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


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

                                    FORM 10-Q

                                   (MARK ONE)

|X|      QUARTERLY  REPORT  PURSUANT  TO SECTION  13 OR 15(D) OF THE  SECURITIES
         EXCHANGE ACT OF 1934.

                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

                                       OR

|_|      TRANSITION  REPORT  PURSUANT  TO SECTION 13 OR 15(D) OF THE  SECURITIES
         EXCHANGE   ACT  OF   1934.

                FOR THE TRANSITION PERIOD FROM _____________ TO

                         COMMISSION FILE NUMBER: 0-26006

                                   ----------

                              TARRANT APPAREL GROUP
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

           CALIFORNIA                                          95-4181026
(STATE OR OTHER JURISDICTION OF                             (I.R.S. EMPLOYER
 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

         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 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]


Number of shares of Common Stock of the  Registrant  outstanding  as of November
10, 2006: 30,543,763.


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





                              TARRANT APPAREL GROUP
                                    FORM 10-Q
                                      INDEX

                          PART I. FINANCIAL INFORMATION
                                                                            PAGE
                                                                            ----
Item 1.  Financial Statements

         Consolidated Balance Sheets at September 30, 2006 (unaudited)
         and December 31, 2005.............................................    2

         Consolidated Statements of Operations  for the Three Months
         and Nine Months Ended September 30, 2006 and September 30, 2005
         (unaudited).......................................................    3

         Consolidated Statements of Cash Flows for the Nine Months
         Ended September 30, 2006 and September 30, 2005 (unaudited).......    4

         Notes to Consolidated Financial Statements (unaudited)............    5

Item 2.  Management's Discussion and Analysis of Financial Condition
         and Results of Operations ........................................   24

Item 3.  Quantitative and Qualitative Disclosures About Market Risk .......   39

Item 4.  Controls and Procedures...........................................   39

                           PART II. OTHER INFORMATION

Item 1.  Legal Proceedings.................................................   40

Item 1A. Risk Factors......................................................   40

Item 6.  Exhibits..........................................................   46

         SIGNATURES........................................................   47


             CAUTIONARY LEGEND REGARDING FORWARD-LOOKING STATEMENTS

         Some of the  information  in this  Quarterly  Report  on Form  10-Q may
constitute  forward-looking  statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the  Securities  Exchange Act of 1934,
both as amended.  These forward-looking  statements are subject to various risks
and uncertainties.  The forward-looking  statements include, without limitation,
statements  regarding our future  business  plans and  strategies and our future
financial  position or results of operations,  as well as other  statements that
are not historical.  You can find many of these  statements by looking for words
like  "will",  "may",   "believes",   "expects",   "anticipates",   "plans"  and
"estimates"  and for similar  expressions.  Because  forward-looking  statements
involve  risks and  uncertainties,  there are many  factors that could cause the
actual  results to differ  materially  from those  expressed  or implied.  These
include, but are not limited to, economic  conditions.  This Quarterly Report on
Form 10-Q contains important  cautionary  statements and a discussion of many of
the  factors   that  could   materially   affect  the   accuracy  of   Tarrant's
forward-looking  statements and such statements and discussions are incorporated
herein by reference.  Any subsequent written or oral forward-looking  statements
made by us or any person acting on our behalf are qualified in their entirety by
the cautionary  statements and factors contained or referred to in this section.
We do not intend or  undertake  any  obligation  to update  any  forward-looking
statements to reflect events or circumstances after the date of this document or
the date on which any subsequent forward-looking statement is made or to reflect
the occurrence of unanticipated events.


                                       1







                         PART I -- FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS.


                              TARRANT APPAREL GROUP
                           CONSOLIDATED BALANCE SHEETS


                                                                SEPTEMBER 30,     DECEMBER 31,
                                                                    2006             2005
                                                                -------------    -------------
                                                                 (Unaudited)
                                                                           
                                ASSETS
Current assets:
   Cash and cash equivalents ................................   $     976,481    $   1,641,768
   Accounts receivable, net .................................      46,175,909       54,598,443
   Due from related parties .................................       3,918,287        3,100,928
   Inventory ................................................      20,455,702       31,628,960
   Temporary quota rights ...................................         111,207             --
   Current portion of notes receivable -- related parties ...            --          5,139,387
   Prepaid expenses .........................................       1,219,895        1,292,441
   Prepaid royalties ........................................            --          1,123,531
   Income taxes receivable ..................................          25,468           25,468
                                                                -------------    -------------
 Total current assets .......................................      72,882,949       98,550,926

   Property and equipment, net  of $11.0 million and $10.8
      million accumulated depreciation at September 30, 2006
      and December 31, 2005, respectively ...................       1,477,101        1,702,840
   Notes receivable - related parties, net of current
      portion, and net of $27.1 million reserve at
      September 30, 2006 ....................................      14,000,000       36,268,446
   Due from related parties .................................       2,213,416        2,994,945
   Equity method investment .................................       2,174,380        2,138,865
   Deferred financing cost, net of $1.5 million and $711,250
      accumulated amortization at September 30, 2006 and
      December 31, 2005, respectively .......................       2,654,952          838,786
   Other assets .............................................         507,379          164,564
   Goodwill .................................................       8,582,845        8,582,845
                                                                -------------    -------------
 Total assets ...............................................   $ 104,493,022    $ 151,242,217
                                                                =============    =============


                 LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
   Short-term bank borrowings ...............................   $  12,534,937    $  13,833,532
   Accounts payable .........................................      18,195,022       33,278,959
   Accrued expenses .........................................       9,777,354        9,503,806
   Income taxes .............................................      17,035,409       16,828,538
   Current portion of long-term obligations and factoring
      arrangement ...........................................      19,769,030       36,109,699
                                                                -------------    -------------
 Total current liabilities ..................................      77,311,752      109,554,534

Term loan, net ..............................................      10,941,948             --
Other long-term obligations .................................          26,380          239,935
Convertible debentures, net .................................            --          5,965,098
Deferred tax liabilities ....................................          39,025           47,098
                                                                -------------    -------------
 Total liabilities ..........................................      88,319,105      115,806,665

Minority interest in consolidated subsidiary ................          57,469           75,241
Commitment and Contingencies

Shareholders' equity:
   Preferred stock, 2,000,000 shares authorized; no shares
      at September 30, 2006 and December 31, 2005 issued
      and outstanding .......................................            --               --
   Common stock, no par value, 100,000,000 shares authorized;
      30,543,763 shares  at September 30, 2006 and 30,553,763
      shares at December 31, 2005 issued and outstanding ....     114,977,465      114,977,465
   Warrants to purchase common stock ........................       7,314,239        2,846,833
   Contributed capital ......................................      10,101,151       10,004,331
   Accumulated deficit ......................................    (114,094,373)     (90,189,615)
   Notes receivable from officer/shareholder ................      (2,182,034)      (2,278,703)
                                                                -------------    -------------
 Total shareholders' equity .................................      16,116,448       35,360,311
                                                                -------------    -------------

 Total liabilities and shareholders' equity .................   $ 104,493,022    $ 151,242,217
                                                                =============    =============


The  accompanying  notes are an integral  part of these  consolidated  financial
statements


                                       2




                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)


                                                      THREE MONTHS ENDED               NINE MONTHS ENDED
                                                         SEPTEMBER 30,                    SEPTEMBER 30,
                                               ------------------------------    ------------------------------
                                                    2006             2005             2006             2005
                                               -------------    -------------    -------------    -------------
                                                                                      
Net sales ..................................   $  54,645,223    $  69,566,080    $ 174,989,008    $ 164,934,075
Cost of sales ..............................      42,844,174       55,020,926      138,006,628      129,988,823
                                               -------------    -------------    -------------    -------------

Gross profit ...............................      11,801,049       14,545,154       36,982,380       34,945,252
Selling and distribution expenses ..........       2,568,038        2,846,445        8,295,815        7,812,476
General and administrative expenses ........       6,551,393        7,398,722       19,914,629       20,270,148
Royalty expenses ...........................         263,583        1,288,634        2,099,392        2,181,325
Loss on notes receivable - related parties .      27,137,297             --         27,137,297             --
                                               -------------    -------------    -------------    -------------

Income (loss) from operations ..............     (24,719,262)       3,011,353      (20,464,753)       4,681,303

Interest expense ...........................      (1,562,426)      (1,301,271)      (4,696,279)      (3,400,081)
Interest income ............................         165,399          505,913        1,131,601        1,575,727
Interest in income (loss) of equity method
   investee ................................          (7,307)         129,587          103,015          475,947
Other income ...............................         109,093           38,589          233,466          277,947
Adjustment to fair value of derivative .....         729,394             --            511,087             --
Other expense ..............................            --               (228)        (400,000)            (559)
Minority interest in consolidated subsidiary          13,641         (163,576)          17,772         (163,576)
                                               -------------    -------------    -------------    -------------

Income (loss) before provision for income
   taxes ...................................     (25,271,468)       2,220,367      (23,564,091)       3,446,708
Provision for income taxes .................          80,946          517,950          340,667          979,272
                                               -------------    -------------    -------------    -------------

Net income (loss) ..........................   $ (25,352,414)   $   1,702,417    $ (23,904,758)   $   2,467,436
                                               =============    =============    =============    =============

   Net income (loss) per share:
   Basic ...................................   $       (0.83)   $        0.06    $       (0.78)   $        0.08
                                               =============    =============    =============    =============
   Diluted .................................   $       (0.83)   $        0.06    $       (0.78)   $        0.08
                                               =============    =============    =============    =============

   Weighted average common and common
     equivalent shares:
   Basic ...................................      30,543,763       30,365,502       30,546,217       29,451,054
                                               =============    =============    =============    =============
   Diluted .................................      30,543,763       30,785,797       30,546,217       29,517,251
                                               =============    =============    =============    =============


The  accompanying  notes are an integral  part of these  consolidated  financial
statements


                                       3




                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)


                                                              NINE MONTHS ENDED SEPTEMBER 30,
                                                              ------------------------------
                                                                   2006             2005
                                                              -------------    -------------
                                                                         
Operating activities:
Net income (loss) .........................................   $ (23,904,758)   $   2,467,436
Adjustments to reconcile net income to net cash provided by
  (used in) operating activities:
   Deferred taxes .........................................          (8,073)         (61,551)
   Depreciation and amortization ..........................       2,383,897        1,738,937
   Adjustment to fair value of derivative .................        (511,087)            --
   Loss on notes receivable - related parties .............      27,137,297             --
   Compensation expense related to stock option ...........            --             38,740
   Provision for returns and discounts ....................         318,208          372,805
   Gain on sale of fixed assets ...........................          (2,054)        (113,968)
   Interest in income of equity method investee ...........        (103,015)        (475,947)
   Minority interest in consolidated subsidiary ...........         (17,772)         163,577
   Stock-based compensation ...............................          96,820             --
   Changes in operating assets and liabilities:
     Accounts receivable ..................................       7,288,752      (27,473,378)
     Due to/from related parties ..........................         (35,830)       1,982,152
     Inventory ............................................      11,173,258       (6,819,037)
     Temporary quota rights ...............................        (111,207)            --
     Prepaid expenses .....................................       1,196,077           54,471
     Accounts payable .....................................     (15,083,937)       3,634,123
     Accrued expenses and income tax payable ..............         480,420        1,689,190
                                                              -------------    -------------

     Net cash provided by (used in) operating activities ..      10,296,996      (22,802,450)

Investing activities:
   Purchase of fixed assets ...............................        (130,177)        (452,930)
   Proceeds from sale of fixed assets .....................           4,707          119,506
   Distribution from equity method investee ...............          67,500          216,000
   Collection on notes receivable, related parties ........       1,086,111          977,500
   Collection of advances from shareholders/officers ......          96,669        2,456,334
                                                              -------------    -------------

     Net cash provided by investing activities ............       1,124,810        3,316,410

Financing activities:
   Short-term bank borrowings, net ........................      (1,298,595)      (2,536,215)
   Proceeds from long-term obligations ....................     183,669,591      167,099,510
   Payment of financing costs .............................      (2,821,647)            --
   Repayments of borrowings from convertible debentures ...      (6,912,626)            --
   Payment of long-term obligations and bank borrowings ...    (184,723,816)    (144,655,258)
                                                              -------------    -------------

     Net cash (used in) provided by financing activities ..     (12,087,093)      19,908,037

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

Increase (decrease) in cash and cash equivalents ..........        (665,287)         421,997
Cash and cash equivalents at beginning of period ..........       1,641,768        1,214,944
                                                              -------------    -------------

Cash and cash equivalents at end of period ................   $     976,481    $   1,636,941
                                                              =============    =============


The  accompanying  notes are an integral  part of these  consolidated  financial
statements


                                       4



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


1.       ORGANIZATION AND BASIS OF CONSOLIDATION

         The accompanying  financial  statements consist of the consolidation of
Tarrant  Apparel  Group,  a  California  corporation,  and  its  majority  owned
subsidiaries  located primarily in the U.S., Asia,  Mexico,  and Luxembourg.  At
September 30, 2006, we own 50.1% of United Apparel  Ventures  ("UAV") and 75% of
PBG7,  LLC  ("PBG7").  We  consolidate  these  entities and reflect the minority
interests  in earnings  (losses) of the ventures in the  accompanying  financial
statements. All inter-company amounts are eliminated in consolidation. The 49.9%
minority  interest  in  UAV is  owned  by  Azteca  Production  International,  a
corporation  owned by the brothers of our Chairman and Interim  Chief  Executive
Officer, Gerard Guez. The 25% minority interest in PBG7 is owned by BH7, LLC, an
unrelated party.

         We serve specialty retail, mass 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.  In  August  2004,  we  entered  into a  purchase  and sale
agreement to sell these facilities to affiliates of Mr. Nacif, which transaction
was  consummated  in the fourth  quarter  of 2004.  See Note 14 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.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         The accompanying  unaudited financial  statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("US GAAP") for interim financial  information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly,  they do not include
all of the information and footnotes  required by US GAAP for complete financial
statements. In the opinion of management,  all adjustments (consisting of normal
recurring accruals)  considered necessary for a fair presentation of the results
of operations for the periods presented have been included.

         The  consolidated  financial  data at December 31, 2005 is derived from
audited  financial  statements  which are included in our Annual  Report on Form
10-K for the year ended  December  31, 2005,  and should be read in  conjunction
with the audited financial statements and notes thereto. Interim results are not
necessarily indicative of results for the full year.

         The accompanying  unaudited  consolidated  financial statements include
all  majority-owned  subsidiaries in which we exercise  control.  Investments in
which we  exercise  significant  influence,  but  which we do not  control,  are
accounted  for under the  equity  method of  accounting.  The  equity  method of
accounting is used when we have a 20% to 50% interest in other entities,  except
for  variable  interest  entities  for  which  we  are  considered  the  primary
beneficiary under Financial Accounting  Standards Board ("FASB")  Interpretation
No. 46,  "Consolidation of Variable Interest Entities," an interpretation of ARB
No. 51. Under the equity method,  original  investments are recorded at cost and
adjusted by our share of undistributed earnings or losses of these entities. All
significant  inter-company  transactions  and balances have been eliminated from
the consolidated financial statements.


                                       5



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


         The  preparation  of financial  statements in  conformity  with US GAAP
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 financial  statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates used by
us  in  preparation  of  the  consolidated  financial  statements  include:  (i)
allowance for returns,  discounts  and bad debts,  (ii)  inventory,  (iii) notes
receivable  -  related  parties  reserve,  (iv)  valuation  of  long  lived  and
intangible  assets and  goodwill,  (v)  income  taxes,  and (vi)  stock  options
valuation. Actual results could differ from those estimates.

