UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K





Annual Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of

1934 for the fiscal year ended January 31, 2008.

Commission File Number 0-22102





CYGNE DESIGNS, INC.

(Exact name of Registrant as specified in its charter)









|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 04-2843286                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



|                                         |  |           
|---------------------------------------- |  | ----------
|11 West 42ndStreet, New York, New York   |  | 10036     
|(Address of principal executive offices) |  | (Zip Code)

Registrants telephone number, including area code: (212) 997-7767

Securities registered pursuant to Section 12(b) of the Act: None

(Title of class)

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

Common Stock, $.01 par value

(Title of class)





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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Act.    Yes   ̈    No  x

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

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Act. Check one)



|                           |  |                      |  |                                                                      |  |                             
|-------------------------- |  | -------------------- |  | -------------------------------------------------------------------- |  | ----------------------------
|Large accelerated filer   ̈ |  | Accelerated filer   ̈ |  | Non-accelerated filer   ̈ (Do not check if smaller reporting company) |  | Smaller reporting company  x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12 b-2 of the
Act).    Yes   ̈    No  x

Based on the closing sale price as reported by The Nasdaq Capital Market on July 31, 2007 the last business day of the registrants most recently completed second fiscal quarter, the aggregate market value
of the registrants Common Stock, par value $.01 per share, held by non-affiliates of the registrant was approximately $14,899,147*.



|* | For purposes of this calculation, the number of shares held by non-affiliates was determined by aggregating the number of shares held by officers and directors of the registrant,
and by others who, to the registrants knowledge, own more than 10% of the registrants Common Stock, and subtracting those shares from the total number of shares outstanding.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of May 2, 2008, 37,917,682 shares of Common Stock, $0.01 par value, of the registrant were outstanding.

Documents incorporated by reference: Portions of the Registrants definitive proxy statement for its 2008 annual meeting of stockholders are
incorporated by reference into Part III of this report.









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STATEMENTS REGARDING FORWARD-LOOKING DISCLOSURE

This report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements
regarding our expected financial position, business and financing plans are forward-looking statements. Forward-looking statements also include representations of our expectations or beliefs concerning future events that involve risks and
uncertainties, including:



| |  |  | the discontinuance of textile import quotas at January 1, 2005 by the United States
| | - |  | -----------------------------------------------------------------------------------



| |  |  | a decline in demand for merchandise offered by us or changes and delays in customer delivery plans and schedules
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | significant regulatory changes, including increases in the rate of import duties or adverse changes in foreign countries export quotas
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | dependence on a limited number of key customers
| | - |  | -----------------------------------------------



| |  |  | risks associated with war and terrorist activities, including reduced shopping activity as a result of public safety concerns and disruption in the receipt and
delivery of merchandise
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| |  |  | risk of operations and suppliers in foreign countries
| | - |  | -----------------------------------------------------



| |  |  | competition
| | - |  | -----------



| |  |  | the loss of key personnel
| | - |  | -------------------------



| |  |  | general economic conditions
| | - |  | ---------------------------



| |  |  | other risks detailed in our filings with the Securities and Exchange Commission, including Item 1A, Risk Factors included in this filing
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

All statements other than statements of historical facts included in this Report, including, without limitation, the
statements under Managements Discussion and Analysis of Financial Condition and Results of Operations, are forward looking statements. Although we believe that the expectations reflected in such forward-looking statements are
reasonable, such expectations may prove to be incorrect. Important factors that could cause actual results to differ materially from our expectations (Cautionary Statements) are disclosed in this Report in conjunction with the
forward-looking statements. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Cautionary Statements. We do not undertake to publicly update
or revise our forward-looking statements as a result of new information, future events or otherwise, except to the extent required by applicable securities laws.



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PART I



|ITEM 1. | BUSINESS
|------- | --------

Unless otherwise noted, all references to
a year refer to our fiscal year commencing in that calendar year and ending in January of the following year. This Report contains forward-looking statements, which involve risks and uncertainties. Our actual results may differ significantly from
the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed below.

Our Company

We are a designer, merchandiser, manufacturer and distributor of branded and private label womens denim,
casual and career apparel and mens denim apparel with sales to retailers located in the United States. Our major customers are currently JC Penney (JCP) and Kohls. In the past three years American Eagle Outfitters
(AEO), Target Stores (Target) and New York & Company (NY&C) have also been our customers. We acquired the assets used in the branded and private label denim apparel business on July 31, 2005 from
Diversified Apparel Resources LLC (Diversified Apparel), and the assets related to the private label apparel division of Innovo Group Inc., or Innovo, on May 12, 2006. Our branded denim products are sold under the names
Hippie and Hint Jeans. As a private label manufacturer, we produce apparel upon orders from our customers for sale under the customers own labels, rather than producing our own inventory of apparel for sale under a
Cygne label.

Hippie is distributed to the missy market to sell at retail price points between $29.99 and $34.99. Hint
Jeans are distributed to the juniors market to sell at retail price points between $29.99 and $34.99.

The manufacture of
private label apparel is characterized by high volume sales to a small number of customers at competitive prices. Although private label gross margins are lower than the gross margins in the brand name apparel industry, markdown costs are typically
commensurably lower, and inventory turns are generally higher. Inventory risks are also generally reduced because the purchasing of fabric and other supplies begins only after purchase commitments have been obtained from customers. We believe that
retailers, including customers of ours, are increasingly sourcing private label products themselves rather than utilizing outside vendors like us.

We source our products through third party manufacturers located in Guatemala, Mexico and the Far East.

We historically have been
dependent on one or more key customers. In 2005, sales to NY&C, JCP and Kohls accounted for 32%, 21% and 18%, respectively, of our net sales. We did not have any other major customers in 2005. In 2006, sales to NY&C, JCP, Kohls,
Target and AEO accounted for 4%, 16%, 14%, 15% and 27%, respectively, of our net sales. We did not have any other major customers in 2006. In 2007, sales to JCP, Kohls, Target and AEO accounted for 23%, 17%, 16% and 33%, respectively, of our
net sales. We did not have any other major customers in 2007. During the fourth quarter of 2007, AEO ceased doing business with us.

On a
pro forma basis, after giving effect to the acquisitions of the assets used in the branded and private label denim apparel business, which we refer to as the Acquired Business, of Commerce Clothing (which was later renamed Diversified Apparel
Resources, LLC) and certain assets of the private label apparel business of Innovo Group, Inc., which we refer to as the Innovo Acquisition, as if both acquisitions had been consummated on February 1, 2005, our pro forma 2005 sales to NY&C,
JCP, Kohls, Target and AEO would have accounted for approximately 11%, 14%, 12%, 7% and 31%, respectively, of our net sales. Our pro forma 2006 sales to NY&C, JCP, Kohls, Target and AEO would have accounted for approximately 4%, 13%,
12%, 19% and 31%, respectively, of our net sales. Historically, our highest shipments are in our second quarter and third quarter, with lower sales in the fourth and first quarter. (See Significant Financial and Business Developments).



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Although we have long-established relationships with our major customers, we do not have long-term
contracts with these customers. Our future success will be dependent upon our ability to attract new customers and to maintain our relationships with our present customers. We continue to strive to maintain our positive working relationships with
our customers by providing on-time deliveries of quality products at competitive prices.

We cannot assure you that our major customers
will continue to purchase merchandise from us at the same rate as they have historically purchased from us, or at all in the future, or that we will be able to attract new customers. In addition, our major customers have the ability to exert
significant control over our business decisions, including prices. As a result of the United States discontinuance of textile import quotas affecting products sourced by us on January 1, 2005, we no longer do business with New York &
Company, which had been a major customer, as New York & Company has opted to place orders in China and other countries in the Far East.

Effective January 1, 2005, the United States (U.S.) discontinued textile import quotas affecting the products sourced by us. As a result, beginning in 2005 the U.S. total imports from China and other countries in the Far
East, including the product categories manufactured by us at the time in Guatemala and Mexico, have increased substantially. The U.S. has established a safeguard program which will limit the increase in apparel imports from China for years 2005
through 2008. In addition, the Central American countries, which include Guatemala, and the U.S., have negotiated a Central America Free Trade Agreement, or CAFTA. CAFTA, which was signed by the U.S. on August 2, 2005, will allow the U.S. duty
free imports from Guatemala if the fabric is manufactured using yarn from the U.S. or a country party to CAFTA. Guatemala ratified CAFTA as of July 1, 2006. Although we anticipated that, over time, CAFTA may have made Guatemala more competitive
with imports from the Far East in the categories manufactured by us in Guatemala, we did not experience an increase in demand for our products manufactured in Guatemala. Accordingly, on November 8, 2007, we made the decision to close our
Guatemalan manufacturing facility. The closure of the Guatemalan manufacturing facility was completed during the three months ended January 31, 2008. The provision for restructuring of $102,000 recorded in the first quarter of 2005 represents
the severance cost associated with the reduction of the production capacity at our Guatemalan facility. We incurred severance costs related to the closure of this facility of approximately $275,000 which was recorded as cost of goods sold and paid
during the three months ended January 31, 2008. The Guatemala Apparel Agency, which has been in business since 1999 and coordinates buying merchandise and supplying it to retailers, was not closed.

In the year ended January 31, 2006, based on an appraisal by an independent third party, we recorded a 100% impairment charge with respect to our
equipment, furniture and fixtures at our Guatemalan facility and established a salvage value of $375,000 for the land, building and building improvements. The land and building are currently for sale.

We have incurred costs for downsizing our operations due to the loss of customers. We are continuing to review our existing business operations and could
incur additional costs in the future associated with the further restructuring of our operations.

The apparel industry is highly
competitive and historically has been subject to substantial cyclical variation, with purchases of apparel and related goods tending to decline during recessionary periods when disposable income is low. This could have a material adverse effect on
our business. Retailers, including our customers, are increasingly sourcing private label products themselves rather than utilizing outside vendors like us.

We are a Delaware corporation that was formed in 1984. Our principal executive offices are located at 11 West 42nd Street, New York, New York 10036, and our telephone number at that address is
(212) 997-7767.



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Significant Financial and Business Developments

Change in Management

On April 25, 2008, we appointed Jay Furrow President and Chief Executive
Officer of Cygne. Mr. Furrow succeeds Bernard Manuel, who has served as our chairman and chief executive officer since October 1988. Mr. Manuel will remain chairman of the Company until at least October 31, 2008. See Item 10.
Directors and Executive Officers of the Registrant.

Acquisitions

Acquisition of the Private Label Division from Innovo Group, Inc. (Innovo Acquisition)

On May 12, 2006, we, Innovo Group Inc, (Innovo), and Innovo Azteca Apparel, Inc., a wholly owned subsidiary of Innovo, closed the transaction contemplated by an Asset Purchase Agreement entered into on March 31, 2006.
Azteca Productions International, Inc. (Azteca Productions) was a party to certain ancillary agreements related to the Asset Purchase Agreement because it was an interested party in the transaction. Innovo is a designer, developer and
worldwide marketer of apparel products. Pursuant to the Asset Purchase Agreement, Innovo sold us certain assets related to its private label apparel division. The purchase price was $10.3 million. Innovo purchased these assets from Azteca
Productions in July 2003 pursuant to an asset purchase agreement referred to as the Blue Concept Asset Purchase Agreement.

Our primary
purpose for the purchase was to diversify our business. We accounted for this transaction as a purchase.

The assets acquired by us
included the private label divisions customer list, the assumption of current workforce related to the private label division, the assumption of all existing purchase orders and inventory related to the private label division, and the
assumption of the benefit of a non-compete clause with Azteca Productions. In exchange for the purchased assets, we assumed certain liabilities associated with the private label division, including the remaining obligation under the original
promissory note executed by Innovo in favor of Azteca Productions under the Blue Concept Asset Purchase Agreement, all other liabilities, other than the original promissory note, owed in connection with the private label division to Azteca
Productions in excess of $1,500,000, all liabilities associated with the private label division outstanding purchase orders and inventory scheduled in the Asset Purchase Agreement, and the obligations to continue to pay the earn-out under the Blue
Concept Asset Purchase Agreement. The aggregate value of the assumed liabilities was $2,500,000, which excluded the remaining unpaid principal amount of the original promissory note of $7.9 million, which was paid through the issuance of shares of
our common stock, as described below, and any amounts which might be owed under the earn-out. No amounts were due under the earn-out agreement.

The Asset Purchase Agreement contained customary terms and conditions, including, among other things, indemnification provisions, representations and warranties and post-closing covenants.

In connection with the Asset Purchase Agreement, the Company entered into a Letter Agreement dated April 24, 2006 among Azteca Productions, Hubert
Guez, Paul Guez and Sweet Sportswear, LLC. Pursuant to the Letter Agreement and in connection with the closing of the Innovo Acquisition, on May 12, 2006 the Company issued 1,000,000 shares of our common stock to each of Hubert Guez and Paul
Guez, for an aggregate issuance of 2,000,000 shares, in lieu of assuming the remaining $7.9 million outstanding balance of the promissory note issued by Innovo to Azteca Productions.

Under the Letter Agreement, the 2,000,000 shares have piggy-back registration rights on any future registration statements on Form S-3 filed by us. These
shares were registered on Form S-3 dated May 14, 2007. Messrs. Hubert and Paul Guez also agreed not to offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any such shares until the
close of trading on April 23, 2007. In addition,



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250,000 of the shares issued to Paul Guez and 250,000 of the shares issued to Hubert Guez were placed in an escrow account until the expiration of the
lock-up period, with the escrowed shares being returned to the Company in the event that the Companys common stock is traded on Nasdaq (or any other stock exchange, market or trading facility on which the shares are traded) at an average price
above $5.00 per share during the one month period ended April 23, 2007. The Company's shares did not reach the average target price and the shares were released from escrow to Paul Guez and Hubert Guez in April 2007.

As of January 23, 2008, Mr. Hubert Guez has reported in filings with the Securities and Exchange Commission that he beneficially owned, had the
power to dispose or direct the disposition of, and to vote or direct the voting of, shares, personally, through various trusts and Diversified Apparel, representing approximately 21.2% of the shares of the Companys common stock. In addition,
Mr. Hubert Guez has advised us that he (i) owns approximately 47% of Azteca Production International, Inc., (ii) has a 50% membership interest in Sweet Sportswear, LLC and (iii) has approximately a 32% membership interest in
Diversified Apparel Resources, LLC.

Acquisition of the denim apparel business from Diversified Apparel Resources LLC. (Acquired Business)

On July 31, 2005, we acquired the assets used in the branded and private label denim apparel business, which we refer to as the
Acquired Business, of Commerce Clothing (which was later renamed Diversified Apparel Resources, LLC), a privately-held company principally owned by Hubert Guez, Diversified Apparels managing member and Chief Executive Officer, pursuant to an
asset purchase agreement. The assets we acquired from Diversified Apparel included, among other things, Diversified Apparels:



| |  |  | tangible personal property;
| | - |  | ---------------------------



| |  |  | open purchase orders;
| | - |  | ---------------------



| |  |  | New York showroom leases for the property located on the fourth floor of 215 West 40th Street; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | trademarks and intellectual property associated with the Acquired Business, including the trademarks for Hippie, Hippie Jeans, Hint
Jeans, and Voyou.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

We did not acquire any cash, accounts receivable, prepaid expenses, deposits (other
than the lease deposit for the showrooms), inventories or stock of any subsidiaries from Diversified Apparel.

Under the asset purchase
agreement, we assumed the following liabilities of Diversified Apparel:



| |  |  | any and all liabilities, obligations and commitments arising after the closing under the Diversified Apparel agreements included in the assets we acquired
(including the New York showroom leases); and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any liability or obligation arising from the operation of the Acquired Business or ownership of the assets we acquired (including the New York showroom leases)
after the closing date.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In consideration for the assets we acquired from Diversified Apparel, we:



| |  |  | issued to Diversified Apparel 10,500,000 shares of our common stock, 7,500,000 of which Diversified Apparel distributed to its members;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | issued to Diversified Apparel a secured subordinated promissory note , which we refer to as the Note, in the principal amount of $47.5 million, subsequently reduced
to $40.0 million through the issuance of 1,428,571 shares of common stock as repayment of $7.5 million of principal, see Note Conversion discussion herein;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | paid $2 million in cash to Diversified Apparel on the closing date; and
| | - |  | -----------------------------------------------------------------------



| |  |  | agreed to pay to Diversified Apparel deferred purchase price payments totaling $1,750,000 in seven monthly installments of $250,000 each, without interest, on the
last day of each month commencing with August 2005 and ending February 2006.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We also entered into several related
agreements, including a registration rights agreement, a supply agreement, a distribution agreement and a restrictive covenant agreement. The supply and distribution arrangements govern purchases of Diversified Apparel products by us, as well as
related advances for inventory purchases. The restrictive covenant agreement sets forth agreed-upon non-competition covenants between Hubert Guez and us. Notes 2 and 10 to the Consolidated Financial Statements provide detailed explanations of each
of these agreements.

Note Conversion

On October 31, 2006, we made a principal payment of $1.5 million due on the Note. Effective November 1, 2006, Diversified Apparel transferred the note to Serge Kraif, a third party. Effective January 31, 2007, we entered into
an agreement with Mr. Kraif, which was approved y our stockholders on August 9, 2007, pursuant to which:



| |  |  | We issued 8,800,000 shares of our common stock to Mr. Kraif in payment of $22.0 million of the Note;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | We issued a convertible note in the principal amount of $15.0 million that is convertible into shares of our common stock at a conversion price of $3.50 per share
in payment of $15.0 million of the Note, and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We issued to Mr. Kraif a warrant to purchase up to 4,400,000 shares of our common stock at a price of $3.00 per share.
| | - |  | ----------------------------------------------------------------------------------------------------------------------

In addition, effective January 31, 2007, Mr. Kraif agreed that (i) the $1.5 million principal payment on the Note originally due on
January 31, 2007 would be postponed and paid by Cygne from time to time when it had available funds and (ii) all accrued but unpaid interest at January 31, 2007 was waived. We have recorded the waiver as a reduction of interest
expense in the year ended January 31, 2007. The holder of the Note has also waived the interest payment due from February 1, 2007 through August 9, 2007 which was also recorded as a reduction of interest expense for the year ended
January 31, 2008.

Effective April 30, 2007, Mr. Kraif agreed that the $1.5 million principal payments on the Note due on
April 30, 2007 and July 31, 2007 could be delayed pending stockholder consideration of the Note conversion proposal discussed above. Cygnes stockholders approved the Note Conversion on August 9, 2007, and this $3.0 million
principal payment was satisfied through the issuance of the common stock, convertible note and warrant discussed above.

As of
October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $1.5 million principal payment on the Note originally due on January 31, 2007. This payment was offset against related party receivables.

On August 9, 2007, the shareholders approved the Note conversion which resulted in the gain on extinguishment of the Note of $1,733,000. The gain
was determined by the change between the carrying value of the Note against the fair value of the Convertible Note of $11,380,000 and the fair value of the warrants of $3,248,000. The fair value of the warrant was determined using the closing price
of the common stock on August 9, 2007, the date that the Conversion Agreement was approved by our stockholders, using the Black-Scholes option pricing model with the following assumptions: stock price at the approval date of the Conversion
Agreement of $1.54; exercise price of $3.00; term of 5 years; volatility factor of 71.2%; dividend yield of zero; discount rate of 4.64%.



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As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $625,000 principal
payments on the Convertible Note due April 30, 2008, July 31, 2008 and October 31, 2008 totaling $1,875,000. As of October 31, 2007, Diversified Apparel agreed to accept $1,422,000 in exchange for immediate payment of these
three payments, which was offset against the related party receivable.

As of January 31, 20008, Mr. Serge Kraif assigned to
Diversified Apparel the $625,000 principal payments on the Convertible Note due January 31, 2009, April 30, 2009, July 31, 2009, October 31, 2009, January 31, 2010, April 30,
2010, July 31, 2010, October 31, 2010, January 31, 2011, and April 30, 2011, totaling $6,250,000. As of January 31, 2008, Diversified Apparel agreed to accept $4,738,125 in exchange for prepayment of these ten
payments, which was offset against the related party receivable.

