3,248,887    $  2,893,217
Foreign trade accounts receivable ..............     17,148,600      19,619,172
Factored accounts receivable ...................     19,452,756      33,222,354
Other receivables ..............................        346,965       1,815,450
Allowance for returns, discounts and bad debts .     (2,437,865)     (2,951,750)
                                                   ------------    ------------
                                                   $ 37,759,343    $ 54,598,443
                                                   ============    ============
</TABLE>

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


                                      F-16
<PAGE>


asset  based  lending  arrangement  was  amended  and  converted  to a factoring
arrangement.   At  December  31,  2005,  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 8
of "Notes to Consolidated Financial Statements."

3.       INVENTORY

Inventory consists of the following:
                                                              DECEMBER 31,
                                                     ---------------------------
                                                         2004            2005
                                                     -----------     -----------

Raw materials, fabric and trim accessories .....     $ 1,164,977     $ 5,079,428
Finished goods shipments-in-transit ............       9,283,022       8,800,014
Finished goods .................................       8,696,106      17,749,518
                                                     -----------     -----------
                                                     $19,144,105     $31,628,960
                                                     ===========     ===========

4.       PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

                                                           DECEMBER 31,
                                                   ----------------------------
                                                       2004            2005
                                                   ------------    ------------

Land ...........................................   $     85,000    $     85,000
Buildings ......................................        819,372         819,372
Equipment ......................................      5,966,453       6,249,487
Furniture and fixtures .........................      2,228,375       2,308,537
Leasehold improvements .........................      2,605,763       2,684,720
Vehicles .......................................        330,564         322,487
                                                   ------------    ------------
                                                     12,035,527      12,469,603

Less accumulated depreciation and amortization .    (10,160,634)    (10,766,763)
                                                   ------------    ------------

                                                   $  1,874,893    $  1,702,840
                                                   ============    ============

Depreciation  expense,  including  amortization of assets recorded under capital
leases,  totaled  $15,663,000,  $7,853,000  and  $727,000  for the  years  ended
December 31, 2003, 2004 and 2005, 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 have picketed our  customers,  stuffed  electronic  mailboxes with
inaccurate,  protest  e-mails,  and threatened  customers with  retaliation  for
continuing  business  with  us.  While  we have  defended  our  position  to our
customers, some of our larger customers for Mexico-produced jeans wear have 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.


                                      F-17
<PAGE>


In connection with our restructuring of our Mexico operations,  we incurred $2.5
million,  $1.1  million  and $0 of  severance  costs  in 2003,  2004  and  2005,
respectively,  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 2003
and 2004  since such  amounts  were all paid in 2003 and 2004.  Severance  costs
incurred in 2003 were included in costs of goods sold and such 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 the following:

         o        $105,400  in cash and  $3,910,000  by  delivery  of  unsecured
                  promissory notes bearing interest at 5.5% per annum; and

         o        $40,204,000,  by delivery of secured  promissory notes bearing
                  interest at 4.5% per annum, maturing on December 31, 2014, and
                  payable  in  equal  monthly   installments  of  principal  and
                  interest over the term of the notes.

Included  in  the  $41.4  million  notes  receivable  -  related  party  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.  The
future  maturities of the note  receivable  from the  purchasers,  including the
Mexican value added tax to be paid by the purchasers, is as follows:


     YEAR ENDING DECEMBER 31,                                   AMOUNT
     -------------------------------------------------       ------------
     2006.............................................       $  5,139,387
     2007.............................................          4,866,963
     2008.............................................          3,835,953
     2009.............................................          3,898,575
     2010.............................................          4,077,855
     2011 and after...................................         19,589,100
                                                             ------------
     Total............................................       $ 41,407,833

Upon consummation of the sale, we entered into a purchase  commitment  agreement
with the purchasers,  pursuant to which we have 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 current maturities balance
is  $429,000  related  to the  2005  balance  due,  which  we  believe  is fully
collectible  and are allowed to be offset against annual  principal and interest
requirements.  We expect to  realize  the note  receivable  from  related  party
through the receipt of fabric manufactured at these facilities over the maturity
period of the notes receivable.

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


                                      F-18
<PAGE>


the licensor of minimum royalties of $10.4 million over the initial 10-year term
of the  agreement.  Private  Brands also  entered  into a  multi-year  exclusive
distribution agreement with Federated  Merchandising Group ("FMG"), the sourcing
arm of Federated  Department  Stores, to supply FMG with American Rag CIE, a new
casual  sportswear  collection  for juniors and young men.  Private  Brands will
design and manufacture a full collection of American Rag apparel,  which will be
distributed by FMG exclusively to Federated stores across the country. Beginning
in August 2003, the American Rag collection was available in  approximately  100
select Macy's, the Bon Marche, Burdines, Goldsmith's,  Lazarus and Rich's-Macy's
locations.  The  investment  in American Rag CIE, LLC totaling  $1.9 million and
$2.1 million at December 31, 2004 and 2005, 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 was as follows:

                Balance as of December 31, 2003    $ 1,434,375
                 Additional capital contribution       137,000
                 Share of income ...............       769,706
                 Distribution ..................      (460,800)
                                                   -----------
                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
                                                   ===========

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 and 2005 was  approximately  $9
million and $10 million,  respectively.  The amount of royalty income paid by us
to American Rag in 2003,  2004 and 2005 was  $250,000,  $500,000  and  $575,000,
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 have not entered into any  obligations  to guarantee the entity's debt nor do
we expect to receive a guaranteed  return on its investment.  We determined that
we are not the primary beneficiary of American Rag and nothing has given rise to
a re-evaluation of the investment for  consolidation  under FIN 46. 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.

The  summarized  combined  financial  information  for American Rag for the year
ended December 31, 2005 was as follows:

                    BALANCE SHEET
                       Current assets ........   $ 1,889,389
                       Non-current assets ....       545,388
                           TOTAL ASSETS ......     2,434,777
                       Current liabilities ...       641,350
                       Non-current liabilities        83,615
                           TOTAL LIABILITIES .   $   724,965

                    STATEMENT OF INCOME
                       Net sales .............   $10,125,563
                       Gross profit ..........     5,092,708
                       Income from operations        585,481
                       Net income ............   $ 1,152,431


                                      F-19
<PAGE>


7.       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.

In 2003, we ceased  directly  operating a substantial  majority of our equipment
and  fixed  assets  in  Mexico,  and  started  leasing  a large  portion  of our
manufacturing  facilities  and  operations  in Mexico to affiliates of Mr. Kamel
Nacif,  a shareholder  at the time of the  transaction,  effective  September 1,
2003.  During 2003,  we made an interim  review of our  goodwill and  intangible
assets  and  wrote  off all  goodwill  and  intangible  assets  affected  by our
strategic changes in Mexico.  Write-offs  included $9.1 million and $2.7 million
directly   relating  to  Tarrant   Mexico  -  Famian  and   Ajalpan   divisions,
respectively,  and  another  $7.5  million  relating  to of  Rocky  Apparel  LLC
("Rocky").  It was unlikely that Tommy  Hilfiger,  whose business we acquired in
the Rocky acquisition, would continue to purchase merchandise from UAV following
implementation  of the restructuring in Mexico. In 2003, we had also written off
the  remaining  goodwill of $150,000  relating  to the  acquisition  of Jane Doe
International, LLC due to litigation with the minority shareholder.

The following table displays the change in the gross carrying amount of goodwill
by reporting units for the years ended December 31, 2004 and 2005. The reporting
unit  below is one level  below the  reportable  segments  included  in Note 16,
"Operations  by  Geographic  Areas".  The  reporting  unit FR TCL. - Chazz & MGI
Division was included within the United States  geographical  segment of Note 16
of the "Notes to the Consolidated Financial Statements."

                                                REPORTING UNITS
                                                FR TCL - CHAZZZ
                                                 & MGI DIVISION
                                                ---------------

                  Balance as of January 1, 2004 .   $8,582,845
                  Activities for the year .......         --
                                                    ----------
                  Balance as of December 31, 2004   $8,582,845
                  Activities for the year .......         --
                                                    ----------
                  Balance as of December 31, 2005   $8,582,845
                                                    ==========


IMPAIRMENT OF OTHER ASSETS

On June 28, 2000, we signed an exclusive  production agreement with Manufactures
Cheja ("Cheja") through February 2002. We had agreed on a new contract to extend
the agreement for an additional quantity of 6.4 million units beginning April 1,
2002,  which was  amended on  November  8, 2002,  for the  manufacturing  of 5.7
million units through September 30, 2004. In June 2003, we determined that we no
longer expected to recoup advances to Cheja related to the production agreement.
In June 2003, we wrote off $2.8 million of remaining advances to Cheja.