         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 certain  percentage of net sales.  Some
of these  agreements  include  minimum  royalties.  See Note 15 of the "Notes to
Consolidated  Financial Statements" regarding various agreements we have entered
into.

         DEFERRED RENT PROVISION

         When a lease requires fixed  escalation of the minimum lease  payments,
rental  expense is  recognized on a straight line basis over the initial term of
the lease,  and the  difference  between the average  rental  amount  charged to
expense and amounts payable under the lease is included in deferred  amount.  As
of September  30, 2006,  deferred  rent of $71,000 was  recorded  under  accrued
expense in our consolidated financial statements.

         VALUATION OF DERIVATIVE INSTRUMENTS

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

         STOCK-BASED COMPENSATION

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

         We  adopted  SFAS  123(R)  using the  modified  prospective  transition
method,  which requires the application of the accounting standard as of January
1, 2006, the first day of our fiscal year 2006.  Our financial  statements as of
and for the nine months  ended  September  30,  2006  reflect the impact of SFAS
123(R).  In accordance  with the modified  prospective  transition  method,  our
financial statements for prior periods have not been restated to reflect, and do
not  include,  the  impact  of SFAS  123(R).  Stock-based  compensation  expense
recognized  under SFAS  123(R)  during the three  months and nine  months  ended
September  30, 2006 was $90,000 and  $97,000.  Basic and  dilutive  earnings per
share for the three  months and nine months  ended  September  30, 2006 were not
affected by the additional stock-based compensation recognized.

         The fair value of each option  granted to  employees  and  directors is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following  weighted  average  assumptions  used for grants in 2006 and 2005:
weighted-average  volatility  factors of the expected market price of our common
stock of 0.70 and 0.55 for the three months ended  September  30, 2006 and 2005,
weighted-average  risk-free interest rates of 5.075% and 4% for the three months
ended  September  30, 2006 and 2005,  dividend  yield of 0% for the three months


                                       6



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


ended  September 30, 2006 and 2005,  and  weighted-average  expected life of the
options of 6.25 years and 4 years for the three months ended  September 30, 2006
and 2005.

         The following table illustrates the effect on net loss and net loss per
share if we had applied  the fair value  recognition  provisions  of SFAS 123 to
stock-based  payment  awards  granted under our stock option plans for the three
and nine months ended September 30, 2005:



                                                    THREE MONTHS      NINE MONTHS
                                                        ENDED            ENDED
                                                    SEPTEMBER 30,    SEPTEMBER 30,
                                                         2005             2005
                                                    -------------    -------------
                                                               
Net income as reported ..........................   $   1,702,417    $   2,467,436
Add stock-based employee compensation charges
   reported in net income .......................          38,740           38,740
Pro forma compensation expense, net of tax ......      (3,248,221)      (4,298,193)
                                                    -------------    -------------
Pro forma net loss ..............................   $  (1,507,064)   $  (1,792,017)
                                                    =============    =============

Net income per share as reported - Basic ........   $        0.06    $        0.08
Add stock-based employee compensation charges
   reported in net income--Basic ................            --               --
Pro forma compensation expense per share - Basic            (0.11)           (0.14)
                                                    -------------    -------------
Pro forma net loss per share - Basic ............   $       (0.05)   $       (0.06)
                                                    =============    =============

Net income per share as reported -Diluted .......   $        0.06    $        0.08
Add stock-based employee compensation charges
   reported in net income - Diluted .............            --               --
Pro forma compensation expense per share -Diluted           (0.11)           (0.14)
                                                    -------------    -------------
Pro forma net loss per share -Diluted ...........   $       (0.05)   $       (0.06)
                                                    =============    =============



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

         On September 23, 2005, the Board of Directors approved the acceleration
of vesting of all our unvested stock options,  including  those not issued under
the plan; see Note 3 of the "Notes to  Consolidated  Financial  Statements."  In
total,  1.7 million stock options with an average exercise price of $3.69 and an
average   remaining   contractual  life  of  7.9  years  were  subject  to  this
acceleration.   The  exercise  prices  and  number  of  shares  subject  to  the
accelerated  options  were  unchanged.  The  acceleration  was  effective  as of
September 23, 2005. As a result,  there were no stock options  granted prior to,
but not yet vested as of January 1, 2006. There was no stock-based  compensation
expense  related to employees or directors stock options  recognized  during the
three months and nine months ended September 30, 2005.

         Stock-based  compensation expense recognized during the period is based
on the value of the portion of  share-based  payment  awards that is  ultimately
expected to vest during the period.  Stock-based compensation expense recognized
in the  consolidated  statements  of  operations  for the three  months and nine
months of 2006 consisted of  compensation  expense for the  share-based  payment
awards granted  subsequent to January 1, 2006 based on the grant date fair value
estimated in  accordance  with the  provisions of SFAS 123(R).  For  stock-based
payment awards issued to employees and directors,  stock-based  compensation  is
attributed to expense using the  straight-line  single option  method,  which is
consistent with how the  prior-period  pro-formas were provided.  As stock-based
compensation expense recognized in the consolidated statements of operations for
the three  months and nine months  ended  September  30, 2006 is based on awards
ultimately expected to vest, it has been reduced for estimated forfeitures which
we estimate to be 7.7%. SFAS 123(R) requires  forfeitures to be estimated at the
time of grant  and  revised,  if  necessary,  in  subsequent  periods  if actual
forfeitures  differ from those estimates.  In our pro-forma  information for the
periods prior to fiscal 2006, we accounted for forfeitures as they occurred.


                                       7



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


         Our  determination  of fair  value of  share-based  payment  awards  to
employees  and  directors  on the date of grant using the  Black-Scholes  model,
which is affected by our stock price as well as  assumptions  regarding a number
of highly complex and subjective variables. These variables include, but are not
limited to our expected stock price volatility over the term of the awards. When
valuing  awards,  we  estimate  its  expected  terms  using  the  "safe  harbor"
provisions  provided in SAB 107 and its  volatility  using  historical  data. We
granted  options to  purchase  260,000  and  1,233,259  shares of common  stock,
respectively,  during the three  months  and nine  months of 2006.  The  options
granted were fair valued in the  aggregate at $341,000 or $1.31 per share during
the third quarter of 2006. The options granted were fair valued in the aggregate
at $1.6 million or the weighted-average  exercise price of $1.86 during the nine
months ended September 30, 2006. The stock-based compensation expense related to
employees or director stock options  recognized during the three months and nine
months ended September 30, 2006 was $90,000 and $97,000, respectively.

           Certain 2005 amounts  have been  reclassified  to conform to the 2006
presentation.

3.       STOCK-BASED COMPENSATION

         Our Employee  Incentive Plan,  formerly the 1995 Stock Option Plan (the
"1995 Plan"),  authorized  the grant of both incentive and  non-qualified  stock
options to our officers, employees,  directors and consultants for shares of our
common  stock.  As of September  30,  2006,  there were  outstanding  options to
purchase a total of  1,319,000  shares of common  stock  granted  under the 1995
Plan.  No further  grants may be made under the 1995 Plan.  On May 25, 2006,  we
adopted  2006 Stock  Incentive  Plan (the "2006  Plan"),  which  authorizes  the
issuance of up to 5,100,000  shares of our common  stock  pursuant to options or
awards  granted  under the 2006  Plan.  As of  September  30,  2006,  there were
outstanding options to purchase a total of 1,228,000 shares of common stock, and
3,872,000 shares remained available for issuance pursuant to award granted under
the 2006 Plan.  The  exercise  price of options  under the plan must be equal to
100% of fair market  value of common  stock on the date of grant.  The 2006 Plan
also  permits  other  types of  awards,  including  stock  appreciation  rights,
restricted stock and other performance-based benefits.

         In October  1998,  we granted  1,000,000  non-qualified  stock  options
outside of 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,  expire in 2008 and vested over four years.  In May 2002,  we granted
3,000,000  non-qualified  stock options outside of the plan. Theses 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,  expire in
2012 and vested 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  outside of the plan to our  Chairman  and Vice  Chairman.  These
options were granted at $3.65 per share,  the closing  sales price of the common
stock on the day of the grant, expire in 2013 and initially provided for vesting
over four years.  In  December  2003,  we granted  400,000  non-qualified  stock
options outside of the plan to one of our employees. The options were granted at
$3.94 per share,  the closing  sales price of the common stock on the day of the
grant, expire in 2013 and initially provided for vesting over four years.


                                       8



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


         A summary of our stock option activity, and related information for the
year ended December 31, 2005 and the nine months ended  September 30, 2006 is as
follows:

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

Options outstanding at December 31, 2004 ......      8,331,962      $1.39-$45.50
Granted .......................................         42,000      $1.95-$3.68
Exercised .....................................           --                --
Forfeited .....................................     (1,573,300)     $1.95-$25.00
Expired .......................................        (67,612)     $       4.50
                                                    ----------      ------------
Options outstanding at December 31, 2005 ......      6,733,050      $1.39-$45.50
Granted .......................................      1,233,259      $1.84-$1.94
Exercised .....................................           --                --
Forfeited .....................................        (19,450)     $1.94-$33.13
Expired .......................................           --                --
                                                    ----------      ------------
Options outstanding at September 30, 2006 .....      7,946,859      $1.39-$45.50


         We had no stock option  outstanding to non-employees as of December 31,
2005 and September 30, 2006.

         The  following  table  summarizes   information   about  stock  options
outstanding and exercisable as of December 31, 2005 and September 30, 2006:

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

As of September 30, 2006:
Employees - Outstanding ........   7,946,859   $    5.56      6.0      $       0
Employees - Expected to vest ...   7,852,283   $    5.61      5.9      $       0
Employees - Exercisable ........   6,718,600   $    6.24      5.3      $       0


         The total intrinsic value of options exercised during 2005 was $0. Cash
received from stock options  exercised  during 2005 was $0. The total fair value
of shares vested during the years ended December 31, 2003,  2004 and 2005,  were
approximately $2.8 million, $4.3 million, and $5.7 million, respectively.

         As of September 30, 2006, there was $1.4 million of total  unrecognized
compensation cost related to non-vested  share-based  compensation  arrangements
granted  under  the  plans.  That cost is  expected  to be  recognized  over the
weighted-average period of 3.7 years.

         When options are exercised, our policy is to issue previously un-issued
shares of common stock to satisfy  share option  exercises.  As of September 30,
2006, we had 69.5 million shares of un-issued shares of common stock.


                                       9



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


4.       ACCOUNTS RECEIVABLE

         Accounts receivable consists of the following:

                                                   SEPTEMBER 30,    DECEMBER 31,
                                                       2006             2005
                                                   ------------    ------------
U.S. trade accounts receivable .................   $  4,236,436    $  2,893,217
Foreign trade accounts receivable ..............     12,943,876      19,619,172
Factored accounts receivable ...................     31,278,819      33,222,354
Other receivables ..............................        979,850       1,815,450
Allowance for returns, discounts and bad debts .     (3,263,072)     (2,951,750)
                                                   ------------    ------------
                                                   $ 46,175,909    $ 54,598,443
                                                   ============    ============

5.       INVENTORY

         Inventory consists of the following:

                                                     SEPTEMBER 30,  DECEMBER 31,
                                                         2006           2005
                                                     ------------   ------------
Raw materials - fabric and trim accessories ......   $  3,896,436   $  5,079,428
Finished goods shipments-in-transit ..............      7,648,321      8,800,014
Finished goods ...................................      8,910,945     17,749,518
                                                     ------------   ------------
                                                     $ 20,455,702   $ 31,628,960
                                                     ============   ============

6.       EQUITY METHOD INVESTMENT - AMERICAN RAG

         In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the  trademark  "American  Rag CIE" and the  operator of  American  Rag
retail  stores for $1.4  million,  and our  subsidiary,  Private  Brands,  Inc.,
acquired  a license  to  certain  exclusive  rights to this  trademark.  We have
guaranteed  the payment to the licensor of minimum  royalties  of $10.4  million
over the initial  10-year term of the agreement.  The guaranteed  annual minimum
royalty  is  payable  in  equal  monthly  installments  during  the  term of the
agreement. The royalty owed to the licensor in excess of the guaranteed minimum,
if any,  is payable no later  than 30 days after the end of the  preceding  full
quarter with the amount for last quarter adjusted based on actual royalties owed
for the year. The guaranteed  annual minimum  royalty for 2006 is $661,000.  The
minimum  royalty  paid and  expensed  for the three months and nine months ended
September  30, 2006 was $165,000 and  $496,000,  respectively.  At September 30,
2006, the total commitment on royalties  remaining on the term was $8.6 million.
Private Brands also entered into a multi-year exclusive  distribution  agreement
with Macy's  Merchandising  Group,  LLC  ("MMG"),  the sourcing arm of Federated
Department  Stores,  to supply MMG with  American  Rag CIE, a casual  sportswear
collection  for juniors and young men.  Under this  arrangement,  Private Brands
designs and  manufactures  American Rag  apparel,  which is  distributed  by MMG
exclusively  to Federated  stores across the country.  Beginning in August 2003,
the American Rag  collection  was available in  approximately  100 select Macy's
locations,  and is  currently  available  in  approximately  600  Macy's  stores
nationally.  In June  2006,  we signed a  guarantee  of certain  liabilities  of
American Rag CIE to California  United Bank to the aggregate amount equal at all
times  to the  lesser  of (A) 45% of the  aggregate  amount  of the  outstanding
liabilities and (B) $675,000.  Upon execution of the guarantee,  we re-evaluated
our investment  under the  provisions of FIN 46. In our analysis,  we determined
that  consolidation  under FIN 46 was still not  appropriate.  The investment in
American Rag CIE, LLC totaling  $2.2 million at September 30, 2006, 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 during the nine months ended  September 30, 2006 was
as follows:

         Balance as of December 31, 2005 .....     $   2,138,865
         Share of income......................           103,015
         Distribution.........................           (67,500)
                                                   -------------

          Balance as of September 30, 2006....     $   2,174,380
                                                   =============


                                       10



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


7.       NOTES RECEIVABLE - RELATED PARTY RESERVE

         In connection  with the sale in 2004 of our assets and real property in
Mexico, the purchasers of the Mexico assets issued us unsecured promissory notes
of $3,910,000 that mature on November 30, 2007 and secured  promissory  notes of
$40,204,000 that mature on December 31, 2014 and are payable in partial or total
amounts  anytime  prior to the  maturity  of each note.  The  secured  notes are
secured  by the  real  and  personal  property  in  Mexico  that  we sold to the
purchasers.  As of September 30, 2006, the outstanding  balance of the notes and
interest receivables were $41.1 million prior to the reserve.  Historically,  we
have placed orders for purchases of fabric from the  purchasers  pursuant to the
purchase  commitment  agreement  we entered  into at the time of the sale of the
Mexico assets,  and we have satisfied our payment  obligations for the fabric by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  the  purchasers  have  recently  ceased  providing  fabric and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable  in a amount equal to the  outstanding  balance less the value of the
underlying assets securing the notes. The loss was estimated to be approximately
$27.1 million, resulting in a net notes receivable balance at September 30, 2006
of approximately $14 million.  We will continue to pursue payment of all amounts
under the notes  receivable  and believe the  remaining  $14 million  balance at
September  30,  2006 is  realizable.  The entire  reserve  was  recorded  in the
Luxembourg geographic reporting segment.