Problems with Sourcing from a Related Party

On December 18, 2007, a creditor company of AZT, a related party to us and the Mexican contractor for our vendor, Diversified Apparel, which is also
a related party to us, obtained a court decree against AZT which allowed this creditor company to obtain possession of all of our fabric, trim, work-in-process and finished goods located at the AZT manufacturing facilities in Mexico.
Mr. Manuel, our CEO, immediately entered into intensive discussion with the creditor company as well as our two customers serviced by the AZT Mexican manufacturing facility. The court decree to AZT was not due to any wrongdoing of the Company
but rather a claim by the creditor company against AZT.

AEOs response was to cancel all orders issued to us and to issue new orders
for the same garments to the creditor company. Shipments to AEO are estimated to be $2,700,000, and our projected sales were reduced by such amount. As a result of this incident, we no longer have AEO as a customer.

Mr. Manuel negotiated an agreement with the creditor company whereby the creditor company would continue to ship to us our second customers
garments with sales estimated at $2,600,000 and invoice us his costs for the garments shipped which shipment was completed in April 2008. We, in turn, invoiced our customer for these garments. We agreed to pay the creditor company thirty days after
shipment of garments. At January 31, 2008, we owed the creditor company $954,000, which has not been paid as of the date hereof.

Diversified Apparel agreed to reimburse us for the cost of the lost fabric and the normal gross profit lost on the sales to AEO and our second customer. The reimbursement to us of the cost of the fabric of $2,480,000, which is included in
our cost of goods sold, and the lost gross profit of $754,000, is shown on the financial statements as an increase to Due from Related Parties and an increase to paid-in-capital. Had we not had this situation with our vendor, we would have shipped
to our customers and collected trade receivables of $5,000,000. Although Diversified Apparel agreed to reimburse us at wholesale prices for the lost shipments, the reimbursement was included in the Due from Related Parties account on the balance
sheet. The Due from Related Parties already included advance made to DAR under the Supply Agreement for costs to make the product. The net financial result of the transaction is that we did recoup our losses through reductions in amounts owed by
Cygne on the Convertible Note which was assigned to Diversified Apparel. We have not received any cash reimbursement from Diversified Apparel in relation to our losses which adversely affected our cash flows.

We no longer source goods from AZT.

Products

We participate in one segment of the apparel market: womens denim, casual and career apparel and mens denim apparel. During
2006 and 2007, our products included denim pants, skirts and jackets.



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Sourcing, Manufacturing and Sales

We source and manufacture garments for our private label customers who have designed and developed their own garments. We design, merchandise, source, manufacture and distribute garments to be sold under our brand
names by our sales force.

During years 2006 and 2007, all of our products were manufactured outside the United States, at either a related
party manufacturer located in Mexico, non-affiliated manufacturers located in Guatemala and in the Far East or at our manufacturing facilities located in Guatemala. In the years 2006 and 2007 we produced goods that accounted for 6% and 2%,
respectively, of our net sales in our manufacturing facility in Guatemala and 1% and zero, respectively, of our net sales in non-affiliated Guatemalan facilities. In the years 2006 and 2007, we produced, through a Mexican facility owned by a related
party, goods that accounted for 71% and 53%, respectively, of our net sales. In years 2006 and 2007, we produced goods that accounted for 22% and 45%, respectively, of our net sales from non-affiliated manufacturers located in the Far East. On a pro
forma basis for year 2006 assuming the Acquired Business and the Innovo Acquisition had been consummated on February 1, 2005, we produced goods that accounted for 5% of our net sales in our manufacturing facilities in Guatemala, and 1% of our
net sales in non-affiliated Guatemalan facilities. On a pro forma basis for the year 2006, we produced goods that accounted for 76% of our net sales from the related party Mexican facilities, and 19% from non-affiliated manufacturers located in the
Far East.

Foreign manufacturing is subject to a number of risks, including work stoppages, transportation delays and interruptions,
political instability, foreign currency fluctuations, economic disruptions, expropriation, nationalization, the imposition of tariffs and import and export controls, changes in governmental policies (including U.S. policy toward these countries) and
other factors which could have an adverse effect on our business. In addition, we may be subject to risks associated with the availability of and time required for the transportation of products from foreign countries. The occurrence of certain of
these factors may delay or prevent the delivery of goods ordered by customers, and such delay or inability to meet delivery requirements would have a severe adverse impact on our results of operations and could have an adverse effect on our
relationships with our customers.

We previously operated a manufacturing facility in Guatemala. On November 8, 2007, we closed the
manufacturing facility and incurred severance costs related to the closure of the facility of approximately $275,000. At January 31, 2006, based on an appraisal by an independent third party, we recorded a 100% impairment charge against our
equipment, furniture and fixtures at our Guatemalan facility and established a salvage value, not subject to depreciation, for the building and building improvements in our Guatemala facility. The Guatemala facility has been placed for sale. We
cannot assure you that we will be able to realize the salvage value recorded at $375,000.

Operating a manufacturing facility rather than
contracting with independent manufacturers required us to maintain a higher level of working capital. In addition, reduced sales had an even greater adverse impact on our results because of the fixed costs needed to own and operate our own factory.
Because our manufacturing operations are located outside the U.S., we are subject to many of the same risks as relying on foreign contract manufacturers. See Item 2. Properties.

Raw Materials

In 2006 and 2007, we supplied the raw
materials to our Guatemalan manufacturing facility and to non-affiliated Guatemalan factories. Starting August 1, 2007, we supplied the raw materials to our contractor located in Mexico. For all other production, the raw materials are purchased
directly by the manufacturer in accordance with our specifications. In both cases, raw materials, which are in most instances made, finished and colored specifically to our order, consist principally of fabric and trim that are readily available
from numerous domestic and foreign sources.



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Our raw material purchases are made on an open account basis. We do not have formal long-term
arrangements with any of our raw material suppliers. We have experienced little difficulty in satisfying our raw material requirements and consider our sources of supply adequate.

Quality Assurance

Our quality assurance program is designed to ensure that our products meet the
quality standards of our customers. We require that our vendors employ qualified quality control personnel.

Competition

We face a variety of competitive challenges from other domestic and Far East apparel producers. We do not currently hold a dominant competitive position
in any market, including the private label apparel market.

In addition, we face competition from our own customers, who have their own
internal product development and sourcing capabilities. We believe that many of our customers who have the know-how and internal resources to develop and source directly a portion of their requirements constitute our major competition.

Most of our competitors are larger in size and have greater resources than we do, and there can be no assurance that we will be successful in
competing with them in the future.

We believe that our business will depend upon our ability to provide apparel products, which are of
good quality and meet our customers pricing and delivery requirements, as well as our ability to maintain relationships with our major customers. There can be no assurance that we will be successful in this regard.

Imports and Import Restrictions

During 2007, we
sourced our products from Guatemala, Mexico and from the Far East. Merchandise that we imported into the United States is subject to the assessment of duty at rates currently ranging from zero to 32% ad valorem. Such merchandise may also be
subject to additional duties, export fees, quotas or other restrictions and are affected by the costs of transportation.

Effective
January 1, 2005, quota on textile and apparel products was eliminated for World Trade Organization (WTO) member countries (which include those countries from which the Company imports its products). However, under Chinas
accession agreement into the WTO, member countries may, under certain circumstances, re-impose quota on some categories of imports from China. In November 2005, the United States and China entered into an agreement imposing quotas through 2008 on
certain categories of textile goods from China.

In August 2005, the United States entered into the Central American Free Trade Agreement
(CAFTA) with five Central American countries. CAFTA became effective in Guatemala in July 2006, thus qualifying importations of textile and apparel goods from Guatemala free of duty and quota.

In the ordinary course of business, the Company may, from time to time, be subject to claims by the U.S. Bureau of Customs and Border Protection
(Customs) for additional duties or charges and likewise, may be entitled to refunds from Customs due to the overpayment of duties.

Backlog

At January 31, 2008 we had unfilled confirmed customer orders of $18,047,000 compared to $27,866,000 at January 31, 2007. The
primary reason for the decrease in the backlog at January 31, 2008 as compared to January 31, 2007 was the loss of American Eagle Outfitters as a customer in December 2007. In general, the amount of unfilled orders at a particular time is
affected by a number of factors, including the scheduling of



10



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manufacture and shipping of the product which, in some instances, depends on the customers demands. Accordingly, a comparison of unfilled orders from
period to period is not necessarily meaningful and may not be indicative of eventual actual shipments. The dilution range on bookings for allowance for chargebacks and trade discounts has historically been in the 8% range.

Employees

At May 2, 2008 we had approximately
70 full-time employees. Approximately 26 employees were located at our facility in Guatemala, 38 employees were located at our facilities in Commerce, and 6 employees were located at our facilities in New York. We consider our relations with our
employees to be satisfactory.



|Item 1A. | RISK FACTORS
|-------- | ------------

You should carefully consider the
risks described below before investing in our common stock. Although the risks described below are all of the risks that we believe are material, they are not the only risks relating to our business and our common stock. Additional risks and
uncertainties not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business operations. Any of the following risks could materially adversely affect our business, financial condition or
results of operations. The trading price of our common stock could decline due to any of these risks and, therefore, you may lose all or part of your investment.

Risk Factors Relating to Our Operations

We rely on a few key customers for the majority of our revenue.

We historically have been dependent on one or more key customers. A significant portion of our sales over the last three years has been to NY&C. Sales
to NY&C accounted for approximately 4%, 32% and 82%, respectively, of our net sales for the years 2006, 2005 and 2004. For the year 2005 our sales to JC Penney and Kohls, our other major customers for that year, accounted for approximately
21% and 18%, respectively. For the year 2006, our sales to JC Penney, Kohls, Target and AEO accounted for approximately 16%, 14%, 15% and 27%, respectively, of our net sales. For the year 2007, sales to JC Penney, Kohls, Target and AEO
accounted for 23%, 17%, 16% and 33%, respectively, of our net sales. Historically, our highest shipments are in our second quarter and third quarter, with lower sales in the fourth and first quarter.

Although we have long-established relationships with our major customers, we do not have long-term contracts with these customers. Our future success
will be dependent upon our ability to attract new customers and to maintain our relationships with our present customers. We continue to strive to maintain our positive working relationships with our customers by providing on-time deliveries of
quality products at competitive prices.

We cannot assure you that our major customers will continue to purchase merchandise from us at the
same rate as they have historically purchased from us, or at all in the future, or that we will be able to attract new customers. In addition, our major customers have the ability to exert significant control over our business decisions, including
prices. As a result of the United States discontinuance of textile import quotas affecting products sourced by us on January 1, 2005, we no longer do business with New York & Company, which had been a major customer, as New
York & Company has opted to place orders in China and other countries in the Far East. Effective December 2007, we no longer do business with American Eagle Outfitters as a customer.

We are subject to the risks of doing business abroad.

During years 2005, 2006 and 2007, all of our products were manufactured outside the United States, at either a related party manufacturer located in Mexico, non-affiliated manufacturers located in Guatemala and in the Far East or at our
manufacturing facilities located in Guatemala, which we closed in November 2007. In the



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years 2005, 2006 and 2007, we produced products that accounted for 25%, 5% and 2%, respectively, of our net sales in our manufacturing facility in Guatemala
and 9%, 1% and zero, respectively, of our net sales in non-affiliated Guatemalan facilities. In the years 2005, 2006 and 2007, we produced, through a Mexican facility owned by a related party, products that accounted for 46%, 71% and 53%,
respectively, of our net sales. In the years 2005, 2006 and 2007, we produced products that accounted for 20%, 19% and 45%, respectively, of our net sales from non-affiliated manufacturers located in the Far East. On a pro forma basis for years 2005
and 2006 assuming the Acquired Business and the Innovo Acquisition had been consummated on February 1, 2005, we produced products that accounted for 9% and 5%, respectively, of our net sales in our manufacturing facilities in Guatemala, and 3%
and 1%, respectively, of our net sales in non-affiliated Guatemalan facilities. On a pro forma basis for years 2005 and 2006, we produced products that accounted for 80% and 78%, respectively, of our net sales from the related party Mexican
facilities, and 8% and 17%, respectively, from non-affiliated manufacturers located in the Far East.

Foreign manufacturing is subject to a
number of risks, including work stoppages, transportation delays and interruptions, political instability, foreign currency fluctuations, economic disruptions, expropriation, nationalization, the imposition of tariffs and import and export controls,
changes in governmental policies (including U.S. policy toward these countries) and other factors which could have an adverse effect on our business. In addition, we may be subject to risks associated with the availability of and time required for
the transportation of products from foreign countries. The occurrence of certain of these factors may delay or prevent the delivery of goods ordered by customers, and such delay or inability to meet delivery requirements would have a severe adverse
impact on our results of operations and could have an adverse effect on our relationships with our customers.

If we experience product quality or
late delivery problems with contract manufacturers, or if our contract manufacturers experience financial problems, our business will be negatively affected.

Historically, a significant portion of our products have been manufactured by non-affiliated contract manufacturers. In connection with the acquisition of the assets of Diversified Apparel, we entered into a Supply
Agreement with AZT International S. de R.L. de C.V., or AZT, an affiliate of Diversified Apparel, and from August 2005 to December 2007 were reliant on AZT to supply most of our denim apparel products. AZTs only manufacturing facilities are
located in Mexico. During 2005, 2006 and 2007, AZT supplied us with products that accounted for approximately 46%, 71%, and 53%, respectively, of our net sales, at specified gross margins. Beginning with the third quarter of 2007, we have primarily
been sourcing such products from non-affiliated contract manufacturers, primarily in the Far East, rather than AZT and since December 2007 we no longer source products from AZT.

We have from time to time experienced difficulties in obtaining timely delivery of products of acceptable quality. Such difficulties have resulted and
may result in cancellation of orders, customer refusals to accept deliveries or reductions in purchase prices, any of which could have a material adverse effect on our financial condition and results of operations. We believe that these difficulties
have resulted and may continue to result from not having sufficient access to and control over the manufacturing processes of non-affiliated contract manufacturers. There can be no assurance that we will not experience difficulties with third
parties responsible for the manufacture of our products, including AZT. In addition, we may have difficulty sourcing the products manufactured by AZT at a similar cost or at all.

On December 18, 2007, a creditor company of AZT obtained a court decree against AZT which allowed this creditor company to obtain possession of all
of our fabric, trim, work-in-process and finished goods located at the AZT manufacturing facilities in Mexico. AEOs response was to cancel all orders issued to us and to issue new orders for the same garments to the creditor company. Shipments
to AEO were estimated to be $2,700,000, and our projected sales were reduced by such amount. We no longer have AEO as a customer. We negotiated an agreement with the creditor company whereby the creditor company would continue to ship to us our
second



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customers garments and invoice us his costs for the garments shipped. We, in turn, invoiced our customers. We agreed to pay the creditor company thirty
days after shipment of garments. At January 31, 2008, we owed the creditor company $954,000, which has not been paid as of the date hereof.

Legislation relating to the importation of or decreasing or increasing the cost of textiles and apparel produced abroad could adversely affect our business and financial condition.

Effective January 1, 2005, the United States, or the US, discontinued textile import quotas affecting the products sourced by us. As a result,
beginning in 2005 the US total imports from China and other countries in the Far East, including the product categories manufactured by us in Guatemala and Mexico, have increased substantially. The US has established a safeguard program which will
limit the increase in apparel imports from China for years 2005 through 2008. Notwithstanding the safeguard program, our results of operations for products manufactured in Guatemala have been adversely affected for the 2005, 2006 and 2007 years and,
as a result, in November 2007 we closed our manufacturing facility in Guatemala. As a result of the United States discontinuance of textile import quotas affecting products sourced by us on January 1, 2005, we no longer do business with New
York & Company, which had been a major customer, as New York & Company has opted to place orders in China and other countries in the Far East.

The provision for restructuring of $102,000 recorded in the first quarter of 2005 represents the severance cost associated with the reduction of the production capacity at our Guatemalan facility. As a result of the
closing of the manufacturing facility in November 2007, we incurred severance costs related to the closure of this facility of approximately $275,000 which was expensed and paid in the three months ended January 31, 2008.

We have expanded our business through acquisitions that could result in diversion of resources and extra expenses. This could disrupt our business and adversely
affect our financial condition.

Historically, we have pursued acquisitions to expand our business. On May 12, 2006, we
acquired certain assets related to the private label apparel division of Innovo and Innovo Azteca Apparel, Inc., a wholly owned subsidiary of Innovo. On July 31, 2005, we acquired Diversified Apparels branded and private label denim
apparel business. As a result of these acquisitions, we had substantial indebtedness that decreased our flexibility to react to changing economic conditions. Three stockholders now control a majority of our outstanding common stock and thus control
many decisions, including the election of directors and the sale of our Company. The negotiation of potential acquisitions as well as the integration of acquired businesses could divert our managements time and resources. Acquired businesses
may not be successfully integrated with our operations. We may not realize the intended benefits of any acquisition.

In connection with
the acquisitions of the Innovo Acquisition and the Acquired Business, we recorded goodwill of $72,877,000 and identified intangible assets which included customer relationships, trademarks and product lines of $4,550,000. In accordance with
Statement of Financial Accounting Standards No. 142 (SFAS No. 142), Goodwill and Other Intangible Assets, we assess the impairment of goodwill whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors we consider to be important which could trigger an impairment review include the following:



| |  |  | Significant underperformance relative to expected historical or projected future operating results;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Significant changes in the manner of use of the acquired assets or the strategy for the overall business; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Significant negative industry or economic trends.
| | - |  | -------------------------------------------------

Accordingly, if sales to customers obtained in the Innovo Acquisition and through the Acquired Business continue to decline, the goodwill we recorded for these acquisitions may be impaired and therefore written-off in
whole or in part. Any such write-off would adversely affect our results of operations.



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In connection with the acquisitions of the Innovo Acquisition and the Acquired Business, we recorded
goodwill of $72,877,000 and identified intangible assets which included customer relationships, trademarks and product lines with a carrying value of $2,650,000 at January 31, 2008. At January 31, 2008, we conducted our annual impairment
assessment of the value of the goodwill and identified intangible assets based on a discounted cash flow model of projected earnings. To aid us, we retained an independent party to perform the valuation. Negative trends in sales and gross margins
resulted in lower projected future earnings. The negative sales trends were the result of market conditions, the loss of two customers in 2007 which accounted for 49% of our 2007 sales, a substantial decrease in demand for our branded jeans and our
non-denim private label products. The negative trends in gross margins resulted from the loss of guaranteed gross margins under the Supply Agreement. Based on the results of the valuation, charges of approximately $59,200,000 were recorded for the
impairment of goodwill and charges of $2,650,000 were recorded to reflect the impairment of the value of the remaining identifiable intangible assets.

The cyclical nature of the apparel industry and uncertainty over future economic prospects could have a material adverse effect on our results of operations.

The fashion apparel industry in which we operate is cyclical. Many factors affect the level of consumer spending in the industry, including, among others:



| |  |  | general business conditions;
| | - |  | ----------------------------



| |  |  | interest rates;
| | - |  | ---------------



| |  |  | the availability of consumer credit;
| | - |  | ------------------------------------



| |  |  | taxation; and
| | - |  | -------------



| |  |  | consumer confidence in future economic conditions.
| | - |  | --------------------------------------------------

Consumer purchases of discretionary items, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower. A downturn in the economies in which we
sell our products, principally the United States, may adversely affect our sales. We expect to receive fewer orders from our customers in 2008 compared to 2007 orders from these customer due to the current economic decline in the US.

In addition, various retailers, including some of our customers, have experienced financial difficulties during recent years, which has increased our
risk of losing customers and increased the risk of extending credit to such retailers.

The seasonal nature of our business makes management more
difficult, severely reduces cash flow and liquidity during parts of the year and could force us to curtail our operations.

Our
business is seasonal. Our greatest volume of shipments and sales occur from late spring through the summer, which coincides with our second and third fiscal quarters. Historically, our cash flow is strongest in the third and fourth fiscal quarters.
Unfavorable economic conditions affecting retailers during the fall and holiday seasons in any year could have a material adverse effect on our results of operations for the year. We are likely to experience periods of negative cash flow throughout
each year and a drop-off in business commencing each December, which could force us to curtail operations if adequate liquidity is not available. We cannot assure you that the effects of such seasonality will diminish in the future.