                                      F-20
<PAGE>


8.       DEBT

Debt consists of the following:

<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                                  ----------------------------
                                                                      2004            2005
                                                                  ------------    ------------
<S>                                                               <C>             <C>
Short-term bank borrowings:
  Import trade bills payable - UPS, DBS Bank and Aurora Capital   $  3,902,714    $  4,165,306
  Bank direct acceptances - UPS and DBS Bank ..................     10,447,855       1,471,476
  Other Hong Kong credit facilities - UPS and DBS Bank ........      3,600,588       8,196,750
                                                                  ------------    ------------
                                                                  $ 17,951,157    $ 13,833,532
                                                                  ============    ============
Long-term debt:
  Vendor financing ............................................   $    135,145    $       --
  Equipment financing .........................................         78,038          83,206
  Term loan - UPS .............................................      5,000,000       2,708,333
  Debt facility - GMAC ........................................     16,960,064      33,558,095
                                                                  ------------    ------------
                                                                    22,173,247      36,349,634
  Less current portion ........................................    (19,628,701)    (36,109,699)
                                                                  ------------    ------------
                                                                  $  2,544,546    $    239,935
                                                                  ============    ============
</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 may  arrange  for the  issuance  of letters of credit  and  acceptances.  The
facility  is  collateralized  by  the  shares  and  debentures  of  all  of  our
subsidiaries  in Hong Kong.  In addition to the  guarantees  provided by Tarrant
Apparel  Group and our  subsidiaries,  Fashion  Resource  (TCL) Inc. and Tarrant
Luxembourg  Sarl,  Gerard  Guez,  our  Chairman,  also signed a guarantee  of $5
million in favor of UPS to secure this facility.  This facility bore interest at
10.25% per annum at December 31, 2005.  Under this facility,  we were subject to
certain restrictive  covenants,  including that we maintain a specified tangible
net worth,  fixed charge ratio, and leverage ratio. On June 27, 2005, we amended
the  letter of credit  facility  with UPS to extend the  expiration  date of the
facility  from June 30, 2005 to August 31, 2005 and to reduce the  tangible  net
worth requirement at June 30, 2005. On August 31, 2005, we amended the letter of
credit  facility with UPS to further extend the expiration  date of the facility
to October 31, 2005,  immediately  reduce the maximum  amount of  borrowings  to
$14.5  million on  September 1, 2005 and further  reduced the maximum  amount of
borrowing to $14.0  million on October 1, 2005.  On October 31, 2005, we further
amended the letter of credit  facility with UPS to extend the expiration date of
the  facility to January 31, 2006 and amend the  interest  rate to "prime  rate"
plus 3%. The  facility  amendment  also  provided  for  reduction in the maximum
amount of borrowings  to $13.5 million  commencing on November 1, 2005, to $13.0
million  commencing  on December 1, 2005,  and to $12.5  million  commencing  on
January 1, 2006.  Additionally,  Gerard Guez,  our Chairman,  pledged to UPS 4.6
million  shares of our common  stock held by Mr. Guez to secure the  obligations
under the credit facility. On January 27, 2006, we further amended the letter of
credit  facility  with UPS to extend the  expiration  date of the facility  from
January 31, 2006 to July 31, 2006.  The amendment  provides for reduction of the
maximum amount of borrowings  under the facility to $12.0 million  commencing on
April 1, 2006, $11.5 million commencing on May 1, 2006, $11.0 million commencing
on June 1,  2006 and to $10.5  million  commencing  on July 1,  2006.  Under the
amended  letter of credit  facility,  we are  subject to  restrictive  financial
covenants  of  maintaining  tangible net worth of $25 million as of December 31,
2005  and the  last  day of each  fiscal  quarter  thereafter.  There  is also a
provision  capping maximum capital  expenditures per quarter of $800,000.  As of
December 31, 2005, we were in compliance with the covenants.  As of December 31,
2005,  $9.2 million was  outstanding  under this facility  with UPS  (classified
above as follows:  $1.9 million in import trade bills  payable;  $1.0 million in
bank direct  acceptances and $6.3 million in other Hong Kong credit  facilities)
and an additional $2.5 million was available for future borrowings. In addition,
$1.3 million of open letters of credit was outstanding as of December 31, 2005.

Since March 2003, DBS Bank (Hong Kong) Limited (formerly known as Dao Heng Bank)
has  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 is a
demand  facility and is secured by the pledge of our office  property,  which is
owned by Gerard Guez, our Chairman,  and Todd Kay, our Vice Chairman, and by our
guarantee.  The  letter of  credit  facility  was  increased  to HKD 30  million


                                      F-21
<PAGE>


(equivalent  to US $3.9  million) in June 2004.  As of December 31,  2005,  $2.9
million was outstanding under this facility.  In addition,  $1.1 million of open
letters of credit was outstanding and $0 was available for future  borrowings as
of  December  31,  2005.  In  October  2005,  a tax loan for HKD  6.233  million
(equivalent   to  US  $804,000)  was  also  made  available  to  our  Hong  Kong
subsidiaries.  As of December 31, 2005,  $675,000 was outstanding under this tax
loan.

As of December 31, 2005, the total balance outstanding under the DBS Bank credit
facilities was $3.6 million (classified above as follows: $1.3 million in import
trade bills payable, $0.5 million in bank direct acceptances and $1.8 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, 2005,  $1.0 million was  outstanding
under this facility (classified above under import trade bills payable) and $7.1
million  of  letters  of  credit  were 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 February 14, 2005, we borrowed $5.0 million from Max Azria, which amount bore
interest at the rate of 4% per annum and was payable in weekly  installments  of
$250,000  beginning on February 28, 2005.  This was an unsecured  loan. In early
August 2005, we repaid the remaining balance of this loan in its entirety.

EQUIPMENT FINANCING

We had three equipment loans  outstanding at December 31, 2005 totaling $83,000.
One of these  equipment  loans  bears  interest  at 6% payable  in  installments
through 2009,  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.

VENDOR FINANCING

During 2000, we financed equipment  purchases for a manufacturing  facility with
certain vendors. A total of $16.9 million was financed with five-year promissory
notes,  which  bear  interest  ranging  from 7.0% to 7.5%,  and were  payable in
semiannual  payments  commencing in February 2000. All remaining  balances under
these  notes  were  paid  off in  February  2005.  A  portion  of the  debt  was
denominated in Euros.  Unrealized  transaction  (loss) gain  associated with the
debt  denominated  in Euros  totaled  $(561,000),  $367,000 and $0 for the years
ended  December  31,  2003,  2004 and 2005,  respectively.  These  amounts  were
recorded in other income (expense) in the accompanying  consolidated  statements
of operations.

TERM LOAN - UPS

On  December  31,  2004,  our Hong  Kong  subsidiaries  entered  into a new 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 is 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.  This  facility  bore interest at 9.25% per annum at December 31, 2005. On
June 27, 2005, we amended the loan agreement with UPS to reduce the tangible net
worth  requirement at June 30, 2005.  Under the amended loan  agreement,  we are
subject to restrictive  financial covenants of maintaining tangible net worth of
$25  million  at  December  31,  2005 and the last  day of each  fiscal  quarter
thereafter.  There is also a provision  capping maximum capital  expenditure per
quarter at $800,000.  As of December 31, 2005,  we were in  compliance  with the
covenants.  As  of  December  31,  2005,  $2.7  million  was  outstanding.   The
obligations  under the loan  agreement are  collateralized  by the same security
interests and guarantees  provided under our letter of credit facility with UPS.
Additionally,  the term loan is  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, our Chairman, of 4.6 million shares of our common stock.


                                      F-22
<PAGE>


DEBT FACILITY AND FACTORING AGREEMENT - GMAC

We were previously party to a revolving credit, factoring and security agreement
(the "Debt  Facility")  with GMAC  Commercial  Credit,  LLC ("GMAC").  This Debt
Facility  provided a revolving  facility of $90  million,  including a letter of
credit  facility  not to exceed  $20  million,  and was  scheduled  to mature on
January 31, 2005.  The Debt  Facility  also provided a term loan of $25 million,
which was being repaid in monthly  installments  of $687,500.  The Debt Facility
provided  for  interest  at LIBOR plus the LIBOR rate margin  determined  by the
Total  Leverage  Ratio (as  defined in the Debt  Facility  agreements),  and was
collateralized  by our  receivables,  intangibles,  inventory  and various other
specified  non-equipment  assets.  In May 2004, the maximum  facility amount was
reduced to $45 million in total and we established new financial  covenants with
GMAC for the fiscal year of 2004.

On October 1, 2004,  we amended  and  restated  the Debt  Facility  with GMAC by
entering  into a new  factoring  agreement  with GMAC.  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.  Pursuant to the terms of the factoring  agreement,  we and
our subsidiaries agree to assign and sell to GMAC, 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, in its discretion,  may make advances to us
up to the lesser of (a) up to 90% of our  accounts on which GMAC has the risk of
loss and (b) $40  million,  minus in each case,  any amount  owed by us to GMAC.
Pursuant to the terms of the PBG7 factoring agreement, PBG7 agreed to assign and
sell to  GMAC,  as  factor,  all  accounts,  which  arise  from  PBG7's  sale of
merchandise or rendition of services created on a going-forward basis. At PBG7's
request, GMAC, in its discretion,  may make advances to PBG7 up to the lesser of
(a) up to 90% of PBG7's  accounts on which GMAC has the risk of loss, and (b) $5
million minus in each case, any amounts owed to GMAC by PBG7. The facility bears
interest at 7.385% per annum and the facility  under PBG7, LLC bears interest at
7.75% per annum at December 31, 2005.  Restrictive  covenants  under the revised
facility include a limit on quarterly  capital expenses of $800,000 and tangible
net worth of $25  million at  December  31,  2005 and at the end of each  fiscal
quarter  thereafter.  As of December 31, 2005,  we were in  compliance  with the
covenants.  A total of $30.6 million was outstanding with respect to receivables
factored under the GMAC facility at December 31, 2005.

In May 2005,  we  amended  our  factoring  agreement  with  GMAC to  permit  our
subsidiaries  party  thereto and us, to borrow up to the lesser of $3 million or
fifty percent (50%) of the value of eligible inventory.  In connection with this
amendment,  we granted  GMAC a lien on certain of our  inventory  located in the
United States.  On January 23, 2006, we further amended our factoring  agreement
with GMAC to increase the amount we may borrow  against  inventory to the lesser
of $5 million or 50% of the value of eligible  inventory.  The $5 million  limit
will be reduced to $4 million on April 1, 2006 and will be further reduced to $3
million on July 1, 2006. The maximum borrowing  availability under the factoring
agreement,  based on the borrowing base formula remains at $40 million.  A total
of $3.0  million was  outstanding  under the GMAC  facility at December 31, 2005
with respect to collateralized inventory.

The  credit   facility  with  GMAC  and  the  credit  facility  with  UPS  carry
cross-default  clauses.  A breach  of a  financial  covenant  set by GMAC or UPS
constitutes an event of default under the other credit facility,  entitling both
financial  institutions  to demand  payment in full of all  outstanding  amounts
under their respective debt and credit facilities.

Annual  maturities for the long-term  debt,  convertible  debentures and capital
lease obligations are $36.1 million (2006), $7.1 million (2007), $14,000 (2008),
and $5,000 (2009).  The effective  interest rate on short-term bank borrowing as
of December 31, 2003, 2004 and 2005 were 5.3%, 5.7% and 7.8%, respectively.