8.       DEBT

         Short-term bank borrowings consist of the following:

                                                   SEPTEMBER 30,    DECEMBER 31,
                                                        2006             2005
                                                    -----------      -----------
Import trade bills payable - UPS, DBS
   Bank and Aurora Capital ...................      $ 4,651,308      $ 4,165,306
Bank direct acceptances - UPS and DBS
   Bank ......................................        3,839,388        1,471,476
Other Hong Kong credit facilities -
   UPS and DBS Bank ..........................        4,044,241        8,196,750
                                                    -----------      -----------
                                                    $12,534,937      $13,833,532
                                                    ===========      ===========

         Long-term obligations consist of the following:

                                                SEPTEMBER 30,       DECEMBER 31,
                                                    2006                2005
                                                ------------       ------------
Equipment financing ......................            46,331             83,206
Term loan - UPS ..........................              --            2,708,333
Debt facility - GMAC CF ..................        19,749,079         33,558,095
Credit facility - Guggenheim, net ........        10,941,948               --
                                                ------------       ------------
                                                  30,737,358         36,349,634
Less current portion .....................       (19,769,030)       (36,109,699)
                                                ------------       ------------
                                                $ 10,968,328       $    239,935
                                                ============       ============


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

         On June 13, 2002,  we entered  into a letter of credit  facility of $25
million with UPS Capital Global Trade Finance  Corporation  ("UPS").  Under this
facility,   we  could  arrange  for  the  issuance  of  letters  of  credit  and
acceptances. The facility was collateralized by the shares and debentures of all
of our  subsidiaries in Hong Kong. In addition to the guarantees  provided by us
and our subsidiaries,  Fashion Resource (TCL) Inc. and Tarrant  Luxembourg Sarl,
Gerard Guez,  our Chairman and Interim Chief  Executive  Officer,  also signed a
guarantee  of $5 million  in favor of UPS to secure  this  facility.  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.
Additionally,  Gerard Guez,  our Chairman and Interim Chief  Executive  Officer,
pledged to UPS 4.6 million shares of our common stock held by Mr. Guez to secure
the  obligations  under the credit  facility.  On June 9, 2006, we completed the
pay-off of all  remaining  amounts due under the letter of credit  facility with
UPS.  As a result of the  payment  of these  obligations,  the  letter of credit
facility was  terminated and all  collateral  released.  There was no prepayment
penalty under this  arrangement.  As of September  30, 2006, $0 was  outstanding
under this facility with UPS.

         Since  March  2003,  DBS Bank  (Hong  Kong)  Limited  ("DBS")  had made
available a letter of credit facility of up to HKD 20 million  (equivalent to US
$2.6 million) to our  subsidiaries  in Hong Kong. This was a demand facility and


                                       11



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


was secured by the pledge of our office property, which is owned by Gerard Guez,
our  Chairman  and  Interim  Chief  Executive  Officer,  and Todd Kay,  our Vice
Chairman,  and by our guarantee.  The letter of credit facility was increased to
HKD 30 million  (equivalent to US $3.9 million) in June 2004. In October 2005, a
tax loan  for HKD  6.233  million  (equivalent  to US  $804,000)  was also  made
available to our Hong Kong  subsidiaries and bears interest at the rate equal to
the Hong Kong prime rate plus 1% and are subject to the same  security.  It bore
interest at 9.25% per annum at  September  30, 2006.  As of September  30, 2006,
$70,000 was outstanding under this tax loan.

         In June 2006, our  subsidiaries in Hong Kong,  Tarrant Company Limited,
Marble  Limited  and Trade  Link  Holdings  Limited,  entered  into a new credit
facility with DBS. Under this facility, we may arrange for letters of credit and
acceptances. The maximum amount our Hong Kong subsidiaries may borrow under this
facility at any time is US $25 million.  The  interest  rate under the letter of
credit  facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if
paid in Hong  Kong  Dollars,  which  the  interest  rate was  8.75% per annum at
September 30, 2006,  or the Standard  Bills Rate quoted by DBS plus 0.5% if paid
in any other  currency,  which the interest rate was 8.6% per annum at September
30, 2006. This is a demand facility and is secured by a security interest in all
the assets of the Hong Kong  subsidiaries,  by a pledge of our  office  property
where  our Hong Kong  office is  located,  which is owned by  Gerard  Guez,  our
Chairman and Interim Chief  Executive  Officer,  and Todd Kay, our Vice Chairman
and by our guarantee. The DBS facility includes customary default provisions. In
addition,  we are subject to certain  restrictive  covenants,  including that we
maintain  a  specified  tangible  net  worth,  and a minimum  level of EBITDA at
December 31, 2006,  interest  coverage ratio,  leverage ratio and limitations on
additional indebtedness. As of September 30, 2006, $12.3 million was outstanding
under this  facility.  In  addition,  $4.7 million of open letters of credit was
outstanding and $8.0 million was available for future borrowings as of September
30, 2006.

         As of September 30, 2006, the total balance  outstanding  under the DBS
credit facilities was $12.4 million  (classified above as follows:  $4.5 million
in import trade bills payable,  $3.8 million in bank direct acceptances and $4.1
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 September 30, 2006, $164,000 was outstanding
under this facility (classified above under import trade bills payable) and $1.0
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 January 19, 2006, we borrowed  $4.0 million from Max Azria  pursuant
to the terms of a promissory  note,  which  amount bore  interest at the rate of
5.5% per annum and was payable in weekly  installments of $200,000  beginning on
March 1, 2006. This was an unsecured loan. We paid off the remaining  balance of
this loan in July 2006. As of September 30, 2006, $0 was outstanding  under this
loan.

EQUIPMENT FINANCING

         We had three equipment  loans  outstanding at December 31, 2005. One of
these equipment loans bore interest at 6% payable in installments  through 2009,
which we paid off in January  2006.  The second  loan  bears  interest  at 15.8%
payable in  installment  through 2007 and the third loan bears interest at 6.15%
payable in installment  through 2007. In August 2006, we entered into a new auto
loan that bears  interest at 4.75%  payable in  installment  through 2008. As of
September 30, 2006, $46,000 was outstanding under the three remaining loans.

TERM LOAN - UPS

         On December 31, 2004,  our Hong Kong  subsidiaries  entered into a loan
agreement  with UPS  pursuant  to which UPS made a $5  million  term  loan,  the
proceeds  of which  were used to repay $5 million  of  indebtedness  owed to UPS
under the letter of credit of facility.  The  principal  amount of this loan was
due and payable in 24 equal monthly installments of approximately $208,333 each,
plus  interest  equivalent to the "prime rate" plus 2% commencing on February 1,
2005. Under the amended loan agreement, we were subject to restrictive financial
covenants of maintaining  tangible net worth of $25 million at December 31, 2005


                                       12



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


and the last day of each fiscal quarter  thereafter.  There was also a provision
capping  maximum capital  expenditure  per quarter at $800,000.  The obligations
under the loan agreement were  collateralized by the same security interests and
guarantees provided under our letter of credit facility with UPS.  Additionally,
the term loan was secured by two promissory notes payable to Tarrant  Luxembourg
Sarl in the amounts of $2,550,000  and  $1,360,000  and a pledge by Gerard Guez,
our Chairman and Interim Chief Executive  Officer,  of 4.6 million shares of our
common stock. On June 9, 2006, we completed the pay-off of all remaining amounts
due under the term loan  agreement with UPS. As a result of the payment of these
obligations, the term loan agreement was terminated and all collateral released.
There was no prepayment penalty under this arrangement.

DEBT FACILITY AND FACTORING AGREEMENT - GMAC CF

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

         On June 16,  2006,  we  expanded  our credit  facility  with GMAC CF by
entering  into a new Loan and Security  Agreement and amending and restating our
previously existing Factoring Agreement with GMAC CF. UPS Capital Corporation is
also a lender under the Loan and Security Agreement.  This is a revolving credit
facility  and has a term of 3 years.  The amount we may borrow under this credit
facility is  determined  by a percentage  of eligible  accounts  receivable  and
inventory,  up to a maximum  of $55  million,  and  includes  a letter of credit
facility of up to $4 million.  Interest on outstanding amounts under this credit
facility is payable  monthly  and  accrues at the rate of the "prime  rate" plus
0.5%. Our obligations under the GMAC CF credit facility are secured by a lien on
substantially  all our domestic  assets,  including a first priority lien on our
accounts  receivable  and inventory.  This credit  facility  contains  customary
financial  covenants,  including  covenants  that we maintain  minimum levels of
EBITDA and interest coverage ratios and limitations on additional  indebtedness.
This  facility  includes  customary  default  provisions,  and  all  outstanding
obligations  may become  immediately  due and payable in the event of a default.
The  facility  bore  interest at 8.75% per annum at September  30,  2006.  As of
September 30, 2006, we were in violation  with the EBITDA  covenant and a waiver
was obtained during the default.  A total of $19.7 million was outstanding  with
respect to  receivables  factored  under the GMAC CF facility at  September  30,
2006.

CREDIT FACILITY FROM GUGGENHEIM CORPORATE FUNDING LLC AND WARRANTS

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


                                       13



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


contains customary  financial  covenants,  including  covenants that we maintain
minimum  levels of EBITDA  and  interest  coverage  ratios  and  limitations  on
additional indebtedness.

         In connection with  Guggenheim  credit  facility,  on June 16, 2006, we
issued the lenders under this  facility  warrants to purchase up to an aggregate
of 3,857,143 shares of our common stock. These warrants have a term of 10 years.
These warrants are exercisable at a price of $1.88 per share with respect to 20%
of the  shares,  $2.00 per share with  respect to 20% of the  shares,  $3.00 per
share with respect to 20% of the shares,  $3.75 per share with respect to 20% of
the shares and $4.50 per share with  respect to 20% of the shares.  The exercise
prices are subject to adjustment for certain dilutive  issuances pursuant to the
terms  of  the  warrants.  357,143  shares  of  the  warrants  will  not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and EITF  00-19 and  determined  to be a  derivative  instrument  due to certain
registration  rights.  As such, the warrants  excluding the ones not exercisable
were valued at $4.9 million using the Black-Scholes  option valuation model with
the following  assumptions:  risk-free interest rate of 5.1%; dividend yields of
0%; volatility factors of the expected market price of our common stock of 0.70;
and  contractual  term of ten  years.  We also paid to  Guggenheim  2.25% of the
committed principal amount of the loans which was $563,000 on June 16, 2006. The
$563,000 fee paid to Guggenheim is included in the deferred  financing cost, and
the value of the warrants to purchase 3.5 million  shares of our common stock of
$4.9 million is recorded as debt  discount,  both of them are amortized over the
life of the loan. As of September 30, 2006, $352,000 was amortized.

         Durham Capital  Corporation acted as our advisor in connection with the
Guggenheim credit facility.  As compensation for its services,  we agreed to pay
Durham  Capital a cash fee in an amount equal to 1% of the  committed  principal
amount of the loans under the Guggenheim credit facility. As a result,  $250,000
was paid on June 16, 2006. In addition,  we issued  Durham  Capital a warrant to
purchase 77,143 shares of our common stock.  This warrant has a term of 10 years
and is  exercisable  at a price of $1.88 per share,  subject to  adjustment  for
certain  dilutive  issuances.  7,143  shares  of this  warrant  will not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and EITF  00-19 and  determined  to be a  derivative  instrument  due to certain
registration  rights.  As such, the warrants  excluding the ones not exercisable
were valued at $105,000 using the Black-Scholes  option valuation model with the
following  assumptions:  risk-free interest rate of 5.1%; dividend yields of 0%;
volatility factors of the expected market price of our common stock of 0.70; and
contractual  term of ten years.  The $250,000 fee paid to Durham Capital and the
value of the warrants to purchase  70,000 shares of our common stock of $105,000
is included in the deferred  financing  cost,  and is amortized over the life of
the loan. As of September 30, 2006, $23,000 was amortized.

         The Guggenheim  facility bore interest at 12.33% per annum at September
30,  2006.  As of  September  30,  2006,  we were in  violation  with the EBITDA
covenant and a waiver was obtained during the default. A total of $10.9 million,
net of $4.6 million of debt  discount,  was  outstanding  under this facility at
September 30, 2006.

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


                                       14



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


$4.5 million;  as a result,  income of $729,000 was recorded as an adjustment to
fair value of derivative on our consolidated statements of operations.

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

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  Debentures  were thus  valued at  $8,996,000,  resulting  in an
effective  conversion  price of $1.799 per  share.  The  intrinsic  value of the
conversion option of $804,000 was being amortized over the life of the loan. The
value of the  warrants of $866,000  and the  intrinsic  value of the  conversion
option of $804,000 were netted from the $10 million presented as the convertible
debentures, net on our accompanying balance sheets at December 31, 2004.

         The placement  agent in the financing,  received  compensation  for its
services in the amount of $620,000 in cash and issuance of five year warrants to
purchase up to 200,000  shares of our common stock at an exercise price of $2.50
per share.  The  warrants to purchase  200,000  shares of our common  stock were
valued at  $138,000  using the  Black-Scholes  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 financing cost paid to the placement  agent
of  $620,000,  and the value of the warrants to purchase  200,000  shares of our
common stock of $138,000 were included in the deferred  financing  cost,  net on
our accompanying balance sheets and was amortized over the life of the loan.

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


                                       15



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


10.      EQUITY TRANSACTIONS

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

11.      RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

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


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

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

12.      INCOME TAXES

         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,  we are 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.


                                       16



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


         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.

13.      NET INCOME (LOSS) PER SHARE

         A  reconciliation  of the numerator and  denominator  of basic earnings
(loss) per share and diluted earnings (loss) per share is as follows:



                                       THREE MONTHS ENDED              NINE MONTHS ENDED
                                          SEPTEMBER 30,                  SEPTEMBER 30,
                                  ----------------------------   ----------------------------
                                      2006            2005           2006           2005
                                  ------------    ------------   ------------    ------------
                                                                     
Basic EPS Computation:
Numerator .....................   $(25,352,414)   $  1,702,417   $(23,904,758)   $  2,467,436
Denominator:
Weighted average common shares
outstanding ...................     30,543,763      30,365,502     30,546,217      29,451,054
                                  ------------    ------------   ------------    ------------

Basic EPS .....................   $      (0.83)   $       0.06   $      (0.78)   $       0.08
                                  ============    ============   ============    ============

Diluted EPS Computation:
Numerator .....................   $(25,352,414)   $  1,702,417   $(23,904,758)   $  2,467,436
Denominator:
Weighted average common shares
outstanding ...................     30,543,763      30,365,502     30,546,217      29,451,054
Incremental shares from assumed
exercise of warrants ..........           --           403,266           --            59,040
options .......................           --            17,029           --             7,157
                                  ------------    ------------   ------------    ------------

Total shares ..................     30,543,763      30,785,797     30,546,217      29,517,251
                                  ------------    ------------   ------------    ------------

Diluted EPS ...................   $      (0.83)   $       0.06   $      (0.78)   $       0.08
                                  ============    ============   ============    ============



         Basic and  diluted  earnings  (loss)  per share  has been  computed  in
accordance with SFAS No. 128, "Earnings Per Share".

         Only  7,157  shares  of  outstanding   options  were  included  in  the
computation of net income per share in the nine months ended September 30, 2005,
as the  exercise  prices of the  remaining  shares were greater than the average
market  price for the nine months ended  September  30,  2005.  All  outstanding
options of 2006 were excluded from the  computation of net loss per share in the
nine months ended September 30, 2006 as the impact would be  anti-dilutive.  All
warrants were excluded  from the  computation  of net income (loss) per share in
the nine  months  ended  September  30,  2006 and 2005,  as the impact  would be
anti-dilutive.  The effect of applying "IF Converted  Method" to the convertible


                                       17



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


debenture was anti-dilutive;  therefore, it was excluded from the computation of
income per share in the nine  months  ended  September  30,  2006 and 2005.  The
following  table  presents   outstanding   options,   warrants  and  convertible
debentures.