We face intense competition in the worldwide apparel industry.

We face a variety of competitive challenges from other domestic and foreign fashion-oriented apparel producers. We do not currently hold a dominant competitive position in any market, including the private label
apparel market, which is highly fragmented. We compete with competitors such as Kellwood and VF Corp. primarily on the basis of:



| |  |  | anticipating and responding to changing consumer demands in a timely manner,
| | - |  | ----------------------------------------------------------------------------



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| |  |  | maintaining favorable brand recognition,
| | - |  | ----------------------------------------



| |  |  | developing innovative, high-quality products in sizes, colors and styles that appeal to customers,
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | appropriately pricing products,
| | - |  | -------------------------------



| |  |  | providing strong and effective marketing support,
| | - |  | -------------------------------------------------



| |  |  | creating an acceptable value proposition for retail customers,
| | - |  | --------------------------------------------------------------



| |  |  | ensuring product availability and optimizing supply chain efficiencies with manufacturers and retailers, and
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | obtaining sufficient retail floor space and effective presentation of our products at retail.
| | - |  | ---------------------------------------------------------------------------------------------

In addition, we face competition from our own customers, who have their own internal product development and sourcing capabilities. We believe that many
of our customers who have the know-how and internal resources to develop and source directly a portion of their requirements constitute our major competition.

Most of our competitors are larger in size and have greater resources than we do, and there can be no assurance that we will be successful in competing with them in the future.

Our business could be negatively impacted by the financial instability or consolidation of our customers.

Our customers are retailers located in the United States. Financial difficulties of a customer could cause us to curtail business with that customer. We
may also assume more credit risk relating to that customers receivables. Our inability to collect on our trade accounts receivable from any one of these customers could have a material adverse effect on our business or financial condition.
More specifically, we are dependent primarily on lines of credit that we establish from time to time with customers, and should a substantial number of customers become unable to pay their respective debts as they become due, we may be unable to
collect some or all of the monies owed by those customers.

Furthermore, in recent years, the retail industry has experienced consolidation
and other ownership changes. Some of our customers have operated under the protection of the federal bankruptcy laws. While to date these changes in the retail industry have not had a material adverse effect on our business or financial condition,
our business could be materially affected by these changes in the future.

We have been dependent on supply and distribution agreements with
Diversified Apparel and its related entities for a substantial portion of our supply, distribution and back office capabilities.

In
connection with our acquisition of Diversified Apparels branded and private label denim apparel business, we entered into a Supply Agreement and a Distribution Agreement with Diversified Apparel and its affiliated entities, which we
collectively refer to as Diversified Apparel.

Under the terms of the Supply Agreement, through the third quarter of 2007 AZT, an affiliate
of Diversified Apparel, manufactured and supplied us with most of our requirements of branded and private label denim apparel products with specified gross margins. Although AZT was obligated to deliver denim products ordered by us under the Supply
Agreement, we had no obligation to source denim products from AZT. AZT no longer manufactures and supplies products to us.

Under the terms
of the Distribution Agreement, Diversified Apparel provides us with specified distribution and back office operations services. In addition, Diversified Apparel has been our vendor for all Far East finished goods purchases.



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Beginning with the third quarter of 2007, we began to primarily rely, and since December 2007, have
relied solely on non-affiliated contract manufacturers, primarily in the Far East, rather than AZT, to manufacture and supply us with goods. We cannot assure you that we will be able to source our products at a cost similar to that charged to us by
Diversified Apparel. Our failure to source our products at a similar cost could have a material adverse effect on our business, results of operations and financial condition.

On July 31, 2007, we modified our Supply and Distribution Agreements with Diversified Apparel. As a result, we purchased the entire inventory at our
Commerce California warehouse and the fabric at AZT. Subsequent to July 31, 2007, we purchased our fabric for production in Mexico. These changes require us to maintain higher inventory balances and consequently, higher balances with our credit
lines.

Our trademark and other intellectual property rights may not be adequately protected.

We believe that our trademarks, whether licensed to or owned by us, and other proprietary rights will be important to our success and our competitive
position in the branded market. We may, however, experience conflict with various third parties who acquire or claim ownership rights in certain trademarks. We cannot assure that the actions we have taken to establish and protect these trademarks
and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the trademarks and proprietary rights of others. In addition, enforcing
rights to our intellectual property may be difficult and expensive, and we may not be successful in combating counterfeit products and stopping infringement of our intellectual property rights, which could make it easier for competitors to capture
market share. Furthermore, our efforts to enforce our trademark and other intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our trademark and other intellectual
property rights. If we are unsuccessful in protecting and enforcing our intellectual property rights, continued sales of such competing products by third parties could harm our brand and adversely impact our business, financial condition and results
of operations.

Our debt levels have limited, and in the future may limit, our flexibility in obtaining additional financing and in pursuing other
business opportunities.

Since July 31, 2005, we have had a significant amount of debt. At January 31, 2007 and
January 31, 2008, we had indebtedness of $38.5 million and $15.9 million, respectively. During the 2006 and the 2005 years, and the six months ended July 31, 2007, we received advances from our factor of approximately 90% of our factored
receivables, or $86.9 million, $49.6 million and $30.0 million, respectively. Starting in August 2007 through January 31, 2008 we borrowed an aggregate of $52 million from Comerica Bank, our current lender, with the largest amount outstanding
at any one time being $14.2 million. Our level of indebtedness could have important consequences to us, including the following:



| |  |  | our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such
financing may not be available on favorable terms;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we will need a substantial portion of our cash flow to make principal and interest payments on our indebtedness, reducing the funds that would otherwise be
available for our operations and future business opportunities;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may issue a substantial portion of our authorized common shares for the purpose of making principal and interest payments on our indebtedness, reducing the
shares that would otherwise be available for financing our future business opportunities and potentially diluting our common stock;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our debt level may make us more vulnerable than our competitors with less debt to competitive pressures or a downturn in our business or the economy generally; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our debt level may limit our flexibility in responding to changing business and economic conditions.
| | - |  | ----------------------------------------------------------------------------------------------------



16



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In addition, any indebtedness we incur will be subject and subordinated to our obligations under our
revolving credit facility with Comerica Bank. Accordingly, our ability to obtain additional debt financing is highly uncertain.

Our
ability to service our indebtedness will depend upon, among other things, our future financial and operating performance and cash flows, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors,
some of which are beyond our control. If our operating results and cash flows are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing or delaying our business activities, acquisitions,
investments and/or capital expenditures, selling assets, restructuring or refinancing our indebtedness, or seeking additional equity capital or bankruptcy protection. We may not be able to affect any of these remedies on satisfactory terms, or at
all. In addition, our obligations under the revolving credit agreement with Comerica Bank are secured by substantially all our assets and if we are unable to repay our indebtedness, the lenders could seek to foreclose on such assets.

If new debt is added to our current debt levels, the related risks that we now face could intensify.

We are currently dependent on our revolving credit facility, which is a critical component of working capital.

We have a $15.0 million secured revolving credit facility with Comerica Bank that provides us with working capital borrowings. Cygne can borrow up to 80%
of eligible receivables, 70% of finished goods inventory located at Cygnes warehouse, up to a maximum of $1.25 million, 80% of eligible in-transit inventory, up to a maximum of $1.5 million, and 15% of undrawn letters of credit up to a maximum
of $350,000. The credit facility terminates on August 31, 2009, although Cygne can terminate it at any time upon 60 days notice and Comerica can terminate at any time upon a default under the credit agreement. The revolving credit facility
contains customary covenants, including limitations on, or relating to, capital expenditures, liens, indebtedness, investments, mergers, acquisitions, and the payment of dividends and other restricted payments. The revolving credit facility also
contains working capital, net worth and EBITDA requirements as well as a debt to net worth ratio requirement to be monitored on a quarterly basis. At January 31, 2008, we were in default with the working capital, net worth, EBITDA and debt to
net equity ratio requirements. Comerica Bank issued a notice of no action to Cygne regarding the default on the covenants. The banks decision to not take action to enforce its rights under the agreement does not constitute a waiver of any of
the Banks rights, powers and remedies with respect to the defaults. If this credit agreement is terminated, the bank demands immediate payment of all outstanding borrowings as a result of being in default of our covenants, or our borrowing
availability is restricted thereunder, we may have difficulty in satisfying our working capital needs, which would have a material adverse effect on our business, results of operations and financial condition.

We are subject to risks associated with war and terrorist activities.

Terrorism, or the threat of terrorism, may have an impact on the general economy, including reduced shopping activity as a result of public safety concerns and disruption in the receipt and delivery of merchandise.

Earthquakes or other events outside of our control may damage our facilities or the facilities of third parties on which we depend.

Our warehouse facility is located in California near major earthquake faults that have experienced earthquakes in the past. An
earthquake or other natural disaster could disrupt our operations. Additionally, the loss of electric power, such as the temporary loss of power caused by power shortages in the grid servicing our warehouse facility, could disrupt operations or
impair critical systems. Any of these disruptions or other events outside of our control could affect our business negatively, harming our operating results. In addition, if any facilities of our suppliers or customers are affected by earthquakes,
power shortages, floods, hurricanes (monsoons), terrorism or other events outside of our control, our business could suffer.



17



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Our business could suffer if our third party manufacturers violate labor laws or fail to conform to generally
accepted ethical standards.

We generally require our third party manufacturers to meet our standards for working conditions and
other matters before we are willing to place business with them. As a result, we may not always obtain the lowest cost production. Moreover, we do not control our third party manufacturers or their respective labor practices. If one of our third
party manufacturers violates generally accepted labor standards by, for example, using forced or indentured labor or child labor, failing to pay compensation in accordance with local law, failing to operate its factories in compliance with local
safety regulations, or diverging from other labor practices generally accepted as ethical, we likely would cease dealing with that manufacturer, and we could suffer an interruption in our product supply. In addition, such a manufacturers
actions could result in negative publicity and may damage our reputation and the value of our brand and discourage retail customers and consumers from buying our products.

Risk Factors Related to Ownership of Our Common Stock

A small number of stockholders are in a position to
substantially control matters requiring a stockholder vote.

As of January 23, 2008, Mr. Hubert Guez has reported in
filings with the Securities and Exchange Commission that he beneficially owned, had the power to dispose or direct the disposition of, and to vote or direct the voting of, shares, personally, through various trusts and Diversified Apparel,
representing approximately 21.2% of the outstanding shares of our common stock. In addition, as of November 23, 2007, Serge Kraif has reported in filings with the Securities and Exchange Commission that he owned, had the power to dispose or
direct the disposition of, and to vote or direct the voting of, shares representing approximately 23.6% of the shares of our outstanding common stock. Further, as of January 31, 2008, Mr. Kraif has the right to acquire up to an additional
6,364,286 shares of common stock (which would increase his ownership to approximately 34.6% of our common stock) through the conversion of the Convertible Note and exercise of the Note Warrant issued to Mr. Kraif. Accordingly, Hubert Guez and
Serge Kraif effectively have the ability to control the outcome on all matters requiring stockholder approval, including, but not limited to, the election of directors and any merger, consolidation or sale of all or substantially all of our assets.
All of the shares beneficially owned by Mr. Guez and Mr. Kraif have been registered for resale under the Securities Act of 1933.

In addition, Mr. Manuel owns 4,946,975 shares of our common stock, which constitutes approximately 13.0% of our outstanding common stock (approximately 11.2% after giving effect to the issuance of common stock to Mr. Kraif upon
conversion of the Convertible Note and the exercise of the Note Warrant). All of the shares beneficially owned by Mr. Manuel were registered for resale in Form S-3 dated January 11, 2008. Our certificate of incorporation, as amended,
prohibits any stockholder from acquiring more than 5% of our outstanding common stock without the prior approval of our Board of Directors.

Our
organizational documents and Delaware law have provisions that could delay or prevent a change in control of our company, which could negatively affect your investment.

In addition to Diversified Apparel, Hubert Guez and Mr. Kraif together beneficially owning a majority of our outstanding common stock, our
certificate of incorporation and bylaws and Delaware law contain provisions that could delay or prevent a change in control of our company that stockholders may consider favorable. Some of these provisions:



| |  |  | limit the persons who can call special stockholder meetings;
| | - |  | ------------------------------------------------------------



| |  |  | require the approval of our Board of Directors for specified transfers of our capital stock;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | require the approval of our Board of Directors for any person to acquire more than five percent of our common stock; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | authorize the issuance of up to 1,000,000 shares of preferred stock that can be created and issued by our board of directors without prior stockholder approval,
commonly referred to as blank check preferred stock, with rights senior to those of our common stock.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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These and other provisions in our incorporation documents and Delaware law could allow our Board of
Directors to affect your rights as a stockholder by making it more difficult for stockholders to replace Board members or take control of us. Because our Board of Directors is responsible for appointing members of our management team, these
provisions could in turn affect any attempt to replace the current management team. In addition, these provisions could deprive our stockholders of opportunities to realize a premium on the shares of common stock owned by them.

The price of our common stock has fluctuated significantly and could continue to fluctuate significantly.

Between February 1, 2004 and January 31, 2008, the market price of our common stock has ranged from a low of $0.25 to a high of $6.74 per share.
On May 2, 2008, the last reported sale price of our common stock on the NASDAQ was $0.43. The market price of our common stock may change significantly in response to various factors and events beyond our control, including:



| |  |  | fluctuations in our quarterly revenues or those of our competitors as a result of seasonality or other factors;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | a shortfall in revenues or net income from that expected by securities analysts and investors;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | changes in securities analysts estimates of our financial performance or the financial performance of our competitors or companies in our industry generally;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | announcements concerning our competitors;
| | - |  | -----------------------------------------



| |  |  | changes in product pricing policies by our competitors or our customers;
| | - |  | ------------------------------------------------------------------------



| |  |  | general conditions in our industry; and
| | - |  | ---------------------------------------



| |  |  | general conditions in the securities markets.
| | - |  | ---------------------------------------------

In addition, on January 11, 2008, we registered the sale of 25,674,078 shares of our common stock, which represents approximately 56.6% of our outstanding shares of common stock (assuming the exercise of warrants
and conversion of convertible securities held by the selling stockholders). The average daily and weekly trading volume of our common stock on the Nasdaq Capital Market is significantly lower than the number of shares that were registered for
resale. Sales of our common stock by these stockholders could negatively impact the price of our common stock.

On January 14, 2008,
we received a Nasdaq Staff Deficiency Letter indicating that we fail to comply with the minimum bid price requirement for continued listing because the bid price of our common stock has closed under $1.00 for the last 30 business days. Under Nasdaq
rules, we have until July 14, 2008 to regain compliance. If at July 14, 2008, our minimum bid price has not closed at $1.00 per share or more for a minimum of 10 consecutive business days but we are otherwise in compliance with the initial
listing criteria, we will have an additional 180 calendar day to come into compliance with the minimum bid requirement. If we cannot come into compliance with the Nasdaq rules within the time periods specified about, our common stock will be
delisted. There can be no assurance that we will be able to come into compliance with the requirements for continued listing on Nasdaq.



| | ITEM 1(B). | UNRESOLVED STAFF COMMENTS
| | ---------- | -------------------------

None



19



---

|ITEM 2. | PROPERTIES
|------- | ----------

Our executive and general offices are located at 11 West 42ndStreet, New York, New York. We rent 7,435 square feet
pursuant to a lease that expires on October 31, 2008.

We lease 4,500 square
feet of showroom space at 215 West 40thStreet, New York, New York under an operating lease that expires on October 31, 2008.

We own a manufacturing facility in Guatemala with approximately 100,000 square feet that we believe is well maintained and in good operating condition.
The land and building at this facility is currently for sale.

On November 14, 2007, with an effective date of January 1, 2008,
Cygne entered into a memorandum of understanding with Shipson, LLC (Shipson). Pursuant to the memo of understanding, Cygne will pay fees to Shipson which will allow Cygne the use of approximately 27,000 square feet of Shipsons
leased space at 4900 Zambrano Street, Commerce, CA 90040 for warehousing, shipping and office space. Cygne can terminate this agreement at any time with 90 days prior notice.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------

We are involved in various legal
proceedings that are incidental to the conduct of our business, none of which the Company believes could reasonably be expected to have a material adverse effect on the Company's financial condition, results of operations or cash flows.

On March 21, 2008, we received a letter from Weltman, Weinberg & Reis Co., LPA informing us that they had been retained by China
Export & Credit Corporation aka Sinosure (Sinosure) to investigate a collection claim by Evolve International Trading (Shanghai) Co. Ltd. (Evolve). Evolve claims that it shipped certain goods to us and that we owe
Evolve $1,519,822 in unpaid invoices for those goods. This letter and the supporting documents were forwarded to Diversified Apparel Resources, LLC (DAR). DAR has examined the documents and informed us that we have no liability
concerning these amounts. Therefore, we consider it remote that we will have to pay this amount and it is not recorded as a liability in the financial statements.

On April 11, 2008, we received a summons and complaint on behalf of M.Y. Accessories Ltd. (M.Y.). M.Y. claims that it sold and delivered certain goods to Diversified Apparel Resources, LLC
(DAR) and us. In the complaint, M.Y. claims that DAR and us are responsible for the $311,373 in unpaid invoices for those goods. This letter and the supporting documents were forwarded to DAR. DAR has examined the documents and informed
us that we have no liability concerning these amounts. Therefore, we consider it remote that we will have to pay this amount and it is not recorded as a liability in the financial statements. In addition, in the above complaint, M.Y. claims that it
sold and delivered goods to us and that we owe it $27,012.60 in unpaid invoices for those goods. We have examined the documents and we believe that it is probable that we will have to pay this amount. Therefore, we have included this claim at the
stated amount as a liability in our financial statements.

On March 20, 2008, we received a summons and complaint on behalf of Copen
Associates, Inc. (Copen). Copen claims that it sold and delivered certain goods to us on January 18, 2007 and November 1, 2007 as agreed upon and that we owe it $55,871 in unpaid invoices for those goods. We have examined the
documents and we believe that it is probable that we will have to pay this amount. Therefore, we have included this claim at the stated amount as a liability in our financial statements.



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

None



20



---

PART II



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

Up to March 22, 2006, our Common Stock was quoted on the OTC Bulletin Board under the symbol CYDS.OB. Since March 22, 2006, our
Common Stock has been quoted on The Nasdaq Capital Market under the symbol CYDS. The following table sets forth for the periods indicated the high and low reported sale prices per share for our Common Stock as reported by the OTC
Bulletin Board and the Nasdaq Capital Market.



|                                          |  |      |      |     |   |     
|----------------------------------------- |  | ---- | ---- | --- | - | ----
|Fiscal Year Ending January 31, 2007       |  | High |      | Low
|First Quarter (through March 21, 2006)    |  | $    | 5.05 |     | $ | 4.18
|First Quarter (commencing March 22, 2006) |  |      | 5.00 |     |   | 3.50
|Second Quarter                            |  |      | 4.30 |     |   | 2.04
|Third Quarter                             |  |      | 5.00 |     |   | 1.85
|Fourth Quarter                            |  |      | 3.34 |     |   | 2.08
|                                          |  |     
|Fiscal Year Ending January 31, 2008       |  |      |      |    
|First Quarter                             |  | $    | 2.50 |     | $ | 1.78
|Second Quarter                            |  |      | 2.58 |     |   | 1.33
|Third Quarter                             |  |      | 1.68 |     |   | 0.97
|Fourth Quarter                            |  |      | 1.08 |     |   | 0.42

The number of stockholders of record of common stock on May 2, 2008 was approximately 98. We
believe that there are a significant number of beneficial owners of our common stock whose shares are held in street name. The closing sale price of our Common Stock on May 2, 2008 was $0.43 per share.