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 have 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 have not had to perform under these
guarantees since inception.  It is not predictable to estimate the fair value of


                                      F-23
<PAGE>


the  guarantee;  however,  we do not  anticipate  that we will incur losses as a
result of these  guarantees.  In April 2005, we terminated these guarantees with
respect to Tag-It's obligations arising after the date of termination.

9.       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 may 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
option valuation 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
bear  interest at a rate of 6% per annum and have a term of three years.  We may
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  contain 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  are 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 convertible  debenture
was 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 is
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  option  valuation  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 $620,000  financing cost paid to the placement
agent and the value of the  warrants  to purchase  200,000  shares of our common
stock of  $138,000  are  included in the  deferred  financing  cost,  net on our
accompanying balance sheets and are 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 2005 was  $474,000.  Total  deferred
financing  cost  amortized  in 2005 was  $189,000.  Total  interest  paid to the
holders of the  Debentures in 2005 was $539,000.  As of December 31, 2005,  $6.0
million,  net of $0.9 million of debt discount,  remained  outstanding under the
Debentures.


                                      F-24
<PAGE>


10.      INCOME TAXES

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

                                            YEAR ENDED DECEMBER 31,
                              -------------------------------------------------
                                  2003               2004               2005
                              -----------        -----------        -----------
Current:
  Federal .............       $ 2,400,000        $ 1,000,000        $      --
  State ...............          (241,948)             8,511              2,425
  Foreign .............         2,106,199          1,400,953          1,091,442
                              -----------        -----------        -----------
                                4,264,251          2,409,464          1,093,867
Deferred:
  Federal .............              --                 --                 --
  State ...............              --                 --                 --
  Foreign .............          (132,622)           (61,345)          (166,686)
                              -----------        -----------        -----------
                                 (132,622)           (61,345)          (166,686)
                              -----------        -----------        -----------

    Total .............       $ 4,131,629        $ 2,348,119        $   927,181
                              ===========        ===========        ===========


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

                                           YEAR ENDED DECEMBER 31,
                            ---------------------------------------------------
                                 2003               2004               2005
                            -------------      -------------      -------------

Federal ...............     $ (18,609,818)     $ (14,271,441)     $  (4,481,879)
Foreign ...............       (13,143,213)       (88,057,111)         6,402,404
                            -------------      -------------      -------------

         Total ........     $ (31,753,031)     $(102,328,552)     $   1,920,525
                            =============      =============      =============

Our effective tax rate differs from the statutory  rate  principally  due to the
following reasons: (1) A full 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.

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

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                --------------------------------------------
                                                    2003            2004            2005
                                                ------------    ------------    ------------
<S>                                             <C>             <C>             <C>
Income tax (benefit) based on federal
   statutory rate ...........................   $(11,113,561)   $(35,814,993)   $    672,184
State income taxes, net of federal benefit ..       (157,266)          5,532        (246,978)
Effect of foreign income taxes ..............      2,862,550       2,749,376      (1,316,085)
Nondeductible goodwill impairment ...........      4,141,426            --              --
Nondeductible impairment of long-lived assets           --        30,463,663            --
Increase in tax reserve .....................      2,400,000       1,000,000            --
Increase in valuation allowance
   and other ................................      5,998,480       3,944,541       1,818,060
                                                ------------    ------------    ------------

                                                $  4,131,629    $  2,348,119    $    927,181
                                                ============    ============    ============
</TABLE>


                                      F-25
<PAGE>


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,
                                                          ----------------------------
                                                              2004            2005
                                                          ------------    ------------
<S>                                                       <C>             <C>
Deferred tax assets:
   Provision for doubtful accounts and unissued credits   $    433,261    $    117,979
   Provision for other reserves .......................      1,533,620       2,874,377
   Domestic and foreign loss carry forwards and foreign
      tax credits .....................................      9,789,485      11,162,380
      Goodwill impairment .............................      2,719,294       2,138,984
                                                          ------------    ------------
      Total deferred tax assets .......................     14,475,660      16,293,720

Deferred tax liabilities:
   Other ..............................................       (213,784)        (47,098)
                                                          ------------    ------------
                                                              (213,784)        (47,098)
Valuation allowance for deferred tax assets ...........    (14,475,660)    (16,293,720)
                                                          ------------    ------------

Net deferred tax liabilities ..........................   $   (213,784)   $    (47,098)
                                                          ============    ============
</TABLE>

At  December  31,  2005,  we have $32.1  million of federal net  operating  loss
carryforwards  expiring in 2024. We also have foreign tax credits  carryforwards
totaling $833,000 that do not expire.

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 $6 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 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 cash  flow.  We  believe  we have
provided  adequate  reserves for any reasonably  foreseeable  outcome related to
these matters on the  consolidated  balance sheets included in the  consolidated
financial  statements  under the caption "Income  Taxes".  The maximum amount of
loss in  excess  of the  amount  accrued  in the  financial  statements  is $7.7
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.

11.      COMMITMENTS AND CONTINGENCIES

We  have  entered  into  various  non-cancelable   operating  lease  agreements,
principally  for  executive  office,   warehousing   facilities  and  production
facilities 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:

     2006...................................................      $ 1,188,000
     2007...................................................          710,000
     2008...................................................          585,000
     2009...................................................          600,000
     2010...................................................          627,000
     Thereafter.............................................        3,128,000
                                                                  -----------

         Total future minimum lease payments................      $ 6,838,000
                                                                  ===========


                                      F-26
<PAGE>


Included  in the  future  minimum  lease  payments,  $420,000  payable  to  Lynx
International Limited, a Hong Kong corporation that is owned by Messrs. Guez and
Kay for leasing our warehouse and office space in Hong Kong.  See Note 15 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  $3,101,000,
$2,128,000 and $1,295,000 for 2003, 2004 and 2005, respectively.

We entered  into a new lease  agreement in June 2005 in New York as 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 had open letters of credit of  $5,976,000,  $9,987,000  and  $9,519,000 as of
December 31, 2003, 2004 and 2005, respectively.

We have 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, 2003, 2004 and 2005.

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 in missy,  juniors and large sizes.  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. As of December 31, 2005, we had an
outstanding  advance of $1.1  million.  In March 2006,  we became  involved in a
dispute  with the  licensor of the  Jessica  Simpson  brands over our  continued
rights to these brands.

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  is a  three-year
contract,  and providing  compliance with all terms of the license, is renewable
for one additional three-year term. Minimum net sales are $10 million in year 1,
$20 million in year 2 and $30  million in year 3. The  agreement  also  provides
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 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.  At December  31,  2005,  the total  commitment  on royalties
remaining on the term was $9.1 million.


                                      F-27
<PAGE>


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 stockholder at the time of 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 in exchange for use of the remaining  facilities.  The term
of  the  management  services  agreement  was  also  for a  period  of 6  years.
Additionally,  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.  See Note 15 of the "Notes to  Consolidated
Financial  Statements."  Using current  market prices,  the purchase  commitment
would be approximately $18 million per year.

In  connection  with  the  restructuring  of our  Mexican  operations,  and  the
resulting  reduction in our Mexican work force, we became the target of workers'
rights activists who have picketed our customers,  stuffed electronic  mailboxes
with inaccurate,  protest e-mails, and threatened customers with retaliation for
continuing  business  with  us.  While  we have  defended  our  position  to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and  contemplated
by these activist  groups.  As a consequence of these actions,  we experienced a
significant  decline in  revenue  of  approximately  $75  million  from sales of
Mexico-produced merchandise in 2004 as compared to 2003.

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 have  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 an
existing purchase commitment  agreement with Mr. Nacif's  affiliates.  In August
2004,  upon  entering  into an  Agreement  for Purchase of Assets,  Mr.  Nacif's
affiliates agreed to suspend our fabric purchase  obligations under the existing
purchase  commitment,  and we agreed to suspend the  affiliates  of Mr.  Nacif's
lease  payment  obligations  under the lease  agreements  pursuant  to which Mr.
Nacif's affiliates operated our manufacturing  facilities in Mexico. See Note 15
of the "Notes to Consolidated Financial Statements."

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.

12.      EQUITY

We have adopted the disclosure  provisions of Statement of Financial  Accounting
Standards  ("SFAS")  No.  148,   "Accounting  for  Stock-Based   Compensation  -
Transition  and  Disclosure,"  an  amendment  of FASB  Statement  No. 123.  This
pronouncement   requires  prominent  disclosures  in  both  annual  and  interim
financial statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported  results.  We account
for stock  compensation  awards under the  intrinsic  value method of Accounting
Principles Board ("APB") Opinion No. 25, rather than the alternative  fair-value
accounting method.  Under the  intrinsic-value  method, if the exercise price of
the employee's  stock options equals the market price of the underlying stock on
the date of the grant, no compensation expense is recognized.

Our Employee Incentive Plan, formerly the 1995 Stock Option Plan, as amended and
restated in May 1999 (the Plan),  has authorized the grant of both incentive and
non-qualified stock options to officers, employees, directors and consultants of
the Company for up to 5,100,000  shares (as adjusted for a stock split effective
May 1998) of our common stock.  The exercise price of incentive  options must be
equal to 100% of fair market  value of common stock on the date of grant and the
exercise price of non-qualified options must not be less than the par value of a
share of common stock on the date of grant.  The Plan was also amended to expand
the types of awards,  which may be  granted  pursuant  thereto to include  stock
appreciation rights,  restricted stock and other performance-based  benefits. At
December 31, 2005, no further options may be granted under the Plan.


                                      F-28
<PAGE>


In October 1998, we granted 1,000,000  non-qualified stock options not under the
Plan.  The options were granted to our Chairman and Vice  Chairman at $13.50 per
share,  the closing sales price of the common stock on the day of the grant. The
options  expire in 2008 and vest  over  four  years.  In May  2002,  we  granted
3,000,000  non-qualified  stock  options not under the Plan.  The  options  were
granted to our  Chairman,  Vice Chairman and Mr. Kamel Nacif at $5.50 per share,
the closing sales price of the common stock on the day of the grant. The options
expire in 2012 and vest over three years. The 1,000,000 stock options granted to
Kamel  Nacif  were  forfeited  in  2005.  In  May  2003,  we  granted  2,000,000
non-qualified  stock  options  not  under  the  Plan to our  Chairman  and  Vice
Chairman.  The options were granted at $3.65 per share,  the closing sales price
of the common stock on the day of the grant. The options expire in 2013 and vest
over four years.  In  December  2003,  we granted  400,000  non-qualified  stock
options not under the Plan to our  President.  The options were granted at $3.94
per share,  the closing sales price of the common stock on the day of the grant.
The options expire in 2013 and vest over four years.