                                            AS OF SEPTEMBER 30,
                                         -----------------------
                                            2006         2005
                                         ----------   ----------

                Options ..............    7,946,859    6,745,175
                Warrants .............    5,931,732    2,361,732
                Convertible debentures         --      3,456,313
                                         ----------   ----------
                Total ................   13,878,591   12,563,220
                                         ==========   ==========

14.      RELATED PARTY TRANSACTIONS

         As of September 30, 2006,  related party affiliates were indebted to us
in the amounts of $8.3 million.  These include amounts due from Gerard Guez, our
Chairman and Interim Chief Executive Officer.  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  in the  third  quarter  of  2006  was
approximately $2,234,000. At September 30, 2006, the entire balance due from Mr.
Guez totaling $2.2 million is payable on demand and has been shown as reductions
to shareholders' equity in the accompanying  financial statements.  All advances
to Mr. Guez bore interest at the rate of 7.75% during the period. Total interest
paid by Mr. Guez was $129,000  and $165,000 for the nine months ended  September
30,  2006 and 2005,  respectively.  Mr.  Guez  paid  expenses  on our  behalf of
approximately $226,000 and $321,000 for the nine months ended September 30, 2006
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 our  executive
officers or directors.

         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 and
Interim Chief  Executive  Officer,  called United  Apparel  Ventures,  LLC. 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
made  purchases from two related  parties in Mexico,  an affiliate of Azteca and
Tag-It Pacific, Inc.

         At September 30, 2006, Messrs.  Guez and Kay beneficially owned 590,000
and 1,003,500  shares,  respectively,  of common stock of Tag-It Pacific,  Inc.,
collectively  representing  approximately 8.7% of Tag-It Pacific's common stock.
Tag-It Pacific is a provider of brand  identity  programs to  manufacturers  and
retailers of apparel and accessories. Starting from 1998, Tag-It Pacific assumed
the  responsibility  for managing and  sourcing all trim and  packaging  used in
connection with products  manufactured  by or on behalf of us in Mexico.  Due to
the restructuring of our Mexico operations, Tag-It Pacific no longer manages our
trim and  packaging  requirements.  We  purchased  $205,000  and $55,000 of trim
inventory  from Tag-It  Pacific in the nine months ended  September 30, 2006 and
2005,  respectively.  Our sales of garment  accessories  to Tag-It  Pacific were
$39,000  and  $0  in  the  nine  months  ended  September  30,  2006  and  2005,
respectively.  We purchased $0 and $135,000 of finished  goods and services from
Azteca and its affiliates in the nine months ended  September 30, 2006 and 2005,
respectively.  Our sales of fabric  and  services  to Azteca in the nine  months
ended September 30, 2006 and 2005 was $9,000 and $63,000, respectively.

         On September 1, 2006,  our  subsidiary  in Hong Kong,  Tarrant  Company
Limited,  entered into an agreement with Seven  Licensing  Company,  LLC ("Seven
Licensing") to be its buying agent to source and purchase  apparel  merchandise.
Seven Licensing is beneficially  owned by Gerard Guez. Net amount due from these
related parties as of September 30, 2006 was $5.5 million.


                                       18



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


         In August 2004,  we entered  into an  Agreement  for Purchase of Assets
with  affiliates  of  Mr.  Kamel  Nacif,  a  shareholder  at  the  time  of  the
transaction,  which  agreement  was  amended in October  2004.  Pursuant  to the
agreement,  as  amended,  on  November  30,  2004,  we  sold  to the  purchasers
substantially  all of our assets and real  property  in  Mexico,  including  the
equipment  and  facilities  we previously  leased to Mr.  Nacif's  affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and  $3,910,000 by delivery of unsecured  promissory  notes bearing  interest at
5.5% per annum;  and b)  $40,204,000,  by delivery of secured  promissory  notes
bearing interest at 4.5% per annum, maturing on December 31, 2005 and every year
thereafter until December 31, 2014. The secured  promissory notes are payable in
partial or total amounts anytime prior to the maturity of each note. Included in
the $41.0 million notes receivable - related party on the  accompanying  balance
sheet as of  September  30, 2006 was $1.3 million of Mexico value added taxes on
the real property  component of this transaction.  Historically,  we have placed
orders for  purchases  of fabric from the  purchasers  pursuant to the  purchase
commitment  agreement  we  entered  into at the time of the  sale of the  Mexico
assets,  and we  have  satisfied  our  payment  obligations  for the  fabric  by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  the  purchasers  have  recently  ceased  providing  fabric and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable in an amount equal to the  outstanding  balance less the value of the
underlying assets securing the notes. The loss was estimated to be approximately
$27.1 million,  resulting in a notes receivable balance at September 30, 2006 of
approximately  $14 million.  We will continue to pursue payments under the notes
receivable  and believe the remaining $14 million  balance at September 30, 2006
is  realizable.  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.  We  purchased  $0 and $4.1  million of fabric  from  Acabados y
Terminados in the nine months ended  September 30, 2006 and 2005,  respectively.
In addition to the above notes receivable,  net amount due from these parties as
of September 30, 2006 was $412,000, related to reimbursement expenses.

         We lease our executive  offices in Los Angeles,  California from GET, a
corporation  which is owned by  Gerard  Guez (our  Chairman  and  Interim  Chief
Executive Officer) and Todd Kay (our Vice Chairman).  Additionally, we lease our
warehouse and office space in Hong Kong from Lynx International  Limited, a Hong
Kong  corporation  that is owned by Messrs.  Guez and Kay. We paid  $807,000 and
$764,000  in  rent in the  nine  months  ended  September  30,  2006  and  2005,
respectively, for office and warehouse facilities. During the first seven months
of 2006,  our Los Angeles  offices and  warehouse was leased on a month to month
basis. On August 1, 2006, we entered into a lease agreement with GET for the Los
Angeles  offices  and  warehouse,  which  lease has a term of five years with an
option to renew for an additional five year term. On January 1, 2006, we renewed
our lease agreement with Lynx International Limited for our office space in Hong
Kong for one year.

         On  May 1,  2006,  we  sublet  our  executive  office  in Los  Angeles,
California  and our sales  office in New York to Seven  Licensing  Company,  LLC
("Seven  Licensing") for a monthly payment of $25,000 on a month to month basis.
Seven Licensing is  beneficially  owned by Gerard Guez, our Chairman and Interim
Chief  Executive  Officer.  We  received  $125,000  in rental  income  from this
sublease in the nine months ended September 30, 2006.

         At September 30, 2006,  we had various  employee  receivables  totaling
$258,000 included in due from related parties.

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

15.      COMMITMENTS AND CONTINGENCIES

         On January 3, 2005, Private Brands,  Inc., our wholly owned subsidiary,
entered into a term sheet exclusive licensing agreement with Beyond Productions,
LLC and Kids  Headquarters  to  collaborate  on the  design,  manufacturing  and
distribution of women's contemporary, large sizes and junior apparel bearing the
brand name "House of  Dereon",  Couture,  Kick and Soul.  This  agreement  was a
three-year contract, and providing compliance with all terms of the license, was
renewable  for one  additional  three-year  term.  The  agreement  also provided
payment  of  royalties  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


                                       19



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


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 the first  year term of the  agreement  and
recognized a corresponding loss in 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.  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.  In December
2004,  we  advanced  $2.2  million  as  payment  for the  first  year's  minimum
royalties.  We applied $1.1 million from the above  advance  against the royalty
and  marketing  expenses in 2005 and $884,000 in the first three months of 2006.
In March  2006,  we had  written off the  capitalized  balance of  $192,000  and
recognized a  corresponding  loss. The loss was classified as royalty expense on
our consolidated statements of operations.  In March 2006, we became involved in
a dispute with the  licensor of the Jessica  Simpson  brands over our  continued
rights to these brands.  We are presently in litigation  with the licensor.  See
Note 17 of the "Notes to Consolidated Financial Statements"

         In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the  trademark  "American  Rag CIE" and the  operator of  American  Rag
retail  stores for $1.4  million,  and our  subsidiary,  Private  Brands,  Inc.,
acquired  a license  to  certain  exclusive  rights to this  trademark.  We have
guaranteed  the payment to the licensor of minimum  royalties  of $10.4  million
over the initial  10-year term of the agreement.  The guaranteed  annual minimum
royalty  is  payable  in  equal  monthly  installments  during  the  term of the
agreement. The royalty owed to the licensor in excess of the guaranteed minimum,
if any,  is payable no later  than 30 days after the end of the  preceding  full
quarter with the amount for last quarter adjusted based on actual royalties owed
for the year. At September 30, 2006, the total commitment on royalties remaining
on the term was $8.6 million.

         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. We purchased
$0 and $3.2  million of fabric  under this  agreement  in the nine months  ended
September 30, 2006 and 2005, respectively.

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

         On September 1, 2006,  our  subsidiary  in Hong Kong,  Tarrant  Company
Limited,  entered into an agreement with Seven  Licensing  Company,  LLC ("Seven
Licensing") to be its buying agent to source and purchase  apparel  merchandise.
Seven Licensing is beneficially  owned by Gerard Guez. Net amount due from these
related parties as of September 30, 2006 was $5.5 million.

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


                                       20



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


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.



                                                                                          ADJUSTMENTS
                                                                                              AND
                            UNITED STATES       ASIA          MEXICO       LUXEMBOURG    ELIMINATIONS       TOTAL
                             ------------   ------------   ------------   ------------   ------------   ------------
                                                                                      
THREE MONTHS ENDED
SEPTEMBER 30, 2006
Sales ....................   $ 53,092,000   $  1,545,000   $      8,000   $       --     $       --     $ 54,645,000
Inter-company sales ......           --       28,221,000           --             --      (28,221,000)          --
                             ------------   ------------   ------------   ------------   ------------   ------------
Total revenue ............   $ 53,092,000   $ 29,766,000   $      8,000   $       --     $(28,221,000)  $ 54,645,000
                             ============   ============   ============   ============   ============   ============

Income (loss) from
   operations ............   $  1,510,000   $  1,057,000   $   (144,000)  $(27,142,000)  $       --     $(24,719,000)
                             ============   ============   ============   ============   ============   ============
Interest income ..........   $    137,000   $    796,000   $       --     $     28,000   $   (796,000)  $    165,000
                             ============   ============   ============   ============   ============   ============
Interest expense .........   $  1,530,000   $     32,000   $      1,000   $    795,000   $   (796,000)  $  1,562,000
                             ============   ============   ============   ============   ============   ============
Provision for depreciation
   and amortization ......   $    574,000   $     28,000   $       --     $       --     $       --     $    602,000
                             ============   ============   ============   ============   ============   ============
Capital expenditures .....   $     31,000   $     36,000   $       --     $       --     $       --     $     67,000
                             ============   ============   ============   ============   ============   ============


THREE MONTHS ENDED
SEPTEMBER 30, 2005
Sales ....................   $ 69,023,000   $    536,000   $      7,000   $       --     $       --     $ 69,566,000
Inter-company sales ......           --       43,576,000           --             --      (43,576,000)          --
                             ------------   ------------   ------------   ------------   ------------   ------------
Total revenue ............   $ 69,023,000   $ 44,112,000   $      7,000   $       --     $(43,576,000)  $ 69,566,000
                             ============   ============   ============   ============   ============   ============

Income (loss) from
   operations ............   $    309,000   $  2,568,000   $    168,000   $    (34,000)  $       --     $  3,011,000
                             ============   ============   ============   ============   ============   ============
Interest income ..........   $     46,000   $    525,000   $       --     $    459,000   $   (524,000)  $    506,000
                             ============   ============   ============   ============   ============   ============
Interest expense .........   $  1,206,000   $     95,000   $       --     $    524,000   $   (524,000)  $  1,301,000
                             ============   ============   ============   ============   ============   ============
Provision for depreciation
   and amortization ......   $    462,000   $     26,000   $       --     $       --     $       --     $    488,000
                             ============   ============   ============   ============   ============   ============
Capital expenditures .....   $    186,000   $     75,000   $    112,000   $       --     $       --     $    373,000
                             ============   ============   ============   ============   ============   ============



                                       21



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)




                                                                                               ADJUSTMENTS
                                                                                                   AND
                             UNITED STATES        ASIA            MEXICO        LUXEMBOURG     ELIMINATIONS        TOTAL
                             -------------    -------------   -------------   -------------   -------------    -------------
                                                                                             
NINE MONTHS ENDED
SEPTEMBER 30, 2006
Sales ....................   $ 172,538,000    $   2,526,000   $     (75,000)  $        --     $        --      $ 174,989,000
Inter-company sales ......            --         89,145,000            --              --       (89,145,000)            --
                             -------------    -------------   -------------   -------------   -------------    -------------
Total revenue ............   $ 172,538,000    $  91,671,000   $     (75,000)  $        --     $ (89,145,000)   $ 174,989,000
                             =============    =============   =============   =============   =============    =============

Income (loss) from
   operations ............   $   3,859,000    $   3,367,000   $    (547,000)  $ (27,144,000)  $        --      $ (20,465,000)
                             =============    =============   =============   =============   =============    =============
Interest income ..........   $     229,000    $   2,190,000   $        --     $     901,000   $  (2,188,000)   $   1,132,000
                             =============    =============   =============   =============   =============    =============
Interest expense .........   $   4,525,000    $     159,000   $      12,000   $   2,188,000   $  (2,188,000)   $   4,696,000
                             =============    =============   =============   =============   =============    =============
Provision for depreciation
   and amortization ......   $   2,302,000    $      82,000   $        --     $        --     $        --      $   2,384,000
                             =============    =============   =============   =============   =============    =============
Capital expenditures .....   $      63,000    $      67,000   $        --     $        --     $        --      $     130,000
                             =============    =============   =============   =============   =============    =============

Total assets .............   $ 114,484,000    $ 117,481,000   $  14,528,000   $ 183,588,000   $(325,588,000)   $ 104,493,000
                             =============    =============   =============   =============   =============    =============


NINE MONTHS ENDED
SEPTEMBER 30, 2005
Sales ....................   $ 163,828,000    $   1,006,000   $     100,000   $        --     $        --      $ 164,934,000
Inter-company sales ......            --        105,576,000            --              --      (105,576,000)            --
                             -------------    -------------   -------------   -------------   -------------    -------------
Total revenue ............   $ 163,828,000    $ 106,582,000   $     100,000   $        --     $(105,576,000)   $ 164,934,000
                             =============    =============   =============   =============   =============    =============

Income (loss) from
   operations ............   $    (537,000)   $   5,444,000   $    (192,000)  $     (34,000)  $        --      $   4,681,000
                             =============    =============   =============   =============   =============    =============
Interest income ..........   $     169,000    $   1,345,000   $        --     $   1,406,000   $  (1,344,000)   $   1,576,000
                             =============    =============   =============   =============   =============    =============
Interest expense .........   $   3,090,000    $     309,000   $       1,000   $   1,344,000   $  (1,344,000)   $   3,400,000
                             =============    =============   =============   =============   =============    =============
Provision for depreciation
 and amortization ........   $   1,664,000    $      75,000   $        --     $        --     $        --      $   1,739,000
                             =============    =============   =============   =============   =============    =============
Capital expenditures .....   $     278,000    $     175,000   $        --     $        --     $        --      $     453,000
                             =============    =============   =============   =============   =============    =============

Total assets .............   $ 141,941,000    $ 128,811,000   $  32,006,000   $ 212,387,000   $(354,447,000)   $ 160,698,000
                             =============    =============   =============   =============   =============    =============