On January 14, 2008, we received a Nasdaq Staff Deficiency Letter indicating that we fail to comply with the minimum bid price requirement for
continued listing because the bid price of our common stock has closed under $1.00 for the last 30 business days. Under Nasdaq rules, we have until July 14, 2008 to regain compliance. If at July 14, 2008, our minimum bid price has not
closed at $1.00 per share or more for a minimum of 10 consecutive business days but we are otherwise in compliance with the initial listing criteria, we will have an additional 180 calendar day to come into compliance with the minimum bid
requirement. If we cannot come into compliance with the Nasdaq rules within the time periods specified, our common stock will be delisted. There can be no assurance that we will be able to come into compliance with the requirements for continued
listing on Nasdaq.

We have never declared or paid a cash dividend on our Common Stock. We anticipate that all future earnings will be
retained for the development of our business. Accordingly, we do not anticipate paying cash dividends on the Common Stock in the foreseeable future. The payment of any future dividends will be at the discretion of our board of directors and will
depend upon, among other things, future earnings, operations, capital requirements, our general financial condition and general business conditions.

Effective January 31, 2007, we entered into an agreement with Mr. Kraif (the Conversion Agreement), which was approved by the Companys stockholders on August 9, 2007, pursuant to
which:



| |  |  | We issued 8,800,000 shares of our common stock to Mr. Kraif in payment of $22.0 million of the Note;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | We issued a convertible note in the principal amount of $15.0 million that is convertible into shares of our common stock at a conversion price of $3.50 per share
in payment of $15.0 million of the Note, and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We issued to Mr. Kraif a warrant to purchase up to 4,400,000 shares of our common stock at a price of $3.00 per share.
| | - |  | ----------------------------------------------------------------------------------------------------------------------



21



---

On August 3, 2007, in a private equity placement, we issued 2,655,073 shares of Common Stock at a
price of $1.38 per share. In addition, we issued to the purchasers warrants to purchase an aggregate of 1,062,030 shares of Common Stock at an exercise price of $1.95 per share.

Cygne has filed a registration statement which was declared effective on May 14, 2007 for resale by certain of its stockholders of an aggregate of
13,928,571 shares of Cygnes common stock. 11,928,571 shares were acquired by Diversified Apparel directly from Cygne in connection with Cygnes acquisition of the branded and private label denim apparel business from Diversified Apparel
and the subsequent conversion of $7,500,000 principal amount of the Note, and 2,000,000 shares were acquired by Hubert Guez and Paul Guez from Cygne in connection with Cygnes acquisition of certain assets of the private label apparel division
of Innovo Group, Inc. on May 12, 2006. The selling stockholders (other than Diversified Apparel and Paul Guez) are members of Diversified Apparel who acquired the shares of common stock by distribution from Diversified Apparel. The 13,928,571
shares offered constitute, in the aggregate, approximately 36.7% of Cygnes shares outstanding as of May 2, 2008.

Cygne has
filed a registration statement which was declared effective on January 11, 2008 for resale by certain of its stockholders of an aggregate of 25,674,078 shares of Cygnes common stock. 16,950,000 shares were acquired by Mr. Kraif in
exchange for $37.0 million principal amount of an outstanding promissory note, 3,717,103 shares were acquired by certain of the selling stockholders in a private placement consummated in August 2007 in connection with Cygnes entering into a
new credit arrangement and 60,000 shares were acquired by non-employee directors pursuant to grants of restricted stock under our 2006 Incentive Plan. The remaining 4,946,975 shares are owned by Mr. Manuel, our Chairman and Chief Executive
Officer.



22



---

Performance Graph

The graph compares our performance from February 1, 2003, the first day of our 2003 fiscal year, to January 31, 2008, the last business day of our fiscal year, against the return of the S&P Apparel,
Accessories & Luxury Goods Index and the Russell 2000 Stock Index. The graph assumes (a) $100 was invested on February 1, 2003 in each of our common stock, the stocks comprising the S&P Apparel, Accessories & Luxury
Goods Index and the stocks comprising the Russell 2000 Stock Index, and (b) the reinvestment of dividends.



|                             |  |        |  |        |  |        |  |        |  |        |  |       
|---------------------------- |  | ------ |  | ------ |  | ------ |  | ------ |  | ------ |  | ------
|                             |  | 2/1/03 |  | 2/1/04 |  | 2/1/05 |  | 2/1/06 |  | 2/1/07 |  | 2/1/08
|Cygne Designs, Inc           |  | 100.0  |  | 304.0  |  | 264.0  |  | 3800.0 |  | 1720.0 |  | 400.0 
|S&P Apparel, Accessory Group |  | 100.0  |  | 117.0  |  | 148.4  |  | 163.5  |  | 208.8  |  | 150.6 
|Russell 2000 Index           |  | 100.0  |  | 156.1  |  | 168.4  |  | 197.8  |  | 216.1  |  | 188.3 

LOGO

Equity Plan Compensation Agreement

The following table sets forth information as of January 31, 2008 with respect to shares of our common stock that could have been issued under our 2006 Incentive Plan, which is our only equity incentive plan and
was approved by stockholders on January 20, 2006.

On April 25, 2008, we appointed Jay Furrow as President and Chief Executive
Officer of Cygne. The Company granted to Mr. Furrow a fully vested 10-year option to purchase one million shares of the Companys common stock at a price of $0.30 per share.



|                                                           |  |                                                                                         |  |                                                                          |      |                                                                                          |          
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ | ---- | ---------------------------------------------------------------------------------------- | ---------
|Plan Category                                              |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights |  | Weighted-averageexercise price ofoutstanding options,warrants and rights |      | Number of securitiesremaining available forfuture issuance underequity compensationplans
|Equity compensation plans approved by security holders     |  | 119,231                                                                                 |  |                                                                          | 0    |                                                                                          | 2,880,769
|Equity compensation plans not approved by security holders |  | 1,000,000                                                                               |  | $                                                                        | 0.30 |                                                                                          | 1,000,000
|                                                           |  |                                                                                         |  |                                                                          |      |                                                                                          |          
|Total                                                      |  | 1,119,231                                                                               |  | $                                                                        | 0.30 |                                                                                          | 3,880,769



23



---

|ITEM 6. | SELECTED CONSOLIDATED FINANCIAL DATA
|------- | ------------------------------------

The following
tables summarize certain selected financial information that should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements, which
have been audited by our registered independent public accounting firm, and the Consolidated Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K. The discontinued operation in 2003, the acquisitions in 2005 and 2006,
the reversal of income tax accrual of $400,000 in 2003, and the recording of the deferred tax liability provision in 2005 and 2006 of $785,000 and $1,686,000, respectively, the deferred tax benefit of $2,471,000 in 2007 and the loss on impairment of
goodwill and intangible assets of $61,850,000 in 2007 materially affect the comparability of the financial data reflected below.

In
addition, problems at our contractor in Mexico as discussed in Item 1, Significant Financial and Business Developments, caused an increase in our cost of goods sold of $2,480,000.

The selected consolidated financial data should be read in conjunction with, and are qualified by reference to, Managements Discussion and
Analysis of Financial Condition and Results of Operations and the historical audited financial statements and the accompanying notes thereto of us and our consolidated subsidiaries. The consolidated statements of income data set forth below
for the 2003 year and the consolidated balance sheet data as of the last day of our fiscal years 2003, 2004 and 2005 are derived from our audited financial statements. The consolidated statements of income data for each of the three years in the
period ended January 31, 2008, and the consolidated balance sheet data as of January 31, 2007 and 2008 are derived from the audited consolidated financial statements and should be read in conjunction with those consolidated financial
statements and the accompanying notes.



24



---

|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|------------------------------------------------------------------------------------------ |  | --------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | -- | ------ | - |  | ---- | ------- | - |  | -- | ------- | -
|                                                                                           |  | Fiscal Year (1)                         |       
|                                                                                           |  | 2003                                    |        |   | 2004 |   |        | 2005 |  |    | 2006   |   |  | 2007 |        
|                                                                                           |  | (In thousands except per share amounts) |       
|Income Statement Data                                                                      |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Net sales                                                                                  |  | $                                       | 27,082 |   |      | $ | 28,960 |      |  | $  | 58,453 |   |  | $    | 118,816 |   |  | $  | 95,753  |  
|Cost of goods sold                                                                         |  |                                         | 22,932 |   |      |   | 25,133 |      |  |    | 46,339 |   |  |      | 93,342  |   |  |    | 79,826  |  
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Gross profit                                                                               |  |                                         | 4,150  |   |      |   | 3,827  |      |  |    | 12,114 |   |  |      | 25,474  |   |  |    | 15,927  |  
|Selling, general and administrative (2)                                                    |  |                                         | 3,411  |   |      |   | 3,246  |      |  |    | 11,174 |   |  |      | 16,619  |   |  |    | 14,348  |  
|Depreciation and amortization (3)                                                          |  |                                         | 37     |   |      |   | 66     |      |  |    | 997    |   |  |      | 2,070   |   |  |    | 2,022   |  
|Loss on impairment of goodwill and intangibles                                             |  |                                         |       |   |      |   |       |      |  |    |       |   |  |      |        |   |  |    | 61,850  |  
|Provision for restructuring                                                                |  |                                         |       |   |      |   |       |      |  |    | 102    |   |  |      |        |   |  |    |        |  
|Gain on extinguishment of debt (4)                                                         |  |                                         |       |   |      |   |       |      |  |    |       |   |  |      |        |   |  |    | (1,733  | )
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Income (loss) from continuing operations before interest, other expense and income taxes   |  |                                         | 702    |   |      |   | 515    |      |  |    | (159   | ) |  |      | 6,785   |   |  |    | (60,560 | )
|Interest income                                                                            |  |                                         | (16    | ) |      |   | (14    | )    |  |    | (22    | ) |  |      |        |   |  |    | (18     | )
|Interest expense, including amortization (5)                                               |  |                                         | 180    |   |      |   | 159    |      |  |    | 5,034  |   |  |      | 5,033   |   |  |    | 5,359   |  
|Other expense                                                                              |  |                                         |       |   |      |   | 26     |      |  |    | 175    |   |  |      |        |   |  |    |        |  
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Income (loss) from continuing operations before income taxes                               |  |                                         | 538    |   |      |   | 344    |      |  |    | (5,346 | ) |  |      | 1,752   |   |  |    | (65,901 | )
|(Benefit) provision for income taxes (6)                                                   |  |                                         | (374   | ) |      |   | 3      |      |  |    | 820    |   |  |      | 1,910   |   |  |    | (2,041  | )
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Income (loss) from continuing operations                                                   |  |                                         | 912    |   |      |   | 341    |      |  |    | (6,166 | ) |  |      | (158    | ) |  |    | (63,860 | )
|(Loss) from discontinued operation, net (includes a loss on disposal of ($479) in 2003 (7) |  |                                         | (528   | ) |      |   | (28    | )    |  |    |       |   |  |      |        |   |  |    |        |  
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Net income (loss)                                                                          |  | $                                       | 384    |   |      | $ | 313    |      |  | ($ | 6,166  | ) |  | ($   | 158     | ) |  | ($ | 63,860  | )
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Income (loss) per share-basic and diluted from continuing operations                       |  | $                                       | 0.07   |   |      | $ | 0.03   |      |  | ($ | 0.34   | ) |  | ($   | 0.01    | ) |  | ($ | 2.00    | )
|(Loss) per share-basic and diluted from discontinued operation                             |  |                                         | (0.04  | ) |      |   |       |      |  |    |       |   |  |      |        |   |  |    |        |  
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Net income (loss) per share-basic and diluted                                              |  | $                                       | 0.03   |   |      | $ | 0.03   |      |  | ($ | 0.34   | ) |  | ($   | 0.01    | ) |  | ($ | 2.00    | )
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Weighted average shares outstanding:                                                       |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Basic                                                                                      |  |                                         | 12,438 |   |      |   | 12,438 |      |  |    | 17,861 |   |  |      | 25,913  |   |  |    | 32,007  |  
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  
|Diluted                                                                                    |  |                                         | 12,441 |   |      |   | 12,443 |      |  |    | 17,861 |   |  |      | 25,913  |   |  |    | 32,007  |  
|                                                                                           |  |                                         |        |   |      |   |        |      |  |    |        |   |  |      |         |   |  |    |         |  

Balance Sheet Data (as of the end of fiscal year)



|                                           |  |                 |       |      |   |       |  |      |        |      |   |         |  |   |       
|------------------------------------------ |  | --------------- | ----- | ---- | - | ----- |  | ---- | ------ | ---- | - | ------- |  | - | ------
|                                           |  | Fiscal Year (1)
|                                           |  | 2003            |       | 2004 |   | 2005  |  | 2006 |        | 2007
|                                           |  | (In thousands) 
|Cash                                       |  | $               | 3,345 |      | $ | 3,575 |  | $    | 977    |      | $ | 1,709   |  | $ | 128   
|Trade accounts receivable, net             |  |                 |      |      |   | 837   |  |      | 70     |      |   | 1,621   |  |   | 9,921 
|Due from factor, net (8)                   |  |                 | 1,775 |      |   |      |  |      | 15,443 |      |   | 9,758   |  |   |      
|Due from related parties (9)               |  |                 |      |      |   |      |  |      |       |      |   | 7,917   |  |   | 6,392 
|Inventories                                |  |                 | 2,206 |      |   | 2,707 |  |      | 4,489  |      |   | 1,937   |  |   | 2,849 
|Intangibles and goodwill (10)              |  |                 |      |      |   |      |  |      | 69,051 |      |   | 77,414  |  |   | 13,677
|Total assets                               |  |                 | 9,529 |      |   | 9,160 |  |      | 91,151 |      |   | 101,283 |  |   | 34,258
|Short-term bank borrowings                 |  |                 |      |      |   |      |  |      |       |      |   |        |  |   | 9,794 
|Secured subordinated promissory note (11)  |  |                 |      |      |   |      |  |      | 29,149 |      |   | 29,917  |  |   |      
|Subordinated convertible note payable (12) |  |                 |      |      |   |      |  |      |       |      |   |        |  |   | 6,111 
|Advances from factor (8)                   |  |                 |      |      |   |      |  |      | 15,887 |      |   | 9,542   |  |   |      
|Due to related parties (9)                 |  |                 |      |      |   |      |  |      | 550    |      |   | 98      |  |   |      
|Stockholders equity                       |  |                 | 7,502 |      |   | 7,715 |  |      | 41,704 |      |   | 49,418  |  |   | 11,240



|(1) | Prior to October 31, 2005, references to year 2003 and 2004 are to our fiscal year commencing in that calendar year and ending on the Saturday closest to
January 31 of the following year and all references to
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



---

| | year 2005, 2006 and 2007 are to our fiscal year commencing in that calendar year and ending on January 31 of the following year. Effective
October 31, 2005, we changed from a thirteen-week quarterly reporting period to last day of month quarterly reporting period, with our fiscal year now ending on January 31 of each year. The change was made to conform to the quarterly
accounting periods of other major apparel companies. The change did not have a material impact on our financial condition, results of operations or cash flows.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The selling, general and administrative expense includes an impairment loss for the Guatemalan facilities of $978,000 (facilities and equipment) in year 2005.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | For years 2003 and 2004, depreciation and amortization related to fixed assets and leaseholds only. In 2005, 2006 and 2007 depreciation and amortization related to fixed assets and
leaseholds amounted to approximately $101,000, $132,000, and $135,000, respectively, and amortization of intangible assets amounted to approximately $896,000, $1,938,000 and $1,887,000, respectively.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | In connection with the conversion of the $37.0 million Note into shares of Common Stock, the Convertible Note and warrants in August 2007, we recorded a gain on extinguishment of
debt of $1,733,000.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | In 2005, interest expense consisted of interest on advances from factor of $454,000, interest on the secured subordinated promissory note of $1,120,000, non-cash interest associated
with the amortization of debt discount on the secured subordinated promissory note of $1,286,000 and non-cash interest associated with the amortization of debt discount on the deferred purchase price of $111,000 and a write-off of $2,063,000 in
connection with the issuance of 1,428,571 shares of our common stock in payment of $7.5 million principal amount of the secured subordinated promissory note issued to Diversified Apparel.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | In 2006, interest consisted of interest on advances from factor of $1,355,000, interest on the secured subordinated promissory note of $1,410,000 and non-cash interest associated
with the amortization of debt discount on the secured subordinated promissory note of $2,268,000.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | In 2007, interest included interest paid to factor of $494,000 on its advances to us, interest on the credit facility of $450,000, the amortization of the discount on the Note of
$1,496,000, amortization of the discount of the Convertible Note of $2,856,000, and amortization of deferred financing costs of $50,000. The holder of the Convertible Note agreed to waive the interest due for the period August 9, 2007 (date of
issuance) through January 31, 2008 of $315,801. We have recorded the waiver as a reduction of interest expense for the year ended January 31, 2008.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | At January 31, 2004, we reversed a part of a tax audit reserve by $400,000 based on our knowledge of the status of the issues of the audit of a subsidiary located in Guatemala.
In 2005 and 2006, we recorded a deferred tax liability provision of $785,000 and $1,686,000, respectively and recorded a reversal of deferred tax liability of $2,471,000 in 2007.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | Pursuant to an agreement dated June 10, 2002 modified by an amendment dated July 29, 2002, we sold our Jordanian business to Century Investment Group (CIG) for
$833,000 plus the assumption of all outstanding liabilities of the Jordanian company of approximately $943,000. The agreement also stated that any disputes between the parties must be submitted to arbitration in Jordan.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The first payment of $400,000 was received at the closing and the final payment of $433,000 was due on April 30, 2003. As we did not receive the final payment of $433,000, we
submitted our claim for this payment to arbitration. As the outcome of this arbitration was uncertain, our management, at January 31, 2004, deemed it appropriate to provide a reserve of $433,000 against this receivable. At January 31,
2006, the Company determined that the payment was unrecoverable and wrote off this receivable and the applicable reserve.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | We agreed not to compete with CIG for knit business in Jordan for five years starting June 1, 2002 in consideration of $350,000 payable by February 5, 2006. In connection
with the non-compete agreement, we recorded deferred income of $350,000 which we were amortizing to income over a five-year period. At January 31, 2004, as a result of the uncertainty of the arbitration with CIG, we discontinued the
amortization of remaining deferred income of $309,000, and reserved the corresponding net receivable of $309,000 and wrote off the related deferred income.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



26



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| | The impact of these transactions had no effect on the results of continuing operations. The sale of the Jordanian business and its related operating results have been excluded from
the results from continuing operations and is classified as a discontinued operation for all periods presented in accordance with the requirements of FAS 144 Accounting for Impairment or Disposal of Long-Lived Assets.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | For 2003, amount due from factor was due from GMAC Commercial Credit LLC. For 2005 and 2006, amount due from factor was due from Milberg Factors, Inc. Advances from factor were
advances from Milberg Factors, Inc.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) | For 2006 and 2007, due from related parties was the net amount due from Hubert Guez and companies controlled by Hubert Guez. For 2005, due to related parties was the net amount due
to Hubert Guez and companies controlled by Hubert Guez.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | We recorded the intangibles and goodwill related to our purchase of the Acquired Business and the Innovo Acquisition. On January 31, 2008, we recorded a loss on impairment of
goodwill and intangibles amounting to $61,850,000.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | We recorded the fair value of the secured subordinated promissory note issued in connection with the acquisition of the Acquired Business from Diversified Apparel at $33,300,000,
which was originally a $14,200,000 discount from the face value of the $47,500,000 Note. The discount to the Note was being amortized over its estimated useful life (7 years), using the interest method, with a corresponding charge to interest
expense. The amortization of debt discount for 2005 was $1,286,000. We recorded a write-off on January 3, 2006 of $2,063,000 in connection with the issuance of 1,428,571 shares of our common stock in payment of $7.5 million principal amount of
the Note issued to Diversified Apparel. We recorded the fair value of the deferred purchase price of $3,750,000 at $3,639,000, representing a discount of $111,000. The discount to the purchase price was amortized over its estimated useful life,
ended January 31, 2006, using the interest method, with a corresponding charge to interest expense.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | On August 9, 2007, we exchanged the Note for shares of common stock, the Convertible Note and warrants. We recognized a gain on extinguishment of the Note, which represents the
carrying value of the Note in excess of the value of the common stock, fair value of the Convertible Note and fair value of the warrant issued in exchange therefore.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(12) | We recorded the fair value of the Convertible Note at $11,380,000, which was originally a $3,620,000 discount from the face value of the $15,000,000 Convertible Note. The discount
is being amortized to interest expense over 6.5 years. During the year ended January 31, 2008, we repaid $8,125,000 of the Convertible Note through a reduction in the amounts due from related parties and $2,856,000 of debt discount amortization
was recorded.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



27



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

Unless otherwise noted, all references to a year are to our fiscal year commencing in that calendar year and ending on the Saturday closest to
January 31 of the following year. Effective October 31, 2005, we changed from a thirteen-week quarterly reporting period to last day of month quarterly reporting period, with our fiscal year now ending on January 31 of each year. The
change was made to conform to the quarterly accounting periods of other major apparel companies. The change did not have a material impact on our financial condition, results of operations, or cash flows. All of the periods discussed are 52 weeks,
except 2005, which was 52 weeks and two days.

