================================================================================


                                  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 JUNE 30, 2007

                                       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 August 10,
2007: 30,543,763.

================================================================================





                              TARRANT APPAREL GROUP
                                    FORM 10-Q
                                      INDEX

                          PART I. FINANCIAL INFORMATION

                                                                           PAGE
                                                                          ------
Item 1.  Financial Statements

         Consolidated Balance Sheets at June 30, 2007
          (unaudited) and December 31, 2006..................................  2

         Consolidated Statements of Operations
           for the Three Months and Six Months Ended
           June 30, 2007 and June 30, 2006 (unaudited).......................  3

         Consolidated Statements of Cash Flows for
           the Six Months Ended June 30, 2007 and
           June 30, 2006 (unaudited).........................................  4

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

Item 2.  Management's Discussion and Analysis of
           Financial Condition and Results of Operations .................... 25

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............................................................ 47

         SIGNATURES.......................................................... 48


             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

                                                                               DECEMBER 31,
                                                             JUNE 30, 2007         2006
                                                             -------------    -------------
                                                              (Unaudited)
                           ASSETS

                                                                        
Current assets:
   Cash and cash equivalents .............................   $     963,858    $     904,553
   Accounts receivable, net of $1.9 million and $2.1
   million allowance for returns, discounts and bad debts
   at June 30, 2007 and December 31, 2006, respectively ..      46,789,279       48,079,527
   Due from related parties ..............................       4,980,533        3,688,355
   Inventory .............................................      18,221,411       17,774,103
   Temporary quota rights ................................          38,770           32,217
   Prepaid expenses ......................................       1,096,052        1,515,087
   Deferred tax assets ...................................         125,401          123,607
   Income taxes receivable ...............................          26,267           25,468
                                                             -------------    -------------
Total current assets .....................................      72,241,571       72,142,917

Property and equipment, net  of $9.5 million and $9.4
   million accumulated depreciation at June 30, 2007 and
   December 31, 2006, respectively .......................       1,479,197        1,414,354
Notes receivable - related parties, net of $27.1 million
   reserve at June 30, 2007 and December 31, 2006 ........      14,000,000       14,000,000
Due from related parties .................................       3,554,117        4,168,205
Equity method investment .................................       2,277,603        2,151,061
Deferred financing cost, net of $1.4 million and $1.7
   million accumulated amortization at June 30, 2007 and
   December 31, 2006, respectively .......................       1,951,043        2,448,526
Other assets .............................................         220,670        6,223,816
Goodwill, net ............................................       8,582,845        8,582,845
                                                             -------------    -------------
Total assets .............................................   $ 104,307,046    $ 111,131,724
                                                             =============    =============

            LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
   Short-term bank borrowings ............................   $  14,841,935    $  13,696,182
   Accounts payable ......................................      19,011,466       22,685,674
   Accrued expenses ......................................      10,021,269        8,907,658
   Derivative liability ..................................            --            195,953
   Income taxes ..........................................      18,253,199       16,865,125
   Current portion of long-term obligations and factoring
     arrangement .........................................      13,337,908       19,586,565
                                                             -------------    -------------
 Total current liabilities ...............................      75,465,777       81,937,157

Term loan,  net of $3.7 million and $4.3 million debt
  discount at June 30, 2007 and December 31, 2006,
  respectively ...........................................      11,754,274       11,212,724
Other long-term obligations ..............................            --              5,338
                                                             -------------    -------------
Total liabilities ........................................      87,220,051       93,155,219

Minority interest in PBG7 ................................          52,890           54,338
Commitments and contingencies

Shareholders' equity:
   Preferred stock, 2,000,000 shares authorized;
     no shares at June 30, 2007 and December 31,
     2006 issued and outstanding .........................            --               --
   Common stock, no par value, 100,000,000 shares
     authorized; 30,543,763 shares at June 30, 2007 and
     December 31, 2006 issued and outstanding ............     114,977,465      114,977,465
   Warrant to purchase common stock ......................       7,314,239        7,314,239
   Contributed capital ...................................      10,413,586       10,191,511
   Accumulated deficit (See Note 12) .....................    (113,602,018)    (112,410,363)
   Notes receivable from officer/shareholder .............      (2,069,167)      (2,150,685)
                                                             -------------    -------------
 Total shareholders' equity ..............................      17,034,105       17,922,167
                                                             -------------    -------------

Total liabilities and shareholders' equity ...............   $ 104,307,046    $ 111,131,724
                                                             =============    =============



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

                                       2




                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)


                                             THREE MONTHS ENDED JUNE 30         SIX MONTHS ENDED JUNE 30
                                           ------------------------------    ------------------------------
                                               2007             2006             2007             2006
                                           -------------    -------------    -------------    -------------
                                                                                  
Net sales ..............................   $  60,100,503    $  59,082,541    $ 116,207,097    $ 120,343,785
Cost of sales ..........................      47,545,805       46,419,973       91,305,819       95,162,454
                                           -------------    -------------    -------------    -------------

Gross profit ...........................      12,554,698       12,662,568       24,901,278       25,181,331
Selling and distribution expenses ......       3,352,007        2,798,086        6,790,740        5,727,776
General and administrative expenses ....       6,240,358        6,903,093       12,726,954       13,363,236
Royalty expenses .......................         433,696          352,864          791,428        1,835,809
Terminated acquisition expenses ........            --               --          2,000,000             --
                                           -------------    -------------    -------------    -------------

Income  from operations ................       2,528,637        2,608,525        2,592,156        4,254,510

Interest expense .......................      (1,219,562)      (1,945,797)      (2,562,886)      (3,133,854)
Interest income ........................          42,857          480,859           87,957          966,202
Interest in income of equity method
   investee ............................          42,793           62,909          126,542          110,322
Other income ...........................          64,748           90,568          152,399          124,373
Adjustment to fair value of derivative .             524         (218,307)         195,953         (218,307)
Other expense ..........................          (9,335)        (400,000)         (11,140)        (400,000)
                                           -------------    -------------    -------------    -------------

Income before provision for income taxes       1,450,662          678,757          580,981        1,703,246
Provision for income taxes .............         641,917           60,110          774,084          259,722
Minority interest ......................             519           (7,363)           1,448            4,131
                                           -------------    -------------    -------------    -------------
Net income (loss) ......................   $     809,264    $     611,284    $    (191,655)   $   1,447,655
                                           =============    =============    =============    =============

Net income (loss ) per share:
   Basic ...............................   $        0.03    $        0.02    $       (0.01)   $        0.05
                                           =============    =============    =============    =============
   Diluted .............................   $        0.03    $        0.02    $       (0.01)   $        0.05
                                           =============    =============    =============    =============

Weighted average common and common
   equivalent shares:
   Basic ...............................      30,543,763       30,543,763       30,543,763       30,378,715
                                           =============    =============    =============    =============
   Diluted .............................      30,543,875       30,544,420       30,543,763       30,378,840
                                           =============    =============    =============    =============



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

                                       3




                              TARRANT APPAREL GROUP

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                                                 SIX MONTHS ENDED JUNE 30,
                                                              ------------------------------
                                                                   2007            2006
                                                              -------------    -------------
                                                                         
Operating activities:
Net income (loss) .........................................   $    (191,655)   $   1,447,655
Adjustments to reconcile net income (loss) to net cash
  provided by (used in) Operating activities:
   Deferred taxes .........................................          (1,794)         (22,414)
   Depreciation and amortization of fixed assets ..........         201,339          246,965
   Amortization of deferred financing cost ................         987,036        1,534,973
   Adjustment to fair value of derivative .................        (195,953)         218,307
   Terminated acquisition expenses ........................       2,000,000             --
   Change in the provision for returns and discounts ......        (204,624)         277,656
   Change in the provision for bad debts ..................          40,081           (5,440)
   Loss (gain) on sale of fixed assets ....................           6,145           (1,283)
   Income from equity method investment ...................        (126,542)        (110,322)
   Minority interest ......................................          (1,448)          (4,131)
   Stock-based compensation ...............................         321,761            7,054
   Changes in operating assets and liabilities:
     Accounts receivable ..................................       1,953,928       (5,789,823)
     Due to/from related parties ..........................      (1,277,229)        (121,160)
     Inventory ............................................        (447,308)      11,440,735
     Temporary quota rights ...............................          (6,553)         (59,153)
     Prepaid expenses .....................................         418,235        1,353,074
     Accounts payable .....................................      (3,674,208)     (12,295,638)
     Accrued expenses and income tax payable ..............       1,501,684         (518,128)
                                                              -------------    -------------

     Net cash provided by (used in) operating activities ..       1,302,895       (2,401,073)

Investing activities:
   Purchase of fixed assets ...............................        (272,327)         (63,418)
   Proceeds from sale of fixed assets .....................            --              2,800
   Due diligence fees in acquisition ......................        (699,764)            --
   Refund of deposit on acquisition .......................       4,750,000             --
   Distribution from equity method investee ...............            --             67,500
   Collection on notes receivable - related parties .......            --            651,666
   Collection of advances from shareholders/officers ......          81,519           44,522
                                                              -------------    -------------

     Net cash provided by investing activities ............       3,859,428          703,070

Financing activities:
   Short-term bank borrowings, net ........................       1,145,754       (1,300,390)
   Proceeds from long-term obligations ....................      98,640,912      132,805,154
   Payment of financing costs .............................            --         (2,231,318)
   Repayments of borrowings from convertible debentures ...            --         (6,912,626)
   Payment of long-term obligations and bank borrowings ...    (104,889,684)    (120,613,274)
                                                              -------------    -------------

     Net cash provided by (used in) financing activities ..      (5,103,018)       1,747,546
                                                              -------------    -------------

Increase in cash and cash equivalents .....................          59,305           49,543
Cash and cash equivalents at beginning of period ..........         904,553        1,641,768
                                                              -------------    -------------

Cash and cash equivalents at end of period ................   $     963,858    $   1,691,311
                                                              =============    =============



              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
June 30, 2007, we own 75% of PBG7,  LLC ("PBG7").  We previously  owned 50.1% of
United Apparel Ventures  ("UAV"),  which was dissolved on February 27, 2007. The
dissolution of UAV did not have a material impact on our consolidated  financial
statements.  We consolidate these entities and reflect the minority interests in
earnings (losses) of the ventures in the accompanying financial statements.  All
inter-company  amounts  are  eliminated  in  consolidation.  The 49.9%  minority
interest  in UAV was owned by Azteca  Production  International,  a  corporation
owned by the  brothers of our  Chairman  and Interim  Chief  Executive  Officer,
Gerard  Guez.  The 25%  minority  interest  in PBG7 is  owned  by BH7,  LLC,  an
unrelated party.

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

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

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         The accompanying  unaudited financial  statements have been prepared in
accordance with generally accepted accounting principles 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, 2006 is derived from
audited  financial  statements  which are included in our Annual  Report on Form
10-K for the year ended  December  31, 2006,  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.

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


                                       5



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

LICENSE AGREEMENTS AND ROYALTY EXPENSES

         We enter into license agreements from time to time that allow us to use
certain trademarks and trade names on certain of our products.  These agreements
require us to pay royalties and marketing fund  commitments,  generally based on
the sales of such products,  and may require  guaranteed  minimum  royalties,  a
portion  of which  may be paid in  advance.  Our  accounting  policy is to match
royalty  expense with revenue by recording  royalties at the time of sale at the
greater of the  contractual  rate or an effective rate  calculated  based on the
guaranteed minimum royalty and our estimate of sales during the contract period.
If a  portion  of  the  guaranteed  minimum  royalty  is  determined  not  to be
recoverable,  the unrecoverable  portion is charged to expense at that time. See
Note 15 of the "Notes to Consolidated  Financial  Statements"  regarding various
agreements we have entered into.

         Royalty  expense  in the six months  ended June 30,  2007 and 2006 were
$791,000 and $1.8 million, respectively.

DEFERRED RENT PROVISION

         When a lease requires fixed  escalation of the minimum lease  payments,
rental  expense is  recognized on a straight line basis over the initial term of
the lease,  and the  difference  between the average  rental  amount  charged to
expense and amounts payable under the lease is included in deferred  amount.  As
of June 30, 2007 and December 31, 2006,  deferred  rent of $133,000 and $93,000,
respectively,  was recorded under accrued expense in our consolidated  financial
statements.

DERIVATIVE ACTIVITIES

WARRANT DERIVATIVES

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

FOREIGN CURRENCY FORWARD CONTRACT

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

         SFAS No. 133 requires measurement of certain derivative  instruments at
their  fair  value for  accounting  purposes.  All  derivative  instruments  are
recorded on our balance sheet at fair value; as a result,  we mark to market all
derivative  instruments.  Derivative  liabilities  are  adjusted to reflect fair
value at each period end,  with any increase or decrease in the fair value being
recorded in  consolidated  statements of operations as adjustments to fair value
of derivatives.  During 2006, we entered into foreign currency forward contracts
to hedge  against  the  effect  of  exchange  rate  fluctuations  on cash  flows
denominated   in  foreign   currencies  and  certain   inter-company   financing
transactions.  At  June  30,  2007,  we had no  open  foreign  exchange  forward
contracts.  Hedge  ineffectiveness  resulted  in an  impact of  $196,000  in our
consolidated statements of operations in the six months of 2007.