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 (revised 2004) "Share-Based Payment" effective in January 2006.


                                      F-29
<PAGE>


A summary of our stock option activity, and related information is as follows:

<TABLE>
<CAPTION>
                                    2003                        2004                         2005
                         ---------------------------  --------------------------  ---------------------------
                                         WEIGHTED                    WEIGHTED                     WEIGHTED
                                          AVERAGE                    AVERAGE                       AVERAGE
                                         EXERCISE                    EXERCISE                     EXERCISE
                           OPTIONS         PRICE        OPTIONS        PRICE         OPTIONS        PRICE
                         -------------  ------------  -------------  -----------  -------------- ------------
<S>                        <C>             <C>         <C>            <C>          <C>             <C>
Options outstanding at
   beginning of year       6,376,487       $ 8.89      8,926,087      $  7.13       8,331,962      $   7.22
      Granted              3,288,100         3.67         83,000         3.04          42,000          2.44
      Exercised                   --           --             --           --              --            --
      Forfeited             (738,500)        6.91       (677,125)        5.43      (1,573,300)        11.40
      Expired                     --           --             --           --         (67,612)         4.50
                           ---------                   ---------                    ---------

Outstanding at end of
   year                    8,926,087       $ 7.13      8,331,962      $  7.22       6,733,050      $   6.25
                           =========                   =========                    =========

Exercisable at end of
   year                    4,028,487       $10.56      5,251,250      $  9.04       6,733,050      $   6.25
Weighted average per
   option fair value
   of options granted
   during the year                         $ 1.92                     $  1.36                      $   1.13
</TABLE>


The following table summarizes  information  about stock options  outstanding at
December 31, 2005:

<TABLE>
<CAPTION>
                                      OPTIONS OUTSTANDING                         OPTIONS EXERCISABLE
                           ---------------------------------------         -------------------------------
                                             WEIGHTED
                                              AVERAGE     WEIGHTED                              WEIGHTED
                                             REMAINING     AVERAGE                               AVERAGE
                              NUMBER        CONTRACTUAL   EXERCISE             NUMBER           EXERCISE
    EXERCISE PRICE          OUTSTANDING        LIFE         PRICE            EXERCISABLE          PRICE
----------------------------------------------------------------------------------------------------------
<S>                        <C>                  <C>      <C>               <C>                   <C>
   $ 1.39 - $ 2.84              56,000          8.1      $  2.41                56,000           $  2.41
   $ 3.60 - $ 3.68           2,388,050          7.5         3.64             2,388,050              3.64
   $ 3.94 - $ 5.09             763,000          7.2         4.30               763,000              4.30
   $ 5.50                    2,004,000          6.3         5.50             2,004,000              5.50
   $ 5.55 - $ 9.97             444,500          2.4         7.05               444,500              7.05
   $13.50 - $15.50           1,011,000          2.7        13.51             1,011,000             13.51
   $18.44 - $18.50              23,000          2.7        18.50                23,000             18.50
   $33.13 - $39.97              41,500          3.1        39.31                41,500             39.31
   $45.50                        2,000          3.2        45.50                 2,000             45.50
                           -----------                                     -----------

   $ 1.39 - $45.50           6,733,050          6.0      $  6.25             6,733,050           $  6.25
                           ===========                                     ===========
</TABLE>


13.      EQUITY TRANSACTIONS

In  October  2003,  we sold an  aggregate  of  881,732  shares  of the  Series A
Convertible  Preferred  Stock,  at $38 per  share,  to a group of  institutional
investors   and  high  net  worth   individuals   and  raised  an  aggregate  of
approximately  $31 million,  after payment of commissions and expenses.  We used
the  proceeds  of this  offering  to pay down  vendors  and  reduce  debts.  The
preferred  stock was converted  into an aggregate of 8,817,320  shares of common
stock following a special  meeting of  shareholders  held on December 4, 2003 in
accordance with the original  conversion terms. We have registered the shares of
common stock  issued upon  conversion  of the Series A Preferred  Stock with the
Securities and Exchange  Commission for resale by the investors.  In conjunction
with the private placement transaction,  we issued a warrant to purchase 881,732
shares of common stock to the  placement  agent.  The  warrants are  exercisable
beginning  April 17, 2004 through October 17, 2008 and have a per share exercise
price of $4.65.  Warrants were valued using the  Black-Scholes  option valuation


                                      F-30
<PAGE>


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 0.51; and an expected life of four years.

As previously  disclosed,  following a review of the accounting treatment of our
October 2003 private  placement of convertible  preferred  stock, we revised our
accounting  treatment  for this  transaction  to record a beneficial  conversion
feature in accordance  with Emerging  Issues Task Force ("EITF") No. 98-5 and to
restate our financial  statements  for the fiscal years ended  December 31, 2003
and  2004 to  reflect  the  beneficial  conversion  feature  of the  convertible
preferred  stock. We restated our 2003 and 2004 financial  statements to reflect
the recording of the beneficial conversion feature of approximately $7.5 million
in the fourth  quarter of 2003  relating to the  issuance  of 881,732  shares of
Series A convertible  preferred stock. The beneficial  conversion feature of the
preferred  shares in the  amount of $7.5  million  was  recorded  in the  fourth
quarter  of  2003,  resulting  in an  increase  in  loss  per  share  to  common
shareholders  for the year ended December 31, 2003 to $(2.38) per share from the
previously reported $(1.97) per share. The beneficial conversion feature did not
change our reported  earnings  (loss) per share for the year ended  December 31,
2004. The effect of recording the beneficial  conversion feature on the December
31, 2004 financial statements was an increase in the accumulated deficit of $7.5
million and an offsetting increase in contributed  capital.  The restatement did
not change total shareholders' equity at December 31, 2003 or 2004.

In November  2003,  we issued an aggregate of 200,000  shares of common stock to
Antonio  Haddad Haddad,  Miguel Angel Haddad Yunes,  Mario Alberto Haddad Yunes,
and  Marco  Antonio  Haddad  Yunes  in  partial  settlement  of the  balance  of
approximately  $2.5 million in obligations  owed these parties  arising from our
acquisition  of their  factories  in 1998.  The fair value of the  common  stock
issued on the date of issuance was $3.94 per share,  resulting in a reduction of
our obligation by $788,000.

During the year of 2003,  we retired a total of 248,872  shares of common  stock
relating  to  shares   repurchased  but  uncancelled   before  2001  and  shares
repurchased in 2003 from Gabe Zeitouni,  upon exercising his put option under an
agreement dated July 10, 2000.

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  option  valuation  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 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 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  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.


                                      F-31
<PAGE>


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

14.      SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION

                                                 YEAR ENDED DECEMBER 31,
                                        ----------------------------------------
                                           2003           2004           2005
                                        ----------     ----------     ----------

Cash paid for interest ............     $2,856,000     $1,796,000     $3,335,000
                                        ==========     ==========     ==========

Cash paid for income taxes ........     $  378,000     $1,196,000     $  875,000
                                        ==========     ==========     ==========

In 1999, we acquired  Industrial  Exportadora  Famian from the Haddad family. In
accordance  with the  acquisition  agreement,  we had to pay  certain  amount of
earnouts to the vendors annually. As of October 31, 2003, total earnouts accrued
but not paid amounted to about $2.5 million.  In November  2003, we entered into
an  agreement  with the Haddad  family to satisfy  the amount owed by issuing to
four family members a total of 200,000 shares of common stock, with a fair value
of  $788,000.  In  addition,  we gave them  400,000  yards of our stock  fabric,
100,000  pairs of pants,  and a fleet of old  vehicles,  with an aggregate  book
value of  approximately  $1.5  million.  Included in other  income was a gain of
$236,000 resulting from this settlement in 2003.

In 2003, we reduced a shareholder  receivable  for $722,000 from Mr. Kamel Nacif
against vendor payables owed to entities controlled by Mr. Nacif.

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  option valuation 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 option valuation 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 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.

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.


                                      F-32
<PAGE>


15.      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,
                                       -----------------------------------------
                                           2003           2004           2005
                                       -----------    -----------    -----------

Sales to related parties ..........    $22,296,000    $ 3,598,000    $    88,000
Purchases from related parties ....    $72,329,000    $17,875,000    $ 6,987,000

As of December 31, 2004 and 2005,  related party  affiliates were indebted to us
in the amounts of $13.1  million and $8.4 million,  respectively.  These include
amounts due from Gerard  Guez,  our Chairman of $2.5 million and $2.3 million at
December 31, 2004 and 2005, respectively, which have been shown as reductions to
shareholders' equity in the accompanying  financial  statements.  Total interest
paid by Mr.  Guez was  $374,000,  $370,000  and  $209,000  for the  years  ended
December 31, 2003, 2004 and 2005, respectively.

From time to time in the past, we borrowed  funds from,  and advanced  funds to,
Mr. Guez. The greatest  outstanding  balance of such advances to Mr. Guez during
2005 was approximately  $4,766,000. At December 31, 2005, the entire balance due
from  Mr.  Guez   totaling   $2.3  million  was  reflected  as  a  reduction  of
shareholders'  equity.  All  advances  to, and  borrowings  from,  Mr. Guez bore
interest at the rate of 7.75% during the period. Total interest paid by Mr. Guez
was $374,000,  $370,000 and $209,000 for the years ended December 31, 2003, 2004
and 2005,  respectively.  Mr. Guez paid expenses on our behalf of  approximately
$400,000  and  $397,000  for  the  years  ended  December  31,  2004  and  2005,
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.