Overview

Acquisition of the Private Label Division from Innovo Group Inc. (Innovo Acquisition)

On May 12,
2006, we, Innovo Group Inc. (Innovo), and Innovo Azteca Apparel, Inc., a wholly owned subsidiary of Innovo, closed the transaction contemplated by an Asset Purchase Agreement entered into on March 31, 2006. Azteca Productions
International, Inc. (Azteca Productions) was a party to certain ancillary agreements related to the Asset Purchase Agreement because it was an interested party in the transaction. Innovo is a designer, developer and worldwide marketer of
apparel products. Pursuant to the Asset Purchase Agreement, Innovo sold us certain assets related to its private label apparel division. Innovo purchased these assets from Azteca Productions in July 2003 pursuant to an asset purchase agreement
referred to as the Blue Concept Asset Purchase Agreement.

Our primary purpose for the purchase was to diversify its business. We accounted
for this transaction as a purchase.

The assets acquired by Cygne included the private label divisions customer list, the assumption
of current workforce related to the private label division, the assumption of all existing purchase orders and inventory related to the private label division, and the assumption of the benefit of a non-compete clause with Azteca Productions. In
exchange for the purchased assets, the Company assumed certain liabilities associated with the private label division, including the remaining obligation under the original promissory note executed by Innovo in favor of Azteca Productions under the
Blue Concept Asset Purchase Agreement, all other liabilities, other than the original promissory note, owed in connection with the private label division to Azteca Productions in excess of $1,500,000, all liabilities associated with the private
label divisions outstanding purchase orders and inventory scheduled in the Asset Purchase Agreement, and the obligations to continue to pay the earn-out under the Blue Concept Asset Purchase Agreement. The aggregate value of the assumed
liabilities was $2,500,000, which excluded the remaining unpaid principal amount of the original promissory note of $7.9 million, which was paid through the issuance of shares of Cygnes common stock, as described below, and any amounts which
might be owed under the earn-out. No amounts were due under the earn-out agreement.

The Asset Purchase Agreement contained customary terms
and conditions, including, among other things, indemnification provisions, representations and warranties and post-closing covenants.

In
connection with the Asset Purchase Agreement, the Company entered into a Letter Agreement dated April 24, 2006 among Azteca Productions, Hubert Guez, Paul Guez and Sweet Sportswear, LLC. Pursuant to the Letter Agreement and in connection with
the closing of the Innovo Acquisition, on May 12, 2006 the Company issued 1,000,000 shares of its common stock to each of Hubert Guez and Paul Guez, for an aggregate issuance of 2,000,000 shares, in lieu of assuming the remaining $7.9 million
outstanding balance of the promissory note issued by Innovo to Azteca Productions. Under the Letter Agreement, the 2,000,000 shares have piggy-back registration rights on any future registration statements on Form S-3 filed by us. Messrs. Hubert and
Paul Guez also agreed not to offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any such shares until the close of trading on April 23, 2007. In addition, 250,000 of the shares
issued to



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Paul Guez and 250,000 of the shares issued to Hubert Guez were placed in an escrow account until the expiration of the lock-up period, with the escrowed
shares being returned to the Company in the event that the Companys common stock is traded on Nasdaq (or any other stock exchange, market or trading facility on which the shares are traded) at an average price above $5.00 per share during the
one month period ended April 23, 2007. Our shares did not reach the average target price and the shares were released from escrow to Paul Guez and Hubert Guez.

As of January 23, 2008, Mr. Hubert Guez has reported in filings with the Securities and Exchange Commission that he beneficially owned, had the power to dispose or direct the disposition of, and to vote or
direct the voting of, shares, personally, through various trusts and Diversified Apparel, representing approximately 21.2% of the shares of the Companys common stock. In addition, Mr. Hubert Guez has advised us that he (i) owns
approximately 47% of Azteca Production International, Inc., (ii) has a 50% membership interest in Sweet Sportswear, LLC and (iii) has approximately a 32% membership interest in Diversified Apparel Resources, LLC. AZT International, S.A. de
C.V is a 100% subsidiary of Azteca Production International, Inc.

Mr. Hubert Guez has advised us that as of May 12, 2006, Azteca
Production International, Inc. may be deemed the beneficial owner of approximately 12.7% of Innovo Group Inc. common stock. Hubert Guez may be deemed to have the sole power to direct the voting and disposition of approximately 5.9% of Innovo Group
Inc. common stock.

The purchase price consideration is comprised of the following:



|                                                                                                |  |                                       |       
|----------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------
|                                                                                                |  | ($ inthousandsexcept pershareamounts)
|Issuance of 2,000,000 shares of Cygne Common Stock at $3.84 per share                           |  | $                                     | 7,680 
|Assumption of liability to Diversified Apparel Resources LLC                                    |  |                                       | 2,500 
|Transaction costs ($110 was paid prior to January 31, 2007 ($11 remains in accrued liabilities) |  |                                       | 121   
|                                                                                                |  |                                       |       
|Total Purchase Price                                                                            |  | $                                     | 10,301
|                                                                                                |  |                                       |       

The purchase price was allocated as follows.



|                                                                                                          |  |                |       
|--------------------------------------------------------------------------------------------------------- |  | -------------- | ------
|                                                                                                          |  | (In thousands)
|Intangible assetscustomer relationships, $400, amortized over 3 months and $3,600 amortized over 3 years |  | $              | 4,000 
|Excess purchase price allocated to goodwill                                                               |  |                | 6,301 
|                                                                                                          |  |                |       
|                                                                                                          |  | $              | 10,301
|                                                                                                          |  |                |       

The amortization of the Innovo intangible assets for the years ended January 31, 2008 and
2007 was $1,200,000 and $1,253,000, respectively. At January 31, 2008, based on our annual impairment assessment, we recorded an impairment of the entire balance of identifiable intangible assets of $1,547,000.

Acquisition of the denim apparel business from Diversified Apparel Resources LLC. (Acquired Business)

On July 31, 2005, we acquired the assets used in the branded and private label denim apparel business, which we refer to as the Acquired Business, of
Commerce Clothing (which was later renamed Diversified Apparel Resources, LLC), a privately-held company principally owned by Mr. Guez, Diversified Apparels managing member and Chief Executive Officer, pursuant to an asset purchase
agreement. The assets we acquired from Diversified Apparel included, among other things, Diversified Apparels:



| |  |  | tangible personal property;
| | - |  | ---------------------------



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| |  |  | open purchase orders;
| | - |  | ---------------------



| |  |  | New York showroom leases for the property located on the fourth floor of 215 West 40th Street; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | trademarks and intellectual property associated with the Acquired Business, including the trademarks for Hippie, Hippie Jeans, Hint
Jeans, and Voyou.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

We did not acquire any cash, accounts receivable, prepaid expenses, deposits (other
than the lease deposit for the showrooms), inventories or stock of any subsidiaries from Diversified Apparel.

Under the asset purchase
agreement, we assumed the following liabilities of Diversified Apparel:



| |  |  | any and all liabilities, obligations and commitments arising after the closing under the Diversified Apparel agreements included in the assets we acquired
(including the New York showroom leases); and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any liability or obligation arising from the operation of the Acquired Business or ownership of the assets we acquired (including the New York showroom leases)
after the closing date.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In consideration for the assets we acquired from Diversified Apparel, we:



| |  |  | issued to Diversified Apparel 10,500,000 shares of our common stock, 7,500,000 of which Diversified Apparel distributed to its members;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | issued to Diversified Apparel a secured subordinated promissory note, which we refer to as the Note, in the principal amount of $47.5 million, subsequently reduced
to $40.0 million as a result of the issuance of 1,428,571 shares of common stock in payment of $7.5 million principal amount of the Note;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | paid $2 million in cash to Diversified Apparel on the closing date; and
| | - |  | -----------------------------------------------------------------------



| |  |  | agreed to pay to Diversified Apparel deferred purchase price payments totaling $1,750,000 in seven monthly installments of $250,000 each, without interest, on the
last day of each month commencing with August 2005 and ending February 2006.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We also entered into several related
agreements, including a registration rights agreement, a supply agreement, a distribution agreement and a restrictive covenant agreement. The supply and distribution arrangements govern purchases of Diversified Apparel products by us, as well as
related advances for inventory purchases. The restrictive covenant agreement sets forth agreed-upon non-competition covenants between Hubert Guez and us. The Registration Rights Agreement required us to use reasonable commercial efforts to register
securities issued as a part of the acquisition price for the Acquired Business within a specified time frame. Notes 1 and 11 to the Consolidated Financial Statements provide detailed explanations of each these agreements.

As the result of our acquisitions, we are a designer, merchandiser, manufacturer and distributor of branded and private label womens denim, causal
and career apparel and mens denim apparel with sales to retailers located in the United States.

Our major customers in 2007 were JC
Penney, or JCP, Kohls, Target Stores, or Target, and until December 2007 American Eagle Outfitters, or AEO. As a private label manufacturer, we produce apparel upon orders from our customers for sale under the customers own labels,
rather than producing our own inventory of apparel for sale under a brand name. Our branded products are sold under the names Hippie and Hint Jeans.

Historically, our highest shipments are in our second quarter and third quarter, with lower sales in the fourth and first quarter.

A manufacturer of private label apparel is characterized by high volume sales to a small number of customers at competitive prices. Although private label gross margins are lower than the gross margins in the



30



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brand name apparel industry, collection and markdown costs are typically commensurably lower, and inventory turns are generally higher. Inventory risks are
also generally reduced because the purchasing of fabric and other supplies begins only after purchase commitments have been obtained from customers. We believe that retailers, including customers of ours, are increasingly sourcing private label
products themselves rather than utilizing outside vendors like us.

We now source our non-denim private label garments through third party
manufacturers. Prior to November 2007, we manufactured these garments in our facility in Guatemala. Our branded and private label denim products are sourced through third party manufacturers in the Far East and Mexico.

We historically have been dependent on one or more key customers. For the year ended January 31, 2008 sales to JC Penney, Kohls, American
Eagle Outfitters (AEO) and Target accounted for 23%, 17%, 33% and 16%, respectively, of our net sales. For the year ended January 31, 2007, sales to JC Penney, Kohls, AEO and Target accounted for approximately 16%, 14%, 27%
and 15%, respectively, of our net sales. For the year ended January 31, 2006, sales to New York & Company (NY&C), JCP and Kohls accounted for 32%, 21% and 18%, respectively, of our net sales.

On a pro forma basis after giving effect to the Innovo Acquisition as if such acquisition had been consummated on February 1, 2006, our sales to JC
Penney, Kohls, American Eagle Outfitters and Target would have accounted for approximately 13%, 12%, 31% and 19%, respectively, of our net sales for the year ended January 31, 2007.

Although we have long-established relationships with our major customers, we do not have long-term contracts with these customers. Our future success
will be dependent upon our ability to attract new customers and to maintain our relationships with our present customers. We continue to strive to maintain our positive working relationships with our customers by providing on-time deliveries of
quality products at competitive prices.

We cannot assure you that our major customers will continue to purchase merchandise from us at the
same rate as they have historically from us, or at all in the future, or that we will be able to attract new customers. In addition, our major customers have the ability to exert significant control over our business decisions, including prices. As
a result of the problem with sourcing from a related party discussed in Item 1, Significant Financial and Business Developments, we no longer have AEO as a customer. Additionally, as a result of the United States discontinuance of
textile import quotas affecting products sourced by us on January 1, 2005, we no longer do business with New York & Company, which had been a major customer, as New York & Company has opted to place orders in China and other
countries in the Far East.

Effective January 1, 2005, the United States (U.S.) discontinued textile import quotas
affecting the products sourced by us. As a result, beginning in 2005 the U.S. total imports from China and other countries in the Far East, including the product categories manufactured by us in Guatemala and Mexico, have increased substantially.
The U.S. has established a safeguard program which will limit the increase in apparel imports from China for years 2005 through 2008. In addition, the Central American countries, which include Guatemala, and the U.S., have negotiated a Central
America Free Trade Agreement, or CAFTA. CAFTA, which was signed by the U.S. on August 2, 2005, will allow the U.S. duty free imports from Guatemala if the fabric is manufactured using yarn from the U.S. or a country party to CAFTA. Guatemala
ratified CAFTA as of July 1, 2006. Although we anticipated that, over time, CAFTA may have made Guatemala more competitive with imports from the Far East in the categories manufactured by us in Guatemala, we did not experience an increase in
demand for our products manufactured in Guatemala. Accordingly, on November 8, 2007, we made the decision to close our Guatemalan manufacturing facility.

In the year ended January 31, 2006, based on an appraisal by an independent third party, we recorded a 100% impairment charge with respect to our equipment, furniture and fixtures at our Guatemalan facility and



31



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established a salvage value of $375,000 for the land, building and building improvements. The land and building is currently for sale, although there can be
no assurance that we will be able to dispose of the land building at salvage value or at all. We incurred severance costs related to the closure of this facility of approximately $275,000 which was recorded as an expense and paid during the three
months ended January 31, 2008.

Based on our annual assessment at January 31, 2008, an impairment of identifiable intangibles and
goodwill of $61,850,000 was recorded on the Consolidated Statement of Operations. Significant management judgment is required in determining whether an indicator of impairment exists and in projecting cash flows. The final impairment loss may
involve revaluation. Cygne has engaged an independent third party to determine the value of the identifiable intangible assets and goodwill.

We have incurred costs in restructuring our operations due to loss of customers. We are continuing to review our existing business operations and could incur additional costs in the future associated with the further restructuring of our
operations.

The apparel industry is highly competitive and historically has been subject to substantial cyclical variation, with purchases
of apparel and related goods tending to decline during recessionary periods when disposable income is low. This could have a material adverse effect on our business. Retailers, including our customers, are increasingly sourcing private label
products themselves rather than utilizing outside vendors like us.

On October 31, 2006, we made a principal payment of $1.5 million
due on the secured subordinated promissory note issued to Diversified Apparel LLC (the Note) in connection with our acquisition of the denim apparel business of Commerce Clothing (the Acquired Business). Effective
November 1, 2006, Diversified Apparel transferred the Note to Serge Kraif. Effective January 31, 2007, we entered into an agreement with Mr. Kraif (the Conversion Agreement), which was approved by the Companys
stockholders on August 9, 2007, pursuant to which:



| |  |  | We issued 8,800,000 shares of our common stock to Mr. Kraif in payment of $22.0 million of the Note;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | We issued a convertible note in the principal amount of $15.0 million that is convertible into shares of our common stock at a conversion price of $3.50 per share
in payment of $15.0 million of the Note, and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We issued to Mr. Kraif a warrant to purchase up to 4,400,000 shares of our common stock at a price of $3.00 per share.
| | - |  | ----------------------------------------------------------------------------------------------------------------------

In addition, effective January 31, 2007, Mr. Kraif agreed that (i) the $1.5 million principal payment on the Note originally due on
January 31, 2007 would be postponed and paid by us from time to time when we have available funds and (ii) all accrued but unpaid interest at January 31, 2007 was waived. We have recorded the waiver as a reduction of interest expense
in the year ended January 31, 2007. As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $1.5 million principal payment on the Note originally due on January 31, 2007. This payment was offset against
related party receivable.

Effective April 30, 2007, Mr. Kraif agreed that the $1.5 million principal payments on the Note due on
April 30, 2007 and July 31, 2007 could be delayed pending stockholder consideration of the Conversion Agreement. Our stockholders approved the Conversion Agreement on August 9, 2007, and this $3.0 million principal payment was
satisfied through the issuance of the common stock, convertible note and warrant discussed above. Mr. Kraif agreed to waive the interest due for the period February 1, 2007 through August 9, 2007. We have recorded the waiver as a
reduction of interest expense for the year ended January 31, 2008. As of January 31, 2008, Mr. Serge Kraif assigned to Diversified Apparel the $625,000 principal payments on the Convertible Note due January 31,
2009, April 30, 2009, July 31, 2009, October 31, 2009, January 31, 2010, April 30, 2010, July 31, 2010, October 31, 2010, January 31, 2011, and April 30, 2011,
totaling $6,250,000. As of January 31, 2008, Diversified Apparel agreed to accept $4,738,125 in exchange for immediate



32



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payment of these ten payments, which was offset against the related party receivable. In addition, Mr. Kraif agreed to waive the interest due for the
period August 9, 2007 through January 31, 2008 of $315,801. We have recorded the waiver as a reduction of interest expense for the year ended January 31, 2008.

On August 9, 2007, the shareholders approved the Note conversion which resulted in the gain on extinguishment of the Note of $1,733,000. The gain
was determined by the change between the carrying value of the Note against the fair value of the Convertible Note of $11,380,000 and the fair value of the warrants of $3,248, 000. The fair value of the warrant was determined using the closing price
of the common stock on August 9, 2007, the date that the Conversion Agreement was approved by the stockholders, using the Black-Scholes option pricing model with the following assumptions: stock price at the approval date of the Conversion
Agreement of $1.54; exercise price of $3.00; term of 5 years; volatility factor of 71.2%; dividend yield of zero; discount rate of 4.64%.

Problems with
Sourcing from a Related Party

On December 18, 2007, a creditor company of AZT, a related party to us and the Mexican contractor
for our vendor, Diversified Apparel which is also a related party to us, obtained a court decree against AZT which allowed this creditor company to obtain possession of all of our fabric, trim, work-in-process and finished goods located at the AZT
manufacturing facility in Mexico. Mr. Manuel, our CEO, immediately entered into intensive discussion with the creditor company as well as our two customers serviced by the AZT Mexican manufacturing facility. The court decree to AZT was not due
to any of our wrongdoing but a claim by the creditor company against AZT.

AEOs response was to cancel all orders issued to us and to
issue new orders for the same garments to the creditor company. Shipments to AEO are estimated to be $2,700,000, and our revenues were reduced by such amount. We no longer have AEO as a customer.

Mr. Manuel negotiated an agreement with the creditor company whereby the creditor company would continue to ship to us our second customer and
invoice us for the garments shipped which shipment was completed in April 2008. We in turn, invoiced our customer. We would pay the creditor company thirty days after shipment of garments. At January 31, 2008, we owed the creditor company
$954,000, which has not been paid as of the date hereof.

Diversified Apparel agreed to reimburse us for the cost of the lost fabric and
the normal gross profit lost on the sales to AEO and our second customer. The cost of the fabric of $2,480,000, which is included in our cost of goods sold, and the lost gross profit of $754,000, are shown on the financial statements as an increase
to Due from Related Parties and an increase to paid-in-capital. Had we not had this situation with our vendor, we would have shipped to our customers and collected trade receivables of $5,000,000. Although Diversified Apparel agreed to reimburse us
at wholesale prices for the lost shipments, the reimbursement was included in the Due from Related Parties account on the balance sheet. The Due from Related Parties already included advances made to DAR under the Supply Agreement for costs to make
the product. The net financial result of the transaction is that we did recoup our losses through reductions in amounts owed by Cygne on the Convertible Note which was assigned to Diversified Apparel. We have not received any cash reimbursement from
Diversified Apparel in relation to our losses which adversely affected our cash flows.

We no longer source goods from AZT.

Critical Accounting Estimates

The preparation of our
financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could
differ materially from those estimates. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.