                                       6



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

ACCOUNTING FOR UNCERTAIN TAX POSITIONS

         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.  We adopted  the
provisions  of FIN 48 on January 1, 2007. As a result of the  implementation  of
FIN 48, we recognized no material  adjustment for  unrecognized tax benefits but
reduced  retained  earnings  as of January 1, 2007 by  approximately  $1 million
attributable  to penalties  accrued as a component of income tax payable.  As of
the date of adoption,  our unrecognized tax benefits totaled  approximately $8.9
million.

         We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions.  We are currently
subject to Internal  Revenue  Service ("IRS") audit for the years including 1996
through  2002 but are not  being  audited  for  state  or  non-U.S.  income  tax
examinations for years open in those taxing jurisdictions.

         In January  2004,  the IRS  completed  its  examination  of our Federal
income tax returns for the years ended  December 31, 1996 through 2001.  The IRS
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.  We are
currently at the appellate level of the IRS and believe the proposed adjustments
made to our federal  income tax returns  for the years ended 1996  through  2002
will be  resolved  within the next  twelve  months and if so,  unrecognized  tax
benefits  related to U.S.  tax  positions  may decrease by up to $6.2 million by
December  31,  2007.  If  the  proposed   adjustments  are  upheld  through  the
administrative  and legal  process,  they could  have a  material  impact on our
earnings and cash flow.  We believe we have provided  adequate  reserves for any
reasonably  foreseeable  outcome  related to these  matters on the  consolidated
balance  sheets  under the caption  "Income  Taxes".  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.

         The total  unrecognized  tax  benefits  as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component  of income tax expense if  recognized.  We  recognize
interest  accrued  related to  unrecognized  tax  benefits  and  penalties  as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties  were $8.0  million  and $1.2  million,  respectively,  excluding  any
related income tax benefits.  As of June 30, 2007, the unrecognized tax benefits
did not change from the date of adoption.

         In many cases,  the  uncertain  tax  positions are related to tax years
that remain subject to examination by the relevant tax authorities.  Federal and
state statutes are open from 1996 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.

         Certain  2006  amounts  have been  reclassified  to conform to the 2007
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 June 30, 2007, there were outstanding  options to purchase a
total of  1,041,000  shares of common  stock  granted  under the 1995  Plan.  No
further  grants may be made under the 1995 Plan. On May 25, 2006, we adopted the
Tarrant  Apparel  Group  2006 Stock  Incentive  Plan (the  "2006  Plan"),  which
authorizes  the issuance of up to 5,100,000  shares of our common stock pursuant
to options or awards  granted  under the 2006 Plan.  As of June 30, 2007,  there
were  outstanding  options  to  purchase a total of  1,858,000  shares of common
stock,  and 3,242,000 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


                                       7




                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

market  value of common  stock on the date of grant.  The 2006 Plan also permits
other types of awards, including stock appreciation rights, restricted stock and
other performance-based benefits.

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

         We adopted SFAS No.  123(R) using the modified  prospective  transition
method,  which requires the application of the accounting standard as of January
1, 2006, the first day of our fiscal year 2006.  Our financial  statements as of
and for the three months and six months ended June 30, 2007 and 2006 reflect the
impact of SFAS No. 123(R).  SFAS No. 123(R)  requires  companies to estimate the
fair value of share-based  payment awards to employees and directors on the date
of grant using an  option-pricing  model.  The value of the portion of the award
that is ultimately  expected to vest is recognized as expense over the requisite
service periods in our consolidated statements of operations.

         A summary of our stock option activity, and related information for the
year  ended  December  31,  2006 and the six months  ended  June 30,  2007 is as
follows:

                                                              EMPLOYEES
                                                      --------------------------
                                                       NUMBER OF      EXERCISE
                                                        SHARES         PRICE
                                                      ----------    ------------
Options outstanding at December 31, 2005 ..........    6,733,050    $1.39-$45.50
Granted ...........................................    1,233,259    $ 1.84-$1.94
Exercised .........................................         --              --
Forfeited .........................................      (19,650)   $1.94-$33.13
Expired ...........................................     (273,000)   $ 6.75-$7.38
                                                      ----------    ------------
Options outstanding at December 31, 2006 ..........    7,673,659    $1.39-$45.50
Granted ...........................................      630,000    $ 1.63-$1.99
Exercised .........................................         --              --
Forfeited .........................................       (2,000)   $      18.50
Expired ...........................................       (2,000)   $       8.50
                                                      ----------    ------------
Options outstanding at June 30, 2007 ..............    8,299,659    $1.39-$45.50

         We had no stock option  outstanding to non-employees as of December 31,
2006 and June 30, 2007.


                                       8



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

         The  following  table  summarizes   information   about  stock  options
outstanding as of December 31, 2006 and June 30, 2007:



                                                                         WEIGHTED
                                                          WEIGHTED        AVERAGE
                                                          AVERAGE        REMAINING
                                            NUMBER OF     EXERCISE      CONTRACTUAL     INTRINSIC
                                             SHARES        PRICE        LIFE (YEARS)      VALUE
                                           ----------     --------      ------------    ---------
                                                                             
As of December 31, 2006
Employees - Outstanding ..............      7,673,659     $  5.52           5.9          $  0
Employees - Expected to vest .........      7,579,083     $  5.57           5.9          $  0
Employees - Exercisable ..............      6,445,400     $  6.22           5.3          $  0

As of June 30, 2007:
Employees - Outstanding ..............      8,299,659     $  5.24           5.8          $  0
Employees - Expected to vest .........      8,156,573     $  5.30           5.7          $  0
Employees - Exercisable ..............      6,684,715     $  6.05           4.9          $  0



         The following  table  summarizes our non-vested  options as of December
31, 2006 and changes during the six months ended June 30, 2007:

                                                                      WEIGHTED
                                                                      AVERAGE
                                                      NUMBER OF      GRANT-DATE
              NON-VESTED OPTIONS                       SHARES        FAIR VALUE
-------------------------------------------------   ------------    ------------
Non-vested at December 31, 2006 .................      1,228,259    $       1.26
  Granted .......................................        630,000    $       1.28
  Vested ........................................       (243,315)   $       1.25
  Forfeited .....................................           --              --
                                                    ------------
Non-vested at June 30, 2007 .....................      1,614,944    $       1.27


         The  following  table  shows the fair value of each  option  granted to
employees and directors  estimated on the date of grant using the  Black-Scholes
model with the following weighted average assumptions used for grants in the six
months ended June 30, 2007 and 2006:

                                                   SIX MONTHS ENDED JUNE 30,
                                                -------------------------------
                                                     2007             2006
                                                --------------   --------------
Expected dividend ...........................              0.0%             0.0%
Risk free interest rate .....................    4.49% to 4.67%            5.13%
Expected volatility .........................               70%              70%
Expected term (in years) ....................     5.75 to 6.18             6.25


                                       9



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

         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 six months
ended  June  30,  2007  and  2006  consisted  of  compensation  expense  for the
share-based  payment awards  granted  subsequent to January 1, 2006 based on the
grant date fair value  estimated in accordance  with the  provisions of SFAS No.
123(R).  For  stock-based  payment  awards  issued to employees  and  directors,
stock-based compensation is attributed to expense using the straight-line single
option  method.   As  stock-based   compensation   expense   recognized  in  the
consolidated  statements of operations for the three months and six months ended
June 30, 2007 and 2006 is based on awards  ultimately  expected to vest,  it has
been reduced for estimated  forfeitures,  which we estimate to be 7.7%. SFAS No.
123(R) requires forfeitures to be estimated at the time of grant and revised, if
necessary,  in  subsequent  periods  if actual  forfeitures  differ  from  those
estimates.

         Our  determination  of fair  value of  share-based  payment  awards  to
employees  and directors on the date of grant using the  Black-Scholes  model 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  the  expected  terms using the "safe  harbor"  provisions
provided in SAB No. 107 and the  volatility  using  historical  data. We granted
973,259  shares of stock options to purchase  shares of common stock for the six
months  ended  June 30,  2006.  The  options  granted  were  fair  valued in the
aggregate at $1.2 million or the  weighted-average  exercise of $1.25 in the six
months  ended June 30,  2006.  We granted  630,000  shares of options in the six
months  ended  June 30,  2007.  The  options  granted  were  fair  valued in the
aggregate  at  $805,000  or the  weighted-average  exercise  of $1.92 in the six
months ended June 30, 2007.  The  stock-based  compensation  expense  related to
employees or director stock options recognized for the six months ended June 30,
2007  was   $322,000,   of  which   $93,000  was  recorded   under  general  and
administrative expenses and $229,000 was recorded under selling and distribution
expenses  in  our   consolidated   statements  of  operation.   The  stock-based
compensation  expense related to employees or director stock options  recognized
for the six months  ended  June 30,  2006 was $7,000  which was  recorded  under
general and administrative expenses in our consolidated statements of operation.
Basic and  dilutive  income per share for the three  months ended June 30, 2007,
and for the three months and six months  ended June 30, 2006 was not  materially
affected  by the  additional  stock-based  compensation  recognized.  Basic  and
dilutive earnings per share for the six months ended June 30, 2007 was decreased
by $0.01  from  $0.00 to  $(0.01)  by the  additional  stock-based  compensation
recognized.

         The total intrinsic value of options exercised for the three months and
six months ended June 30, 2007 and 2006 was $0. Cash received from stock options
exercised  for the three  months and six months ended June 30, 2007 and 2006 was
$0. The total fair value of shares vested for the six months ended June 30, 2007
and 2006 were approximately $304,000 and $0, respectively.

         As of June 30,  2007,  there  was $1.8  million  of total  unrecognized
compensation cost related to non-vested  share-based  compensation  arrangements
granted  under  the  plans.  That cost is  expected  to be  recognized  over the
weighted-average period of 2.9 years.

         When options are exercised,  our policy is to issue previously unissued
shares of common stock to satisfy share option  exercises.  As of June 30, 2007,
we had 69.5 million shares of authorized, unissued shares of common stock.

4.       ACCOUNTS RECEIVABLE

         Accounts receivable consists of the following:

                                                  JUNE 30,         DECEMBER 31,
                                                    2007               2006
                                                ------------       ------------
U.S. trade accounts receivable ...........      $  3,639,079       $  2,975,840
Foreign trade accounts receivable ........        15,694,183         16,986,357
Factored accounts receivable .............        28,658,895         29,697,935
Other receivables ........................           709,438            496,253
Allowance for returns, discounts
  and bad debts ..........................        (1,912,316)        (2,076,858)
                                                ------------       ------------
                                                $ 46,789,279       $ 48,079,527
                                                ============       ============


                                       10



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

5.       INVENTORY

         Inventory consists of the following:



                                                   JUNE 30, 2007     DECEMBER 31, 2006
                                                 -----------------   -----------------
                                                               
Raw materials - fabric and trim accessories...   $       3,155,130   $       3,271,610
Work in process ..............................              13,065                --
Finished goods shipments-in-transit ..........           7,311,640           7,331,422
Finished goods ...............................           7,741,576           7,171,071
                                                 -----------------   -----------------
                                                 $      18,221,411   $      17,774,103
                                                 =================   =================


6.       NOTES RECEIVABLE - RELATED PARTY RESERVE

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

         On March 21, 2007,  our  wholly-owned  subsidiary,  Tarrant  Luxembourg
S.a.r.l.,  entered into a letter agreement with Solticio,  Inmobiliaria Cuadros,
S.A. de C.V.  ("Inmobiliaria"),  and Acotex,  (Acotex and together with Solticio
and Inmobiliaria,  the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"). On July
19, 2007, the parties amended the letter agreement.

         Pursuant to the agreement,  as amended,  Tavex has the right and option
(but not an obligation), at any time on or prior to September 1, 2007, to pay to
Tarrant Luxembourg an aggregate of U.S. $17.75 million in cash, whereupon, among
other things:

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

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

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


                                       11



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

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

         The Sellers also agreed during the option period,  to work  exclusively
with Tavex in respect of the payment of the Solticio and Acotex promissory notes
and the other  transactions  contemplated  by the letter  agreement,  and not to
enter into any  agreement  with any person  other than Tavex with respect to the
payment and/or  assignment of the Solticio and Acotex  promissory  notes and the
transactions contemplated by the agreement.

7.       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  advance in monthly  installments  during the term of the
agreement. The royalty owed to the licensor in excess of the guaranteed minimum,
if any,  is payable no later  than 30 days after the end of the  preceding  full
quarter with the amount for last quarter adjusted based on actual royalties owed
for the year. If a portion of the guaranteed  minimum  royalty is determined not
to be recoverable, the unrecoverable portion is charged to expense at that time.
The guaranteed  annual minimum  royalty for 2007 is $760,000.  At June 30, 2007,
the  total  commitment  on  royalties  remaining  on the term was $8.0  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.  The  investment  in American Rag CIE, LLC totaling  $2.3 million at
June 30, 2007,  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 six month ended
June 30, 2007 was as follows:

Balance as of December 31, 2006 .........................           $ 2,151,061
Share of income .........................................               126,542
Distribution ............................................                    (0)
                                                                    -----------
Balance as of June 30, 2007 .............................           $ 2,277,603
                                                                    ===========

8.       OTHER ASSETS AND WRITE OFF OF ACQUISITION EXPENSES

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

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

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

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


                                       12



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

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

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

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

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

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

         At signing of the Purchase Agreement,  we delivered $5.0 million to the
sellers as a deposit against the purchase price payable under the agreement.