In February  2004, our Hong Kong  subsidiary  entered into a 50/50 joint venture
with Auto Enterprises  Limited, an unrelated third party, to source products for
Seven  Licensing  Company,  LLC and our private  brands  subsidiary  in mainland
China. On May 31, 2004,  after realizing an accumulated loss from the venture of
approximately  $200,000  (our share being half),  we sold our interest for $1 to
Asia Trading  Limited,  a company owned by Jacqueline Rose, wife of Gerard Guez.
The venture owed us $221,000 as of December 31, 2004.  This amount was repaid in
the first quarter of 2005.

On July 1, 2001, we formed an entity to jointly market,  share certain risks and
achieve   economics  of  scale  with  Azteca  Production   International,   Inc.
("Azteca"),  a corporation  owned by the brothers of Gerard Guez,  our Chairman,
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 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.  Due
to the restructuring of our Mexico operations, we discontinued manufacturing for
UAV  customers  in the second  quarter  of 2004.  UAV makes  purchases  from two
related parties in Mexico, an affiliate of Azteca and Tag-It Pacific, Inc.

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 years ended December 31, 2003, 2004 and 2005
were $8.1  million,  $2.6  million and $0,  respectively.  In 1998, a California
limited  liability  company  owned by our Chairman and Vice  Chairman  purchased
2,300,000  shares of the common stock of Tag-It  Pacific,  Inc.  ("Tag-It")  (or
approximately 37% of such common stock then  outstanding).  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.  We believe that the terms of this
arrangement,  which is subject to the acceptance of our  customers,  are no less


                                      F-33
<PAGE>


favorable to us than could be obtained from unaffiliated  third parties.  Due to
the  restructuring of our Mexico  operations,  Tag-It no longer manages our trim
and  packaging  requirements.  We  purchased  $16.8  million,  $1.0  million and
$450,000 of trim  inventory  from Tag-It for the years ended  December 31, 2003,
2004 and 2005,  respectively.  We also sold to Tag-It $1.5 million from our trim
and fabric  inventory for the year ended  December 31, 2003. We purchased  $37.1
million,  $11.5  million and $135,000 of finished  goods and service from Azteca
and its  affiliates  for the  years  ended  December  31,  2003,  2004 and 2005,
respectively.  Azteca is owned by the brothers of our Chairman, Gerard Guez, and
is the minority  member of our  subsidiary,  United Apparel  Ventures,  LLC. Our
total  sales of fabric and  service  to Azteca in 2003,  2004 and 2005 were $9.9
million,  $1.0  million and $88,000,  respectively.  Two and one half percent of
gross sales as management  fees were paid in 2003,  2004 and 2005 to each of the
members of UAV,  per the  operating  agreement.  The amount paid to Azteca,  the
minority member of UAV, totaled $1.7 million,  $179,000 and $0 in 2003, 2004 and
2005,  respectively.  Net amounts due from these related  parties as of December
31, 2004 and 2005 were $7.8 million and $5.5 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.  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.  See  Note  11
"Commitments  and  Contingencies,"  of  the  "Notes  to  Consolidated  Financial
Statements."  Using current  market  prices,  the purchase  commitment  would be
approximately  $18 million per year. We agreed to pay $1 for each yard of fabric
that we fail to purchase under the agreement. We purchased $3.6 million and $5.3
million of fabric from  Acabados y Terminados  under this  agreement in 2003 and
2004, respectively.

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 have  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.
Net amount due from these related parties as of December 31, 2005 was $236,000.

We  lease  our  executive  offices  in  Los  Angeles,  California  from  GET,  a
corporation  which is owned by Gerard Guez and Todd Kay,  our  Chairman and Vice
Chairman, respectively. 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. We paid $1,330,000 in rent annually in each of 2003 and
2004 and $1,019,000 in 2005 for office and warehouse facilities. Our Los Angeles
offices and  warehouse is leased on a month to month basis.  On January 1, 2006,
we entered into a one year lease agreement with Lynx  International  Limited for
our office space in Hong Kong.

We reimbursed Mr. Guez, our Chairman,  for 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.

At December  31, 2004 and 2005,  we had various  employees  receivable  totaling
$403,000 and $370,000, respectively, included in due from related parties.

We  entered  into  lease   agreements  with  the  former  owners  of  Industrial
Exportadora  Famian and our  former  employees.  Under  theses  leases,  we paid
$943,000  in 2003,  for rent for  sewing and  washing  facilities  in  Tehuacan,
Mexico. All these lease agreements were cancelled in November 2003.


                                      F-34
<PAGE>


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.  The investment in American Rag
Cie, LLC totaling  $2.1 million at December 31, 2005 was accounted for under the
equity method and included in equity  method of  investment on the  accompanying
consolidated balance sheets.

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-35
<PAGE>


16.      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>
2003
Sales......................    $ 291,993,000    $   7,359,000    $   21,071,000    $          --    $          --     $ 320,423,000
Inter-company sales........       33,441,000      112,481,000        75,716,000               --     (221,638,000)               --
                               -------------    -------------    --------------    -------------    --------------    -------------
Total revenue..............    $ 325,434,000    $ 119,840,000    $   96,787,000    $          --    $(221,638,000)    $ 320,423,000
                               =============    =============    ==============    =============    =============     =============

Income (loss) from operations  $(11,078,000)    $   7,556,000    $  (30,116,000)   $          --    $          --     $ (33,638,000)
                               ============     =============    ==============    =============    =============     =============
Interest income............    $     419,000    $     725,000    $        6,000    $          --    $    (725,000)    $     425,000
                               =============    =============    ==============    =============    =============     =============
Interest expense...........    $   5,215,000    $      41,000    $      347,000    $     725,000    $    (725,000)    $   5,603,000
                               =============    =============    ==============    =============    =============     =============
Provision for depreciation
 and amortization..........    $   1,547,000    $     261,000    $   14,290,000    $          --    $          --     $  16,098,000
                               =============    =============    ==============    =============    =============     =============
Capital expenditures.......    $      94,000    $      84,000    $      190,000    $          --    $          --     $     368,000
                               =============    =============    ==============    =============    =============     =============

Total assets...............    $ 128,058,000    $ 117,783,000    $  201,050,000    $ 213,051,000    $(406,837,000)    $ 253,105,000
                               =============    =============    ==============    =============    =============     =============


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
                               =============    =============    ==============    =============    =============     =============
</TABLE>


                                      F-36
<PAGE>


17.      EMPLOYEE BENEFIT PLANS

On  August  1,  1992,  Tarrant  Hong Kong  established  a  defined  contribution
retirement  plan covering all of its Hong Kong employees whose period of service
exceeds 12 months. Plan assets are monitored by a third-party investment manager
and are segregated from those of Tarrant Hong Kong.  Participants may contribute
up to 5% of their  salary to the plan.  We make annual  matching  contributions.
Costs of the plan  charged to  operations  for 2003,  2004 and 2005  amounted to
approximately $157,000, $131,000 and $160,000, 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 2003,  2004 and 2005  amounted  to  approximately  $256,000,
$226,000 and $199,000, respectively.

On December 27, 1995, we established a deferred  compensation plan for executive
officers. Participants may contribute a specific portion of their salary to such
plan. We do not contribute to the Plan.

18.      OTHER INCOME AND EXPENSE

Other income and expense consists of the following:

                                                  YEAR ENDED DECEMBER 31,
                                            ------------------------------------
                                               2003         2004         2005
                                            ----------   ----------   ----------

Rental income ...........................   $3,957,365   $5,854,698   $  193,127
Gain on sale of fixed assets ............         --           --        124,041
Unrealized gain on foreign currency .....         --        367,262         --
Realized gain on foreign currency .......      304,060         --           --
Gain on legal settlement ................      235,785         --           --
Other items .............................      287,269      144,677       37,179
                                            ----------   ----------   ----------
Total other income ......................   $4,784,479   $6,366,637   $  354,347
                                            ==========   ==========   ==========

Unrealized loss on foreign currency .....      560,602         --           --
Realized loss on foreign currency .......         --        511,586         --
Loss on sale of fixed assets ............      593,626         --           --
Other items .............................       28,692       17,671          580
                                            ----------   ----------   ----------
Total other expense .....................   $1,182,920   $  529,257   $      580
                                            ==========   ==========   ==========


19.      LEGAL PROCEEDINGS

1.       PATRICK BENSIMON

On April 12, 2000, we formed a company, Jane Doe International,  LLC ("JDI") for
the sole purpose of purchasing the assets of Needletex,  Inc., owner of the Jane
Doe brand.  JDI was owned 51% by Fashion  Resource (TCL),  Inc., our subsidiary,
and 49% by Needletex,  Inc. In  connection  with the  establishment  of JDI, JDI
entered into an  employment  agreement  with  Patrick  Bensimon,  the  principal
shareholder  of Needletex,  Inc.,  which provided for the payment of a salary to
Patrick  Bensimon  and a  bonus  tied to the new  company's  sales  performance.
Thereafter  a dispute  arose as to whether  Patrick  Bensimon  had  performed in
accordance  with his terms of employment set forth in the Employment  Agreement.
When an amicable  resolution  of this  dispute  could not be  achieved,  Patrick
Bensimon commenced an arbitration  preceding against his employer,  JDI, Fashion
Resource (TCL),  Inc., the managing member of Jane Doe  International and us. On
April 7, 2003,  the  arbitration  panel issued a final award in favor of Patrick


                                      F-37
<PAGE>


Bensimon of $1,425,655 for salary and bonus, plus interest accrued and his costs
and  attorneys  fees in the amount of $489,640.  In January 2004, we settled the
employment  litigation  with  Patrick  Bensimon  for  $1.2  million  in cash and
forgiveness of approximately $859,000 in debts owed by Needletex Inc. As part of
the  settlement,  we received the remaining 49% interest in JDI. We also settled
with our insurance carrier for a cash payment of $330,000. An additional expense
of  approximately  $379,000 was made in the fourth  quarter of 2003 to cover the
forgiveness of debts.