                                       22



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)


17.      LITIGATION

         On or about April 6, 2006, we commenced an action  against the licensor
of the  Jessica  Simpson  brands  (captioned  Tarrant  Apparel  Group v.  Camuto
Consulting  Group,  Inc.,  VCJS LLC, With You, Inc. and Jessica  Simpson) in the
Supreme  Court of the State of New York,  County  of New  York.  The suit  named
Camuto Consulting  Group,  Inc., VCJS LLC, With You, Inc. and Jessica Simpson as
defendants,  and asserts that the defendants  failed to provide promised support
in connection with our sublicense  agreement for the Jessica Simpson brands. Our
complaint  includes eight causes of action,  including two seeking a declaration
that the sublicense agreement is exclusive and remains in full force and effect,
as well as claims for breach of  contract  by Camuto  Consulting,  breach of the
duty of good faith and fair dealing and  fraudulent  inducement  against  Camuto
Consulting,  and a claim against With You,  Inc. and Ms.  Simpson that we are an
intended third party  beneficiary of the licenses  between those  defendants and
Camuto  Consulting.  On or about April 26, 2006,  Camuto  Consulting  served its
answer to our complaint and included a counterclaim against us for breach of the
sublicense  agreement and alleging damages of no less than $100 million.  Camuto
Consulting  has  also  served a motion  to  dismiss  our  cause  of  action  for
fraudulent  inducement.  On or about May 22, 2006, we served our reply to Camuto
Consulting's  counterclaim.  On or about April 27, 2006,  Ms.  Simpson  served a
motion  seeking  dismissal  of the cause of action  asserted  against her. On or
about May 10, 2006, we served our  opposition to Ms.  Simpson motion to dismiss.
On or about June 14, 2006, we served a  cross-motion  seeking leave to amend our
complaint to add Vincent Camuto as a defendant.  On October 18, 2006, the Court:
(i) granted our  cross-motion  seeking leave to file a supplemental  summons and
amended  complaint  adding Vincent Camuto as a defendant and  supplementing  the
allegations of fraud against Camuto Consulting;  (ii) denied Camuto Consulting's
motion to  dismiss  the cause of action  for  fraudulent  inducement;  and (iii)
denied Ms. Simpson's motion to dismiss the cause of action asserted against her.
On or about October 30, 2006,  Camuto Consulting and Vincent Camuto served their
answer to the amended complaint, with a counterclaim that is virtually identical
to the  original  counterclaim.  We  intend to  continue  to  vigorously  defend
Camuto's  counterclaim and vigorously oppose Ms. Simpson's motion.  Discovery in
the matter has been  underway  since May 2006. A status  conference is scheduled
before the Court on November 21, 2006.

         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 November 27,
2006. We will continue to vigorously  defend  against the breach of contract and
unjust enrichment claim.

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


                                       23



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS.

BUSINESS OVERVIEW AND RECENT DEVELOPMENTS

         We are a design and  sourcing  company  for  private  label and private
brand casual apparel  serving mass  merchandisers,  department  stores,  branded
wholesalers  and specialty  chains located  primarily in the United States.  Our
major  customers  include leading  retailers,  such as Kohl's,  Chico's,  Macy's
Merchandising Group, Mervyn's,  Mothers Work, Sears, Wal-Mart,  Dillard's,  Lane
Bryant,  Lerner New York,  and the Avenue.  Our products are  manufactured  in a
variety of woven and knit  fabrications  and include  jeans wear,  casual pants,
t-shirts,  shorts,  blouses,  shirts and other tops,  dresses and  jackets.  Our
private brands include American Rag Cie and Alain Weiz.

PRIVATE LABEL

         Private  label  business has been our core  competency  for over twenty
years, and involves a one to one relationship with a large, centrally controlled
retailer   with  whom  we  can   develop   product   lines  that  fit  with  the
characteristics  of their  particular  customer.  Private label net sales in the
first nine months of 2006 were $135.8 million  compared to $119.5 million in the
first nine months of 2005.

         The exposure of developing  private brands  collections has created new
opportunities  within the private label business to add value in the development
and marketing of new initiatives for Sears,  Mothers Work, Avenue,  Chico's, and
other retailers.  These  initiatives were launched during 2005, and are on track
to be significant growth areas for 2006.

PRIVATE BRANDS

         We launched our private brands initiative in 2003, pursuant to which we
acquire ownership of or license rights to a brand name and sell apparel products
under this brand,  generally  to a single  retail  company  within a  geographic
region.  Private  brands net sales in the first  nine  months of 2006 were $39.2
million  compared to $45.4 million in the first nine months of 2005.  During the
nine  months  ended  September  30,  2006,  we owned or  licensed  rights to the
following private brands:

         o        AMERICAN  RAG CIE:  During  the  first  quarter  of  2005,  we
                  extended our  agreement  with Macy's  Merchandising  Group for
                  nine years,  pursuant to which we  exclusively  distribute our
                  American Rag Cie brand through  Macy's  Merchandising  Group's
                  national  Department  Store  organization  of  more  than  600
                  stores.  Net sales of American Rag Cie branded apparel totaled
                  $23.1 million in the first nine months of 2006.

         o        ALAIN WEIZ: We continue to sell Alan Weiz apparel  exclusively
                  to  Dillard's  Department  Stores.  Net  sales of  Alain  Weiz
                  branded  apparel totaled $4.6 million in the first nine months
                  of 2006.

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

         o        GEAR 7: During the fourth quarter of 2005, K-Mart discontinued
                  sales of Gear 7 products, which resulted in a decline in sales
                  for  this  brand in the  fourth  quarter  of  2005.  We do not
                  anticipate sales of Gear 7 branded apparel in 2006.

         o        JESSICA  SIMPSON  brands:  The JS by Jessica Simpson brand was
                  originally launched as a denim line with Charming Shoppes. Net
                  sales of JS by Jessica Simpson and Princy by Jessica  Simpson,
                  which is the  department  store  and  better  specialty  store
                  brand,  totaled $9.3 million in the first  quarter of 2006. In
                  March 2006, we became  involved in a dispute with the licensor
                  of the Jessica  Simpson  brands over our  continued  rights to
                  these brands,  and we are  presently in  litigation  with this
                  licensor.  Accordingly,  we did not have any sales of  Jessica
                  Simpson branded apparel after the first quarter of 2006 and do
                  not  anticipate  any  sales  unless  and  until we are able to
                  successfully  resolve  our  dispute  and  retain our rights to
                  these brands.


                                       24



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

NOTES RECEIVABLE - RELATED PARTY RESERVE

         In connection  with the sale in 2004 of our assets and real property in
Mexico, the purchasers of the Mexico assets issued us unsecured promissory notes
of $3,910,000 that mature on November 30, 2007 and secured  promissory  notes of
$40,204,000 that mature on December 31, 2014 and are payable in partial or total
amounts  anytime  prior to the  maturity  of each note.  The  secured  notes are
secured  by the  real  and  personal  property  in  Mexico  that  we sold to the
purchasers.  As of September 30, 2006, the outstanding  balance of the notes and
interest receivables were $41.1 million prior to the reserve.  Historically,  we
have placed orders for purchases of fabric from the  purchasers  pursuant to the
purchase  commitment  agreement  we entered  into at the time of the sale of the
Mexico assets,  and we have satisfied our payment  obligations for the fabric by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  the  purchasers  have  recently  ceased  providing  fabric and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable  in a amount equal to the  outstanding  balance less the value of the
underlying assets securing the notes. The loss was estimated to be approximately
$27.1 million, resulting in a net notes receivable balance at September 30, 2006
of approximately $14 million.  We will continue to pursue payment of all amounts
under the notes  receivable  and believe the  remaining  $14 million  balance at
September  30,  2006 is  realizable.  The entire  reserve  was  recorded  in the
Luxembourg geographic reporting segment.

CREDIT FACILITY REFINANCING

         In June 2006,  we entered into a new $65 million  credit  facility with
Guggenheim  Corporate  Funding,  LLC (as agent for certain lenders) and expanded
our existing  facilities with GMAC Commercial  Finance Credit,  LLC and DBS Bank
(Hong Kong) Limited.  The credit facility with Guggenheim consists of an initial
term loan of $25  million,  of which $15.5  million was  advanced at the initial
closing.  The initial  term loan was or will be used to repay  certain  existing
indebtedness and fund general operating and working capital needs. A second term
loan of up to $40 million will be available to finance  acquisitions  acceptable
to Guggenheim as agent. In addition, in June 2006, our credit facility with GMAC
Commercial  Finance Credit, LLC and other lenders was increased from $45 million
to $55 million,  and our credit  facility  with DBS Bank (Hong Kong) Limited was
increased from $4.5 million to $25 million.  These financings significant expand
our borrowing base, which provides enhanced financial flexibility to us.

INTERNAL REVENUE SERVICE AUDIT

         In January 2004, the Internal Revenue Service completed its examination
of our Federal  income tax returns for the years ended December 31, 1996 through
2001.  The IRS has proposed  adjustments  to increase our income tax payable for
the six years under examination. This adjustment would also result in additional
state taxes and  interest.  In  addition,  in July 2004,  the IRS  initiated  an
examination  of our Federal  income tax return for the year ended  December  31,
2002. In March 2005,  the IRS proposed an  adjustment  to our taxable  income of
approximately $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.  We believe that we have  meritorious  defenses to
and intend to vigorously  contest the proposed  adjustments  made to our federal
income tax  returns  for the years  ended 1996  through  2002.  If the  proposed
adjustments are upheld through the administrative and legal process,  they could
have a  material  impact on our  earnings  and cash  flow.  We  believe  we have
provided  adequate  reserves for any reasonably  foreseeable  outcome related to
these matters on the  consolidated  balance sheets included in the  consolidated
financial  statements  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


                                       25



from the IRS  examination,  will result in an  additional  income tax  liability
beyond what is recorded in the accompanying consolidated balance sheets.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

         We believe the following critical  accounting  policies affect our more
significant  judgments and estimates used in the preparation of our consolidated
financial  statements.  For a further discussion on the application of these and
other accounting  policies,  see Note 1 of the "Notes to Consolidated  Financial
Statements"  included  in our  Annual  Report  on Form  10-K for the year  ended
December 31, 2005.

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  chargebacks  based on our  historical  collection
experience.  If our 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 September  30, 2006,  the balance in the  allowance  for returns,
discounts and bad debts reserves was $3.3 million.

INVENTORY

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

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

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


                                       26



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

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

         o        a significant negative industry or economic trend.

         Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards 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. As of September 30, 2006, we have a goodwill balance of $8.6 million, and
a net property and equipment balance of $1.5 million.

INCOME TAXES

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

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

DEBT COVENANTS

         Our debt agreements require certain covenants including a minimum level
of  EBITDA  and  tangible  net  worth as  discussed  in Note 8 of the  "Notes to
Consolidated  Financial  Statements."  As of  September  30,  2006,  we  were in
violation  with the  EBITDA  covenants  and  waivers  were  obtained  during the
default.  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 obtain 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,
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.

VALUATION OF DERIVATIVE INSTRUMENTS

         Statements  of  Financial   Accounting   Standards   ("SFAS")  No.  133
"Accounting  for  Derivative   Instruments  and  Hedging  Activities"   requires
measurement of certain derivative instruments at their fair value for accounting
purposes.   In   determining   the   appropriate   fair   value,   we  use   the
Black-Scholes-Merton Option Pricing Formula (the


                                       27



"Black-Scholes  Model").  Derivative  liabilities  are  adjusted to reflect fair
value at each period end,  with any increase or decrease in the fair value being
recorded in  consolidated  statements of operations as adjustments to fair value
of derivatives.

NEW ACCOUNTING PRONOUNCEMENTS

         For a description  of recent  accounting  pronouncements  including the
respective  expected  dates of adoption and effects on results of operations and
financial  condition,  see  Note  11 of the  "Notes  to  Consolidated  Financial
Statements."

RESULTS OF OPERATIONS

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



                                          THREE MONTHS ENDED           NINE MONTHS ENDED
                                             SEPTEMBER 30,                SEPTEMBER 30,
                                      -------------------------     -------------------------
                                         2006           2005           2006           2005
                                      ----------     ----------     ----------     ----------
                                                                            
Net sales .........................        100.0%         100.0%         100.0%         100.0%
Cost of sales .....................         78.4           79.1           78.9           78.8
                                      ----------     ----------     ----------     ----------
Gross profit ......................         21.6           20.9           21.1           21.2
Selling and distribution expenses .          4.7            4.1            4.7            4.7
General and administration expenses         12.0           10.6           11.4           12.3
Royalty expenses ..................          0.5            1.9            1.2            1.3
Loss on notes receivable - related
   parties ........................         49.7           --             15.5           --
                                      ----------     ----------     ----------     ----------
Income (loss) from operations .....        (45.3)           4.3          (11.7)           2.9
Interest expense ..................         (2.8)          (1.9)          (2.7)          (2.1)
Interest Income ...................          0.3            0.7            0.7            1.0
Interest in income (loss) of equity
   method investee ................          0.0            0.2            0.1            0.3
Other income ......................          0.2            0.1            0.1            0.1
Adjustment to fair value of
   derivative .....................          1.3           (0.0)           0.3           (0.0)
Other expense .....................          0.0           (0.0)          (0.2)          (0.0)
Minority interest in consolidated
   subsidiary .....................          0.0           (0.2)           0.0           (0.1)
                                      ----------     ----------     ----------     ----------
Income (loss) before taxes ........        (46.3)           3.2          (13.4)           2.1
Income taxes ......................          0.1            0.7            0.2            0.6
                                      ----------     ----------     ----------     ----------
Net income (loss) .................        (46.4)%          2.5%         (13.6)%          1.5%
                                      ==========     ==========     ==========     ==========


THIRD QUARTER 2006 COMPARED TO THIRD QUARTER 2005

         Net sales decreased by $14.9 million, or 21.4%, to $54.6 million in the
third quarter of 2006 from $69.6 million in the third quarter of 2005.  Sales of
private label in the third quarter of 2006 were $46.1 million  compared to $47.0
million in the same period of 2005, with the decrease  resulting  primarily from
decreased  sales to  Wal-Mart,  offset by increased  sales to  Charlotte  Russe,
Mothers Work and Mervyn's.  Sales of private brands in the third quarter of 2006
were $8.5 million  compared to $22.6 million in the same period of 2005 with the
decrease  resulting  primarily from no sales of Gear7 and Jessica Simpson brands
in the third quarter of 2006.

         Gross profit  consists of net sales less product  costs,  direct labor,
manufacturing  overhead,  duty, quota,  freight in, brokerage,  and warehousing.
Gross profit  decreased by $2.7 million to $11.8 million in the third quarter of
2006 from $14.5  million in the third  quarter of 2005.  The  decrease  in gross
profit occurred primarily because of a decrease in sales. As a percentage of net
sales,  gross profit  increased from 20.9% in the third quarter of 2005 to 21.6%
in the  third  quarter  of 2006.  The  increase  in gross  margin  is  primarily
attributable  to changes in customer mix in private label and improved  sourcing
in private  brand  business in the third quarter of 2006 as compared to the same
period of 2005.

         Selling and distribution  expenses  decreased by $278,000,  or 9.8%, to
$2.6 million in the third quarter of 2006 from $2.8 million in the third quarter
of 2005. As a percentage of net sales,  these expenses  increased to 4.7% in the
third  quarter of 2006 from 4.1% in the third  quarter of 2005 due to  decreased
sales during the third quarter of 2006.