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

9.       DEBT

         Short-term bank borrowings consist of the following:

                                             JUNE 30, 2007     DECEMBER 31, 2006
                                           -----------------   -----------------
Import trade bills payable - DBS
  Bank and Aurora Capital ................ $       6,902,696   $       5,844,887
Bank direct acceptances - DBS Bank .......         1,939,870           3,368,054
Other Hong Kong credit facilities - DBS
Bank .....................................         5,999,369           4,483,241
                                           -----------------   -----------------
                                           $      14,841,935   $      13,696,182
                                           =================   =================

         Long-term obligations consist of the following:

                                           JUNE 30, 2007      DECEMBER 31, 2006
                                         -----------------    -----------------
Equipment financing .................... $          23,555    $          38,148
Credit facility - Guggenheim, net ......        11,754,274           11,212,724
Debt facility and factoring agreement -
  GMAC CF ..............................        13,314,353           19,553,755
                                         -----------------    -----------------
                                                25,092,182           30,804,627
Less current portion ...................       (13,337,908)         (19,586,565)
                                         -----------------    -----------------
                                         $      11,754,274    $      11,218,062
                                         =================    =================

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

         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 at June 30,  2007) to our  subsidiaries  in Hong Kong.  This was a
demand


                                       13



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

facility and was secured by the pledge of our office property, which is owned by
Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd Kay, our
Vice Chairman; and by our guarantee. The letter of credit facility was increased
to HKD 30 million  (equivalent  to US $3.9  million) in June 2004.  In September
2006, a tax loan for HKD 8.438 million  (equivalent to US $1.1 million) was also
made  available  to our Hong Kong  subsidiaries  and bears  interest at the rate
equal to the Hong Kong prime rate plus 1% and are subject to the same  security.
It bore interest at 9% per annum at June 30, 2007. As of June 30, 2007, $374,000
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 8.5% per annum at June
30,  2007,  or the  Standard  Bills Rate  quoted by DBS plus 0.5% if paid in any
other  currency,  which the interest  rate was 8.59% per annum at June 30, 2007.
This is a demand  facility  and is  secured by a  security  interest  in all the
assets of the Hong Kong  subsidiaries;  by a pledge of our office property where
our Hong Kong office is located, which is owned by Gerard Guez and Todd Kay; and
by our guarantee.  The DBS facility includes  customary default  provisions.  In
addition,  we are subject to certain  restrictive  covenants,  including that we
maintain  a  specified  tangible  net  worth,  and a minimum  level of EBITDA at
December 31, 2006,  interest  coverage ratio,  leverage ratio and limitations on
additional  indebtedness.  We are in the process of revising these covenants for
2007. As of June 30, 2007, $13.9 million was outstanding under this facility. In
addition,  $7.8  million of open  letters of credit  were  outstanding  and $3.3
million was available for future borrowings as of June 30, 2007.

         As of June 30, 2007, the total balance  outstanding  under the DBS Bank
credit facilities was $13.9 million  (classified above as follows:  $6.0 million
in import trade bills payable,  $1.9 million in bank direct acceptances and $6.0
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 June 30, 2007,  $949,000 was  outstanding
under this  facility  (classified  above under import  trade bills  payable) and
$704,000  of  letters  of  credit  was open  under  this  arrangement.  We pay a
commission fee of 2.25% on all letters of credits issued under this arrangement.

EQUIPMENT FINANCING

         We had three equipment loans outstanding at June 30, 2007. One of these
equipment loans bore interest at 15.8% payable in installments through 2007. The
second loan bears interest at 6.15% payable in installments through 2007 and the
third loan bears interest at 4.75% payable in  installments  through 2008. As of
June 30, 2007, $24,000 was outstanding under these loans.

DEBT FACILITY AND FACTORING AGREEMENT - GMAC COMMERCIAL FINANCE

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


                                       14



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

         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  amount 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 June 30, 2007. As of June 30,
2007, we were in violation with the EBITDA covenant and a waiver was obtained on
August 10,  2007.  A total of $13.3  million  was  outstanding  with  respect to
receivables factored under the GMAC CF facility at June 30, 2007.

CREDIT FACILITY FROM GUGGENHEIM CORPORATE FUNDING LLC AND WARRANTS

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

         In connection with  Guggenheim  credit  facility,  on June 16, 2006, we
issued the lenders under this  facility  warrants to purchase up to an aggregate
of 3,857,143 shares of our common stock. These warrants have a term of 10 years.
These warrants are exercisable at a price of $1.88 per share with respect to 20%
of the  shares,  $2.00 per share with  respect to 20% of the  shares,  $3.00 per
share with respect to 20% of the shares,  $3.75 per share with respect to 20% of
the shares and $4.50 per share with  respect to 20% of the shares.  The exercise
prices are subject to adjustment for certain dilutive  issuances pursuant to the
terms  of  the  warrants.  357,143  shares  of  the  warrants  will  not  become
exercisable  unless and until a specified  portion of the  initial  term loan is
actually  funded by the lenders.  The warrants were evaluated under SFAS No. 133
and Emerging  Issues Task Force ("EITF") No. 00-19,  "Accounting  for Derivative
Financial  Instruments  Indexed to, and Potentially  Settled in, a Company's Own
Stock" and determined to be a derivative  instrument due to certain registration
rights. As such, the warrants  excluding the ones not exercisable were valued at
$4.9  million  using the  Black-Scholes  model with the  following  assumptions:
risk-free  interest rate of 5.1%;  dividend yields of 0%; volatility  factors of
the expected market price of our common stock of 0.70; and  contractual  term of
ten years. We also paid to Guggenheim 2.25% of the committed principal amount of
the  loans  which  was  $563,000  on June 16,  2006.  The  $563,000  fee paid to
Guggenheim  is included in the  deferred  financing  cost,  and the value of the
warrants to purchase  3.5 million  shares of our common stock of $4.9 million is
recorded as debt discount, both of them are amortized over the life of the loan.
For the six months ended June 30, 2007, $604,000 was amortized.

         Durham  Capital   Corporation   ("Durham")  acted  as  our  advisor  in
connection  with  the  Guggenheim  credit  facility.  As  compensation  for  its
services,  we  agreed to pay  Durham a cash fee in an amount  equal to 1% of the
committed principal amount of the loans under the Guggenheim credit facility. As
a result,  $250,000 was paid on June 16, 2006.  In addition,  we issued Durham a
warrant to purchase  77,143 shares of our common stock.  This warrant has a term
of 10 years  and is  exercisable  at a price  of $1.88  per  share,  subject  to
adjustment for certain dilutive issuances. 7,143 shares of this warrant will not
become exercisable unless and until a specified portion of the initial term loan
is actually  funded by the lenders.  The warrants were evaluated  under SFAS No.
133 and EITF 00-19 and determined to be a derivative instrument due to


                                       15



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

certain  registration  rights.  As such,  the  warrants  excluding  the ones not
exercisable  were  valued at  $105,000  using the  Black-Scholes  model with the
following  assumptions:  risk-free interest rate of 5.1%; dividend yields of 0%;
volatility factors of the expected market price of our common stock of 0.70; and
contractual  term of ten years. The $250,000 fee paid to Durham and the value of
the  warrants  to  purchase  70,000  shares of our common  stock of  $105,000 is
included in the deferred  financing  cost, and is amortized over the life of the
loan. For the six months ended June 30, 2007, $39,000 was amortized.

         The  Guggenheim  facility bore interest at 11.82% per annum at June 30,
2007. As of June 30, 2007, we were in violation  with the EBITDA  covenant and a
waiver was obtained on August 10, 2007.  A total of $11.8  million,  net of $3.7
million of debt discount, was outstanding under this facility at June 30, 2007.

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

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

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

10.      DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS

         We use forward currency contracts to manage risks generally  associated
with  foreign  exchange  rate.  During 2006,  we entered  into foreign  currency
forward  contracts to hedge against the effect of exchange rate  fluctuations on
cash flows denominated in foreign currencies and certain inter-company financing
transactions.  At  June  30,  2007,  we had no  open  foreign  exchange  forward
contracts.  Hedge  ineffectiveness  resulted  in an  impact of  $196,000  in our
consolidated statements of operations in the six months of June 30, 2007.


                                       16



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

11.      RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS


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

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

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

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

12.      INCOME TAXES

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

         In June 2006, the FASB issued  Interpretation  No. 48,  "Accounting for
Uncertainty in Income Taxes - An  Interpretation of FASB Statement No. 109." 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.  We adopted  the
provisions  of FIN 48 on January 1, 2007. As a result of the  implementation  of
FIN 48, we recognized no material  adjustment for  unrecognized tax benefits but
reduced  retained  earnings  as of January 1, 2007 by  approximately  $1 million
attributable  to penalties  accrued as a component of income tax payable.  As of
the date of adoption,  our unrecognized tax benefits totaled  approximately $8.9
million.

         We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions.  We are currently
subject to an IRS audit for the years  including  1996  through 2002 but are not
being audited for state or non-U.S.  income tax  examinations  for years open in
those taxing jurisdictions.


                                       17



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

         In January  2004,  the IRS  completed  its  examination  of our Federal
income tax returns for the years ended  December 31, 1996 through 2001.  The IRS
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.  We are
currently at the appellate level of the IRS and believe the proposed adjustments
made to our federal  income tax returns  for the years ended 1996  through  2002
will be  resolved  within the next  twelve  months and if so,  unrecognized  tax
benefits  related to U.S.  tax  positions  may decrease by up to $6.2 million by
December  31,  2007.  If  the  proposed   adjustments  are  upheld  through  the
administrative  and legal  process,  they could  have a  material  impact on our
earnings and cash flow.  We believe we have provided  adequate  reserves for any
reasonably  foreseeable  outcome  related to these  matters on the  consolidated
balance  sheets  under the caption  "Income  Taxes".  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.

         The total  unrecognized  tax  benefits  as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component  of income tax expense if  recognized.  We  recognize
interest  accrued  related to  unrecognized  tax  benefits  and  penalties  as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties  were $8.0  million  and $1.2  million,  respectively,  excluding  any
related income tax benefits.  As of June 30, 2007, the unrecognized tax benefits
did not change from the date of adoption.

         In many cases,  the  uncertain  tax  positions are related to tax years
that remain subject to examination by the relevant tax authorities.  Federal and
state statutes are open from 1996 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.

13.      NET INCOME (LOSS) PER SHARE

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



                                 THREE MONTHS ENDED JUNE 30,     SIX MONTHS ENDED JUNE 30,
                                 ---------------------------   ----------------------------
                                     2007           2006           2007            2006
                                 ------------   ------------   ------------    ------------
                                                                   
Basic EPS Computation:
Numerator ....................   $    809,264   $    611,284   $   (191,655)   $  1,447,655
Denominator:
Weighted average common shares
outstanding ..................     30,543,763     30,543,763     30,543,763      30,378,715
                                 ------------   ------------   ------------    ------------

Basic EPS ....................   $       0.03   $       0.02   $      (0.01)   $       0.05
                                 ============   ============   ============    ============

Diluted EPS Computation:
Numerator ....................   $    809,264   $    611,284   $   (191,655)   $  1,447,655
Denominator:
Weighted average common share
outstanding ..................     30,543,763     30,543,763     30,543,763      30,378,715
options ......................            112            657           --               125
                                 ------------   ------------   ------------    ------------

Total shares .................     30,543,875     30,544,420     30,543,763      30,378,840
                                 ------------   ------------   ------------    ------------

Diluted EPS ..................   $       0.03   $       0.02   $      (0.01)   $       0.05
                                 ============   ============   ============    ============


         Only 112 shares and 657 shares of outstanding  options were included in
the  computation of income per share in the three months ended June 30, 2007 and
2006, respectively,  as the exercise prices of the remaining shares were greater
than the average market price for the three months ended June 30, 2007 and 2006.
Only 125 shares of  outstanding  options  were  included in the  computation  of
income per share in the six months ended June 30, 2006,  as the exercise  prices
of the remaining  shares were greater than the average  market price for the six
months ended June 30, 2006.  All options were excluded from the  computation  of
net loss per share in the six months  ended June 30, 2007 as the impact would be
anti-


                                       18



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

dilutive.  All warrants were excluded from the  computation of net income (loss)
per share in the three  months and six months  ended June 30, 2007 and 2006,  as
the exercise  prices of the warrants were greater than the average  market price
for the three months and six months ended June 30, 2007 and 2006.  The following
table presents  potentially  dilutive  securities  that were not included in the
computation of income (loss) per share:

                                                         AS OF JUNE 30,
                                               ---------------------------------
                                                  2007                   2006
                                               ----------             ----------
Options ..........................              8,299,659              7,694,034
Warrants .........................              5,931,732              5,931,732
                                               ----------             ----------
Total ............................             14,231,391             13,625,766
                                               ==========             ==========

14.      RELATED PARTY TRANSACTIONS

         As of June 30, 2007,  related party  affiliates  were indebted to us in
the amounts of $12.2  million.  These include  amounts due from Gerard Guez, our
Chairman and Interim Chief Executive Officer.  From time to time in the past, we
had advanced funds to, Mr. Guez. These were net advances to Mr. Guez or payments
paid on his behalf before the enactment of the  Sarbanes-Oxley  Act in 2002. The
promissory note documenting  these advances contains a provision that the entire
amount  together with accrued  interest is immediately  due and payable upon our
written demand. The greatest outstanding balance of such advances to Mr. Guez in
the second quarter of 2007 was approximately  $2,087,000.  At June 30, 2007, the
entire  balance  due from Mr.  Guez  totaling  $2.1  million  has been  shown as
reductions to shareholders' equity in the accompanying financial statements. All
amounts due from Mr. Guez bore  interest at the rate of 7.75% during the period.
Total interest paid by Mr. Guez was $81,000 and $87,000 for the six months ended
June 30, 2007 and 2006,  respectively.  Mr. Guez paid  expenses on our behalf of
approximately  $162,000  and $132,000 for the six months ended June 30, 2007 and
2006,  respectively,  which amounts were applied to reduce accrued  interest and
principal on Mr. Guez's loan.  These amounts  included fuel and related expenses
incurred by 477 Aviation,  LLC, a company owned by Mr. Guez, when our executives
used this company's aircraft for business  purposes.  Since the enactment of the
Sarbanes-Oxley Act in 2002, no further personal loans (or amendments to existing
loans) have been or will be made to our executive officers or directors.