33



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Accounts Receivable, Due from Factor and Allowance for Customer Chargebacks and Trade Discounts and Allowance for
Doubtful Accounts

Through August 2, 2007, a significant portion of our accounts receivable were factored without recourse. We
estimate the allowances for customer chargebacks and trade discounts to be applied against our factored trade accounts receivable considering both historical and anticipated deductions taken by customers. As of January 31, 2007, we reserved
approximately $1,510,000 for allowances for customer chargebacks and trade discounts.

We terminated our Factoring Agreement on
July 31, 2007. For shipments subsequent to July 31, 2007, we have assumed the credit risk for all of our trade receivables. We estimate a reserve for doubtful accounts considering delinquent customer payments and customer credit reports,
as well as continuing to estimate the allowances for customer chargebacks and trade discounts to be applied against our trade accounts receivable considering both historical and anticipated deductions taken by customers. At January 31, 2008, we
have reserved approximately $1,831,000 for allowances for customer chargebacks and trade discounts and approximately $94,000 for allowance for doubtful accounts. A change in this estimate could result in the need to record additional reserves.

Marketable Securities

Our marketable
securities are comprised of public company securities. All investments are classified as available for sale and are recorded at market, using the specific identification method. Realized and unrealized recognized gains and losses are reflected in
other income and expense while unrealized gains are included as a separate component of stockholders equity. A change in our determination of the permanent portion of losses on marketable securities could result in additional expense charged
to operations.

Inventories

We
estimate the amount of goods that we will not be able to sell in the normal course of business and write down the value of these goods to the recovery value expected to be realized through off-price channels. In addition, we review the amount of
goods for which we have purchase commitments to determine what we will not be able to sell in the normal course of business and record the anticipated loss on these goods based on the recovery value of the goods expected to be realized through
off-price channels. A change in this estimate could result in the need to record additional reserves.

Income Taxes

We estimate the amounts of additional income taxes that may be assessed by the various taxing authorities upon audit of our filed tax returns based upon
our knowledge of the cases and upon the advice of our tax counsel. A change in the estimated additional liability for income taxes could result in a higher provision for income taxes.

We estimate the valuation allowance against our deferred tax asset. We have recorded a valuation allowance against the net deferred tax asset due to our
history of losses and near break-even results. However, should we conclude that utilization of deferred tax assets is more likely than not, the value of the deferred tax asset would be increased by eliminating some or all of the valuation allowance.
The deferred tax assets are net of deferred tax liabilities except for deferred tax liabilities originating from our taxable business combinations that resulted in tax-deductible goodwill. In these instances, deferred tax liabilities accumulate over
time as goodwill is deducted on tax returns but not amortized for financial reporting purposes. These deferred tax liabilities will reverse if impairment charges are recognized or when the business is disposed of through sale or otherwise. Because
of the uncertainty of the timing of the reversal of the deferred tax liability related to the goodwill temporary difference, these deferred tax liabilities are not netted against our deferred tax assets in determining the valuation allowance.



34



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Contingencies

We account for contingencies in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (SFAS No. 5). SFAS No. 5 requires that we record an estimated loss from a
loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the
loss can be reasonably estimated. Accounting for contingencies such as legal and income tax matters requires management to use judgment. Many of these legal and tax contingencies can take years to be resolved. Management believes that the accruals
we have made for these matters are adequate. Should events or circumstances change, we could have to record additional accruals.

Depreciation and
Amortization

Depreciation of property, plant and equipment is provided for by the straight-line method over the estimated useful lives
of the assets. Leasehold improvements are amortized using the straight-line method over the term of the related lease.

Impairment of Long-Lived Assets
and Goodwill

Long-lived assets consist of property and equipment, intangible assets, and goodwill. Intangible assets are comprised of
trademarks, costs to create product lines, and the value of existing purchase orders acquired in the Acquired Business and Innovo Acquisition. In accordance with SFAS 142, Goodwill and Other Intangible Assets, we assess the impairment of
identifiable intangibles and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider to be important which could trigger an impairment review include the following:



| |  |  | Significant underperformance relative to expected historical or projected future operating results;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Significant changes in the manner of use of the acquired assets or the strategy for the overall business; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Significant negative industry or economic trends.
| | - |  | -------------------------------------------------

We evaluate long-lived assets, including property, plant and equipment and intangible assets other than goodwill for impairment in accordance with Statement of Financial Accounting Standard No. 144 (SFAS
No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the estimated future cash flows (undiscounted and
without interest charges) from the use of an asset are less than the carrying value, a write-down would be recorded to reduce the related asset to its estimated fair value.

When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of
impairment and the carrying value of the asset cannot be recovered from projected undiscounted cash flows, we record an impairment charge. We measure any goodwill impairment based on a projected discounted cash flow method using a discount rate
determined by management to be commensurate with the risk inherent in the current business model. Significant management judgment is required in determining whether an indicator of impairment exists and in projecting cash flows.

In connection with the Innovo Acquisition and acquisition of the Acquired Business, we recorded goodwill of $72,877,000 and identified intangible assets
which included customer relationships, trademarks and product lines with a carrying value of $2,650,000 at January 31 2008. At January 31, 2008, we conducted our annual impairment assessment of the value of the goodwill and identified
intangible assets based on a discounted cash flow model of projected earnings. Negative trends in sales and gross margins resulted in lower projected future earnings. To aid us, we retained an independent party to perform the valuation. The negative
sales trends were the result of market conditions, the loss of two customers in 2007 which accounted for 49% of our 2007 sales, a



35



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substantial decrease in demand for our branded jeans and our non-denim private label products. The negative trends in gross margins resulted from the loss of
guaranteed gross margins under the Supply Agreement. Based on the results of the valuation, charges of approximately $59,200,000 were recorded for the impairment of goodwill and charges of $2,650,000 were recorded to reflect the impairment of the
value of the remaining identifiable intangible assets.

Amortization of Discounts on Secured Subordinated Promissory Note and on Deferred Purchase Price

We recorded the fair value of the Note in the original principal amount of $47,500,000 issued in connection with the acquisition of the
Acquired Business at $33,300,000, which was originally a $14,200,000 discount from the face value of the Note. The discount to the Note was being amortized to interest expense over the term of the Note. On August 9, 2007, we extinguished the
Note and offset the remaining unamortized discount to gain on extinguishment of debt.

We recorded the fair value of the $15,000,000
Convertible Note issued in partial payment of the Note at a discount of $3,620,000 from its face value. Beginning August 10, 2007, this discount to the Convertible Note is being amortized to interest expense over the remaining 6.5 year term of
the Convertible Note. During the year ended January 31, 2008, $2,856,000 of debt discount amortization was recorded. The normal amortization was $418,000. As a result of the partial prepayment of the Convertible Note at a discount, we recorded
additional debt amortization of $2,438,000.

Revenue Recognition

Revenues are recorded at the time of shipment of merchandise, provided that the price is fixed, title has been transferred, collection of the resulting receivable is reasonably assured and the Company has no
significant obligations remaining to be performed. The Company establishes reserves for allowances for customer chargeback and trade discounts and doubtful accounts. Such reserves amounted to $1,831,000, $1,510,000 and $1,962,000 at January 31,
2008, 2007 and 2006, respectively. Should events or circumstances change, we could have to record additional accruals for increased reserves.

Reclassification

Certain reclassifications have been made to the January 31, 2007 Balance Sheet to conform to the
January 31, 2008 Balance Sheet, relating to amounts due from related parties, due to related parties and accounts payable. This reclassification results from the right of offset among the related parties and an unrelated party.

Foreign Currency Exchange

The Company negotiates
substantially all its purchase orders with its foreign manufacturers in U.S. dollars. Thus, notwithstanding any fluctuation in foreign currencies, the Company's cost for any purchase order is not subject to change after the time the order is placed.
However, the weakening of the U.S. dollar against local currencies could lead certain manufacturers to increase their U.S. dollar prices for products. The Company believes it would be able to compensate for any such price increase.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by U.S. generally accepted accounting principles with no need for managements judgment in their application. There are also areas in which managements judgment in selecting any available alternative
would not produce a materially different result. See our audited consolidated financial statements and notes thereto which begin on page F-1 of this Annual Report on Form 10-K, which contain accounting policies and other disclosures required by U.S.
generally accepted accounting principles.

If we incorrectly anticipate these trends or unexpected events occur, our results of operations
could be materially affected.



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Results of Operations

The following table is derived from the Companys consolidated statements of operations for continuing operations and expresses for the periods indicated certain data as a percentage of net sales.



|                                                              |  |       |    |  |       |    |  |       |   
|------------------------------------------------------------- |  | ----- | -- |  | ----- | -- |  | ----- | --
|                                                              |  | Year  |   
|                                                              |  | 2007  |    |  | 2006  |    |  | 2005  |   
|Net Sales                                                     |  | 100.0 | %  |  | 100.0 | %  |  | 100.0 | % 
|                                                              |  |       |    |  |       |    |  |       |   
|Gross profit                                                  |  | 16.6  |    |  | 21.4  |    |  | 20.7  |   
|Selling, general and administrative expenses                  |  | 15.0  |    |  | 14.0  |    |  | 19.1  |   
|Depreciation and amortization                                 |  | 2.1   |    |  | 1.7   |    |  | 1.7   |   
|Loss on impairment of goodwill and intangible assets          |  | 64.6  |    |  |      |    |  |      |   
|Gain on extinguishment of debt                                |  | (1.8  | )  |  |      |    |  |      |   
|Provision for restructuring                                   |  |      |    |  |      |    |  | 0.1   |   
|                                                              |  |       |    |  |       |    |  |       |   
|(Loss) income before interest, other expense and income taxes |  | (63.3 | )  |  | 5.7   |    |  | (0.2  | ) 
|Interest expense, net                                         |  | 5.5   |    |  | 4.2   |    |  | 8.6   |   
|Other expense                                                 |  |      |    |  |      |    |  | 0.3   |   
|Provision for income taxes                                    |  | (2.1  | )  |  | 1.6   |    |  | 1.4   |   
|                                                              |  |       |    |  |       |    |  |       |   
|Net (loss)                                                    |  | (66.7 | )% |  | (0.1  | )% |  | (10.5 | )%
|                                                              |  |       |    |  |       |    |  |       |   

2007 compared to 2006

Acquisition of Companies

On May 12, 2006, we acquired the private label division of Innovo Group Inc.
(Innovo Acquisition). We accounted for this transaction as a purchase. Accordingly, a comparison of our results of operations for the year ended January 31, 2008 and 2007 may not necessarily be meaningful.

Net Sales

Net sales for the year 2007 were
$95,753,000, a decrease of $23,063,000, or 19.4%, from net sales of $118,816,000 for the year 2006.

The decrease in sales for the year
2007 compared to year 2006 of $23,063,000 was mainly attributable to a decrease in sales of our branded jeans of $21,487,000, a decrease in sales of $2,177,000 from the May 12, 2006 Innovo Acquisition, and a decrease in sales of our non-denim
private label garments of $4,795,000, partially offset by an increase in sales to mid-tier and department stores of $5,396,000.

Our
branded jeans sales decreased by $21,487,000 due to our discontinuance of our Hippie premium brand of junior jeans which amounted to $4,619,000 and less demand for our Hint brand of junior jeans which amounted to $16,868,000.

Our decrease in sales of $2,177,000 from the May 12, 2006 Innovo Acquisition was caused by less demand from our customers for the garments that we
exclusively produce for them.

Our sales of non-denim products, which are manufactured in our Guatemalan manufacturing facility, decreased
by $4,795,000. Although we anticipated that over time CAFTA may have made Guatemala more competitive with imports from the Far East in the product categories manufactured by us in Guatemala, we did not experience an increase in demand for our
products manufactured in Guatemala. Accordingly, in November 2007 we closed our Guatemalan manufacturing facility.

The increase in sales
of $5,396,000 of our mid-tier and department stores was primarily the result of greater consumer demand for private label jeans sold by these stores.



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In 2006, sales to JCP, Kohls, Target and American Eagle Outfitters (AEO) accounted for
16%, 14%, 15% and 27%, respectively, of our net sales. In 2007, sales to JCP, Kohls, Target and AEO accounted for 23%, 17%, 16% and 33%, respectively, of our net sales. Target and AEO became our customers through the May 12, 2006 Innovo
Acquisition. As a result of the problem with sourcing from a related party discussed in Item 1, Significant Financial and Business Developments, we no longer have AEO as a customer. In 2007, sales to AEO were $31,239,000.

Gross Profit

The gross profit for the year 2007 was $15,927,000 (16.6% of net sales), a decrease of $9,547,000, or 37.5%, from the gross profit of $25,474,000 (21.4% of net sales) for the year 2006.

The decrease in gross profit for the year 2007 compared to 2006 of $9,547,000 was the result of a decrease in sales volume, which caused a decrease in
gross profit of $4,945,000, a decrease in gross profit of $1,847,000 due to mix of products sold as well as the items listed below.

As a
result of the problem with sourcing from a related party in Mexico, the decrease in gross profit also includes the cost of our lost fabric of $2,480,000, which is included in our cost of goods sold.

The remaining decrease in gross profit is due to severance costs related to the closure of our Guatemalan manufacturing facility of approximately
$275,000 which were recorded in cost of goods sold and paid during the three months ended January 31, 2008.

The gross margins are
guaranteed for all products produced in Mexico at Diversified Apparels facilities, a related party. This arrangement expired on January, 31, 2008; as a result, our gross margin could decrease, which will result in a decrease in our gross
profit, which will have a material adverse effect on our results of operations and financial condition.

Selling, General and Administrative Expenses
(SG&A)

Selling, general and administrative expenses for the year 2007 were $14,348,000, a decrease of $2,271,000,
or 13.7%, from $16,619,000 for the year 2006. The decrease in SG&A expenses for the year 2007 compared to 2006 of $2,271,000 was mainly attributable to decreased expenses of $2,431,000 comprised of (i) expense reductions of $835,000 on
account of lower sales, which included a decrease in distribution and operating service expenses of $356,000 to ship and invoice our decreased sales, a decrease in non-compete payments of $186,000, a decrease in factoring fees of $285,000 on account
of a decrease in volume and termination of our factoring arrangement in August 2007 and a decrease in sales expense of $8,000; (ii) a decrease of $380,000 that resulted from our reduction of payroll associated with operations to support orders
placed by our former customer, New York & Company; and (iii) a decrease in all other expenses of $1,325,000 mainly comprised of reductions in pre-production and design personnel expenses. Most of the pre-production and design service
functions have been transferred to our Far East vendors. This decrease in expenses was partially offset by an increase in expenses of $215,000 comprised of (a) operating expenses of $100,000 for the Innovo Acquisition business acquired on
May 12, 2006; (b) an increase in professional fees of $60,000 in connection with various SEC filings, exploration of financing options and obtaining stockholder approval of the conversion of the Note into shares of common stock, the
Convertible Note and a warrant; and (c) an increase in severance costs of $109,000 related to the closure of the Guatemalan manufacturing facility.

Depreciation and Amortization

Depreciation on furniture, fixtures and leasehold improvements was $135,000 and
132,000, respectively, for the year 2007 and the year 2006. Amortization of intangible assets, which resulted from our acquisitions, was $1,887,000 and $1,938,000 for the year 2007 and the year 2006, respectively. The decrease in amortization in the
year 2007 compared to 2006 was mainly due to the accelerated amortization of customer relationships acquired in the Innovo Acquisition.



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Loss on Impairment of Goodwill and Intangible Assets

At January 31, 2008, based on the Companys annual assessment, an impairment of identifiable intangibles of $2,650,000 and goodwill of
$59,200,000, for a total of $61,850,000 was recorded.

In connection with the Innovo Acquisition and the acquisition of the Acquired
Business, we recorded goodwill of $72,877,000 and identified intangible assets which included customer relationships, trademarks and product lines, with a carrying value of $2,650,000 at January 31, 2008. At January 31, 2008, we conducted
our annual impairment assessment of the value of the goodwill and identified intangible assets based on a discounted cash flow model of projected earnings. To aid us, we retained an independent party to perform the valuation. Negative trends in
sales and gross margins resulted in lower projected future earnings. The negative sales trends were the result of market conditions, the loss of two customers in 2007 which accounted for 49% of our 2007 sales, a substantial decrease in demand for
our branded jeans and our non-denim private label products. The negative trends in gross margins resulted from the loss of guaranteed gross margins under the Supply Agreement. Based on the results of the valuation, charges of approximately
$59,200,000 were recorded for the impairment of goodwill and charges of $2,650,000 were recorded to reflect the impairment of the value of the remaining identifiable intangible assets.

Gain on Extinguishment of Debt

As a result of the conversion of the $37 million Note into
common stock, the Convertible Note, and warrants, we recorded a gain on extinguishment of debt of $1,733,000.

Interest Expense

Interest expense for the year 2007 was approximately $5,675,000 as compared to $5,033,000 for the year 2006. Interest expense for the year 2007
included interest paid to factor of $494,000 on its advances to us, interest on the credit facility of $450,000, amortization of the discount on the Note of $1,496,000, amortization of the discount on the Convertible Note of $2,856,000 and
amortization of deferred financing costs of $50,000. Interest expense for the year 2007 was offset by interest income of $18,000. The Note holder waived payment of the interest on the Note and the Convertible Note of approximately $955,000 and
$315,801, respectively, for the year 2007. We have recorded the waiver as a reduction in interest expense.

Interest expense for the year
2006 includes interest paid to factor of $1,355,000 on its advances to us, interest on the Note of $1,410,000 and the amortization of the discount on the Note of $2,268,000. Interest expense for 2006 was net of the waiver by the Note holder of the
interest of $453,000 for the three months ended January 31, 2007.

Provision for Income Taxes

The (benefit) provision for income taxes for the year 2007 and 2006 was ($2,041,000) and $1,910,000, respectively. The benefit for 2007 was comprised of a
provision of United States and State and local income taxes of $448,000, a reversal of tax reserves of $18,000 and a deferred tax reversal of prior years deferred tax provisions of $2,471,000. Goodwill is deductible for income tax purposes but
it is not amortized for financial reporting purposes. The deferred tax provision provides for the tax on the goodwill when the goodwill is extinguished or an impairment to the goodwill is recorded. At January 31, 2008, an impairment to goodwill
of $59,200,000 was recorded leaving the remaining goodwill at $13,677,000. The provision for United States and state and local income tax includes the effects of the United States net operating loss carryforwards and foreign operations. As of
January 31, 2007 the deferred tax assets were net of deferred tax liabilities except for deferred tax liabilities originating from the Companys taxable business combinations that resulted in tax-deductible goodwill. In these instances,
deferred tax liabilities accumulate over time as goodwill was deducted on tax returns but not amortized for financial reporting purposes. These deferred tax liabilities will reverse if impairment charges are recognized or when the business is
disposed of through sale or otherwise. Because of the uncertainty of the timing of the reversal of the



39



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deferred tax liability related to the goodwill temporary difference at January 31, 2008, these deferred tax liabilities are not netted against the
Companys net deferred tax asset in determining the valuation allowance. At January 31, 2008, the deferred tax liability related to the goodwill was reversed as a result of the goodwill impairment and a deferred tax asset was recorded for
the difference in the carrying value of goodwill between the book and tax purposes, which was fully offset by a valuation allowance.

The
provision for 2006 was comprised of $56,000 of federal tax, $200,000 of state and local income taxes and a deferred tax provision of $1,686,000 related to the difference between book and tax basis from indefinite lived goodwill. We recorded a tax
provision of $785,000 related to the difference between book and tax basis from indefinite lives of goodwill acquired in connection with the acquisition of the Acquired Business and the Innovo Acquisition. Goodwill is deductible for income tax
purposes but it is not amortized for financial reporting purposes. The deferred tax provision provides for the tax on the goodwill when the goodwill is extinguished. The provision for income tax includes the effects of the United States net
operating loss carryforwards, foreign operations and deferred tax on goodwill amortization.

For the year 2007, our effective tax rate of
3% differs from the federal statutory rate of 34% and our normal effective state and local tax rate of 6% (for a total tax rate of 40%) mainly due to United States and State net operating loss carryforwards, foreign operations, deferred tax on
goodwill amortization, goodwill impairment and gain on debt conversion.