                                       28



         General and administrative expenses decreased by $847,000, or 11.5%, to
$6.6 million in the third quarter of 2006 from $7.4 million in the third quarter
of 2005. The decrease was primarily due to reduced overhead  associated with our
private brands business.  As a percentage of net sales, these expenses increased
to 12.0% in the third  quarter of 2006 from  10.6% in the third  quarter of 2005
due to decreased sales during the third quarter of 2006.

         Royalty and marketing  allowance expenses decreased by $1.0 million, or
79.5%,  to $264,000 in the third  quarter of 2006 from $1.3 million in the third
quarter of 2005. As a percentage of net sales,  these expenses decreased to 0.5%
in the third quarter of 2006 from 1.9% in the third quarter of 2005.

         Loss on notes receivable - related parties was $27.1 million,  or 49.7%
of net sales, in the third quarter of 2006,  compared to $0 in the third quarter
of 2005.  The  purchasers of the Mexico assets have  recently  ceased  providing
fabric and are not currently  making  payments under the notes. We evaluated the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable in an amount equal to the  outstanding  balance less the value of the
underlying  assets securing the notes.  See Note 7 of the "Notes to Consolidated
Financial Statements".

         Operating  loss in the  third  quarter  of 2006 was $24.7  million,  or
(45.3)% of net sales,  compared to operating income of $3.0 million,  or 4.3% of
net sales,  in the  comparable  period of 2005,  primarily  due to loss on notes
receivable  -  related  parties  in the  amount of $27.1  million  and the other
factors discussed above.

         Interest  expense  increased by $261,000,  or 20.1%, to $1.6 million in
the third  quarter of 2006 from $1.3 million in the third  quarter of 2005. As a
percentage of net sales,  this expense increased to 2.8% in the third quarter of
2006  from 1.9% in the third  quarter  of 2005.  Interest  income  decreased  by
$341,000,  or 67.3%,  to $165,000 in the third  quarter of 2006 from $506,000 in
the third  quarter of 2005.  Other income was  $109,000 in the third  quarter of
2006, compared to $39,000 in the third quarter of 2005. Adjustment to fair value
of derivative  was $729,000 in the third quarter of 2006,  compared to $0 in the
third  quarter of 2005.  Other  expense was $0 in the third  quarter of 2006 and
2005.

         Losses  allocated to minority  interests  in the third  quarter of 2006
were  $14,000,  representing  the  minority  partner's  share of losses in PBG7.
Income  allocated  to  minority  interests  in the  third  quarter  of 2005 were
$164,000, representing the minority partner's share of profit in PBG7.

FIRST NINE MONTHS OF 2006 COMPARED TO FIRST NINE MONTHS OF 2005

         Net sales increased by $10.1 million, or 6.1%, to $175.0 million in the
first nine months of 2006 from $164.9  million in the first nine months of 2005.
Sales of private  label in the first  nine  months of 2006 were  $135.8  million
compared  to  $119.5  million  in the same  period  of 2005,  with the  increase
resulting  primarily from increased sales to Kohl's,  Charlotte Russe,  Chico's,
Mervyn's and Mothers Work and offset by decreased  sales to Wal-Mart and Lerner.
Sales of private  brands in the nine months of 2006 were $39.2 million  compared
to $45.4 million in the same period of 2005.

         Gross profit  increased  by $2.0 million to $37.0  million in the first
nine  months of 2006 from $34.9  million in the first nine  months of 2005.  The
increase in gross profit occurred  primarily because of an increase in sales. As
a percentage  of net sales,  gross profit  decreased  slightly from 21.2% in the
first nine months of 2005 to 21.1% in the first nine months of 2006.

         Selling and distribution  expenses  increased by $483,000,  or 6.2%, to
$8.3  million  in the first nine  months of 2006 from $7.8  million in the first
nine months of 2005,  due primarily to increased  sales.  As a percentage of net
sales,  these expenses  remained  unchanged at 4.7% for the first nine months of
2005 and 2006.

         General and administrative  expenses decreased by $356,000, or 1.8%, to
$19.9  million in the first nine months of 2006 from $20.3  million in the first
nine months of 2005. As a percentage of net sales,  these expenses  decreased to
11.4% in the first nine  months of 2006 from  12.3% in the first nine  months of
2005 due to increased  sales during the first nine months 2006.  Included in the
general  and  administrative  expenses  in the  first  nine  months  of 2006 was
$284,000 of expensing  the financing  cost paid to the  placement  agent and the
remaining value of the


                                       29



warrants to  placement  agent and  $171,000 of  prepayment  penalty  paid to the
debenture holders as a result of the repayment of the Debentures.

         Royalty and marketing allowance expenses decreased by $82,000, or 3.8%,
to $2.1  million in the first nine months of 2006 from $2.2 million in the first
nine months of 2005. As a percentage of net sales,  these expenses  decreased to
1.2% in the first  nine  months of 2006  from 1.3% in the first  nine  months of
2005.

         Loss on notes receivable - related parties was $27.1 million,  or 15.5%
of net sales, in the first nine months of 2006, compared to $0 in the first nine
months of 2005.  The  purchasers  of the  Mexico  assets  have  recently  ceased
providing  fabric and are not  currently  making  payments  under the notes.  We
evaluated the  recoverability of the notes receivable and recorded a loss on the
notes receivable in an amount equal to the outstanding balance less the value of
the  underlying  assets  securing  the  notes.  See  Note  7 of  the  "Notes  to
Consolidated Financial Statements".

         Operating loss for the first nine months of 2006 was $20.5 million,  or
(11.7)% of net sales,  compared to operating income of $4.7 million,  or 2.9% of
net sales,  in the  comparable  prior  period of 2005 as a result of the loss on
notes  receivable - related parties in the amount of $27.1 million and the other
factors discussed above.

         Interest expense increased by $1.3 million or 38.1%, to $4.7 million in
the first nine  months of 2006 from $3.4  million  in the first  nine  months of
2005. As a percentage of net sales,  this expense increased to 2.7% in the first
nine months of 2006 from 2.1% in the first nine months of 2005. The increase was
primarily  due to  expensing  $711,000  in the first nine months of 2006 of debt
discount  related to the intrinsic value of the conversion  option of Debentures
and the remaining  value of the warrants to holders of Debentures as a result of
the  repayment of the  Debentures  in June 2006.  Interest  income  decreased by
$444,000  or 28.2%,  to $1.1  million in the first nine months of 2006 from $1.6
million in the first nine months of 2005. Other income was $233,000 in the first
nine  months of 2006,  compared  to  $278,000  in the first nine months of 2005.
Adjustment to fair value of derivative  was $511,000 in the first nine months of
2006,  compared  to $0 in the first  nine  months  of 2005.  Other  expense  was
$400,000  in the first  nine  months of 2006,  compared  to $0 in the first nine
months of 2005.

         Losses allocated to minority interests in the first nine months of 2006
were  $18,000,  representing  the  minority  partner's  share of losses in PBG7.
Income  allocated  to minority  interests  in the first nine months of 2005 were
$164,000, representing the minority partner's share of profit in PBG7.

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

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

         o        decreases in market prices for our products;

         o        increases in costs of raw materials; and

         o        changes in our working capital requirements.


                                       30



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

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

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

         Cash flows for the nine months ended  September  30, 2006 and 2005 were
as follows (dollars in thousands):

CASH FLOWS:                                             2006             2005
                                                      --------         --------
Net cash provided by (used in)
  operating activities .......................        $ 10,297         $(22,802)
Net cash provided by investing
  activities .................................        $  1,125         $  3,316
Net cash (used in) provided by
  financing activities .......................        $(12,087)        $ 19,908

         During the first nine months of 2006,  net cash  provided by  operating
activities  was  $10.3  million,  as  compared  to net  cash  used in  operating
activities  of $22.8  million for the same period in 2005.  Net cash provided by
operating  activities in the first nine months of 2006 resulted primarily from a
net loss of $23.9 million and the decrease of $15.1 million in accounts payable,
offset by $27.1  million of loss on notes  receivable  - related  parties,  $2.4
million of depreciation and amortization  expense, a decrease of $7.3 million in
accounts receivable,  and a decrease in inventory of $11.2 million. The decrease
in inventory was primarily due to the increase in sales in the first nine months
of 2006,  and the  decrease in accounts  payable  resulted  from the pay down of
payables.

         During the first nine months of 2006,  net cash  provided by  investing
activities  was $1.1  million,  as  compared to net cash  provided by  investing
activities  of $3.3  million for the same period in 2005.  Net cash  provided by
investing  activities in the first nine months of 2006 resulted  primarily  from
the collection on notes receivable.

         During  the  first  nine  months of 2006,  net cash  used in  financing
activities  was $12.1  million,  as compared to net cash  provided by  financing
activities  of $19.9  million  for the same  period  in 2005.  Net cash  used in
financing  activities in the first nine months of 2006 resulted  primarily  from
$1.3 million net repayments of our short-term bank borrowings, net repayments of
our long-term  obligations of $16.5 million,  and repayments of borrowings  from
convertible  debentures  of $6.9  million,  offset by financing of $15.5 million
under our credit facility with Guggenheim.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

         Following is a summary of our  contractual  obligations  and commercial
commitments available to us as of September 30, 2006 (in millions):



                                                          PAYMENTS DUE BY PERIOD
                                          ----------------------------------------------------
                                                       Less     Between    Between
                                                       than       2-3        4-5       After
CONTRACTUAL OBLIGATIONS                    Total      1 year     years      years     5 years
                                          --------   --------   --------   --------   --------
                                                                       
Long-term debt (1) ....................   $   45.1   $   23.4   $    3.9   $   17.8   $   --
Operating leases ......................        9.2        1.5        2.5        2.5        2.7
Minimum royalties .....................       14.6        5.1        3.5        2.4        3.6
Purchase commitment ...................       45.4        9.2       10.0       10.0       16.2
                                          --------   --------   --------   --------   --------
Total Contractual Cash Obligations ....   $  114.3   $   39.2   $   19.9   $   32.7   $   22.5


(1)      Includes interest on long-term debt  obligations.  Based on outstanding
         borrowings as of September 30, 2006, and assuming all such indebtedness
         remained  outstanding  and the interest  rates remained  unchanged,  we
         estimate   that  our  interest   cost  on   long-term   debt  would  be
         approximately $9.8 million.


                                       31





                                                     AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
                                                  -------------------------------------------------
                                       TOTAL
                                      AMOUNTS        LESS       BETWEEN      BETWEEN
COMMERCIAL COMMITMENTS               COMMITTED       THAN        2 -3         4 -5         AFTER
   AVAILABLE TO US                     TO US        1 YEAR       YEARS        YEARS       5 YEARS
----------------------------------   ----------   ----------   ----------   ----------   ----------
                                                                          
Lines of credit ..................   $     80.0   $     80.0   $     --     $     --     $     --
Letters of credit (within lines of
   credit) .......................   $     25.0   $     25.0   $     --     $     --     $     --
Total commercial commitments .....   $     80.0   $     80.0   $     --     $     --     $     --


         On June 13, 2002,  we entered  into a letter of credit  facility of $25
million with UPS Capital Global Trade Finance  Corporation  ("UPS").  Under this
facility,   we  could  arrange  for  the  issuance  of  letters  of  credit  and
acceptances. The facility was collateralized by the shares and debentures of all
of our  subsidiaries in Hong Kong. In addition to the guarantees  provided by us
and our subsidiaries,  Fashion Resource (TCL) Inc. and Tarrant  Luxembourg Sarl,
Gerard Guez,  our Chairman and Interim Chief  Executive  Officer,  also signed a
guarantee  of $5 million  in favor of UPS to secure  this  facility.  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.
Additionally,  Gerard Guez,  our Chairman and Interim Chief  Executive  Officer,
pledged to UPS 4.6 million shares of our common stock held by Mr. Guez to secure
the  obligations  under the credit  facility.  On June 9, 2006, we completed the
pay-off of all  remaining  amounts due under the letter of credit  facility with
UPS.  As a result of the  payment  of these  obligations,  the  letter of credit
facility was  terminated and all  collateral  released.  There was no prepayment
penalty under this  arrangement.  As of September  30, 2006, $0 was  outstanding
under this facility with UPS.

         On December 31, 2004,  our Hong Kong  subsidiaries  entered into a loan
agreement  with UPS  pursuant  to which UPS made a $5  million  term  loan,  the
proceeds  of which  were used to repay $5 million  of  indebtedness  owed to UPS
under the letter of credit of facility.  The  principal  amount of this loan was
due and payable in 24 equal monthly installments of approximately $208,333 each,
plus  interest  equivalent to the "prime rate" plus 2% commencing on February 1,
2005. Under the amended loan agreement, we were 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 was also a provision
capping  maximum capital  expenditure  per quarter at $800,000.  The obligations
under the loan agreement were  collateralized by the same security interests and
guarantees provided under our letter of credit facility with UPS.  Additionally,
the term loan was secured by two promissory notes payable to Tarrant  Luxembourg
Sarl in the amounts of $2,550,000  and  $1,360,000  and a pledge by Gerard Guez,
our Chairman and Interim Chief Executive  Officer,  of 4.6 million shares of our
common stock. On June 9, 2006, we completed the pay-off of all remaining amounts
due under the term loan  agreement with UPS. As a result of the payment of these
obligations, the term loan agreement was terminated and all collateral released.
There was no prepayment penalty under this arrangement.

         Since  March  2003,  DBS Bank  (Hong  Kong)  Limited  ("DBS")  had made
available a letter of credit facility of up to HKD 20 million  (equivalent to US
$2.6 million) to our  subsidiaries  in Hong Kong. This was a demand facility and
was secured by the pledge of our office property, which is owned by Gerard Guez,
our  Chairman  and  Interim  Chief  Executive  Officer,  and Todd Kay,  our Vice
Chairman,  and by our guarantee.  The letter of credit facility was increased to
HKD 30 million  (equivalent to US $3.9 million) in June 2004. In October 2005, a
tax loan  for HKD  6.233  million  (equivalent  to US  $804,000)  was also  made
available to our Hong Kong  subsidiaries and bears interest at the rate equal to
the Hong Kong prime rate plus 1% and are subject to the same  security.  It bore
interest at 9.25% per annum at  September  30, 2006.  As of September  30, 2006,
$70,000 was outstanding under this tax loan.

         In June 2006, our  subsidiaries in Hong Kong,  Tarrant Company Limited,
Marble  Limited  and Trade  Link  Holdings  Limited,  entered  into a new credit
facility with DBS. Under this facility, we may arrange for letters of credit and
acceptances. The maximum amount our Hong Kong subsidiaries may borrow under this
facility at any time is US $25 million.  The  interest  rate under the letter of
credit  facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if
paid in Hong  Kong  Dollars,  which  the  interest  rate was  8.75% per annum at
September 30, 2006,  or the Standard  Bills Rate quoted by DBS plus 0.5% if paid
in any other  currency,  which the interest rate was 8.6% per annum at September
30, 2006. This is a demand facility and is secured by a security interest in all
the assets of the Hong Kong  subsidiaries,  by a pledge of our  office  property
where  our Hong Kong  office is  located,  which is owned by  Gerard  Guez,  our
Chairman and Interim Chief  Executive  Officer,  and Todd Kay, our Vice Chairman
and by our guarantee. The DBS facility includes customary default provisions. In
addition,  we are subject


                                       32



to  certain  restrictive  covenants,  including  that we  maintain  a  specified
tangible net worth, and a minimum level of EBITDA at December 31, 2006, interest
coverage ratio, leverage ratio and limitations on additional indebtedness. As of
September  30, 2006,  $12.3  million was  outstanding  under this  facility.  In
addition,  $4.7  million  of open  letters of credit  was  outstanding  and $8.0
million was available for future borrowings as of September 30, 2006.