         Azteca Production International, Inc. ("Azteca") is a corporation owned
by the  brothers  of Gerard  Guez,  our  Chairman  and Interim  Chief  Executive
Officer. We purchased $499,000 and $0 of finished goods, fabric and service from
Azteca  and its  affiliates  in the six  months  ended  June 30,  2007 and 2006,
respectively.  Our total sales of fabric and service to Azteca in the six months
ended June 30, 2007 and 2006 were $0 and $9,000, respectively.

         At June 30, 2007,  Messrs.  Guez and Kay beneficially owned 488,400 and
1,003,500  shares,  respectively,  of  common  stock  of  Tag-It  Pacific,  Inc.
("Tag-It"),  collectively  representing  approximately  8.0% of Tag-It's  common
stock.  Tag-It is a provider of brand  identity  programs to  manufacturers  and
retailers of apparel and accessories. We purchased $140,000 and $202,000 of trim
from Tag-It in the six months  ended June 30, 2007 and 2006,  respectively.  Our
sales of garment  accessories  to Tag-It  were  $76,000 and $0 in the six months
ended June 30, 2007 and 2006, 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 act as its buying  agent to source  apparel  merchandise.  Seven
Licensing is beneficially  owned by Gerard Guez.  Total sales to Seven Licensing
in the six months  ended June 30,  2007 were $6.9  million.  Net amount due from
these related parties as of June 30, 2007 and December 31, 2006 was $8.1 million
and $7.5 million, respectively.

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


                                       19



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

2006, the  outstanding  balance of the notes and interest  receivables was $41.1
million prior to the reserve.  Historically,  we had placed orders for purchases
of fabric from the purchasers pursuant to the purchase  commitment  agreement we
entered into at the time of the sale of the Mexico assets,  and we had satisfied
our payment obligations for the fabric by offsetting the amounts payable against
the  amounts  due to us under the notes.  However,  during the third  quarter of
2006,  the  purchasers  ceased  providing  fabric and are not  currently  making
payments under the notes. We further  evaluated the  recoverability of the notes
receivable  and recorded a loss on the notes  receivable in the third quarter of
2006 in an  amount  equal  to the  outstanding  balance  less  the  value of the
underlying assets securing the notes. The loss was estimated to be approximately
$27.1 million,  resulting in a notes receivable balance at September 30, 2006 of
approximately  $14  million.   We  believe  there  was  no  significant   change
subsequently  on  the  value  of  the  underlying  assets  securing  the  notes;
therefore,  we did not have additional  reserve after the third quarter of 2006.
We will continue to pursue  payments under the notes  receivable and believe the
remaining $14 million balance at June 30, 2007 is realizable.  See Note 6 of the
"Notes to Consolidated Financial Statements".

         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 did not purchase fabric from Acabados y Terminados in the six
months  ended June 30,  2007 and 2006.  Net amount due from these  parties as of
June 30, 2007 was $159,000.

         We lease our executive offices and warehouse in Los Angeles, California
from GET.  Additionally,  we lease our office  space and  warehouse in Hong Kong
from Lynx International  Limited.  GET and Lynx  International  Limited are each
owned by Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd
Kay, our Vice Chairman.  We paid $563,000 and $538,000 in rent in the six months
ended June 30, 2007 and 2006, respectively, for office and warehouse facilities.
On  August 1,  2006,  we  entered  into a lease  agreement  with GET for the Los
Angeles  offices  and  warehouse,  which  lease has a term of five years with an
option to renew for an  additional  five year term.  On  February  1,  2007,  we
entered into a one year lease agreement with Lynx International  Limited for our
office space and warehouse in Hong Kong.

         On May 1,  2006,  we sublet a portion  of our  executive  office in Los
Angeles, California and our sales office in New York to Seven Licensing Company,
LLC for a monthly payment of $25,000 on a month to month basis.  Seven Licensing
is beneficially owned by Gerard Guez. We received $150,000 and $50,000 in rental
income  from this  sublease  in the six  months  ended  June 30,  2007 and 2006,
respectively.

         At June 30, 2007, we had various employee receivables totaling $235,000
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

         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  advance in monthly  installments  during the term of the
agreement. The royalty owed to the licensor in excess of the guaranteed minimum,
if any,  is payable no later  than 30 days after the end of the  preceding  full
quarter with the amount for last quarter adjusted based on actual royalties owed
for the year. If a portion of the guaranteed  minimum  royalty is determined not
to be recoverable, the unrecoverable portion is charged to expense at that time.
At June 30, 2007,  the total  commitment on royalties  remaining on the term was
$8.0 million.

         On October 17, 2004,  Private  Brands,  Inc.  entered into an agreement
with J.S. Brand Management to design, manufacture and distribute Jessica Simpson
branded jeans and casual apparel. This agreement has an initial three-year term,
and provided we are in compliance with the terms of the agreement,  is renewable
for one additional  two-year term.  Minimum net sales are $20 million in year 1,
$25  million in year 2 and $30  million in year 3. The  agreement  provides  for


                                       20



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

payment of a sales royalty and advertising  commitment at the rate of 8% and 3%,
respectively,  of net sales,  for a total  minimum  payment  obligation  of $8.3
million  over  the  initial  term of the  agreement.  On July 19,  2005,  Camuto
Consulting  Group  replaced J.S.  Brand  Management as the master  licensor.  In
December  2004, we advanced $2.2 million as payment for the first year's minimum
royalties.  We applied $1.1 million from the above  advance  against the royalty
and  marketing  expenses in 2005 and $884,000 in the first three months of 2006.
In March  2006,  we had  written off the  capitalized  balance of  $192,000  and
recognized a  corresponding  loss. The loss was classified as royalty expense on
our consolidated statements of operations.  In March 2006, we became involved in
a dispute with the  licensor of the Jessica  Simpson  brands over our  continued
rights to these brands.  We are presently in litigation  with the licensor.  See
Note 17 of the "Notes to Consolidated  Financial  Statements".  The licensor has
refused to accept payments and maintains that the agreement has been terminated.
There have been no sales of new products since the licensor  started refusing to
approve  products for  manufacture and sale. If we are successful in the lawsuit
against the  licensor,  then we expect to be able to reduce or  eliminate  these
payment  obligations  as an  offset  to  damages  sustained  by us. If we do not
succeed in our  claims,  we believe we will  likely not be  required to make the
entire guaranteed  payments  contemplated  under the agreement.  As a result, in
2006 and in the first six months of 2007,  we did not accrue for the payments of
minimum  royalty,  sales  royalty and  advertising  commitment  of $3.6  million
pursuant to the agreement.

         On January 3, 2005, Private Brands,  Inc., our wholly owned subsidiary,
entered into a term sheet exclusive licensing agreement with Beyond Productions,
LLC and Kids  Headquarters  to  collaborate  on the  design,  manufacturing  and
distribution of women's contemporary, large sizes and junior apparel bearing the
brand name "House of  Dereon",  Couture,  Kick and Soul.  This  agreement  was a
three-year contract, and providing compliance with all terms of the license, was
renewable  for one  additional  three-year  term.  The  agreement  also provided
payment  of  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
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 are no longer  involved in the sales of this private
brand. Prior to December 31, 2005, we had written off the capitalized balance of
$1.2 million  related to the first year term of the agreement  and  recognized a
corresponding loss in 2005.

         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 did not
purchase fabric in the six months ended June 30, 2007 and 2006.

         On September 1, 2006,  our  subsidiary  in Hong Kong,  Tarrant  Company
Limited,  entered into an agreement with Seven Licensing Company,  LLC to act as
its buying agent to source apparel merchandise.  Seven Licensing is beneficially
owned by Gerard  Guez.  Total sales to Seven  Licensing  in the six months ended
June 30, 2007 were $6.9 million.


                                       21



                              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 two  geographic
regions:  the United  States and Asia.  We evaluate  performance  of each region
based on profit or loss from  operations  before  income taxes not including the
cumulative  effect of change in  accounting  principles.  Information  about our
operations  in the United  States  and Asia is  presented  below.  Inter-company
revenues and assets have been eliminated to arrive at the consolidated amounts.



                                                                        ADJUSTMENTS
                                                                            AND
                                    UNITED STATES         ASIA          ELIMINATIONS           TOTAL
                                   ---------------   ---------------   ---------------    ---------------
                                                                              
THREE MONTHS ENDED JUNE 30, 2007
Sales ..........................   $    55,694,000   $     4,407,000   $          --      $    60,101,000
Inter-company sales ............              --          36,579,000       (36,579,000)              --
                                   ---------------   ---------------   ---------------    ---------------
Total revenue ..................   $    55,694,000   $    40,986,000   $   (36,579,000)   $    60,101,000
                                   ===============   ===============   ===============    ===============

Income from operations .........   $       774,000   $     1,755,000   $          --      $     2,529,000
                                   ===============   ===============   ===============    ===============
Interest income ................   $        41,000   $         2,000   $          --      $        43,000
                                   ===============   ===============   ===============    ===============
Interest expense ...............   $     1,173,000   $        47,000   $          --      $     1,220,000
                                   ===============   ===============   ===============    ===============
Provision for depreciation
 and amortization ..............   $       564,000   $        39,000   $          --      $       603,000
                                   ===============   ===============   ===============    ===============
Capital expenditures ...........   $        49,000   $       135,000   $          --      $       184,000
                                   ===============   ===============   ===============    ===============


THREE MONTHS ENDED JUNE 30, 2006
Sales ..........................   $    58,783,000   $       300,000   $          --      $    59,083,000
Inter-company sales ............              --          31,573,000       (31,573,000)              --
                                   ---------------   ---------------   ---------------    ---------------
Total revenue ..................   $    58,783,000   $    31,873,000   $   (31,573,000)   $    59,083,000
                                   ===============   ===============   ===============    ===============

Income from operations .........   $     1,462,000   $     1,147,000   $          --      $     2,609,000
                                   ===============   ===============   ===============    ===============
Interest income (1) ............   $       480,000   $         1,000   $          --      $       481,000
                                   ===============   ===============   ===============    ===============
Interest expense ...............   $     1,876,000   $        70,000   $          --      $     1,946,000
                                   ===============   ===============   ===============    ===============
Provision for depreciation
 and amortization ..............   $     1,382,000   $        27,000   $          --      $     1,409,000
                                   ===============   ===============   ===============    ===============
Capital expenditures ...........   $        23,000   $        18,000   $          --      $        41,000
                                   ===============   ===============   ===============    ===============


SIX MONTHS ENDED JUNE 30, 2007
Sales ..........................   $   107,791,000   $     8,416,000   $          --      $   116,207,000
Inter-company sales ............              --          60,815,000       (60,815,000)              --
                                   ---------------   ---------------   ---------------    ---------------
Total revenue ..................   $   107,791,000   $    69,231,000   $   (60,815,000)   $   116,207,000
                                   ===============   ===============   ===============    ===============

Income from operations .........   $       220,000   $     2,372,000   $          --      $     2,592,000
                                   ===============   ===============   ===============    ===============
Interest income ................   $        86,000   $         2,000   $          --      $        88,000
                                   ===============   ===============   ===============    ===============
Interest expense ...............   $     2,473,000   $        90,000   $          --      $     2,563,000
                                   ===============   ===============   ===============    ===============
Provision for depreciation
 and amortization ..............   $     1,126,000   $        62,000   $          --      $     1,188,000
                                   ===============   ===============   ===============    ===============
Capital expenditures ...........   $       114,000   $       158,000   $          --      $       272,000
                                   ===============   ===============   ===============    ===============

Total assets (2) ...............   $    88,543,000   $   126,168,000   $  (110,404,000)   $   104,307,000
                                   ===============   ===============   ===============    ===============


SIX MONTHS ENDED JUNE 30, 2006
Sales ..........................   $   119,363,000   $       981,000   $          --      $   120,344,000
Inter-company sales ............              --          60,924,000       (60,924,000)              --
                                   ---------------   ---------------   ---------------    ---------------
Total revenue ..................   $   119,363,000   $    61,905,000   $   (60,924,000)   $   120,344,000
                                   ===============   ===============   ===============    ===============

Income from operations .........   $     1,944,000   $     2,311,000   $          --      $     4,255,000
                                   ===============   ===============   ===============    ===============
Interest income (3) ............   $       965,000   $         1,000   $          --      $       966,000
                                   ===============   ===============   ===============    ===============
Interest expense ...............   $     3,006,000   $       128,000   $          --      $     3,134,000
                                   ===============   ===============   ===============    ===============
Provision for depreciation
 and amortization ..............   $     1,728,000   $        54,000   $          --      $     1,782,000
                                   ===============   ===============   ===============    ===============
Capital expenditures ...........   $        32,000   $        31,000   $          --      $        63,000
                                   ===============   ===============   ===============    ===============

Total assets (4) ...............   $   136,573,000   $   115,445,000   $  (106,822,000)   $   145,196,000
                                   ===============   ===============   ===============    ===============


(1)      Interest income in the U.S.  included $432,000 interest earned from the
         notes  receivable  related to the sale of our fixed assets in Mexico of
         which notes are recorded in Luxembourg.