2.       NICOLAS NUNEZ

In March 2005, we reached a settlement of a dispute  involving a former employee
named  Nicolas  Nunez.  Mr.  Nunez  was  employed  by us  pursuant  to a written
employment  agreement  until he was  terminated  in or about  November  2000. In
connection to this  employment,  we agreed to acquire  Nunez' company by merger.
Mr. Nunez  claimed to be entitled to shares of our common stock up to a value of
$500,000  assuming we did not otherwise have valid  defenses to such claims.  In
connection with the  settlement,  we agreed to compensate Mr. Nunez in the total
amount of $875,000. The full amount of $875,000 had been accrued and included in
accrued liabilities in the accompanying  balance sheet at December 31, 2004. All
parties to both  proceedings have agreed to exchange full mutual releases of any
and all  claims,  known or  unknown,  and will  dismiss  both  proceedings  with
prejudice, without admitting any liability.

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.

3.       MR. BENJAMIN DOMINGUEZ GONZALEZ

On December  10, 2004 and December 14, 2004,  Mr.  Benjamin  Dominguez  Gonzalez
brought suits against our Mexico Subsidiary, Tarrant Mexico, S. de R.L. de C.V.,
in Puebla,  Puebla,  Mexico: (a) "Juicio Ejecutivo Mercantil  887/2004,  Juzgado
Dicimo de lo Civil del  Estado de Puebla,  Puebla,  Mexico,  Dominguez  Gonzalez
Benjamin vs. Tarrant  Mexico S. de R.L. de C.V. e  Inmobiliaria  Cuadros S.A. de
C.V."; and (b) "Juicio Ejecutivo Mercantil 889/2004,  Juzgado Noveno de lo Civil
del Estado de Puebla,  Puebla,  Mexico,  Dominguez Gonzalez Benjamin vs. Tarrant
Mexico  S. de R.L.  de C.V.  e  Inmobiliaria  Cuadros  S.A.  de  C.V.",  for the
non-payment  of  approximately  $14  million in  principal  amount  and  accrued
interest on two  promissory  notes,  which Mr.  Gonzalez  asserts were issued by
Tarrant Mexico.  The amounts Mr.  Gonzalez  claimed were due and owing under the
notes  previously had been paid in full. In April 2005, Mr.  Gonzalez  agreed to
dismiss his claims, which agreement has been approved by the court.

4.       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.  This case is currently  pending in the United States District Court
for the Southern District of New York and is scheduled for trial on December 18,
2006. We will continue to vigorously  defend  against the breach of contract and
unjust enrichment claim.


                                      F-38
<PAGE>


20.      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>
2004
Net sales ..........................   $ 42,155    $ 38,489    $ 38,102    $ 36,707
Gross profit .......................      7,500       5,266       4,135       4,060
Operating loss .....................     (5,963)    (84,585)     (3,626)    (27,613)
Net loss ...........................   $ (2,974)   $(68,567)   $ (4,019)   $(29,117)
Net loss per common share:
   Basic ...........................   $  (0.10)   $  (2.39)   $  (0.14)   $  (1.01)
   Diluted .........................   $  (0.10)   $  (2.39)   $  (0.14)   $  (1.01)
Weighted average shares outstanding:
   Basic ...........................     28,485      28,649      28,815      28,815
   Diluted .........................     28,485      28,649      28,815      28,815

2005
Net sales ..........................   $ 44,830    $ 50,538    $ 69,566    $ 49,714
Gross profit .......................      8,946      11,454      14,545       9,936
Operating income ...................        233       1,437       3,011      (1,056)
Net income (loss) ..................   $   (106)   $    871    $  1,702    $ (1,474)
Net 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
</TABLE>


                                      F-39
<PAGE>


21.      SUBSEQUENT EVENTS

On January 19, 2006, we borrowed $4 million from Max Azria pursuant to the terms
of a promissory  note, which amount bears interest at the rate of 5.5% per annum
and is payable in weekly  installments  of $200,000  beginning on March 1, 2006.
This is an unsecured loan.

On January 23, 2006,  we further  amended our factoring  agreement  with GMAC to
increase the amount we may borrow against  inventory to the lesser of $5 million
or 50% of the value of eligible inventory.  The $5 million limit will be reduced
to $4 million on April 1, 2006 and will be further reduced to $3 million on July
1, 2006. The maximum borrowing availability under the factoring agreement, based
on the borrowing base formula remains at $40 million.

On January 27, 2006, we further  amended the letter of credit  facility with UPS
to extend the expiration  date of the facility from January 31, 2006 to July 31,
2006.  The amendment  provides for reduction of the maximum amount of borrowings
under the facility to $12.0 million  commencing on April 1, 2006,  $11.5 million
commencing on May 1, 2006, $11.0 million commencing on June 1, 2006 and to $10.5
million commencing on July 1, 2006. Under the amended letter of credit facility,
we are subject to restrictive  financial  covenants of maintaining  tangible net
worth of $25  million as of  December  31,  2005 and the last day of each fiscal
quarter   thereafter.   There  is  also  a  provision  capping  maximum  capital
expenditures per quarter of $800,000.

In March 2006, we terminated our license agreement for the brand House of Dereon
by Tina  Knowles  branded  apparel,  and sold  our  remaining  inventory  to the
licensor.  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 March 2006, we became  involved in a dispute with the master  licensor of the
JS by Jessica Simpson,  Princy and Sweet Kisses brands over our continued rights
to these brands.  Accordingly,  we do not  anticipate  sales of Jessica  Simpson
branded  apparel unless and until we  successfully  resolve our dispute with the
licensor.  Net sales of Jessica  Simpson and Princy by Jessica  Simpson  totaled
$12.6 million in 2005.


                                      F-40
<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, 2003
  Allowance for returns and discounts...   $ 3,134,768   $      --     $      --     $  (324,387)   $ 2,810,381
  Allowance for bad debt ...............   $ 1,181,853   $   234,149   $      --     $      --      $ 1,416,002
    Inventory reserve ..................   $      --     $10,986,153   $      --     $      --      $10,986,153
                                           ===========   ===========   ===========   ===========    ===========

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
                                           ===========   ===========   ===========   ===========    ===========
</TABLE>


                                      F-41
<PAGE>



                                                                    AMERICAN RAG
                                                   COMBINED FINANCIAL STATEMENTS
                                                              FOR THE YEAR ENDED
                                                               DECEMBER 31, 2005






                                      F-42
<PAGE>


                          INDEPENDENT AUDITOR'S REPORT


To the Board of Directors
American Rag
Montebello, California

We have audited the  accompanying  combined  balance  sheet of American Rag (the
"Company")  and its  combined  affiliate as of December 31, 2005 and the related
combined  statements of income,  stockholders'  equity/members'  equity and cash
flows for the year then ended. 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 auditing standards  generally accepted
in the  United  States of  America.  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  audit  provides  a
reasonable basis for our opinion.

In our opinion,  the combined  financial  statements  referred to above  present
fairly, in all material respects, the financial position of American Rag and its
combined  affiliate as of December 31, 2005 and the results of their  operations
and their cash flows for the year then  ended,  in  conformity  with  accounting
principles generally accepted in the United States of America.

As described in Note 2 to the financial  statements,  the accompanying  combined
financial statements for the year ended December 31, 2005 have been restated.


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


Los Angeles, California
September 26, 2007


                                      F-43
<PAGE>


                                                                    AMERICAN RAG
                                                          COMBINED BALANCE SHEET
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------

ASSETS

CURRENT ASSETS
   Cash and cash equivalents ....................................     $  149,136
   Accounts receivable ..........................................         43,654
   Accounts receivable from member ..............................         41,000
   Note receivable from member ..................................         75,000
   Inventory, net ...............................................      1,571,458
   Prepaid expenses and other current assets ....................          9,141
                                                                      ----------

         Total current assets ...................................      1,889,389

PROPERTY AND EQUIPMENT, net of accumulated
   depreciation and amortization ................................        480,540

DEPOSITS ........................................................         64,848
                                                                      ----------

TOTAL ASSETS ....................................................     $2,434,777
                                                                      ==========

LIABILITIES AND STOCKHOLDERS' EQUITY/MEMBERS' EQUITY

CURRENT LIABILITIES
   Accounts payable .............................................     $  282,748
   Accrued expenses .............................................        209,143
   Unearned revenue .............................................         22,816
   Deferred rent - current portion ..............................          4,232
   Notes payable ................................................        114,629
   Current maturities on obligations under capital lease ........          7,782
                                                                      ----------

         Total current liabilities ..............................        641,350

OBLIGATIONS UNDER CAPITAL LEASE, LESS CURRENT MATURITIES ........         19,462

DEFERRED RENT - LONG TERM PORTION ...............................         64,153
                                                                      ----------

         Total liabilities ......................................        724,965

STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
   American Rag Compagnie, Inc. .................................        316,910
   American Rag CIE, LLC ........................................      1,392,902
                                                                      ----------

           Total stockholders' equity/members' equity ...........      1,709,812
                                                                      ----------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY/MEMBERS' EQUITY ......     $2,434,777
                                                                      ==========


    The accompanying notes are an integral part of these financial statements


                                      F-44
<PAGE>


                                                                    AMERICAN RAG
                                                    COMBINED STATEMENT OF INCOME
                                            FOR THE YEAR ENDED DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------




NET SALES ...................................................        $10,125,563
COST OF SALES ...............................................          5,032,855
                                                                     -----------

GROSS PROFIT ................................................          5,092,708
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ................          4,507,227
                                                                     -----------

INCOME FROM OPERATIONS ......................................            585,481

INTEREST EXPENSE ............................................             17,433
OTHER INCOME (EXPENSE) ......................................            602,449
                                                                     -----------

INCOME BEFORE INCOME TAXES ..................................          1,170,497
INCOME TAXES ................................................             18,066
                                                                     -----------

NET INCOME ..................................................        $ 1,152,431
                                                                     ===========


    The accompanying notes are an integral part of these financial statements


                                      F-45
<PAGE>


<TABLE>

                                                                                                      AMERICAN RAG
                                                        COMBINED STATEMENT OF STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
                                                                              FOR THE YEAR ENDED DECEMBER 31, 2005
                                                                                                          RESTATED
------------------------------------------------------------------------------------------------------------------
<CAPTION>
                                 American
                                 Rag CIE,
                                   LLC                     American Rag Compagnie, Inc.
                               -----------    ----------------------------------------------------        Total
                                 Members'          Common Stock (a)                                   Stockholders'
                                 Equity       -------------------------   Additional                      Equity
                               -----------      Shares                      Paid-in       Retained      /Members'
                                 Amount       Outstanding     Amount        Capital       Earnings        Equity
                               -----------    -----------   -----------   -----------   -----------    -----------
<S>                            <C>                 <C>      <C>           <C>           <C>            <C>
Balance at January 1, 2005 .   $ 1,216,807         10,870   $   100,000   $     2,618   $   215,914    $ 1,535,339


Distributions ..............      (977,958)          --            --            --            --         (977,958)


Net income (loss) ..........     1,154,053           --            --            --          (1,622)     1,152,431
                               -----------    -----------   -----------   -----------   -----------    -----------

Balance at December 31, 2005   $ 1,392,902         10,870   $   100,000   $     2,618   $   214,292    $ 1,709,812
                               ===========    ===========   ===========   ===========   ===========    ===========
</TABLE>



(a) Common stock,  no par value,  500,000  shares  authorized  and 10,870 shares
issued at January 1, 2005 and December 31, 2005.