         As of September 30, 2006, the total balance  outstanding  under the DBS
credit facilities was $12.4 million  (classified above as follows:  $4.5 million
in import trade bills payable,  $3.8 million in bank direct acceptances and $4.1
million in other Hong Kong credit facilities).

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

         On June 16,  2006,  we  expanded  our credit  facility  with GMAC CF by
entering  into a new Loan and Security  Agreement and amending and restating our
previously existing Factoring Agreement with GMAC CF. UPS Capital Corporation is
also a lender under the Loan and Security Agreement.  This is a revolving credit
facility  and has a term of 3 years.  The amount we may borrow under this credit
facility is  determined  by a percentage  of eligible  accounts  receivable  and
inventory,  up to a maximum  of $55  million,  and  includes  a letter of credit
facility of up to $4 million.  Interest on outstanding amounts under this credit
facility is payable  monthly  and  accrues at the rate of the "prime  rate" plus
0.5%. Our obligations under the GMAC CF credit facility are secured by a lien on
substantially  all our domestic  assets,  including a first priority lien on our
accounts  receivable  and inventory.  This credit  facility  contains  customary
financial  covenants,  including  covenants  that we maintain  minimum levels of
EBITDA and interest coverage ratios and limitations on additional  indebtedness.
This  facility  includes  customary  default  provisions,  and  all  outstanding
obligations  may become  immediately  due and payable in the event of a default.
The  facility  bore  interest at 8.75% per annum at September  30,  2006.  As of
September 30, 2006, we were in violation  with the EBITDA  covenant and a waiver
was obtained during the default.  A total of $19.7 million was outstanding  with
respect to  receivables  factored  under the GMAC CF facility at  September  30,
2006.

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

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


                                       33



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

         In connection with  Guggenheim  credit  facility,  on June 16, 2006, we
issued the lenders under this  facility  warrants to purchase up to an aggregate
of 3,857,143 shares of our common stock. These warrants have a term of 10 years.
These warrants are exercisable at a price of $1.88 per share with respect to 20%
of the  shares,  $2.00 per share with  respect to 20% of the  shares,  $3.00 per
share with respect to 20% of the shares,  $3.75 per share with respect to 20% of
the shares and $4.50 per share with  respect to 20% of the shares.  The exercise
prices are subject to adjustment for certain dilutive  issuances pursuant to the
terms  of  the  warrants.  357,143  shares  of  the  warrants  will  not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and EITF  00-19 and  determined  to be a  derivative  instrument  due to certain
registration  rights.  As such, the warrants  excluding the ones not exercisable
were valued at $4.9 million using the Black-Scholes  option valuation model with
the following  assumptions:  risk-free interest rate of 5.1%; dividend yields of
0%; volatility factors of the expected market price of our common stock of 0.70;
and  contractual  term of ten  years.  We also paid to  Guggenheim  2.25% of the
committed principal amount of the loans which was $563,000 on June 16, 2006. The
$563,000 fee paid to Guggenheim is included in the deferred  financing cost, and
the value of the warrants to purchase 3.5 million  shares of our common stock of
$4.9 million is recorded as debt  discount,  both of them are amortized over the
life of the loan. As of September 30, 2006, $352,000 was amortized.

         Durham Capital  Corporation acted as our advisor in connection with the
Guggenheim credit facility.  As compensation for its services,  we agreed to pay
Durham  Capital a cash fee in an amount equal to 1% of the  committed  principal
amount of the loans under the Guggenheim credit facility. As a result,  $250,000
was paid on June 16, 2006. In addition,  we issued  Durham  Capital a warrant to
purchase 77,143 shares of our common stock.  This warrant has a term of 10 years
and is  exercisable  at a price of $1.88 per share,  subject to  adjustment  for
certain  dilutive  issuances.  7,143  shares  of this  warrant  will not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and EITF  00-19 and  determined  to be a  derivative  instrument  due to certain
registration  rights.  As such, the warrants  excluding the ones not exercisable
were valued at $105,000 using the Black-Scholes  option valuation model with the
following  assumptions:  risk-free interest rate of 5.1%; dividend yields of 0%;
volatility factors of the expected market price of our common stock of 0.70; and
contractual  term of ten years.  The $250,000 fee paid to Durham Capital and the
value of the warrants to purchase  70,000 shares of our common stock of $105,000
is included in the deferred  financing  cost,  and is amortized over the life of
the loan. As of September 30, 2006, $23,000 was amortized.

         The Guggenheim  facility bore interest at 12.33% per annum at September
30,  2006.  As of  September  30,  2006,  we were in  violation  with the EBITDA
covenant and a waiver was obtained during the default. A total of $10.9 million,
net of $4.6 million of debt  discount,  was  outstanding  under this facility at
September 30, 2006.

         As of June  30,  2006,  the  warrants  were  being  accounted  for as a
liability  pursuant to the  provisions of SFAS No. 133 and Emerging  Issues Task
Force  ("EITF") No. 00-19,  "Accounting  for  Derivative  Financial  Instruments
Indexed to, and  Potentially  Settled in, a Company's Own Stock" ("EITF 00-19").
This is because we granted the warrant holders certain  registration rights that
are outside our control. In accordance with SFAS No. 133, the warrants are being
valued  at  each  reporting  period.  Changes  in fair  value  are  recorded  as
adjustment  to fair value of derivative in the  statements  of  operations.  The
outstanding  warrants  were  fair  valued  on June  16,  2006,  the  date of the
transaction,  at $5.0 million and we, in accordance with SFAS 133,  re-evaluated
the warrants on June 30, 2006 at


                                       34



the  closing  stock  price on June 30,  2006 to $5.2  million;  as a result,  an
expense of $218,000 was recorded as an adjustment to fair value of derivative on
our consolidated statements of operations.  On August 11, 2006, the registration
rights agreement relating to the warrants was amended to provide that if we were
unable to file or have the  registration  statement  declared  effective  by the
required  deadlines,  we would  be  required  to pay the  warrant  holders  cash
payments  as  partial  liquidated  damages  each  month  until the  registration
statement was filed and/or declared effective. The liquidated damages payable by
us to the warrant holders are limited to 20% of the purchase price of the shares
underlying  the warrants,  which we  determined to be a reasonable  discount for
restricted  stock as compared to registered  stock.  As a result of amending the
registration  rights  relating to the warrants on August 11, 2006,  the warrants
were reclassified from debt to equity in accordance with EITF 00-19 in the third
quarter of 2006. The outstanding  warrants were revaluated on August 11, 2006 at
the closing stock price on August 11, 2006 to $4.5 million; as a result,  income
of $729,000 was recorded as an  adjustment  to fair value of  derivative  on our
consolidated statements of operations.

         On December 14, 2004, we completed a $10 million  financing through the
issuance of (i) 6% Secured Convertible  Debentures and (ii) warrants to purchase
up to 1,250,000 shares of our common stock. Prior to maturity, the investors may
convert the convertible 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  convertible
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  convertible  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  convertible  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 convertible  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  debentures  were thus valued at
$8,996,000,  resulting in an effective conversion price of $1.799 per share. The
intrinsic  value of the conversion  option of $804,000 was being  amortized over
the life of the loan.  The value of the warrants of $866,000  and the  intrinsic
value of the  conversion  option of  $804,000  were  netted from the $10 million
presented as the convertible debentures,  net on our accompanying balance sheets
at December 31, 2004.

         The placement  agent in the financing,  received  compensation  for its
services in the amount of $620,000 in cash and issuance of five year warrants to
purchase up to 200,000  shares of our common stock at an exercise price of $2.50
per share.  The  warrants to purchase  200,000  shares of our common  stock were
valued at  $138,000  using the  Black-Scholes  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 financing cost paid to the placement  agent
of  $620,000,  and the value of the warrants to purchase  200,000  shares of our
common stock of $138,000 were included in the deferred  financing  cost,  net on
our accompanying balance sheets and was amortized over the life of the loan.

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


                                       35



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

         We had three equipment  loans  outstanding at December 31, 2005. One of
these equipment loans bore interest at 6% payable in installments  through 2009,
which we paid off in January  2006.  The second  loan  bears  interest  at 15.8%
payable in  installment  through 2007 and the third loan bears interest at 6.15%
payable in installment  through 2007. In August 2006, we entered into a new auto
loan that bears  interest at 4.75%  payable in  installment  through 2008. As of
September 30, 2006, $46,000 was outstanding under the three remaining loans.

         From time to time, we open letters of credit under an uncommitted  line
of credit from Aurora Capital  Associates  which issues these letters of credits
out of Israeli Discount Bank. As of September 30, 2006, $164,000 was outstanding
under this facility (classified above under import trade bills payable) and $1.0
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.

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

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

         The Internal  Revenue  Service has proposed  adjustments to our Federal
income tax  returns to  increase  our income  tax  payable  for the years  ended
December 31, 1996 through 2001. This adjustment  would also result in additional
state taxes and  interest.  In  addition,  in July 2004,  the IRS  initiated  an
examination  of our Federal  income tax return for the year ended  December  31,
2002. In March 2005,  the IRS proposed an  adjustment  to our taxable  income of
approximately $6 million related to similar issues  identified in their audit of
the 1996  through  2001  federal  income tax  returns.  We believe  that we have
meritorious   defenses  to  and  intend  to  vigorously   contest  the  proposed
adjustments  made to our  federal  income tax  returns  for the years ended 1996
through 2002. If the proposed  adjustments are upheld through the administrative
and legal  process,  they could have a material  impact on our earnings  and, in
particular, cash flow. We may not have an adequate cash reserve to pay the final
adjustments resulting from the IRS examination.  As a result, we may be required
to arrange for payments  over time,  to borrow  additional  funds under our bank
facilities or raise additional  capital in order to meet these  obligations.  We
believe  we have  provided  adequate  reserves  for any  reasonably  foreseeable
outcome related to these matters on the consolidated  balance sheets 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.

         We may seek to  finance  future  capital  investment  programs  through
various methods, including, but not limited to, borrowings under our bank credit
facilities,  issuance of long-term debt, sales of equity securities,  leases and
long-term  financing  provided by the sellers of  facilities or the suppliers of
certain  equipment used in such  facilities.  To date,  there is no plan for any
major capital expenditure.

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

RELATED PARTY TRANSACTIONS

         We lease our executive  offices in Los Angeles,  California from GET, a
corporation  which is owned by  Gerard  Guez (our  Chairman  and  Interim  Chief
Executive  Officer)  and  Todd  Kay  (our  Vice  Chairman),  both of  which  are
significant shareholders.  Additionally, we lease our warehouse and office space
in Hong Kong from Lynx


                                       36



International Limited, a Hong Kong corporation that is owned by Messrs. Guez and
Kay. We paid  $807,000 and  $764,000 in rent in the nine months ended  September
30, 2006 and 2005, respectively, for office and warehouse facilities. During the
first seven months of 2006, our Los Angeles  offices and warehouse was leased on
a month to month basis.  On August 1, 2006,  we entered  into a lease  agreement
with GET for the Los Angeles  offices and  warehouse,  which lease has a term of
five years with an option to renew for an additional  five year term. On January
1, 2006, we renewed our lease agreement with Lynx International  Limited for our
office space in Hong Kong for one year.

         On  May 1,  2006,  we  sublet  our  executive  office  in Los  Angeles,
California  and our sales  office in New York to Seven  Licensing  Company,  LLC
("Seven  Licensing") for a monthly payment of $25,000 on a month to month basis.
Seven Licensing is  beneficially  owned by Gerard Guez, our Chairman and Interim
Chief  Executive  Officer.  We  received  $125,000  in rental  income  from this
sublease in the nine months ended September 30, 2006.

         On September 1, 2006,  our  subsidiary  in Hong Kong,  Tarrant  Company
Limited,  entered into an agreement with Seven  Licensing to be its buying agent
to source and purchase apparel merchandises.

         In August 2004,  we entered  into an  Agreement  for Purchase of Assets
with  affiliates  of  Mr.  Kamel  Nacif,  a  shareholder  at  the  time  of  the
transaction,  which  agreement  was  amended in October  2004.  Pursuant  to the
agreement,  as  amended,  on  November  30,  2004,  we  sold  to the  purchasers
substantially  all of our assets and real  property  in  Mexico,  including  the
equipment  and  facilities  we previously  leased to Mr.  Nacif's  affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and  $3,910,000 by delivery of unsecured  promissory  notes bearing  interest at
5.5% per annum;  and b)  $40,204,000,  by delivery of secured  promissory  notes
bearing interest at 4.5% per annum, maturing on December 31, 2005 and every year
thereafter until December 31, 2014. The secured  promissory notes are payable in
partial or total amounts anytime prior to the maturity of each note. Included in
the $41.0 million notes receivable - related party on the  accompanying  balance
sheet as of  September  30, 2006 was $1.3 million of Mexico value added taxes on
the real property  component of this transaction.  Historically,  we have placed
orders for  purchases  of fabric from the  purchasers  pursuant to the  purchase
commitment  agreement  we  entered  into at the time of the  sale of the  Mexico
assets,  and we  have  satisfied  our  payment  obligations  for the  fabric  by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  the  purchasers  have  recently  ceased  providing  fabric and are not
currently   making   payments  under  the  notes.   We  further   evaluated  the
recoverability  of  the  notes  receivable  and  recorded  a loss  on the  notes
receivable in an amount equal to the  outstanding  balance less the value of the
underlying assets securing the notes. The loss was estimated to be approximately
$27.1 million,  resulting in a notes receivable balance at September 30, 2006 of
approximately  $14  million.  We will  continue to pursue  payments on the notes
receivable  and believe the remaining $14 million  balance at September 30, 2006
is  realizable.  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.  We  purchased  $0 and $4.1  million of fabric  from  Acabados y
Terminados in the nine months ended  September 30, 2006 and 2005,  respectively.
In addition  to the notes  receivable,  net amount due from these  parties as of
September 30, 2006 was $412,000, related to reimbursement expenses.

         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 in the third quarter of 2006 was approximately $2,234,000. At September 30,
2006,  the entire  balance due from Mr. Guez totaling $2.2 million is payable on
demand  and  has  been  shown  as  reductions  to  shareholders'  equity  in the
accompanying financial statements. All advances to Mr. Guez bore interest at the
rate of 7.75% during the period.  Total  interest  paid by Mr. Guez was $129,000
and  $165,000  for  the  nine  months  ended   September   30,  2006  and  2005,
respectively. Mr. Guez paid expenses on our behalf of approximately $226,000 and
$321,000 for the nine months ended  September  30, 2006 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 our executive officers or directors.

         At September 30, 2006,  we had various  employee  receivables  totaling
$258,000 included in due from related parties.


                                       37



         On July 1, 2001, we formed an entity to jointly  market,  share certain
risks and achieve economies of scale with Azteca Production International,  Inc.
("Azteca"), a corporation owned by the brothers of Gerard Guez, our Chairman and
Interim Chief  Executive  Officer,  called United  Apparel  Ventures,  LLC. 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
made  purchases from two related  parties in Mexico,  an affiliate of Azteca and
Tag-It Pacific, Inc.