(2)      Total  assets in the U.S.  included  $15,973,000  from  Luxembourg  and
         $7,720,000 from Mexico.


                                       22



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

(3)      Interest income in the U.S.  included $873,000 interest earned from the
         notes  receivable  related to the sale of our fixed assets in Mexico of
         which notes are recorded in Luxembourg.

(4)      Total  assets in the U.S.  included  $41,586,000  from  Luxembourg  and
         $8,528,000 from Mexico.

17.      LITIGATION

JESSICA SIMPSON & CAMUTO CONSULTING GROUP

          On or about April 6, 2006, we commenced an action against the licensor
of the  Jessica  Simpson  brands  (captioned  Tarrant  Apparel  Group v.  Camuto
Consulting  Group,  Inc.,  VCJS LLC, With You, Inc. and Jessica  Simpson) in the
Supreme  Court of the State of New York,  County  of New  York.  The suit  named
Camuto Consulting  Group,  Inc., 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,  as
well as fraud  against  Camuto  Consulting.  The  complaint  was  amended to add
Vincent Camuto as a defendant and includes nine 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,  breach of the
duty of good faith and fair dealing and  fraudulent  inducement  against  Camuto
Consulting,   a  claim  against  Vincent  Camuto   individually  for  fraudulent
inducement,  and a claim against With You,  Inc. and Ms.  Simpson that we are an
intended  third party  beneficiary of the license  between those  defendants and
Camuto  Consulting.  On or about October 30, 2006, Camuto  Consulting,  VCJS and
Vincent  Camuto served their answer to the amended  complaint,  which included a
counterclaim  against  us for breach of the  sublicense  agreement  and  alleged
damages of no less than $100 million.  With You,  Inc. and Jessica  Simpson also
filed  counterclaims   against  us  alleging  trademark   infringement,   unfair
competition and business practices,  violation of the right of privacy and other
claims,  and seeking injunctive relief and damages in an amount to be determined
but no less than $100 million plus treble and punitive  damages.  By Order filed
January 17, 2007, the Court granted the motion of With You, Inc. and Ms. Simpson
to  discontinue   all  of  Ms.   Simpson's   counterclaims,   and  her  personal
counterclaims  were dismissed with  prejudice.  With You,  Inc.'s  counterclaims
remain. Ms. Simpson and With You, Inc. appealed the trial Court's ruling denying
their motion to dismiss the claim against them. The trial Court's  determination
was affirmed on appeal in a decision dated May 31, 2007. Accordingly,  our claim
against With You, Inc. and Ms. Simpson  remains.  On or about February 27, 2007,
we served a motion seeking  dismissal of two of With You, Inc.'s  counterclaims.
With You, Inc. did not oppose the motion and by Order dated March 22, 2007,  the
Court granted our motion,  dismissing two of With You, Inc.'s counterclaims.  On
July 5, 2007,  the trial Court denied a motion filed in December  2006 by Camuto
Consulting,  VCJS and  Vincent  Camuto to dismiss  our  claims  for  declaratory
judgment  seeking a declaration  that the sublicense is exclusive and remains in
full  force and  effect  and those  aspects  of our  claims  that seek  specific
performance. Discovery in the matter has been underway since May 2006. We intend
to continue vigorously to pursue this action and defend the counterclaims.

BAZAK INTERNATIONAL CORPORATION

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

         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



                              TARRANT APPAREL GROUP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)

18.      SUBSEQUENT EVENTS

         On July 19,  2007,  our  wholly-owned  subsidiary,  Tarrant  Luxembourg
S.a.r.l.  entered into an amendment to a letter  agreement dated March 21, 2007,
with Solticio,  S.A. de C.V., Inmobiliaria Cuadros, S.A. de C.V., and Acabados y
Cortes  Textiles,  S.A.  de C.V.,  and Tavex  Algodonera,  S.A.  Pursuant to the
original letter agreement, Tavex obtained the right and option to pay to Tarrant
Luxembourg  an aggregate of U.S. $20 million in cash and  promissory  notes,  in
full  satisfaction  of all  indebtedness  owed to  Tarrant  Luxembourg  from the
Sellers,  whereupon Tarrant  Luxembourg would,  among other things,  release all
liens it has on certain property owned by the Sellers' in Mexico. The amendment:

         (i)      extended the period during which Tavex may exercise the option
                  from July 19, 2007 until September 1, 2007;

         (ii)     amended  the  consideration  to be paid by  Tavex  to  Tarrant
                  Luxembourg  upon  exercise  of the option to U.S.  $17,750,000
                  payable in cash concurrently upon exercise of the option; and

         (iii)    Amended  Tarrant  Luxembourg's  obligation to purchase  fabric
                  from Tavex  following  exercise  of the option,  reducing  the
                  purchase  commitment  to U.S.  $1,250,000 in denim fabric that
                  must  be  purchased  prior  to the  end of  fiscal  2007,  and
                  requiring Tarrant  Luxembourg to deliver an irrevocable letter
                  of credit for the full purchase price.

         See Note 6 of the "Notes to Consolidated Financial Statements" for more
information.


                                       24



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

         The  following  management's  discussion  and  analysis  should be read
together with the Consolidated Financial Statements of Tarrant Apparel Group and
the "Notes to Consolidated Financial Statements" included elsewhere in this Form
10-Q.  This  discussion   summarizes  the  significant   factors  affecting  the
consolidated operating results, financial condition and liquidity and cash flows
of Tarrant  Apparel Group for the quarterly  periods and year to date ended June
30, 2007 and 2006. Except for historical  information,  the matters discussed in
this management's  discussion and analysis of financial condition and results of
operations are forward looking  statements that involve risks and  uncertainties
and are based upon  judgments  concerning  various  factors  that are beyond our
control. See "Item 1A. Risk Factors" in Part II of this Form 10-Q.

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 retailers,  such as Macy's  Merchandising Group, Kohl's,
New York & Co., Mervyn's, Mothers Work, Chico's, Wal-Mart,  Charlotte Russe, the
Avenue, Lane Bryant,  Sears, and J.C. Penney. Our products are manufactured in a
variety of woven and knit  fabrications  and include  jeans wear,  casual pants,
shorts, skirts, dresses,  t-shirts,  blouses, shirts and other tops and jackets.
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 sales in the first
six months of 2007 were $96.1 million compared to $89.7 million in the first six
months of 2006.

PRIVATE BRANDS

         We launched our private brands initiative in 2003, pursuant to which we
acquire ownership of or license rights to a brand name and sell apparel products
under this brand,  generally  to a single  retail  company  within a  geographic
region.  Private brands sales in the first six months of 2007 were $20.1 million
compared to $30.6  million in the first six months of 2006. At June 30, 2007, we
owned or licensed rights to the following private brands:

         o        AMERICAN  RAG CIE:  During  the  first  quarter  of  2005,  we
                  extended our agreement with Macy's Merchandising Group through
                  2014, pursuant to which we exclusively distribute our American
                  Rag CIE brand through Macy's  Merchandising  Group's  national
                  Department  Store  organization  of more than 600 stores.  Net
                  sales  of  American  Rag CIE  branded  apparel  totaled  $19.8
                  million  in the first six  months  of 2007  compared  to $15.5
                  million in the first six months of 2006.

         o        ALAIN  WEIZ:  We  have   previously  sold  Alan  Weiz  apparel
                  exclusively to Dillard's Department Stores. Net sales of Alain
                  Weiz  branded  apparel  totaled  $3.2 million in the first six
                  months of 2006. From January 1, 2007, we may sell our licensed
                  brand "Alain Weiz" to specialty stores and department  stores.
                  There were no sales in the first six months of 2007.

         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 $9.7 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.


                                       25



THE BUFFALO GROUP

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

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

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

NOTES RECEIVABLE - RELATED PARTY RESERVE

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

         On March 21, 2007,  our  wholly-owned  subsidiary,  Tarrant  Luxembourg
S.a.r.l.,  entered into a letter agreement with Solticio,  Inmobiliaria Cuadros,
S.A. de C.V., and Acotex,  (Acotex and together with Solticio and  Inmobiliaria,
the "Sellers"), and Tavex Algodonera, S.A. On July 19, 2007, the parties amended
the letter agreement.

         Pursuant to the agreement,  as amended,  Tavex has the right and option
(but not an obligation), at any time on or prior to September 1, 2007, to pay to
Tarrant Luxembourg an aggregate of U.S. $17.75 million in cash, whereupon, among
other things:

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


                                       26



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

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

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

         The Sellers also agreed during the option period,  to work  exclusively
with Tavex in respect of the payment of the Solticio and Acotex promissory notes
and the other  transactions  contemplated  by the letter  agreement,  and not to
enter into any  agreement  with any person  other than Tavex with respect to the
payment and/or  assignment of the Solticio and Acotex  promissory  notes and the
transactions contemplated by the agreement.

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

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

         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, 2006.

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
us could be reduced by a material amount.


                                       27



         As of  June  30,  2007,  the  balance  in the  allowance  for  returns,
discounts and bad debts reserves was $1.9 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:

         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 June 30, 2007, 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,   we  are  required  to  estimate   income  taxes  in  each  of  the
jurisdictions  in which we  operate.  The  process  involves  estimating  actual
current tax expense along with assessing  temporary  differences  resulting from
differing treatment of items for book and tax purposes. These timing differences
result in  deferred  tax  assets  and  liabilities,  which are  included  in our
consolidated  balance sheet.  We record a valuation  allowance to reduce our net
deferred  tax assets to the amount that is more likely than not to be  realized.
We have considered future taxable income and ongoing tax planning  strategies in
assessing  the need for the  valuation  allowance.  Increases  in the  valuation
allowance result in additional  expense to be reflected within the tax provision
in the consolidated statement of operations.

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

         In June 2006, the FASB issued  Interpretation  No. 48,  "Accounting for
Uncertainty in Income Taxes - An  Interpretation of FASB Statement No. 109." 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


                                       28



benefit.  Additionally,  FIN 48  provides  guidance  on  de-recognition,  income
statement  classification  of  interest  and  penalties,  accounting  in interim
periods,  disclosure,  and  transition.  We adopted the  provisions of FIN 48 on
January 1, 2007. As a result of the  implementation  of FIN 48, we recognized no
material  adjustment for unrecognized tax benefits but reduced retained earnings
as of January 1, 2007 by  approximately  $1 million  attributable  to  penalties
accrued as a component  of income tax payable.  As of the date of adoption,  our
unrecognized tax benefits totaled approximately $8.9 million.

         We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions.  We are currently
subject to an IRS audit for the years  including  1996  through 2002 but are not
being audited for state or non-U.S.  income tax  examinations  for years open in
those taxing jurisdictions.

         In January  2004,  the IRS  completed  its  examination  of our Federal
income tax returns for the years ended  December 31, 1996 through 2001.  The IRS
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.  We are
currently at the appellate level of the IRS and believe the proposed adjustments
made to our federal  income tax returns  for the years ended 1996  through  2002
will be  resolved  within the next  twelve  months and if so,  unrecognized  tax
benefits  related to U.S.  tax  positions  may decrease by up to $6.2 million by
December  31,  2007.  If  the  proposed   adjustments  are  upheld  through  the
administrative  and legal  process,  they could  have a  material  impact on our
earnings and cash flow.  We believe we have provided  adequate  reserves for any
reasonably  foreseeable  outcome  related to these  matters on the  consolidated
balance  sheets  under the caption  "Income  Taxes".  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.

         The total  unrecognized  tax  benefits  as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component  of income tax expense if  recognized.  We  recognize
interest  accrued  related to  unrecognized  tax  benefits  and  penalties  as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties  were $8.0  million  and $1.2  million,  respectively,  excluding  any
related income tax benefits.  As of June 30, 2007, the unrecognized tax benefits
did not change from the date of adoption.