    The accompanying notes are an integral part of these financial statements


                                      F-46
<PAGE>


                                                                    AMERICAN RAG
                                                COMBINED STATEMENT OF CASH FLOWS
                                            FOR THE YEAR ENDED DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
     Net income ...............................................     $ 1,152,431

     ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
         PROVIDED BY OPERATING ACTIVITIES
            Depreciation and amortization .....................          76,241

     CHANGES IN ASSETS AND LIABILITIES
         (INCREASE) DECREASE IN ASSETS
            Accounts receivable ...............................         (11,983)
            Accounts receivable from members ..................          60,495
            Inventory .........................................        (356,472)
            Prepaid expenses and other current assets .........           6,820
            Deposits ..........................................         (30,813)

         INCREASE (DECREASE) IN LIABILITIES
            Accounts payable ..................................         (96,740)
            Accrued expenses ..................................          74,461
            Deferred Rent .....................................          68,385
            Unearned revenue ..................................          22,816
                                                                    -----------

               Net cash provided by operating activities ......         965,641

CASH FLOWS (USED IN) INVESTING ACTIVITIES

     Payments to acquire property and equipment ...............         (22,111)
                                                                    -----------

               Net cash used in investing activities ..........         (22,111)

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
     Note receivable from member ..............................         300,000
     Payments on capital lease obligations ....................          (6,370)
     Payments on notes payable ................................        (149,239)
     Distributions to members .................................        (977,958)
                                                                    -----------

               Net cash used in financing activities ..........        (833,567)
                                                                    -----------

NET INCREASE IN CASH ..........................................         109,963
CASH, beginning of year .......................................          39,173
                                                                    -----------

CASH, end of year .............................................     $   149,136
                                                                    ===========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
     Interest paid ............................................     $    17,433
                                                                    ===========
     Taxes paid ...............................................     $    13,390
                                                                    ===========


    The accompanying notes are an integral part of these financial statements


                                      F-47
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 1 - NATURE OF BUSINESS,  OWNERSHIP  AND SUMMARY OF  SIGNIFICANT  ACCOUNTING
         POLICIES

         NATURE OF BUSINESS

         BUSINESS ACTIVITY
         The Company imports and operates retail men's and women's  Avante-Garde
         lifestyle clothing,  including emerging  designers,  jeans wear, shoes,
         accessories, home furnishings,  vintage clothing, CDs and other related
         items, in its Los Angeles and San Francisco stores.

         PRINCIPLES OF COMBINATION AND BASIS OF PRESENTATION
         The combined financial  statements include the accounts of American Rag
         CIE, LLC and American Rag Compagnie,  Inc., collectively referred to as
         "American  Rag" or the  "Company,"  which are  affiliated  by virtue of
         common ownership. All significant intercompany transactions and related
         party balances have been eliminated in combination.

         OWNERSHIP
         American Rag CIE, LLC is a California  limited  liability  company that
         was formed on June 19, 2003, with a term through December 15, 2080. 55%
         of American  Rag CIE, LLC is owned by American Rag CIE II, Inc. and 45%
         owned by Tarrant Apparel Group.

         American Rag Compagnie, Inc. was incorporated on July 6, 1984, and is a
         C Corporation.

         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         FAIR VALUE
         Unless otherwise indicated,  the fair values of all reported assets and
         liabilities,  which represent financial instruments,  none of which are
         held for trading purposes, approximate carrying values of such amounts.

         USE OF ESTIMATES
         The  preparation of combined  financial  statements in conformity  with
         generally accepted  accounting  principles  requires management to make
         estimates and  assumptions  that affect the reported  amounts of assets
         and liabilities and disclosure of contingent  assets and liabilities at
         the date of the combined financial  statements and the reported amounts
         of revenues and expenses  during the reporting  period.  Actual results
         could differ from those estimates.

         REVENUE RECOGNITION
         The Company recognizes revenue upon the sale of retail merchandise, net
         of returns and discounts.

         COST OF SALES
         Cost of sales includes cost related to product costs, and freight in.


                                      F-48
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 1 - NATURE OF  BUSINESS  OWNERSHIP  AND SUMMARY OF  SIGNIFICANT  ACCOUNTING
         POLICIES (CONTINUED)

         SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
         Selling,  general and administrative  expenses include expenses related
         to salaries,  rent, insurance,  bank charges, travel and entertainment,
         professional  fees,  depreciation  and  amortization,  and other office
         expenses.

         UNEARNED REVENUE
         The Company records unearned revenue in the accompanying  balance sheet
         on gift  cards sold but not  redeemed  by  customers  at the end of the
         year.

         DEFERRED RENT
         The  Company  records  rent  expense  related  to  its   non-cancelable
         operating  leases on a straight line basis over the initial term of the
         lease.  The  difference  between the average  rental amount  charged to
         expense  and  amounts  payable  under the lease is included in deferred
         rent in the accompanying balance sheet.

         ADVERTISING
         The  Company  expenses  advertising  costs,   consisting  primarily  of
         placement  in multiple  publications,  along with  design and  printing
         costs of sales materials.

         Advertising  expense for the year ended  December 31, 2005  amounted to
         $6,792.

         CASH AND CASH EQUIVALENTS
         The  Company  maintains  its  cash  balances  in  high  credit  quality
         financial  institutions;  balances,  at  times,  may  exceed  federally
         insured  limits.  The  Company has not  experienced  any losses in such
         accounts.  For purposes of reporting the  statement of cash flows,  the
         Company  considers  all  cash  accounts,   which  are  not  subject  to
         withdrawal  restrictions  or  penalties,  and all  highly  liquid  debt
         instruments  purchased  with a maturity  of three  months or less to be
         cash equivalents.

         INVENTORY
         Inventory  is valued  at the  lower of cost or  market  on a  first-in,
         first-out basis.  Inventory consists of men's and women's  Avante-Garde
         lifestyle clothing,  including emerging  designers,  jeans wear, shoes,
         accessories, home furnishings,  vintage clothing, CDs and other related
         items.

         ACCOUNTS RECEIVABLE
         Accounts receivable are receivables outstanding from commercial buyers.
         Accounts  receivable  are  evaluated on an  item-by-item  basis and are
         written-off if deemed uncollectible.


                                      F-49
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 1 - NATURE OF  BUSINESS  OWNERSHIP  AND SUMMARY OF  SIGNIFICANT  ACCOUNTING
         POLICIES (CONTINUED)

         PROPERTY AND EQUIPMENT
         Property and equipment is stated at cost. Depreciation and amortization
         are provided by the use of straight-line  and accelerated  methods over
         the estimated  useful lives of the assets.  Leasehold  improvements are
         amortized  using  the  straight-line  method  over the  lesser of their
         estimated useful lives or the term of the lease.

         INCOME TAXES
         American  Rag  Compagnie,  Inc. is a California  C  Corporation  with a
         fiscal year-end of December 31.

         The Company recognizes deferred tax assets and liabilities with respect
         to the tax  consequences  attributable to the  differences  between the
         financial  statements  carrying  values  and tax  bases of  assets  and
         liabilities.  Deferred tax assets and  liabilities  are measured  using
         enacted tax rates  expected to apply to taxable  income in the years in
         which these  temporary  differences  are  expected to be  recovered  or
         settled.  Further, the effect on deferred tax assets and liabilities of
         a change  in tax rates is  recognized  in  income  in the  period  that
         includes the enactment  date.  Deferred tax assets and  liabilities are
         immaterial.

         The  Company  has a  California  net  operating  loss carry  forward of
         $50,034 which expires in 2013.

         American Rag CIE, LLC, and its members,  elected income tax status as a
         limited  liability  company from its  inception.  Under this  election,
         members of the American Rag CIE, LLC are personally  liable for federal
         and state income  taxes.  American Rag CIE, LLC is liable for its state
         taxes based on revenues.


                                      F-50
<PAGE>



                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


         NOTE 2 - RESTATED FINANCIAL STATEMENTS

         The Company has restated its financial  statements as of the year ended
         December 31, 2005 and the related notes to the financial statements.

         This  restatement is to correct  errors  identified in: (a) the revenue
         recognition  related to gift cards sold that were  recorded  as revenue
         rather than an unearned  revenue.  The  revenue has been  corrected  to
         reflect  recognition of the revenue as the gift cards are used. (b) the
         Company had not record its operating  lease expense on a  straight-line
         basis as required  under GAAP.  The  statements  have been  restated to
         correct this accounting treatment.

         The  following  table  shows the  impact of these  restatements  on the
         financial statements as of and for the year ended December 31, 2005.