For the year 2006, our effective tax rate of 109% differs from the
federal statutory rate of 34% and our normal effective state and local tax rate of 6% (for a total tax rate of 40%) due to United States and State net operating loss carryforwards, foreign operations and deferred tax on goodwill amortization.

2006 compared to 2005

Acquisition of Companies

On May 12, 2006, we acquired the private label division of Innovo Group Inc. (Innovo Acquisition). We accounted
for this transaction as a purchase.

On July 31, 2005, we acquired the assets used in the branded and private label denim apparel
business, which we refer to as the Acquired Business, of Commerce Clothing (which was later renamed Diversified Apparel Resources, LLC), a privately-held company principally owned by Hubert Guez, Diversified Apparels managing member and Chief
Executive Officer, pursuant to an asset purchase agreement. We accounted for this transaction as a purchase. In connection with this transaction, Mr. Guez became our principal stockholder. Because of the two acquisitions, the results for the
years ended January 31, 2007 and 2006 are not necessarily comparable.

Net Sales

Net sales for the year 2006 were $118,816,000, an increase of $60,363,000, or 103%, from net sales of $58,453,000 for the year 2005.

The increase in sales for the year 2006 compared to year 2005 of $60,363,000 was attributable to the increase in sales from the Acquired Business and the
addition of sales from the Innovo Acquisition amounting in the aggregate to $73,202,000, which was mainly offset by decreased sales to NY&C of $12,839,000.

The decrease in the programs offered by NY&C to us for the year 2006 compared to the year 2005 was a direct result of NY&C placing orders in China and other countries in the Far East.

In 2005, sales to NY&C, JCP and Kohls accounted for 32%, 21% and 18%, respectively, of our net sales. In 2006, sales to NY&C, JCP,
Kohls, Target and AEO accounted for 4%, 16%, 14%, 15% and 27%, respectively, of our net sales.



40



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At January 31, 2007 we had unfilled confirmed customer orders of $27,866,000 compared to $23,029,000
at January 31, 2006. All of the increase in backlog is the result of our Innovo Acquisition. In general, the amount of unfilled orders at a particular time is affected by a number of factors, including the scheduling of manufacture and shipping
of the product which, in some instances, depends on the customers demands. Accordingly, a comparison of unfilled orders from period to period is not necessarily meaningful and may not be indicative of eventual actual shipments. The Acquired
Business has a dilution range of 10% to 11% on bookings for allowance for chargebacks and trade discounts. The Innovo Acquisition has a dilution range of 1.5% to 2.0% on bookings for allowance for chargebacks and trade discounts. This dilution rate
is consistent with the prior year.

Gross Profit

The gross profit for the year 2006 was $25,474,000 (21.4% of net sales), an increase of $13,360,000, or 110%, from the gross profit of $12,114,000 (20.7% of net sales) for the year 2005.

The increase in gross profit for the year 2006 compared to the year 2005 of $13,360,000 was attributable to the increase in gross profit from the
Acquired Business and the Innovo Acquisition amounting in the aggregate to $16,627,000, which was mainly offset by a decrease in gross profit from NY&C to $3,267,000 due to decreased sales, lower prices and unfavorable factory variances
resulting from NY&C decreased sales.

As of January 31, 2006 based on an appraisal by an independent third party, we recorded a
100% impairment charge against the equipment, furniture and fixtures at our Guatemalan facility and established a salvage value, not subject to depreciation, for our building and building improvements in our Guatemala facility. Thus, there was no
depreciation expense for the Guatemalan facility in the year 2006 as compared to $191,000 for the year 2005. The Guatemalan facility depreciation was charged to cost of goods sold.

The gross margins are guaranteed for all products produced in Mexico at Diversified Apparels facilities, a related party. This arrangement expired
on January 31, 2008; as a result, our gross margin could decrease, which will result in a decrease in our gross profit, which will have a material adverse effect on our results of operations and financial condition.

Selling, General and Administrative Expenses (SG&A)

Selling, general and administrative expenses for the year 2006 were $16,619,000, an increase of $5,445,000, or 49%, from $11,174,000 for the year 2005.

The increase in SG&A expenses for 2006 compared to 2005 of $5,445,000 was mainly attributable to (i) an increase in non-compete and earn-out
fees of $1,024,000 due to higher sales volume in 2006 than 2005, (ii) an increase in professional fees of $393,000 which was comprised of (a) accounting and legal services performed in connection with various SEC filings of $196,000,
(b) an increase in our audit fees of $138,000, (c) fees of $163,000 to examine our systems and procedures at our Guatemalan facility in connection with the discovery of unauthorized use of cash at our Guatemalan subsidiaries, (d) fees
of $70,000 to review alternative capitalization models suitable for our business, (e) legal fees of $31,000 to protect our trademarks, (f) increase in all other fees of $79,000 mostly attributable to tax preparation and a goodwill
impairment review, and (g) a decrease in fees of $284,000 relating to the NASDAQ National Market and SEC investigations, (iii) an increase in NASD fees of $79,000, (iv) an increase in the cost of the board of directors of $58,000 due
to more directors, (v) an increase of $113,000 for those shares of the directors restricted stock which became vested during 2006, (vi) an increase in the customer service and shipment control staff of $1,282,000 on account of the
present and anticipated increase in sales volume, (vii) an increase in the research and development expenses of $1,560,000 to develop our present and future products, (viii) an increase in our selling cost of $660,000 on account of higher
sales volume, (ix) an increase in distribution and operating service expenses of $1,445,000 to ship and invoice our increased sales, and (x) an increase in direct administrative expenses in the amount of $917,000 as a result of the growth
in our business. These increases of $7,531,000 were offset by (a) the elimination of a 2005 new account factor fee of



41



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$87,000, (b) a decrease in advertising expense of $206,000 due to a decrease in our branded sales, (c) a reduction of $927,000, including a
reduction in severance pay of $131,000, that resulted from our reduction of payroll associated with operations to support orders placed by NY&C, and (d) in 2005 we recognized an impairment charge of $978,000 against the assets located in
Guatemala which did not recur in 2006. In addition, the SG&A expenses in 2005 benefited from the reversal of certain accruals no longer required amounting to $112,000. There was no similar benefit in 2006.

Depreciation and Amortization

Depreciation on
furniture, fixtures and leasehold improvements was $132,000 and $101,000, respectively, for the year 2006 and the year 2005. Amortization of intangible assets, which resulted from the acquisition of the Acquired Business and the Innovo Acquisition,
was $1,938,000 and $896,000, respectively, for the year 2006 and the year 2005.

Provision for Restructuring

The provision for restructuring of $102,000 recorded in year 2005 represents the severance cost associated with the reduction of the production capacity
at our Guatemalan manufacturing facility. On January 1, 2005, the United States discontinued its textile import quotas. As a result, our customers have been able to secure some of their products previously purchased from us from China and other
countries in the Far East at a lower price.

Interest Expense

Interest expense for the year 2006 was approximately $5,033,000 as compared to $5,034,000 for the year 2005.

Interest expense for the year 2006 consists of interest paid to factor of $1,355,000 on its advances to us, interest on the secured subordinated promissory note (Note) of $1,410,000 and the amortization of the discount on the
Note of $2,268,000. Interest expense for 2006 was net of the waiver by the Note holder of the interest of $453,000 for the three months ended January 31, 2007.

Interest expense for the year 2005 consists of interest paid to factor of $455,000 on its advances to us, interest on the Note of $1,142,000 and the amortization of the discount on the Note of $3,437,000.

The increase in interest paid to the factor of $900,000 is attributable to increased usage of advances from the factor for our working capital due to
our increased sales.

We recorded the fair value of the Note issued in connection with the acquisition of the Acquired Business at
$33,300,000, which was a $14,200,000 discount from the face value of the $47,500,000 Note. A third party valued the Note. The discount to the Note is being amortized to interest expense over the term of the Note.

Other Expense

In year 2005, we realized a
loss of $175,000 in respect of marketable securities because we determined the loss to be other than temporary. Our original cost of the 59,880 shares purchased on Nasdaq in November 2002 was $3.60 per share, for a total cost of $215,568. Throughout
the quarters January 2004 through January 2006, the fair value of the security declined steadily. For purposes of calculating the permanent impairment, we used the average market price for February 2006 of $0.67, as management determined that the
most recent full months data was most indicative of current market value. We determined that the security is impaired based on the consistent and substantial declines in the market value of the securities since purchased, as reflected in the
Nasdaq public market.



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Provision for Income Taxes

The provision for income taxes for the year 2006 and 2005 was $1,910,000 and $820,000, respectively. The provision for the year 2006 was comprised of $56,000 of federal tax, $200,000 of state and local income taxes,
and a deferred tax provision of $1,686,000 related to the difference between book and tax basis from indefinite lived goodwill. We recorded a tax provision of $785,000 related to the difference between book and tax basis from indefinite lives of
goodwill acquired in connection with the acquisition of the Acquired Business and the Innovo Acquisition. Goodwill is deductible for income tax purposes but it is not amortized for financial reporting purposes. The deferred tax provision provides
for the tax on the goodwill when the goodwill is extinguished.

The state and local income tax provision was offset by a reversal of
$32,000 of prior years tax provision. A valuation allowance has been provided against net deferred tax assets except for deferred tax liabilities originating from our taxable business combinations that resulted in tax-deductible goodwill.

The provision for the year 2005 was $820,000, which was comprised of $46,000 of minimum state and local income taxes and a deferred tax
provision of $785,000 related to the difference between book and tax basis from indefinite lived goodwill. The minimum state and local income tax provision was offset by a reversal of $11,000 of prior years tax provision. A valuation allowance
has been provided against net deferred tax assets except for deferred tax liabilities originating from our taxable business combinations that resulted in tax-deductible goodwill.

For the year 2006, our effective tax rate of 109% differs from the federal statutory rate of 34% and our normal effective state and local tax rate of 6%
(for a total tax rate of 40%) due to United States and State net operating loss carryforwards, foreign operations and deferred tax on goodwill amortization.

For the year 2005, our effective tax rate of 15.3% differs from the federal statutory rate of 34% and our normal minimum state and local tax rate of 6% (for a total tax rate of 40%) due to United States operating
losses, foreign tax-free operations and deferred tax on goodwill amortization.

Pro forma statement of operations

The condensed unaudited pro forma statement of operations for the twelve months ended January 31, 2007 and for the twelve months ended
January 31, 2006 have been prepared in accordance with U.S. generally accepted accounting principles to give effect to the July 31, 2005 acquisition of the Acquired Business and the May 12, 2006 consummation of the Innovo Acquisition
as if the transactions occurred on February 1, 2005, the first day of our fiscal year. Both acquisitions were accounted for using the purchase method of accounting.

The Acquired Business pro forma adjustments include the adjustment of the historical gross profit to the contractual gross profit which is defined in our supply agreement with Diversified Apparel, adjustment of
historical distribution and occupancy costs to the contractual cost as defined in our distribution agreement with Diversified Apparel, the recording of the expense under the restrictive covenant agreement with Hubert Guez, the recording of the
amortization of the intangible assets, recording of the deferred tax liability and the adjustment to reflect the interest expense to include the amortization of debt discount expense on the secured subordinated promissory note issued in connection
with the acquisition of the Acquired Business. The intangible assets include values for trademarks, costs to create product lines and value for customer relationships.

The Innovo Acquisition pro forma adjustments include the elimination of historical building occupancy costs, the adjustment of the historical amortization of intangibles to the amortization of our intangibles, the
recording of the deferred tax liability and the elimination of the Innovo Acquisition impairment of goodwill which was recorded on the financial statements of Innovo Group, Inc.



43



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The unaudited pro forma information is presented for illustration purposes only and is not necessarily
indicative of the financial position or results of operations which would actually have been reported had the acquisitions been in effect during these periods or which might be reported in the future. The unaudited pro forma financial information
includes expenses allocated by Innovo Group Inc. to the Innovo Acquisition which may not be indicative of future results, which will include actual expenses.



|                                       |  |                                          |         |   |               |   |         |               |  |   |         |  
|-------------------------------------- |  | ---------------------------------------- | ------- | - | ------------- | - | ------- | ------------- |  | - | ------- | -
|                                       |  | (In thousands, except per share amounts) |        
|                                       |  | Year ended January 31,                   |        
|                                       |  | 2008Actual                               |         |   | 2007Pro forma |   |         | 2006Pro forma | 
|Net sales                              |  | $                                        | 95,753  |   |               | $ | 138,796 |               |  | $ | 171,522 |  
|Net income                             |  | $                                        | (63,860 | ) |               | $ | (262    | )             |  | $ | (200    | )
|Net income per sharebasic and diluted |  | $                                        | (2.00   | ) |               | $ | (0.01   | )             |  | $ | (0.01   | )

Non-GAAP financial measures

Earnings before interest, taxes, depreciation and amortization (EBITDA) is used as a supplemental financial measure by management and by
external users of our financial statements, such as investors and our lenders, to assess:



| |  |  | the financial performance of our assets without regard to financing methods, capital structures or historical cost basis;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | the ability of our assets to generate cash sufficient to pay interest on our indebtedness; and
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | our operating performance and return on invested capital as compared to those of other companies in the apparel business, without regard to financing methods and
capital structure,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

EBITDA should not be considered an alternative to net income, operating income, cash flow from
operating activities or any other measure of financial performance or liquidity presented in accordance with general accepted accounting principles (GAAP).

EBITDA excludes some, but not all, items that affect net income and operating income, and these measures may vary among other companies. Therefore, the adjusted EBITDA as presented below may not be comparable to
similarly titled measures of other companies.



|                                                     |  |                                     |         |   |      |   |       |  
|---------------------------------------------------- |  | ----------------------------------- | ------- | - | ---- | - | ----- | -
|                                                     |  | Adjusted EBITDA                     |        
|                                                     |  | (In thousands)Year Ended January 31 |        
|                                                     |  | 2008                                |         |   | 2007 |  
|Reconciliation of EBITDA to net (loss)               |  |                                     |         |   |      |   |       |  
|Net (loss)                                           |  | $                                   | (63,860 | ) |      | $ | (158  | )
|Loss on impairment of goodwill and intangible assets |  |                                     | 61,850  |   |      |   |      |  
|Depreciation and amortization                        |  |                                     | 2,022   |   |      |   | 2,070 |  
|Interest expense                                     |  |                                     | 5,341   |   |      |   | 5,033 |  
|(Benefit) Provision for income taxes                 |  |                                     | (2,041  | ) |      |   | 1,910 |  
|                                                     |  |                                     |         |   |      |   |       |  
|Gross EBITDA                                         |  |                                     | 3,312   |   |      |   | 8,855 |  
|Less, Gain on extinguishment of debt                 |  |                                     | 1,733   |   |      |   |      |  
|                                                     |  |                                     |         |   |      |   |       |  
|Adjusted EBITDA                                      |  | $                                   | 1,579   |   |      | $ | 8,855 |  



44



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Liquidity and Capital Resources

On July 31, 2007, we modified our Supply and Distribution Agreements with Diversified Apparel, a related party. (see footnote 10 to Consolidated
Financial Statements). As a result, we purchased the entire inventory at our Commerce California warehouse and the fabric at AZT, a related party in Mexico. From July 31, 2007 to December 18, 2007, we purchased our fabric for production in
Mexico.

These changes require us to maintain higher inventory balances and consequently, higher balances with our credit lines.

On December 18, 2007, a creditor company of AZT, a related party to us and the Mexican contractor for our vendor, Diversified
Apparel, which is also a related party to us, obtained a court decree against AZT which allowed this creditor company to obtain possession of all of our fabric, trim, work-in-process and finished goods located at the AZT manufacturing facilities in
Mexico. Mr. Manuel, our CEO, immediately entered into intensive discussion with the creditor company as well as our two customers serviced by the AZT Mexican manufacturing facility. The court decree to AZT was not due to any wrongdoing of the
Company but a claim by the creditor company against AZT.

AEOs response was to cancel all orders issued to us and to issue new orders
for the same garments to the creditor company. Shipments to AEO are estimated to be $2,700,000, and our projected sales were reduced by such amount. As a result of this incident, we no longer have AEO as a customer.

Mr. Manuel negotiated an agreement with the creditor company whereby the creditor company would continue to ship to us our second customers
garments with sales estimated at $2,600,000 and invoice us his costs for the garments shipped which shipment was completed in April 2008. We, in turn, invoiced our customer for these garments. We agreed to pay the creditor company thirty days after
shipment of garments. At January 31, 2008, we owed the creditor company $954,000, which has not been paid as of the date hereof.

Diversified Apparel agreed to reimburse us for the cost of the lost fabric and the normal gross profit lost on the sales to AEO and our second customer. The cost of the fabric of $2,480,000, which is included in our cost of goods sold, and
the lost gross profit of $754,000, are shown on the financial statements as an increase to Due from Related Parties and an increase to paid-in-capital. Had we not had this situation with our vendor, we would have shipped to our customers and
collected trade receivables of $5,000,000. Although Diversified Apparel agreed to reimburse us at wholesale prices for the lost shipments, the reimbursement was included in the Due from Related Parties account on the balance sheet. The Due from
Related Parties already included advance made to DAR under the Supply Agreement for costs to make the product. The net financial result of the transaction is that we did recoup our losses through reductions in amounts owed by Cygne on the
Convertible Note which was assigned to Diversified Apparel. We have not received any cash reimbursement from Diversified Apparel in relation to our losses which adversely affected our cash flows and liquidity.

Net cash used in operating activities for the year 2007 was $5,208,000. The components of cash used in operating activities totaling $19,948,000 are
(i) an increase in trade receivables of $10,225,000, which reflects the replacement of the factoring agreement with the Comerica Bank credit facility, pursuant to which we retain ownership of, and responsibility for collecting, receivables,
(ii) an increase in inventories of $3,392,000, which reflects the change in inventory due to the modification of our Supply and Distribution agreements with a related party as described above, (iii) an increase in prepaid expenses and
deposits of $410,000, which reflects prepaid professional fees in connection with the new Comerica bank agreement and deposits on inventory, (iv) a decrease in accounts payable of $3,151,000 due to an increase in payables to related parties for
items which were obtained from third party vendors in the prior year, (v) an increase in income taxes payable of $195,000 as the tax payments were less than the tax provision for the twelve months ended January 31, 2008 and (vii) a
decrease in amounts due from related parties of $2,965,000 primarily due to non-cash payment from related parties of $4,738,000. The cash used in operating activities was offset by cash provided of $14,740,000. The components



45



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of cash provided are (a) net income of $3,347,000, which consists of (i) the gross loss of $63,860,000, (ii) depreciation of $135,000,
(iii) amortization of intangible assets of $1,887,000, (iv) amortization of debt discount of $4,352,000, (v) increase in allowance for customer chargebacks and trade discounts of $394,000, (vi) increase in allowance for doubtful
accounts of $94,000, decrease in deferred taxes of $2,471,000, (viii) non-cash stock compensation of $109,000, (x) loss on Mexican inventory of $2,480,000, (xi) loss on impairment of goodwill and intangible assets of $61,850,000,
(xii) issuance of restricted stock units to our directors valued at $60,000 and (xiii) amortization of deferred financing costs of $50,000, partially offset by a gain on extinguishment of debt of $1,733,000, (b) a decrease in due from
factor of $11,195,000 as our factoring agreement was cancelled and replaced by the Comerica Bank credit facility and (c) an increase in accrued expenses of $216,000 mainly due to an increase in finished goods in transit.