         In many cases,  the  uncertain  tax  positions are related to tax years
that remain subject to examination by the relevant tax authorities.  Federal and
state statutes are open from 1996 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.

DEBT COVENANTS

         Our debt agreements require certain covenants including a minimum level
of EBITDA and specified tangible net worth; and required interest coverage ratio
and  leverage  ratio  as  discussed  in  Note 9 of the  "Notes  to  Consolidated
Financial Statements." If our results of operations erode and we are not able to
obtain  waivers from the  lenders,  the debt would be in default and callable by
our  lenders.  In  addition,  due  to  cross-default   provisions  in  our  debt
agreements,  substantially all of our long-term debt would become due in full if
any of the debt is in default.  In anticipation of us not being able to meet the
required  covenants due to various  reasons,  we either negotiate for changes in
the relative  covenants or 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.  As of June
30,  2007,  we were in  violation  of the  EBITDA  covenant  and  waivers of the
defaults were obtained in August 2007 from our lenders.

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."


                                       29



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 JUNE 30,      SIX MONTHS ENDED JUNE 30,
                                              ----------------------------    -----------------------------
                                                  2007            2006            2007             2006
                                              ------------    ------------    ------------     ------------
                                                                                          
Net sales .................................          100.0%          100.0%          100.0%           100.0%
Cost of sales .............................           79.1            78.6            78.6             79.1
                                              ------------    ------------    ------------     ------------
Gross profit ..............................           20.9            21.4            21.4             20.9
Selling and distribution expenses .........            5.6             4.7             5.8              4.8
General and administration expenses .......           10.4            11.7            11.0             11.1
Royalty expenses ..........................            0.7             0.6             0.7              1.5
Terminated acquisition expenses ...........           --              --               1.7             --
                                              ------------    ------------    ------------     ------------
Income from operations ....................            4.2             4.4             2.2              3.5
Interest expense ..........................           (2.0)           (3.3)           (2.2)            (2.6)
Interest Income ...........................            0.1             0.8             0.1              0.8
Interest in income of equity method
   investee ...............................            0.0             0.1             0.1              0.1
Other income ..............................            0.1             0.2             0.1              0.1
Adjustment to fair value of derivative ....           (0.0)           (0.4)            0.2             (0.2)
Other expense .............................           (0.0)           (0.7)           (0.0)            (0.3)
                                              ------------    ------------    ------------     ------------
Income before taxes .......................            2.4             1.1             0.5              1.4
Income taxes ..............................            1.1             0.1             0.7              0.2
Minority interest in consolidated
   subsidiary .............................            0.0             0.0             0.0              0.0
                                              ------------    ------------    ------------     ------------
Net income (loss) .........................            1.3%            1.0%           (0.2)%            1.2%
                                              ============    ============    ============     ============



SECOND QUARTER 2007 COMPARED TO SECOND QUARTER 2006

         Net sales  increased  by $1.0  million,  or 1.7%,  to $60.1  million in
second quarter of 2007 from $59.1 million in the second  quarter of 2006.  Sales
of private label in the second  quarter of 2007 were $47.9  million  compared to
$47.6 million in the same period of 2006.  Sales of private brands in the second
quarter of 2007 were $12.2 million  compared to $11.4 million in the same period
of 2006 with the increase  resulting  primarily from increased sales of American
Rag brand to Macy's Merchandising Group in the second quarter of 2007.

         Gross profit  consists of net sales less product  costs,  direct labor,
duty, quota, freight in, and brokerage,  warehouse handling and markdown.  Gross
profit decreased by $108,000 to $12.6 million in the second quarter of 2007 from
$12.7 million in the second quarter of 2006. As a percentage of net sales, gross
profit decreased from 21.4% in the second quarter of 2006 to 20.9% in the second
quarter of 2007.  The decrease in gross margin in the second quarter of 2007 was
due primarily to a greater  proportion of sales of lower margin  products in the
current period.

         Selling and distribution  expenses increased by $554,000,  or 19.8%, to
$3.4  million  in the  second  quarter  of 2007 from $2.8  million in the second
quarter of 2006. As a percentage of net sales,  these expenses increased to 5.6%
in the  second  quarter of 2007 from 4.7% in the  second  quarter  of 2006.  The
increase in selling and  distribution  expenses  was  primarily  due to overhead
related  to a new label and  increased  advertising  expenses  during the second
quarter of 2007.

         General and administrative  expenses decreased by $663,000, or 9.6%, to
$6.2  million  in the  second  quarter  of 2007 from $6.9  million in the second
quarter of 2006. As a percentage of net sales, these expenses decreased to 10.4%
in the second quarter of 2007 from 11.7% in the second quarter of 2006.  General
and  administrative  expenses in the second quarter of 2006 included $284,000 of
expenses of financing cost paid to the placement  agent and the remaining  value
of the warrants to placement  agent and $171,000 of  prepayment  penalty paid to
the  debenture  holders as a result of the  repayment of the  debentures in June
2006, as compared to no such expense in second quarter of 2007.


                                       30



         Royalty and  marketing  allowance  expenses  increased  by $81,000,  or
22.9%,  to  $434,000 in the second  quarter of 2007 from  $353,000 in the second
quarter of 2006.  The increase was  primarily  due to an increase in sales under
American Rag brand in the second  quarter of 2007. As a percentage of net sales,
these  expenses  increased  slightly to 0.7% in the second  quarter of 2007 from
0.6% in the second quarter of 2006.

         Operating  income in the second  quarter of 2007 was $2.5  million,  or
4.2% of net  sales,  compared  to $2.6  million,  or 4.4% of net  sales,  in the
comparable period of 2006, because of the factors discussed above.

         Interest  expense  decreased by $726,000,  or 37.3%, to $1.2 million in
the second quarter of 2007 from $1.9 million in the second quarter of 2006. As a
percentage of net sales, this expense decreased to 2.0% in the second quarter of
2007 from 3.3% in the second quarter of 2006.  The decrease in interest  expense
was  primarily due to expensing  $711,000 in the second  quarter of 2006 of debt
discount  related to the intrinsic value of the conversion  option of debentures
and the  remaining  value of the warrants  issued to holders of  debentures as a
result of the  repayment  of the  debentures  in June 2006,  compared to no such
expenses in the second quarter of 2007.  Interest income  decreased by $438,000,
or 91.1%,  to $43,000 in the second  quarter of 2007 from $481,000 in the second
quarter of 2006.  The  decrease  in  interest  income was  primarily  due to the
interest  earned  from the  notes  receivable  related  to the sale of our fixed
assets in Mexico in the second quarter of 2006, but no such income in the second
quarter of 2007.

         Interest in income of equity method  investee was $43,000 in the second
quarter of 2007,  compared to $63,000 in the second quarter of 2006. Interest in
income of equity method investee represented our 45% share of equity interest in
the owner of the  trademark  "American Rag CIE" and the operator of American Rag
retail stores.  Other income was $65,000 in the second quarter of 2007, compared
to $91,000 in the second quarter of 2006. Other expense was $9,000 in the second
quarter of 2007, compared to $400,000 in the second quarter of 2006.

         Loss  allocated to minority  interest in the second quarter of 2007 was
$1,000,  representing  the minority  partner's  share of losses in PBG7.  Income
allocated to minority interests in the second quarter of 2006 was $7,000.

FIRST SIX MONTHS OF 2007 COMPARED TO FIRST SIX MONTHS OF 2006

         Net sales decreased by $4.1 million,  or 3.4%, to $116.2 million in the
first six  months of 2007 from  $120.3  million in the first six months of 2006.
Sales of  private  label in the first six  months  of 2007  were  $96.1  million
compared  to  $89.7  million  in the same  period  of  2006,  with the  increase
resulting  primarily from increased sales to New York & Co and Seven  Licensing,
and  partially  offset by  decreased  sales to Kohl's in the first six months of
2007. Sales of private brands in the first six months of 2007 were $20.1 million
compared  to $30.6  million in the same  period of 2006.  The decline in private
brands sales is the result of sales of Alain Weiz,  Jessica Simpson and House of
Dereon brands in the first six months of 2006,  compared to no such sales in the
first six  months of 2007,  and  partially  offset  by an  increase  in sales of
American  Rag brand to  Macy's  Merchandising  Group in the first six  months of
2007.

         Gross profit  consists of net sales less product  costs,  direct labor,
duty, quota, freight in, and brokerage,  warehouse handling and markdown.  Gross
profit  decreased  by $280,000 to $24.9  million in the first six months of 2007
from $25.2 million in the first six months of 2006. 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 first six months of 2006 to 21.4% in
the first six months of 2007. The increase in gross margin in the current period
is primarily attributable to the absence of sales from the lower margin House of
Dereon and Jessica  Simpson  brand  apparel that were  included in the first six
months of 2006.

         Selling and distribution  expenses increased by $1.1 million, or 18.6%,
to $6.8  million in the first six months of 2007 from $5.7  million in the first
six months of 2006. As a percentage of net sales,  these expenses increased from
4.8% for the first six  months of 2006 to 5.8% for the first six months of 2007.
The increase in selling and distribution  expenses was primarily due to overhead
related to a new label and increased  advertising  expenses during the first six
months of 2007.

         General and administrative  expenses decreased by $636,000, or 4.8%, to
$12.7  million in the first six  months of 2007 from $13.4  million in the first
six months of 2006. As a percentage of net sales, these expenses


                                       31



decreased  to 11.0% in the first six  months of 2007 from 11.1% in the first six
months of 2006. General and  administrative  expenses in the first six months of
2006 included $284,000 of expenses of financing cost paid to the placement agent
and the  remaining  value of the  warrants to  placement  agent and  $171,000 of
prepayment penalty paid to the debenture holders as a result of the repayment of
the  debentures  in June 2006,  as compared to no such expenses in the first six
months of 2007.

         Royalty and marketing  allowance expenses decreased by $1.0 million, or
56.9%,  to  $791,000  in the first six  months of 2007 from $1.8  million in the
first six months of 2006. As a percentage of net sales, these expenses decreased
to 0.7% in the  first six  months  of 2007 from 1.5% in the first six  months of
2006 due to royalties on sales under the licensed Jessica Simpson and Alain Weiz
brands in the first six  months of 2006,  for which  there were no such sales in
the first six months of 2007.

         Terminated acquisition expenses in the first six months of 2007 were $2
million,  or 1.7% of net  sales,  compared  to no such  expense in the first six
months of 2006.  These  expenses  consisted  of the  non-refunded  portion  of a
deposit in the amount of  $250,000  and other due  diligence  fees  incurred  in
connection with the proposed acquisition of The Buffalo Group, which transaction
was mutually terminated on April 19, 2007.

         Operating income for the first six months of 2007 was $2.6 million,  or
2.2% of net sales,  compared to operating income of $4.3 million, or 3.5% of net
sales,  in the  comparable  prior  period  of 2006 as a  result  of the  factors
discussed above.

         Interest expense decreased by $571,000 or 18.2%, to $2.6 million in the
first six months of 2007 from $3.1 million in the first six months of 2006. As a
percentage  of net sales,  interest  expense  decreased to 2.2% in the first six
months  of 2007 from 2.6% in the first  six  months of 2006.  The  decrease  was
primarily  due to expensing  $711,000 in the six months of 2006 of debt discount
related to the intrinsic  value of the  conversion  option of debentures and the
remaining  value of the warrants  issued to holders of debentures as a result of
the repayment of the  debentures in June 2006,  but no such expense in the first
six months of 2007. Interest income decreased by $878,000,  or 90.9%, to $88,000
in the first six months of 2007 from  $966,000  in the first six months of 2006.
The decrease in interest  income was primarily  due to the interest  earned from
the notes  receivable  related to the sale of our fixed  assets in Mexico in the
first six months of 2006, but no such income in the first six months of 2007.

         Interest in income of equity method  investee was $127,000 in the first
six  months of 2007,  compared  to  $110,000  in the  first six  months of 2006.
Interest in income of equity method investee represented our 45% share of equity
interest in the owner of the  trademark  "American  Rag CIE" and the operator of
American Rag retail stores. Other income was $152,000 in the first six months of
2007,  compared to $124,000 in the first six months of 2006.  Adjustment to fair
value of  derivative  was $196,000 in the first six months of 2007,  compared to
$(218,000)  in the first six months of 2006.  Other  expense  was $11,000 in the
first six months of 2007, compared to $400,000 in the first six months of 2006.

         Loss  allocated  to  minority  interest  in the six  months of 2007 was
$1,000,  representing  the  minority  partner's  share of losses  in PBG7.  Loss
allocated to minority interest in the first six months of 2006 was $4,000.

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


                                       32



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.

         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.

         As of June 30, 2007,  we had $964,000 in cash and cash  equivalents  as
noted on our  consolidated  balance  sheet and  statement  of cash  flows.  This
represented an increase of $59,000 or 6.6% compared to a total of $905,000 as of
December 31, 2006.