<TABLE>
<CAPTION>
                                                PREVIOUSLY
                                                 REPORTED                     RESTATED
                                               DECEMBER 31,                 DECEMBER 31,
                                                   2005      ADJUSTMENTS        2005
                                               -----------   -----------    -----------
<S>                                            <C>           <C>            <C>
BALANCE SHEET
Deferred rent - current portion ............   $      --     $     4,232    $     4,232
Deferred rent - long term portion ..........          --          64,153         64,153
Unearned revenue ...........................          --          22,816         22,816
         TOTAL LIABILITIES .................       633,764        91,201        724,965

American Rag Compangnie, Inc. ..............       322,981        (6,071)       316,910
American Rag CIE, LLC ......................     1,478,032       (85,130)     1,392,902
         TOTAL STOCKHOLDER'S EQUITY ........   $ 1,801,013   $   (91,201)   $ 1,709,812

STATEMENT OF CASH FLOWS
Deferred rent ..............................   $      --     $    68,385    $    68,385
Unearned revenue ...........................   $      --     $    22,816    $    22,816

STATEMENT OF INCOME
Net sales ..................................   $10,148,379   $   (22,816)   $10,125,563
Selling, general and administrative expenses     4,438,842        68,385      4,507,227
Net income .................................   $ 1,243,632   $   (91,201)   $ 1,152,431
</TABLE>


                                      F-51
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 3 - ACCOUNT RECEIVABLE FROM MEMBER

         As of December 31, 2005, there was an outstanding, non-interest bearing
         advance to one of the members for $41,000. The advance was to be repaid
         before the end of the following year.

NOTE 4 - NOTE RECEIVABLE FROM MEMBER

         Effective  June 19,  2003,  American  Rag CIE,  LLC  received a capital
         contribution  and a note  receivable in the amount of $1,000,000 from a
         member who has a 45%  ownership  in  American  Rag CIE,  LLC.  Payments
         totaling  $925,000 were received through December 31, 2005. At December
         31, 2005,  the balance on the note  receivable  was $75,000.  The final
         payment is due March 31, 2006 with  interest at 4% per annum.  The note
         is secured by the member's interest in American Rag CIE, LLC.


NOTE 5 - INVENTORY

         Inventory  consists  of  men's  and  women's   Avante-Garde   lifestyle
         clothing, including emerging designers, jeans wear, shoes, accessories,
         home furnishings, vintage clothing, CDs and other related items.


NOTE 6 - PROPERTY AND EQUIPMENT

         A summary is as follows:

          Furniture and equipment ......................   $  912,508
          Leasehold improvements .......................      764,029
          Automobiles ..................................      114,359
          Hydraulic press and forklift .................       31,085
                                                           ----------

                                                            1,821,981
          Less accumulated depreciation and amortization    1,341,441
                                                           ----------

                                                           $  480,540
                                                           ==========

         Depreciation  and amortization for the year ended December 31, 2005 was
         $76,241.

NOTE 7 - DEPOSIT

         The Company paid security  deposits on leased  facilities.  At December
         31, 2005, the Company had paid $64,848.


                                      F-52
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 8 - NOTE PAYABLE

         The Company may borrow up to $250,000  under a revolving line of credit
         agreement  expiring June 3, 2006.  Interest is payable monthly at prime
         plus 1%. At December 31, 2005, the Company had borrowings of $88,045.

         The Company entered into a note for $300,000  bearing interest at prime
         plus 1% and is due on May 8, 2006.  Monthly  payments of $9,037 include
         variable  interest,  as  charged  on the  outstanding  debt,  with  the
         remaining portion of the payment  consisting of principal.  At December
         31, 2005, the Company had borrowings of $26,584.

         The notes are  secured by all  assets of the  Company  and by  personal
         guaranties from the majority stockholders.

         A summary is as follows:

                         Line of credit ...   $ 88,045
                         Note payable, bank     26,584
                                              --------
                                              $114,629
                                              ========

NOTE 9 - OBLIGATION UNDER CAPITAL LEASE

         The Company leases an automobile from an unrelated party under terms of
         a  capital  lease  at an  annual  interest  rate of  6.85%  payable  in
         installments  through  2009.  The  lease  is  secured  by  the  related
         automobile costing $40,122 with accumulated  depreciation of $15,625 at
         December 31, 2005.  Interest  expense on the capital lease  amounted to
         $2,176 for the year ended December 31, 2005.

         The  following  is a  schedule  by years of  future  minimum  principal
         payments required under the capital lease:

         Year ending December 31,
                    2006                              $  9,027
                    2007                                 9,027
                    2008                                 9,027
                    2009                                 1,699
                                                      --------

         Total minimum lease payments                   28,780
         Less amounts representing interest              1,536
                                                      --------

         Present value of minimum lease payments        27,244
         Less current maturities                         7,782
                                                      --------

                                                      $ 19,462
                                                      ========


                                      F-53
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 10 - RELATED PARTY

         The Company  rents  office  space from HKW Partners on a month to month
         basis at a rate of $2,500. HKW Partners is beneficially owned by one of
         the members.


NOTE 11 - LICENSING AGREEMENT

         On April 1, 2003, the Company  entered into an agreement to license the
         use of the American Rag trademark to Tarrant  Apparel  Group's  related
         company,  allowing  the  licensee to  manufacture  and sell apparel and
         accessories under this trademark. The term of the license is from April
         1, 2003 to December 31,  2013,  and the licensee may elect to renew for
         three  consecutive  ten-year  periods on the same terms and conditions.
         The  license  calls for the  licensee to make  royalty  payments to the
         Company of 2.05% of net sales of all  licensee  products  in the United
         States,  Canada,  Mexico,  and  Bermuda,  and  4% of net  sales  of all
         licensed  products  worldwide,  except Japan,  with guaranteed  minimum
         annual royalty payments as follows:

                                             GUARANTEED
         YEAR                              MINIMUM ROYALTY
         ----                             ---------------
         2006                             $       661,250
         2007                                     760,438
         2008                                     874,504
         2009                                   1,005,680
         2010                                   1,156,532
         2011                                   1,330,012
         2012                                   1,529,514
         2013                                   1,750,000
                                          ---------------
         Total                            $     9,067,930
                                          ===============
         Annually thereafter              $     1,750,000
                                          ===============

         Royalty income  amounted to the minimum  guaranteed  royalty payment of
         $575,000 for the year ended December 31, 2005.


                                      F-54
<PAGE>


                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTE 12 - COMMITMENTS

         The  Company  conducts  its  operations  in  leased   facilities  under
         operating  leases  expiring at various  dates.  Certain of these leases
         contain  base rent  escalation  as well as renewal  provisions.  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.  The following is a schedule by years based on cash payments on
         future minimum rental payments required under the operating leases that
         have  non-cancelable  lease  terms in excess of one year as of December
         31, 2005:

                                           OPERATING     SUBLEASE
                                             LEASES       INCOME        TOTAL
                                          -----------   ----------   -----------
         Year ending December 31,
                  2006                    $   726,625   $   54,500   $   672,125
                  2007                        737,950            -       737,950
                  2008                        658,440            -       658,440
                  2009                        493,016            -       493,016
                  2010                        376,499            -       376,499
                  After 2010                2,164,871            -     2,164,871
                                          -----------   ----------   -----------

                                          $ 5,157,401   $   54,500   $ 5,102,901
                                          ===========   ==========   ===========

         Rent is adjusted  annually  based on increases  in the  Consumer  Price
         Index, if any, and payments of certain  additional  expenses  including
         utilities,  property  taxes and other  operating  expenses is required.
         Certain leases provide for renewal options.

         Rent expense  charged to  operations  amounted to $842,398 for the year
         ended  December 31, 2005.  As of December  31, 2005,  deferred  rent of
         $68,385 was recorded in the Company's combined balance sheet.

         Sublease rental income amounted to $101,012 for the year ended December
         31, 2005.

         The Company  also rents  office  space from HKW  Partners on a month to
         month basis at a rate of $2,500.  HKW Partners is beneficially owned by
         one of the members.


                                      F-55
<PAGE>



                                                                    AMERICAN RAG
                                          NOTES TO COMBINED FINANCIAL STATEMENTS
                                                               DECEMBER 31, 2005
                                                                        RESTATED
--------------------------------------------------------------------------------


NOTES 13 - SUBSEQUENT EVENTS

         NEW STORE LOCATION
         In September 2006, the Company opened a new store in the Fashion Island
         shopping center in Newport Beach, California.

         LEASE AMENDMENT
         In June 2007,  the Company  amended  the lease for its  Fashion  Island
         location.  The  Company  will  pay  rent at the  rate  of 12% of  sales
         effective  March 1, 2007.  The  difference  between that amount and the
         prior rental rate will be deferred until the store achieves  annualized
         sales that exceed $5,500,000.

         BANK LINE OF CREDIT / NOTES PAYABLE - CALIFORNIA UNITED BANK
         In June 2006, the Company negotiated a new bank line and note facility.
         The terms are summarized as follows:

         Line of credit facility of $500,000,  secured by  substantially  all of
         the Company's  assets,  payable in full on maturity date April 15, 2007
         at 8% per annum;

         Note payable facility of $500,000,  secured by substantially all of the
         Company's assets, payable in equal monthly installments of $13,889 plus
         interest of 8.50% through maturity of December 15, 2009;

         Note payable facility of $500,000,  secured by substantially all of the
         Company's  assets,  payable in equal monthly  installments  of $13,889,
         commencing  July 15, 2007,  plus interest of 8.50% through  maturity at
         June 15, 2010.

         The Company is in the process of renewing the line of credit facility.


                                      F-56
<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
                                                Chairman of the Board



         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
             ---------                       -----                    ----

                                   Chief Executive Officer      October 10, 2007
         /S/ GERARD GUEZ           and Chairman of the Board
--------------------------------   of Directors (Principal
           Gerard Buez             Executive Officer)

         /S/ DAVID BURKE           Chief Financial Officer      October 10, 2007
--------------------------------   (Principal Financial
           David Burke             and Accounting Officer)

                *                  Vice Chairman of the Board   October 10, 2007
--------------------------------   of Directors
            Todd Kay

                *                  Director                     October 10, 2007
--------------------------------
         Milton Koffman

                *                  Director                     October 10, 2007
--------------------------------
        Stephane Farouze

                *                  Director                     October 10, 2007
--------------------------------
         Mitchell Simbal

                *                  Director                     October 10, 2007
--------------------------------
         Joseph Mizrachi

                *                  Director                     October 10, 2007
--------------------------------
           Simon Mani


* By: /S/ GERARD GUEZ
      --------------------------------
      Gerard Guez, As Attorney-In-Fact


                                      S-1