         At September 30, 2006, Messrs.  Guez and Kay beneficially owned 590,000
and 1,003,500  shares,  respectively,  of common stock of Tag-It Pacific,  Inc.,
collectively  representing  approximately 8.7% of Tag-It Pacific's common stock.
Tag-It Pacific is a provider of brand  identity  programs to  manufacturers  and
retailers of apparel and accessories. Starting from 1998, Tag-It Pacific assumed
the  responsibility  for managing and  sourcing all trim and  packaging  used in
connection with products  manufactured  by or on behalf of us in Mexico.  Due to
the restructuring of our Mexico operations, Tag-It Pacific no longer manages our
trim and  packaging  requirements.  We  purchased  $205,000  and $55,000 of trim
inventory  from Tag-It  Pacific in the nine months ended  September 30, 2006 and
2005,  respectively.  Our sales of garment  accessories  to Tag-It  Pacific were
$39,000  and  $0  in  the  nine  months  ended  September  30,  2006  and  2005,
respectively.  We purchased $0 and $135,000 of finished  goods and services from
Azteca and its affiliates in the nine months ended  September 30, 2006 and 2005,
respectively.  Our sales of fabric  and  services  to Azteca in the nine  months
ended  September  30, 2006 and 2005 was $9,000 and  $63,000,  respectively.  Net
amount due from these related parties as of September 30, 2006 was $5.5 million.

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


                                       38



ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

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

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

         Our interest  expense is  sensitive to changes in the general  level of
U.S.  interest  rates.  In this regard,  changes in U.S.  interest  rates affect
interest paid on our debt. A majority of our credit  facilities  are at variable
rates.

ITEM 4.  CONTROLS AND PROCEDURES.

         EVALUATION OF CONTROLS AND PROCEDURES

         Members of the our management,  including our Chief  Executive  Officer
and Chief Financial  Officer have evaluated the  effectiveness of our disclosure
controls  and  procedures,  as defined by  paragraph  (e) of Exchange  Act Rules
13a-15 or 15d-15,  as of September  30, 2006,  the end of the period  covered by
this  report.  Members  of the our  management,  including  our Chief  Executive
Officer  and Chief  Financial  Officer,  also  conducted  an  evaluation  of our
internal  control over  financial  reporting  to  determine  whether any changes
occurred during the further quarter of 2006 that have  materially  affected,  or
are reasonably likely to materially  affect, our internal control over financial
reporting.  Based upon that  evaluation,  the Chief Executive  Officer and Chief
Financial  Officer  concluded  that our  disclosure  controls and procedures are
effective.

         CHANGES IN CONTROLS AND PROCEDURES

         There were no significant  changes in our internal controls or in other
factors that could  significantly  affect internal controls,  known to the Chief
Executive  Officer or the Chief  Financial  Officer  during the third quarter of
2006.


                                       39



                          PART II -- OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

         On or about April 6, 2006, we commenced an action  against the licensor
of the  Jessica  Simpson  brands  (captioned  Tarrant  Apparel  Group v.  Camuto
Consulting  Group,  Inc.,  VCJS LLC, With You, Inc. and Jessica  Simpson) in the
Supreme  Court of the State of New York,  County  of New  York.  The suit  named
Camuto Consulting  Group,  Inc., VCJS LLC, With You, Inc. and Jessica Simpson as
defendants,  and asserts that the defendants  failed to provide promised support
in connection with our sublicense  agreement for the Jessica Simpson brands. Our
complaint  includes eight causes of action,  including two seeking a declaration
that the sublicense agreement is exclusive and remains in full force and effect,
as well as claims for breach of  contract  by Camuto  Consulting,  breach of the
duty of good faith and fair dealing and  fraudulent  inducement  against  Camuto
Consulting,  and a claim against With You,  Inc. and Ms.  Simpson that we are an
intended third party  beneficiary of the licenses  between those  defendants and
Camuto  Consulting.  On or about April 26, 2006,  Camuto  Consulting  served its
answer to our complaint and included a counterclaim against us for breach of the
sublicense  agreement and alleging damages of no less than $100 million.  Camuto
Consulting  has  also  served a motion  to  dismiss  our  cause  of  action  for
fraudulent  inducement.  On or about May 22, 2006, we served our reply to Camuto
Consulting's  counterclaim.  On or about April 27, 2006,  Ms.  Simpson  served a
motion  seeking  dismissal  of the cause of action  asserted  against her. On or
about May 10, 2006, we served our  opposition to Ms.  Simpson motion to dismiss.
On or about June 14, 2006, we served a  cross-motion  seeking leave to amend our
complaint to add Vincent Camuto as a defendant.  On October 18, 2006, the Court:
(i) granted our  cross-motion  seeking leave to file a supplemental  summons and
amended  complaint  adding Vincent Camuto as a defendant and  supplementing  the
allegations of fraud against Camuto Consulting;  (ii) denied Camuto Consulting's
motion to  dismiss  the cause of action  for  fraudulent  inducement;  and (iii)
denied Ms. Simpson's motion to dismiss the cause of action asserted against her.
On or about October 30, 2006,  Camuto Consulting and Vincent Camuto served their
answer to the amended complaint, with a counterclaim that is virtually identical
to the  original  counterclaim.  We  intend to  continue  to  vigorously  defend
Camuto's  counterclaim and vigorously oppose Ms. Simpson's motion.  Discovery in
the matter has been  underway  since May 2006. A status  conference is scheduled
before the Court on November 21, 2006.

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

ITEM 1A. RISK FACTORS.

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

RISKS RELATED TO OUR BUSINESS

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

         Five customers accounted for approximately 64% and 48% of our net sales
in  first  nine  months  of  2006  and  2005,  respectively.   We  believe  that
consolidation  in the retail industry has centralized  purchasing  decisions and
given customers  greater  leverage over  suppliers,  like us, and we expect this
trend to continue. If this consolidation continues, our net sales and results of
operations  may be  increasingly  sensitive to  deterioration  in the  financial
condition of, or other adverse developments with, one or more of our customers.

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


                                       40



consolidation of ownership,  increased  centralization of purchasing  decisions,
restructurings, bankruptcies and liquidations.

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

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

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

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

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

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

         We are  currently  in  litigation  with the  licensors  of the  Jessica
Simpson brands regarding our rights to sell apparel under these brands. See Part
II of this report, Item 1 "Legal Proceedings" for a detailed description of this
lawsuit.  The licensor has filed a counterclaim against us seeking damage. These
claims may divert  financial and management  resources  that would  otherwise be
used to benefit our  operations.  Although we believe  that we have  meritorious
defenses  to the claims  made  against  us, and  intend to contest  the  lawsuit
vigorously, no assurances can be given that the results of these matters will be
favorable to us. An adverse  resolution  of any of these  lawsuits  could have a
material  adverse  affect on our financial  position and results of  operations.
Additionally,  we have incurred  significant legal fees in this litigation,  and
unless the case is settled,  we will continue to incur  additional legal fees in
increasing amounts as the case accelerates to trial.

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

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

OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.

         We have experienced, and expect to continue to experience,  substantial
variations  in our net sales and operating  results from quarter to quarter.  We
believe that the factors which influence this  variability of quarterly  results
include  the  timing of our  introduction  of new  product  lines,  the level of
consumer  acceptance  of each new product  line,  general  economic and industry
conditions  that  affect  consumer   spending  and  retailer   purchasing,   the
availability of manufacturing  capacity, the seasonality of the markets in which
we participate,  the timing of trade


                                       41



shows,  the product  mix of  customer  orders,  the timing of the  placement  or
cancellation  of  customer  orders,  the  weather,  transportation  delays,  the
occurrence of charge backs in excess of reserves and the timing of  expenditures
in  anticipation  of  increased  sales  and  actions  of  competitors.   Due  to
fluctuations   in  our  revenue  and   operating   expenses,   we  believe  that
period-to-period  comparisons  of  our  results  of  operations  are  not a good
indication of our future performance. It is possible that in some future quarter
or quarters,  our operating results will be below the expectations of securities
analysts  or  investors.   In  that  case,  our  stock  price  could   fluctuate
significantly or decline.

WE DEPEND ON OUR COMPUTER AND COMMUNICATIONS SYSTEMS.

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

WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE.

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

OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.

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

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

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

         We depend on independent contract  manufacturers to secure a sufficient
supply of raw  materials  and  maintain  sufficient  manufacturing  and shipping
capacity in an environment  characterized by declining  prices,  labor shortage,
continuing  cost  pressure  and  increased  demands for product  innovation  and
speed-to-market.  This  dependence  could  subject us to difficulty in obtaining
timely delivery of products of acceptable quality.  In addition,  a contractor's
failure to ship


                                       42



products  to us in a timely  manner or to meet the  required  quality  standards
could cause us to miss the delivery  date  requirements  of our  customers.  The
failure to make timely  deliveries  may cause our  customers  to cancel  orders,
refuse to accept  deliveries,  impose  non-compliance  charges  through  invoice
deductions or other charge-backs, demand reduced prices or reduce future orders,
any of which could harm our sales,  reputation and overall profitability.  We do
not have material  long-term  contracts with any of our independent  contractors
and any of these contractors may unilaterally  terminate their relationship with
us at  any  time.  To  the  extent  we  are  not  able  to  secure  or  maintain
relationships  with  independent  contractors  that  are  able  to  fulfill  our
requirements, our business would be harmed.

         We have  initiated a factory  compliance  agreement with our suppliers,
and monitor our independent  contractors' compliance with applicable labor laws,
but we do not control our contractors or their labor practices. The violation of
federal,  state or foreign labor laws by one of the our contractors could result
in our being subject to fines and our goods that are  manufactured  in violation
of such laws being seized or their sale in interstate commerce being prohibited.
From  time to  time,  we  have  been  notified  by  federal,  state  or  foreign
authorities that certain of our contractors are the subject of investigations or
have been found to have  violated  applicable  labor laws.  To date, we have not
been subject to any sanctions that, individually or in the aggregate, have had a
material  adverse  effect on our business,  and we are not aware of any facts on
which any such  sanctions  could be based.  There can be no assurance,  however,
that in the future we will not be subject to sanctions as a result of violations
of applicable  labor laws by our  contractors,  or that such  sanctions will not
have a material  adverse  effect on our business and results of  operations.  In
addition,  certain of our customers,  require strict compliance by their apparel
manufacturers, including us, with applicable labor laws and visit our facilities
often.  There can be no assurance that the violation of applicable labor laws by
one  of  our  contractors  will  not  have  a  material  adverse  effect  on our
relationship with our customers.

OUR DEPENDENCE ON THIRD PARTIES FOR BRANDED APPAREL PRODUCTS REDUCES OUR ABILITY
TO CONTROL THE MARKETING  PROCESS,  WHICH COULD HARM OUR SALES,  REPUTATION  AND
OVERALL PROFITABILITY.

         For certain branded apparel lines, in particular  celebrity  brands, we
depend on the cooperation and efforts of the celebrity personality and/or master
licensor to support our design and  marketing  efforts for apparel  products.  A
celebrity's  failure to adequately support our marketing efforts could adversely
affect the sales for new products and lines. In addition,  we are subject to the
terms of our agreements  with the master licensor for licensed  brands,  and our
rights to exploit certain brands may therefore be limited. Further, we may, from
time to time,  become involved in disputes with the master licensor with respect
to our  contractual  relationship.  To the  extent  we are not  able to  receive
adequate  support from the master  licensor  and/or  celebrity or maintain  good
working relationships with master licensors, our business would be harmed.

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

         Approximately  81% of our products  were imported from outside the U.S.
in fiscal 2005. We are subject to the risks  associated  with doing  business in
foreign  countries,  including,  but not limited to,  transportation  delays and
interruptions,  political instability,  expropriation, currency fluctuations and
the imposition of tariffs, import and export controls, other non-tariff barriers
and cultural  issues.  Any changes in those countries' labor laws and government
regulations may have a negative effect on our profitability.

RISK ASSOCIATED WITH OUR INDUSTRY

OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES.

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


                                       43



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

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

         o        anticipating  and  quickly  responding  to  changing  consumer
                  demands;

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

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

         o        the need to provide strong and effective marketing support.

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

         Our success is largely  dependent upon our ability to gauge the fashion
tastes of our customers and to provide  merchandise  that  satisfies  retail and
customer demand in a timely manner. The apparel business fluctuates according to
changes in consumer  preferences  dictated in part by fashion and season. To the
extent we misjudge  the market for our  merchandise;  our sales may be adversely
affected.  Our ability to anticipate and effectively respond to changing fashion
trends depends in part on our ability to attract and retain key personnel in our
design,  merchandising  and marketing staff.  Competition for these personnel is
intense,  and we  cannot be sure that we will be able to  attract  and  retain a
sufficient number of qualified personnel in future periods.

OUR BUSINESS IS SUBJECT TO SEASONAL TRENDS.

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

OTHER RISKS RELATED TO AN INVESTMENT IN OUR COMMON STOCK

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

         In January 2004, the Internal Revenue Service  proposed  adjustments to
increase  our federal  income tax payable for the years ended  December 31, 1996
through  2001.  This  adjustment  would also result in  additional  state taxes,
penalties  and  interest.  In  addition,  in July  2004,  the IRS  initiated  an
examination  of our Federal  income tax return for the year ended  December  31,
2002. In March 2005,  the IRS proposed an  adjustment  to our taxable  income of
approximately $6 million related to similar issues  identified in their audit of
the 1996  through  2001  federal  income tax  returns.  We believe  that we have
meritorious   defenses  to  and  intend  to  vigorously   contest  the  proposed
adjustments  made to our  federal  income tax  returns  for the years ended 1996
through 2002. If the proposed  adjustments are upheld through the administrative
and legal  process,  they could have a material  impact on our earnings and cash
flow.  We  believe  we  have  provided  adequate  reserves  for  any  reasonably
foreseeable outcome related to these matters on the consolidated  balance sheets
included in the Consolidated Financial Statements. The maximum amount of loss in
excess of the amount accrued in the financial statements is $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.


                                       44



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

         As of September  30, 2006,  our  executive  officers and  directors and
their affiliates owned approximately 43% of the outstanding shares of our common
stock.  Gerard Guez, our Chairman and Interim Chief Executive Officer,  and Todd
Kay, our Vice Chairman, alone own approximately 33.1% and 8.4%, respectively, of
the outstanding  shares of our common stock at September 30, 2006.  Accordingly,
our executive  officers and directors have the ability to affect the outcome of,
or  exert  considerable   influence  over,  all  matters  requiring  shareholder
approval,  including  the election  and removal of  directors  and any change in
control.  This  concentration  of  ownership  of our common stock could have the
effect  of  delaying  or  preventing  a change  of  control  of us or  otherwise
discouraging  or  preventing  a potential  acquirer  from  attempting  to obtain
control of us. This, in turn,  could have a negative  effect on the market price
of our common stock.  It could also prevent our  shareholders  from  realizing a
premium over the market prices for their shares of common stock.

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

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

OUR STOCK PRICE HAS BEEN VOLATILE.

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

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

ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO YOU.

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


                                       45



ITEM 6.  EXHIBITS.

Exhibit
Number   Description
-------  -----------------------------------------------------------------------
10.39.1  Amendment No. 1 to Credit  Agreement,  dated July 5, 2006, by and among
         Tarrant Apparel Group,  Fashion  Resource  (TCL),  Inc., Tag Mex, Inc.,
         United Apparel Ventures, LLC, Private Brands, Inc. and NO! Jeans, Inc.,
         the  Guarantor  a  party  thereto,  the  Lenders  a party  thereto  and
         Guggenheim Corporate Funding, LLC.

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.


                                       46



                                   SIGNATURES

         Pursuant to the  requirements  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

Date:    November 14, 2006                 By: /s/ Corazon Reyes
                                               ---------------------------------
                                               Corazon Reyes,
                                               Chief Financial Officer


Date:    November 14, 2006                 By: /s/ Gerard Guez
                                               ---------------------------------
                                               Gerard Guez,
                                               Interim Chief Executive Officer


                                       47