         Cash  flows for the six  months  ended  June 30,  2007 and 2006 were as
follows (dollars in thousands):

CASH FLOWS:                                                   2007        2006
                                                            -------     -------
Net cash provided by (used in) operating activities ....    $ 1,303     $(2,401)
Net cash provided by investing activities ..............    $ 3,859     $   703
Net cash provided by (used in) financing activities ....    $(5,103)    $ 1,748

         During the first six months of 2007,  net cash  provided  by  operating
activities  was  $1.3  million,  as  compared  to net  cash  used  in  operating
activities  of $2.4  million for the same period in 2006.  Net cash  provided by
operating  activities in the first six months of 2007 resulted  primarily from a
net loss of $192,000 and a decrease of accounts  payable of $3.7 million  offset
by depreciation and amortization  expense of $1.2 million and a $2.0 million due
diligence  fees  expensed  in  connection  with   termination  of  our  proposed
acquisition of The Buffalo Group.

         During the first six months of 2007,  net cash  provided  by  investing
activities  was $3.9  million,  as  compared to net cash  provided by  investing
activities  of  $703,000  for the same  period  in 2006.  Net cash  provided  by
investing  activities in the first six months of 2007 resulted  primarily from a
return of $4.75  million  of deposit  offset by  approximately  $700,000  of due
diligence fees incurred in connection  with previously  proposed  acquisition of
The Buffalo Group.

         During  the  first  six  months  of 2007,  net cash  used in  financing
activities  was $5.1  million,  as  compared to net cash  provided by  financing
activities  of $1.7  million  for the  same  period  in 2006.  Net cash  used in
financing activities in the first six months of 2007 resulted primarily from pay
down of $6.2 million of our long-term bank borrowings offset by $1.1 million net
proceeds from our short-term bank borrowings.


                                       33



CONTRACTUAL OBLIGATIONS AND COMMITMENTS

         Following is a summary of our  contractual  obligations  and commercial
commitments available to us as of June 30, 2007 (in millions):



                                                            PAYMENTS DUE BY PERIOD
                                          ---------------------------------------------------------
                                                      Less than    Between     Between      After
CONTRACTUAL OBLIGATIONS                     Total       1 year    2-3 years   4-5 years    5 years
---------------------------------------   ---------   ---------   ---------   ---------   ---------
                                                                           
Long-term debt (1) ....................   $    36.3   $    16.3   $     3.7   $    16.3   $   --
Operating leases ......................         8.5         1.7         2.6         2.1         2.1
Minimum royalties (2) .................        14.1         6.9         2.0         2.7         2.5
Purchase commitment ...................        45.4        12.9        10.0        10.0        12.5
                                          ---------   ---------   ---------   ---------   ---------
Total Contractual Cash Obligations ....   $   104.3   $    37.8   $    18.3   $    31.1   $    17.1


(1)      Includes interest on long-term debt  obligations.  Based on outstanding
         borrowings  as of June 30, 2007,  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 $7.5 million.

(2)      Includes minimum royalties of $6.1 million under the agreement with the
         licensor of the Jessica Simpson brands.



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


         Since March 2003,  DBS Bank (Hong  Kong)  Limited had made  available a
letter of credit facility of up to HKD 20 million (equivalent to US $2.6 million
at June 30, 2007) to our  subsidiaries  in Hong Kong. This was a demand facility
and was secured by the pledge of our office  property,  which is owned by Gerard
Guez, our Chairman and Interim Chief Executive  Officer,  and Todd Kay, our Vice
Chairman;  and by our guarantee.  The letter of credit facility was increased to
HKD 30 million  (equivalent to US $3.9 million) in June 2004. In September 2006,
a tax loan for HKD 8.438 million  (equivalent  to US $1.1 million) was also made
available to our Hong Kong  subsidiaries and bears interest at the rate equal to
the Hong Kong prime rate plus 1% and are subject to the same  security.  It bore
interest at 9% per annum at June 30,  2007.  As of June 30,  2007,  $374,000 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 8.5% per annum at June
30,  2007,  or the  Standard  Bills Rate  quoted by DBS plus 0.5% if paid in any
other  currency,  which the interest  rate was 8.59% per annum at June 30, 2007.
This is a demand  facility  and is  secured by a  security  interest  in all the
assets of the Hong Kong  subsidiaries;  by a pledge of our office property where
our Hong Kong office is located, which is owned by Gerard Guez and Todd Kay; and
by our guarantee.  The DBS facility includes  customary default  provisions.  In
addition,  we are subject to certain  restrictive  covenants,  including that we
maintain  a  specified  tangible  net  worth,  and a minimum  level of EBITDA at
December 31, 2006,  interest  coverage ratio,  leverage ratio and limitations on
additional  indebtedness.  We are in the process of revising these covenants for
2007. As of June 30, 2007, $13.9 million was outstanding under this facility. In
addition,  $7.8  million of open  letters of credit  were  outstanding  and $3.3
million was available for future borrowings as of June 30, 2007.

         On October 1, 2004,  we amended and  restated our  previously  existing
credit  facility  with  GMAC  Commercial  Finance  LLC  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


                                       34



GMAC  CF.  Pursuant  to  the  terms  of the  factoring  agreement,  we  and  our
subsidiaries  agree to assign and sell to GMAC CF, as factor, all accounts which
arise from our sale of  merchandise  or rendition of service  created on a going
forward basis. At our request, GMAC CF, in its discretion,  may make advances to
us up to the  lesser of (a) up to 90% of our  accounts  on which GMAC CF has the
risk of loss or (b) $40  million,  minus in each case,  any amount owed by us to
GMAC CF. In May 2005, we amended our factoring  agreement with GMAC CF to permit
our subsidiaries  party thereto and us, to borrow up to the lesser of $3 million
or 50% of the value of eligible inventory. In connection with this amendment, we
granted GMAC CF a lien on certain of our inventory located in the United States.
On January 23, 2006, we further amended our factoring  agreement with GMAC CF to
increase  the  amount we might  borrow  against  inventory  to the  lesser of $5
million or 50% of the value of  eligible  inventory.  The $5  million  limit was
reduced to $4 million on April 1, 2006.

         On June 16,  2006,  we  expanded  our credit  facility  with GMAC CF by
entering  into a new Loan and Security  Agreement and amending and restating our
previously existing Factoring Agreement with GMAC CF. UPS Capital Corporation is
also a lender under the Loan and Security Agreement.  This is a 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  amount 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 June 30, 2007. As of June 30,
2007, we were in violation with the EBITDA covenant and a waiver was obtained on
August 10,  2007.  A total of $13.3  million  was  outstanding  with  respect to
receivables factored under the GMAC CF facility at June 30, 2007.

         The amount we can borrow under the new 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.

         On June 16,  2006,  we entered  into a Credit  Agreement  with  certain
lenders  and  Guggenheim  Corporate  Funding  LLC, 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 No. 00-19, "Accounting for Derivative Financial


                                       35



Instruments  Indexed to, and Potentially  Settled in, a Company's Own Stock" and
determined to be a derivative  instrument due to certain registration rights. As
such,  the  warrants  excluding  the ones not  exercisable  were  valued at $4.9
million using the Black-Scholes model with the following assumptions:  risk-free
interest rate of 5.1%; dividend yields of 0%; volatility factors of the expected
market price of our common stock of 0.70; and contractual  term of ten years. We
also paid to  Guggenheim  2.25% of the committed  principal  amount of the loans
which was $563,000 on June 16, 2006.  The  $563,000  fee paid to  Guggenheim  is
included  in the  deferred  financing  cost,  and the value of the  warrants  to
purchase  3.5 million  shares of our common stock of $4.9 million is recorded as
debt discount, both of them are amortized over the life of the loan. For the six
months ended June 30, 2007, $604,000 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 a cash fee in an amount equal to 1% of the committed  principal amount of
the loans under the Guggenheim credit facility.  As a result,  $250,000 was paid
on June 16, 2006.  In addition,  we issued  Durham a warrant to purchase  77,143
shares  of our  common  stock.  This  warrant  has a  term  of 10  years  and is
exercisable  at a price of $1.88 per share,  subject to  adjustment  for certain
dilutive  issuances.  7,143 shares of this  warrant will not become  exercisable
unless and until a specified portion of the initial term loan is actually funded
by the lenders.  The warrants were  evaluated  under SFAS No. 133 and EITF 00-19
and determined to be a derivative instrument due to certain registration rights.
As such, the warrants excluding the ones not exercisable were valued at $105,000
using the Black-Scholes model with the following assumptions: risk-free interest
rate of 5.1%;  dividend yields of 0%; volatility  factors of the expected market
price of our  common  stock of 0.70;  and  contractual  term of ten  years.  The
$250,000  fee paid to Durham and the value of the  warrants to  purchase  70,000
shares of our common  stock of $105,000 is  included in the  deferred  financing
cost,  and is amortized over the life of the loan. For the six months ended June
30, 2007, $39,000 was amortized.

         The  Guggenheim  facility bore interest at 11.82% per annum at June 30,
2007. As of June 30, 2007, we were in violation  with the EBITDA  covenant and a
waiver was obtained on August 10, 2007.  A total of $11.8  million,  net of $3.7
million of debt discount, was outstanding under this facility at June 30, 2007.

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

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

         We had three equipment loans outstanding at June 30, 2007. One of these
equipment loans bore interest at 15.8% payable in installments through 2007. The
second loan bears interest at 6.15% payable in installments through 2007 and the
third loan bears interest at 4.75% payable in  installments  through 2008. As of
June 30, 2007, $24,000 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 June 30, 2007,  $949,000 was  outstanding
under  this  facility  and  $704,000  of  letters  of credit was open under this
arrangement.  We pay a commission  fee of 2.25% on all letters of credits issued
under this arrangement.

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


                                       36



         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.

         In January 2004, the Internal Revenue Service completed its examination
of our Federal  income tax returns for the years ended December 31, 1996 through
2001.  The IRS has proposed  adjustments  to increase our income tax payable for
the six years under examination. In addition, in July 2004, the IRS initiated an
examination  of our Federal  income tax return for the year ended  December  31,
2002.  We are  currently  at the  appellate  level  of the IRS and  believe  the
proposed  adjustments made to our federal income tax returns for the years ended
1996  through  2002 will be resolved  within the next  twelve  months and if so,
unrecognized  tax benefits  related to U.S. tax  positions may decrease by up to
$6.2  million by December  31,  2007.  If the  proposed  adjustments  are upheld
through the administrative and legal process,  they could have a material impact
on our earnings and cash flow. We believe we have provided adequate reserves for
any reasonably  foreseeable outcome related to these matters on the consolidated
balance  sheets  under the caption  "Income  Taxes".  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.

         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 and warehouse in Los Angeles, California
from GET.  Additionally,  we leased office space and warehouse in Hong Kong from
Lynx International Limited. GET and Lynx International Limited are each owned by
Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd Kay, our
Vice Chairman.  We believe,  at the time the leases were entered into, the rents
on these  properties were  comparable to then  prevailing  market rents. We paid
$563,000  and  $538,000 in rent in the six months  ended June 30, 2007 and 2006,
respectively, for office and warehouse facilities. On August 1, 2006, we entered
into a lease agreement with GET for the Los Angeles offices and warehouse, which
lease has a term of five  years with an option to renew for an  additional  five
year term. On February 1, 2007, we entered into a one year lease  agreement with
Lynx International Limited for our office space and warehouse in Hong Kong.

         On May 1,  2006,  we sublet a portion  of our  executive  office in Los
Angeles, California and our sales office in New York to Seven Licensing Company,
LLC for a monthly payment of $25,000 on a month to month basis.  Seven Licensing
is beneficially owned by Gerard Guez. We received $150,000 and $50,000 in rental
income  from this  sublease  in the six  months  ended  June 30,  2007 and 2006,
respectively.

         In August 2004,  we entered  into an  Agreement  for Purchase of Assets
with  affiliates  of  Mr.  Kamel  Nacif,  a  shareholder  at  the  time  of  the
transaction,  which  agreement  was  amended in October  2004.  Pursuant  to the
agreement,  as  amended,  on  November  30,  2004,  we  sold  to the  purchasers
substantially  all of our assets and real  property  in  Mexico,  including  the
equipment  and  facilities  we previously  leased to Mr.  Nacif's  affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and  $3,910,000 by delivery of unsecured  promissory  notes bearing  interest at
5.5% per annum;  and b)  $40,204,000,  by delivery of secured  promissory  notes
bearing  interest at 4.5% per annum,  with payments due on December 31, 2005 and
every year thereafter until December 31, 2014. The secured  promissory notes are
payable in partial or total amounts  anytime prior to the maturity of each note.
As of September  30,  2006,  the  outstanding  balance of the notes and interest
receivables was $41.1 million prior to the reserve.  Historically, we had placed
orders for  purchases  of fabric from the  purchasers  pursuant to the  purchase
commitment  agreement  we  entered  into at the time of the  sale of the  Mexico
assets,  and  we had  satisfied  our  payment  obligations  for  the  fabric  by
offsetting  the amounts  payable  against the amounts due to us under the notes.
However,  during the third  quarter of 2006,  the  purchasers  ceased  providing
fabric  and are not  currently  making  payments  under the  notes.  We  further
evaluated the  recoverability of the notes receivable and recorded a loss on the
notes  receivable  in the  third  quarter  of 2006  in an  amount  equal  to the
outstanding  balance less the value of the underlying assets securing the notes.
The loss was estimated to be approximately $27.1 million,


                                       37



resulting in a notes  receivable  balance at September 30, 2006 of approximately
$14 million.  We believe there was no  significant  change  subsequently  on the
value of the underlying  assets securing the notes;  therefore,  we did not have
additional  reserve  after the third quarter of 2006. We will continue to pursue
payments  under the notes  receivable  and  believe  the  remaining  $14 million
balance  at June 30,  2007 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 did not purchase fabric from
Acabados y Terminados in the six months ended June 30, 2007 and 2006. Net amount
due from  these  parties  as of June 30,  2007 was  $159,000.  See Note 6 of the
"Notes to Consolidated Financial Statements".

         From time to time in the past, we had advanced funds to Mr. Guez. These
were  net  advances  to Mr.  Guez or  payments  paid on his  behalf  before  the
enactment of the  Sarbanes-Oxley  Act in 2002. The promissory  note  documenting
these advances contains a provision that the entire amount together with accrued
interest is immediately  due and payable upon our written  demand.  The greatest
outstanding  balance of such advances to Mr. Guez in the second  quarter of 2007
was approximately  $2,087,000. At June 30, 2007, the entire balance due from Mr.
Guez totaling $2.1 million is payable on demand and has been shown as reductions
to shareholders' equity in the accompanying  financial  statements.  All amounts
due from Mr. Guez bore  interest at the rate of 7.75%  during the period.  Total
interest  paid by Mr. Guez was $81,000 and $87,000 for the six months ended June
30,  2007 and 2006,  respectively.  Mr.  Guez  paid  expenses  on our  behalf of
approximately  $162,000  and $132,000 for the six months ended June 30, 2007 and
2006,  respectively,  which amounts were applied to reduce accrued  interest and
principal on Mr. Guez's loan.  These amounts  included fuel and related expenses
incurred by 477 Aviation,  LLC, a company owned by Mr. Guez, when our executives
used this company's aircraft for business  purposes.  Since the enactment of the
Sarbanes-Oxley Act in 2002, no further personal loans (or amendments to existing
loans) have been or will be made to our executive officers or directors.

         Azteca  Production  International,  Inc. is a corporation  owned by the
brothers of Gerard Guez, our Chairman and Interim Chief  Executive  Officer.  We
purchased $499,000 and $0 of finished goods,  fabric and service from Azteca and
its affiliates in the six months ended June 30, 2007 and 2006, respectively. Our
total  sales of fabric and  service  to Azteca in the six months  ended June 30,
2007 and 2006 were $0 and $9,000, respectively.

         On September 1, 2006,  our  subsidiary  in Hong Kong,  Tarrant  Company
Limited,  entered into an agreement with Seven Licensing Company,  LLC to act as
its buying agent to source apparel merchandise.  Seven Licensing is beneficially
owned by Gerard  Guez.  Total sales to Seven  Licensing  in the six months ended
June 30, 2007 were $6.9 million. Net amount due from these related parties as of
June  30,  2007  and  December  31,  2006 was  $8.1  million  and $7.5  million,
respectively.

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


                                       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.  At June 30, 2007, we had no
open foreign exchange forward contracts.  We do not utilize derivative financial
instruments for trading or other speculative  purposes. We actively evaluate the
creditworthiness  of the  financial  institutions  that are  counter  parties to
derivative  financial  instruments,  and we do not expect any counter parties to
fail to meet their obligations.

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

         Our interest  expense is  sensitive to changes in the general  level of
U.S.  interest  rates.  In this regard,  changes in U.S.  interest  rates affect
interest paid on our debt. A majority of our credit  facilities  are at variable
rates.  As of June 30, 2007, we had $973,000 of fixed-rate  borrowings and $42.7
million of variable-rate borrowings outstanding. A one percentage point increase
in interest rates would result in an annualized  increase to interest expense of
approximately $0.4 million on our variable-rate borrowings.

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 June 30,  2007,  the end of the period  covered by this
report. Members of the our management, including our Chief Executive Officer and
Chief Financial  Officer,  also conducted an evaluation of our internal  control
over financial  reporting to determine  whether any changes  occurred during the
second quarter of 2007 that have materially  affected,  or are reasonably likely
to materially affect, our internal control over financial reporting.  Based upon
that  evaluation,  the  Chief  Executive  Officer  and Chief  Financial  Officer
concluded that our disclosure controls and procedures are effective.

CHANGES IN CONTROLS AND PROCEDURES

         During the second quarter ended June 30, 2007, there were no changes in
our internal control over financial accounting that has materially affected,  or
is reasonably likely to materially  affect,  our internal control over financial
reporting.

SARBANES-OXLEY ACT OF 2002 SECTION 404 COMPLIANCE

         In 2003,  we began  our  efforts  to  comply  with  Section  404 of the
Sarbanes-Oxley  Act  of  2002  ("SOX  404"),  which  requires  detailed  review,
documentation  and testing of our internal  controls over  financial  reporting.
This detailed  review,  documentation  and testing includes an assessment of the
risks that could  adversely  affect the timely and accurate  preparation  of our
financial  statements  and the  identification  of  internal  controls  that are
currently in place to mitigate the risks of untimely or  inaccurate  preparation
of these  financial  statements.  We will be  required  to  include  a report on
management's  assessment of internal  controls over  financial  reporting in our
annual report on Form 10-K for the fiscal year ended December 31, 2007.

         At the end of 2008, our independent  registered public accountants will
be  required  to  audit  management's  assessment.  We  are in  the  process  of
performing the system and process documentation, evaluation and testing required
for management to make this assessment and for its independent registered public
accountants  to provide their  attestation  report.  We have not completed  this
process or its assessment,  and this process will require significant amounts of
management  time  and  resources.  In the  course  of  evaluation  and  testing,
management  may  identify  deficiencies  that  will  need  to be  addressed  and
remediated.  We have invested significant internal resources and time in the SOX
404  compliance  process,  and we believe that we are on schedule to comply with
SOX 404.


                                       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,  as
well as fraud  against  Camuto  Consulting.  The  complaint  was  amended to add
Vincent Camuto as a defendant and includes nine 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,  breach of the
duty of good faith and fair dealing and  fraudulent  inducement  against  Camuto
Consulting,   a  claim  against  Vincent  Camuto   individually  for  fraudulent
inducement,  and a claim against With You,  Inc. and Ms.  Simpson that we are an
intended  third party  beneficiary of the license  between those  defendants and
Camuto  Consulting.  On or about October 30, 2006, Camuto  Consulting,  VCJS and
Vincent  Camuto served their answer to the amended  complaint,  which included a
counterclaim  against  us for breach of the  sublicense  agreement  and  alleged
damages of no less than $100 million.  With You,  Inc. and Jessica  Simpson also
filed  counterclaims   against  us  alleging  trademark   infringement,   unfair
competition and business practices,  violation of the right of privacy and other
claims,  and seeking injunctive relief and damages in an amount to be determined
but no less than $100 million plus treble and punitive  damages.  By Order filed
January 17, 2007, the Court granted the motion of With You, Inc. and Ms. Simpson
to  discontinue   all  of  Ms.   Simpson's   counterclaims,   and  her  personal
counterclaims  were dismissed with  prejudice.  With You,  Inc.'s  counterclaims
remain. Ms. Simpson and With You, Inc. appealed the trial Court's ruling denying
their motion to dismiss the claim against them. The trial Court's  determination
was affirmed on appeal in a decision dated May 31, 2007. Accordingly,  our claim
against With You, Inc. and Ms. Simpson  remains.  On or about February 27, 2007,
we served a motion seeking  dismissal of two of With You, Inc.'s  counterclaims.
With You, Inc. did not oppose the motion and by Order dated March 22, 2007,  the
Court granted our motion,  dismissing two of With You, Inc.'s counterclaims.  On
July 5, 2007,  the trial Court denied a motion filed in December  2006 by Camuto
Consulting,  VCJS and  Vincent  Camuto to dismiss  our  claims  for  declaratory
judgment  seeking a declaration  that the sublicense is exclusive and remains in
full  force and  effect  and those  aspects  of our  claims  that seek  specific
performance. Discovery in the matter has been underway since May 2006. We intend
to continue vigorously to pursue this action and defend the counterclaims.

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

ITEM 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.

         Three  customers  accounted for  approximately  45% of our net sales in
first six months of 2007. We believe that  consolidation  in the retail industry
has centralized  purchasing  decisions and given customers greater leverage over
suppliers,  like us, and we expect this trend to continue. If this consolidation
continues, our net sales and results of operations may be increasingly sensitive
to  deterioration in the financial  condition of, or other adverse  developments
with, one or more of our customers.

         While we have long-standing customer relationships, we generally do not
have  long-term  contracts with them except for Macy's  Merchandising  Group for
American Rag CIE.  Purchases  generally occur on an  order-by-order  basis,  and
relationships  exist as long as there is a perceived benefit to both parties.  A
decision by a major customer, whether motivated


                                       40



by competitive considerations,  financial difficulties,  and economic conditions
or otherwise, to decrease its purchases from us or to change its manner of doing
business with us, could adversely  affect our business and financial  condition.
In addition,  during  recent years,  various  retailers,  including  some of our
customers,  have experienced  significant  changes and  difficulties,  including
consolidation of ownership,  increased  centralization of purchasing  decisions,
restructurings, bankruptcies and liquidations.

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

FAILURE 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 pursue  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


                                       41



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

WE DEPEND ON OUR COMPUTER AND COMMUNICATIONS SYSTEMS.

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

WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE.

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

OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.

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

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


                                       42



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

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

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

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

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

RISK ASSOCIATED WITH OUR INDUSTRY

OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES.

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

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

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

         o        anticipating  and  quickly  responding  to  changing  consumer
                  demands;


                                       43



         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 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.  We are  currently  at the  appellate  level  of the IRS and  believe  the
proposed  adjustments made to our federal income tax returns for the years ended
1996  through  2002 will be resolved  within the next  twelve  months and if so,
unrecognized  tax benefits  related to U.S. tax  positions may decrease by up to
$6.2  million by December  31,  2007.  If the  proposed  adjustments  are upheld
through the administrative and legal process,  they could have a material impact
on our earnings and cash flow. We believe we have provided adequate reserves for
any reasonably  foreseeable outcome related to these matters on the consolidated
balance  sheets  under the caption  "Income  Taxes".  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.

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

         Effective internal control over financial reporting is necessary for us
to provide reliable financial reports and effectively prevent fraud. Section 404
of the  Sarbanes-Oxley  Act of 2002  requires us to  evaluate  and report on our
internal  control over financial  reporting  beginning with our annual report on
Form  10-K for the  fiscal  year  ending  December  31,  2007.  Our  independent
registered   public  accounting  firm  will  need  to  annually  attest  to  our
evaluation,  and issue their own opinion on our internal  control over financial
reporting  beginning  with our annual  report on Form 10-K for the  fiscal  year
ending  December 31, 2008. We are preparing for  compliance  with Section 404 by
strengthening,  assessing  and  testing  our  system of  internal  control  over
financial  reporting  to  provide  the  basis for our  report.  The  process  of
strengthening  our internal control over financial  reporting and complying with
Section 404 is expensive and time consuming, and requires significant management
attention.  We cannot be certain that the measures we will undertake will ensure
that we will  maintain  adequate  controls  over  our  financial  processes  and
reporting in the future. Failure to implement required controls, or difficulties
encountered in their  implementation,  could harm our operating results or cause
us to fail to meet our reporting


                                       44



obligations.  If we or our auditors discover a material weakness in our internal
control over  financial  reporting,  the  disclosure  of that fact,  even if the
weakness  is quickly  remedied,  could  diminish  investors'  confidence  in our
financial statements and harm our stock price. In addition,  non-compliance with
Section 404 could subject us to a variety of administrative sanctions, including
the  suspension  of trading,  ineligibility  for listing on NASDAQ or one of the
national securities exchanges, and the inability of registered broker-dealers to
make a market in our common stock, which would further reduce our stock price.

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

         As of August 10, 2007,  our executive  officers and directors and their
affiliates  owned  approximately  43% of our  common  stock.  Gerard  Guez,  our
Chairman and Interim Chief Executive  Officer,  and Todd Kay, our Vice Chairman,
alone own approximately 33% and 8%, respectively,  of our common stock at August
10, 2007. Accordingly,  our executive officers and directors have the ability to
affect  the  outcome  of, or exert  considerable  influence  over,  all  matters
requiring shareholder approval,  including the election and removal of directors
and any change in control.  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.


                                       45



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.


                                       46



ITEM 6.  EXHIBITS.

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

         10.19.2  Amendment No. 2 to Loan and Security  Agreement,  dated May 9,
                  2007,  by and among GMAC  Commercial  Finance LLC, the Lenders
                  signatory  thereto,  Tarrant Apparel Group,  Fashion  Resource
                  (TCL), Inc., Tag Mex, Inc., and Private Brands, Inc.

         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.


                                       47



                                   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:    August 13, 2007                    By:  /s/  David Burke
                                                 -------------------------------
                                                 David Burke,
                                                 Chief Financial Officer


Date:    August 13, 2007                    By:  /s/ Gerard Guez
                                                 -------------------------------
                                                 Gerard Guez,
                                                 Interim Chief Executive Officer


                                       48