Net cash provided by our operating activities for the year 2006 was $7,490,000. Gross cash provided by operating activities amounting to $14,521,000 was
comprised of (i) our net income of $5,558,000, which included cash provided by depreciation of $132,000, amortization of intangible assets of $1,938,000, amortization of debt discount of $2,268,000, deferred income tax provision of $1,686,000,
non-cash stock compensation of $149,000 and write-off of leasehold improvements of $27,000, partially offset by cash used, which included our net loss of $158,000, a decrease in allowance for customer chargebacks and trade discounts of $452,000 and
a reversal of prior period income tax reserves of $32,000, (ii) a decrease in due from factor of $6,137,000, which was mainly due to a decrease in sales in the fourth quarter 2006 as compared to the fourth quarter of 2005, (iii) a decrease
in inventories of $2,552,000 which reflects less denim finish garments and less non-denim fabric, (iv) a decrease in other receivables and prepaid expenses of $131,000, which was mainly caused by a decrease in prepaid personnel costs,
(v) an increase in income taxes payable of $139,000 which reflects higher taxes due for 2006 as compared to 2005, and (vi) an increase in accrued expenses of $4,000. The gross cash provided by operations was partially offset by gross cash
used in operations totaling $7,031,000, consisting of (a) an increase in non-factored trade receivables of $1,551,000 caused by an increase in trade receivables from American Eagle Outfitters (b) an increase in due from related parties of
$4,487,000 due to amounts advanced under the Supply Agreement of $5,041,000 and a decrease in amounts payable to First Finish, Inc. of $32,000 partially offset by an increase in the fees due on the restrictive covenant and earn-out agreements of
$586,000 and (c) a decrease in accounts payable of $993,000, which was principally caused by a decrease in the amounts due to our fabric vendors.

Cash used in investing activities for the year 2007 of $179,000 consisted of expenditures incurred in connection with the purchase of computers of $73,000 and leasehold improvements of $106,000.

Cash used in investing activities for the year 2006 of $414,000 consisted of expenditures incurred in connection with the purchase of the Acquired
Business from Diversified Apparel of $250,000 and the Innovo Acquisition of $110,000 and the purchase of computers of $54,000.

Cash
provided by financing activities for the year 2007 of $3,806,000 consisted of the proceeds from the short-term borrowings of $52,345,000, repayments of short-term borrowings of $42,551,000, the advances from the factor of $30,024,000, repayments to
the factor of $39,566,000, proceeds from the issuance of common stock of $3,664,000, and costs incurred in connection with the issuance of common stock of $110,000.

The financing activities for the year 2006 of $6,344,000 consisted of cash received of $1,000 from the exercise of stock options, advances from the factor of $86,928,000 and repayment of advances to the factor of
$93,273,000.

We intend to finance our operations for the next twelve months through the use of operating profits, borrowings under our
Comerica Bank revolving credit facility, loans from third parties, extended payment terms with our vendors and the sale of our stock.

Our
financial performance for the next twelve months will depend on a variety of factors, principally the amount of sales to JC Penney and, Kohls, our cost of goods sold and our ability to raise capital. If we have



46



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significant operating losses, we could face severe liquidity pressures, which would adversely affect our financial condition and results of operations and
cash flows. We have in the past incurred costs in restructuring our operations due to the loss of customers and could incur additional costs in the future associated with the restructuring of our operations. We believe that we will have sufficient
working capital to support our business for the next twelve months if our assumptions regarding our anticipated operating profits are correct, credit is available to us on reasonable terms, and we obtain loans from third parties. We are also
currently seeking extended payment terms with our vendors.

Secured Subordinated Promissory Note (Note)

In connection with the acquisition of Diversified Apparel, we issued a secured subordinated promissory note to Diversified Apparel, a related party. The
maturity date of the Note was April 30, 2012. The Note bears interest at 4.7% per annum, compounded annually. Quarterly interest and principal payments on the Note commenced on October 31, 2006. After giving effect to the conversion
of $7,500,000 principal amount of the Note into common stock as described below under Note Conversion Agreement, the principal amount of the Note was payable as follows: (i) ten quarterly payments of $1,500,000 commencing on October 31,
2006; and (ii) ten quarterly payments of $2,500,000 commencing on April 30, 2009, with the final payment to be made on July 31, 2011.

Prior to the transfer of the Note by Diversified Apparel to an at the time unrelated third party with an effective date of November 1, 2006, our obligations under the Note were secured by a pledge of the
trademarks purchased by us under the Agreement, pursuant to a Security Agreement entered into with Diversified Apparel. The Note Transfer Agreement is described below.

Note Conversion Agreement

On January 3, 2006, we and Diversified Apparel entered into a Note
Conversion Agreement providing for the conversion of $7,500,000 principal amount of the Note issued to Diversified Apparel into 1,428,571 shares of our common stock at the rate of $5.25 per share. Accordingly, we canceled the principal payments due
October 31, 2011, January 31, 2012 and April 30, 2012. In connection with the conversion of the $7,500,000 of the Note, the amortization of the debt discount was increased by approximately $2,063,000 which represented the
pro-rata unamortized discount.

On October 31, 2006, we made a principal payment of $1.5 million due on the Note through reduction of
the amounts owed by Diversified Apparel.

Note Transfer Agreement

Effective November 1, 2006, Diversified Apparel transferred the Note to Mr. Serge Kraif, a third party not related to us at the time of transfer. Effective January 31, 2007, we entered into an agreement
with Mr. Kraif (the Conversion Agreement) which our stockholders approved on August 9, 2007, pursuant to which:



| |  |  | we issued 8,800,000 shares of our common stock to Mr. Kraif in payment of $22.0 million of the Note;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | we issued a convertible note in the principal amount of $15.0 million (the Convertible Note) that is convertible into shares of our common stock at a
conversion price of $3.50 per share in payment of $15.0 million of the Note; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we issued to Mr. Kraif a warrant to purchase up to 4,400,000 shares of our common stock at a price of $3.00 per share (the Warrant).
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------

The total value of our common stock, the Convertible Note and warrant issued to Mr. Kraif on August 9, 2007
was approximately $28.3 million.

In addition, effective January 31, 2007, Mr. Kraif agreed that (i) the $1.5 million
principal payment on the Note originally due January 31, 2007 would be postponed and paid by Cygne from time to time when it had



47



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available funds and (ii) all accrued but unpaid interest at January 31, 2007 was waived. The holder of the Note also has waived the interest
payment due from February 1 through August 9, 2007. As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $1.5 million principal payment on the Note originally due on January 31, 2007. This payment was
offset against related party receivables.

On August 9, 2007, the shareholders approved the Note conversion which resulted in the gain
on extinguishment of the Note of $1,733,000. The gain was determined by the change between the carrying value of the Note against the fair value of the Convertible Note of $11,380,000 and the fair value of the warrants of $3,248, 000. The fair value
of the warrant was determined using the closing price of the common stock on August 9, 2007, the date that the Conversion Agreement was approved by the stockholders, using the Black-Scholes option pricing model with the following assumptions:
stock price at the approval date of the Conversion Agreement of $1.54; exercise price of $3.00; term of 5 years; volatility factor of 71.2%; dividend yield of zero; discount rate of 4.64%.

The Convertible Note bears interest at the annual rate of 4.7%. Twenty-four (24) quarterly principal payments of $625,000 will be payable on the
Convertible Note beginning April 30, 2008 and ending on the maturity date of January 31, 2014. Interest will be paid quarterly on the principal balance outstanding prior to the quarterly principal payment. Any principal outstanding on the
Convertible Note will be convertible at the conversion price of $3.50 a share. We, at our option, may prepay the principal balance outstanding at any time with payment discount rates ranging from 24.19% if prepayment occurred before January 31,
2008 declining to 3.43% if payment occurs between February 1, 2013 and January 31, 2014. The Convertible Note is subordinated to borrowings from Comerica Bank.

The Warrant is exercisable at any time and from time to time between February 15, 2009 and January 31, 2012.

As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $625,000 principal payments on the Convertible Note due April 30, 2008, July 31, 2008 and October 31, 2008
totaling $1,875,000. As of October 31, 2007, Diversified Apparel agreed to accept $1,422,000 in exchange for immediate payment of these three payments which was offset against related party receivable.

As of January 31, 20008, Mr. Serge Kraif assigned to Diversified Apparel the $625,000 principal payments on the Convertible Note due
January 31, 2009, April 30, 2009, July 31, 2009, October 31, 2009, January 31, 2010, April 30, 2010, July 31, 2010, October 31, 2010, January 31, 2011, and
April 30, 2011, totaling $6,250,000. As of January 31, 2008, Diversified Apparel agreed to accept $4,738,125 in exchange for immediate payment of these ten payments, which was offset against the related party receivable.

In addition, Mr. Serge Kraif has waived all the accrued but unpaid interest for the period of August 9, 2007 through January 31, 2008 of
approximately $316,000.

All shares of our common stock issued pursuant to the Conversion Agreement, upon conversion of the Convertible
Note or upon exercise of the Warrant were registered for resale under the Securities Act on January 11, 2008.

Based on a third party
valuation, we determined the fair value of the $15,000,000 Convertible Note. As a result, we recorded a debt discount of $3,620,000 to reduce the carrying value of the $15,000,000 Convertible Note to its face value of $11,380,000. The discount is
being amortized to interest expense over 6.5 years. During the year 2007, $2,856,000 of debt discount amortization was recorded. The normal amortization was $418,000. As a result of the partial prepayment of the Convertible Note at a discount, we
recorded additional debt amortization of $2,438,000.



48



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Secured Revolving Credit Facility

On August 3, 2007, we entered into a $15 million secured revolving credit facility with Comerica Bank (credit facility). The credit facility, which replaced our expired Factoring Agreement with
Milberg Factors, Inc. (Milberg), provides us with a $15 million working capital line of credit, as well as a $2 million stand-by letter of credit in favor of one of our suppliers. We can borrow up to 80% of eligible receivables with a
cap of $15 million. The credit facility terminates on August 31, 2009, although we can terminate it at any time upon 60 days notice and Comerica can terminate at any time upon a default under the credit agreement. Borrowings bear interest at
prime plus 0.25%. Prime rate at January 31, 2008 was 6.0%. The short-term borrowings under this facility were $9,795,000 at January 31, 2008. As security for our obligations under the credit facility, we granted to Comerica Bank a
continuing security interest in substantially all of our property. The Convertible Note is subordinated to borrowings from Comerica Bank.

The revolving credit facility contains customary covenants, including limitations on, or relating to, capital expenditures, liens, indebtedness, investments, mergers, acquisitions, and the payment of dividends and other restricted payments.
The revolving credit facility also contains working capital, net worth and EBITDA requirements as well as a debt to net worth ratio requirement to be monitored on a quarterly basis. As of January 31, 2008, the Company was in default with the
working capital, net worth, EBITDA and debt to net equity ratio requirements. Comerica Bank issued a notice of no action to Cygne regarding the default on the covenants.

On January 31, 2008, $200,000 of the standby letter of credit was outstanding.

On November 7,
2007, we and Comerica Bank amended the credit facility to allow us to borrow from Comerica Bank 50% of eligible finished goods inventory located at our warehouses with maximum borrowings of $1.5 million plus 50% of eligible in-transit inventory with
maximum borrowings of $1 million. This amendment did not increase the credit facilitys cap of $15.0 million.

In March 2008, we and
Comerica Bank amended the credit facility to allow us to borrow from Comerica Bank 15% of all letters of credit issued in our favor with maximum borrowings of $350,000.

On May 5, 2008, we and Comerica Bank amended the credit facility to allow us to borrow from Comerica Bank 70% of eligible finished goods inventory located at our warehouses with maximum borrowings of $1.25
million plus 80% of eligible in-transit inventory with maximum borrowings of $1.5 million for the period May 5, 2008 through June 30, 2008. Effective July 1, 2008, the credit facility reverts back to the prior terms allowing us to
borrow 50% of eligible finished goods inventory located at our warehouses with maximum borrowings of $1.25 million plus 50% of eligible in-transit inventory with maximum borrowings of $1.5 million. The amendment also allows us to borrow from
Comerica Bank 30% of all letters of credit issued in our favor with maximum borrowings of $750,000 for the period May 5, 2008 through June 30, 2008.

Factoring Agreement

From July 31, 2005 through August 2, 2007, we used Milberg for credit administration purposes
pursuant to a factoring agreement (the Factoring Agreement).

Under the Factoring Agreement, we sold to Milberg without
recourse all of our receivables which were acceptable to Milberg. Milberg was responsible for collection, assumed all credit risk, and obtained all of our rights and remedies against our customers for those receivables purchased by Milberg without
recourse. Payment was due from Milberg upon the payment of the receivable to Milberg by our customer less a Milberg reserve for known future chargebacks from all customers plus a special reserve at July 31, 2007.

The factor fees for the year 2007 and 2006 were approximately $182,000 and $479,000, respectively.



49



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Due from factor, net of factor advances and allowances for customer chargebacks and trade discounts, as
shown on the balance sheet at January 31, 2007 is summarized below.



|                                                                                                      |  |                 |       
|----------------------------------------------------------------------------------------------------- |  | --------------- | ------
|                                                                                                      |  | (In thousands) 
|                                                                                                      |  | January 31,2007
|Outstanding factored receivables                                                                      |  | $               | 11,268
|Less, reserve for allowances for chargebacks and trade discounts                                      |  |                 | 1,510 
|                                                                                                      |  |                 |       
|Due from factor, net of reserve for allowances for chargebacks and trade discounts                    |  |                 | 9,758 
|Less, advances from factor                                                                            |  |                 | 9,542 
|                                                                                                      |  |                 |       
|Due from factor net of factor advances and reserve for allowances for chargebacks and trade discounts |  | $               | 216   
|                                                                                                      |  |                 |       

Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments at January 31, 2008 are as follows:



|                                                   |  |                               |            |        |   |            |  |           |         |  |   |          
|-------------------------------------------------- |  | ----------------------------- | ---------- | ------ | - | ---------- |  | --------- | ------- |  | - | ---------
|                                                   |  | Payments Due By Period Within
|                                                   |  | Total                         |            | 1 Year |   | 2-3 Years  |  | 4-5 Years
|Contractual Obligations                            |  |                               |            |        |   |            |  |           |         |  |   |          
|Operating leases (1)                               |  | $                             | 256,000    |        | $ | 254,000    |  | $         | 2,000   |  | $ |         
|Purchase obligations for inventory (2)             |  |                               | 23,668,000 |        |   | 23,668,000 |  |           |        |  |   |         
|Principal payments on Convertible note payable (3) |  |                               | 6,875,000  |        |   |           |  |           |        |  |   | 6,875,000
|Interest payments on Convertible note payable (3)  |  |                               | 1,438,491  |        |   | 320,469    |  |           | 639,168 |  |   | 478,854  
|Employment agreement (4)                           |  |                               | 878,240    |        |   | 702,592    |  |           | 175,648 |  |   |         
|                                                   |  |                               |            |        |   |            |  |           |         |  |   |          
|Total Contractual Obligations                      |  | $                             | 33,115,731 |        | $ | 24,945,061 |  | $         | 816,816 |  | $ | 7,353,854
|                                                   |  |                               |            |        |   |            |  |           |         |  |   |          



|(1) | See Note 12 to the Consolidated Financial Statements for detailed information on operating leases.
|--- | --------------------------------------------------------------------------------------------------

|(2) | As of January 31, 2008, we have outstanding short-term purchase order commitments to non-related parties of approximately $23,668,000. We generally do not make unconditional
purchase commitments for goods and services other than inventory.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | As of January 31, 2008, we have future minimum repayment obligations under a Convertible Note, as detailed in Note 7 to the Consolidated Financial Statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | We have an employment agreement with an officer through April 30, 2009. The officer may receive additional compensation based upon discretionary bonuses approved by the Board
of Directors and an annual cost of living increase for salary. The agreement was terminated on April 25, 2008.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Off-Balance Sheet
Arrangements

We have not created, and we are not party to, any special-purpose or off-balance sheet entities for the purpose of raising
capital, incurring debt or operating our business.

We have entered into various agreements at July 31, 2005, as subsequently amended,
with companies controlled by our second largest shareholder, Hubert Guez.

The Supply Agreement: Prior to July 31, 2007, AZT
International S. de R.L. de C.V. (AZT), an affiliate of Hubert Guez, manufactured on a non-exclusive basis branded and private label denim apparel for us in Mexico at specified gross margins. Pursuant to the Supply Agreement, AZT shipped
its manufactured apparel to the United States and invoiced Diversified Apparel, an affiliate of Hubert Guez. Diversified Apparel invoiced us when products were shipped to our customers. At the end of each month, Diversified Apparel invoiced us for
the apparel it had on hand that we estimated we would ship to our customers in the subsequent month. We renewed



50



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the Supply Agreement for one year until July 31, 2008. We ceased sourcing products from AZT on December 18, 2007. The guarantee of our gross
margins for products manufactured for Target and American Eagle Outfitters (AEO) under the Supply Agreement expired on January 31, 2008.

On July 31, 2007 we purchased from AZT all of the fabric allocated to Cygne production. Starting August 1, 2007, we purchase all of the fabric for the garments to be manufactured for us in the AZT
facilities. In addition, on July 31, 2007, we purchased from Diversified Apparel the entire finished stock inventory located in the warehouse located in Commerce, California, which was not included in the contractual month-end inventory
purchases.

Under the Supply Agreement, we were obligated to advance to Diversified Apparel up to 50% of the amount of purchase orders
outstanding, if Diversified Apparel requests such advance in writing. The repayment terms for the outstanding advances were to deduct the advances from the payments made in connection with future inventory purchases. The apparel purchased under the
Supply Agreement from Diversified Apparel for the years 2007 and 2006 was approximately $32,224,000 and $64,246,000, respectively, of which zero and $992,000 was in inventory at January 31, 2008 and 2007, respectively. There was no inventory
manufactured under the Supply Agreement at January 31, 2008. The purchases for the year 2007 exclude the fabric purchased at July 31, 2007. The decrease in purchases for the year 2007 over 2006 resulted from the transfer of production from
Mexico to the Far East and the reduction in sales volume of the inventory being manufactured in Mexico.

The Distribution Agreement:
Diversified Apparel provides distribution and operating services including building occupancy costs for us. We renewed the Distribution Agreement, which had an expiration date of July 31, 2007, for a one-year period until July 31, 2008.
The distribution agreement cost for the year ended January 31, 2008 and 2007 was $2,493,000 and $2,934,000, respectively. Cygne and Diversified Apparel cancelled this agreement effective February 1, 2008. In addition, the cost of the
packing materials purchased from Diversified Apparel for the year 2007 was $248,000 compared to $284,000 for 2006. All amounts are included in Selling, General and Administrative expenses in the statement of operations.

Pursuant to the Distribution Agreement, we purchased all of our denim apparel manufactured outside of Mexico from Diversified Apparel. Diversified
Apparel received this apparel in its United States warehouse and at the end of each month Diversified Apparel invoiced us for the apparel it had on hand that we estimated that it would ship to its customers in the subsequent month.

On July 31, 2007, we purchased from Diversified Apparel the entire finished stock inventory located in the warehouse located in Commerce, California
which was not included in the contractual month-end inventory purchases. We are now invoiced by Diversified Apparel for all finished garment inventory on the date that the finished garments are delivered to the warehouse. Effective December 5,
2007, we notified Diversified Apparel that all our Far East purchase orders to Diversified Apparel would be cancelled and replaced by purchase orders made directly with our Far East vendors.

Under the Distribution Agreement, prior to December 5, 2007, we were obligated to advance to Diversified Apparel up to 50% of the amount of purchase
orders outstanding, if Diversified Apparel requested such advance in writing. The repayment terms for the outstanding advances were to deduct the advances from the payments made in connection with future inventory purchases.

The apparel purchased from Diversified Apparel under the Distribution Agreement for the years 2007 and 2006 was approximately $26,459,000 and
$19,462,000, respectively, of which approximately zero and $664,000, is in inventory at January 31, 2008 and January 31, 2007, respectively.

At January 31, 2008 and January 31, 2007, outstanding advances to Diversified Apparel under all agreements were approximately zero and $7,917,000, respectively.

At January 31, 2008 and January 31, 2007, we had outstanding short-term purchase order commitments to Diversified Apparel, a related party, for
approximately zero and $31,768,000, respectively. In addition, at



51



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January 31, 2008 and January 31, 2007, we had outstanding short-term purchase order commitments to non-related third parties of approximately
$23,668,000 and $545,000. The decrease in purchase order commitments to Diversified Apparel and the corresponding increase in purchase orders to non-related third parties was caused by our decision to source garments directly from the Far East
vendors.

We guaranteed payment to American Eagle Outfitters for purchases of fabric made by AZT, a related party, from Cone Denim LLC to
fulfill purchase orders from American Eagle Outfitters for finished product. The guarantee limit was $3,500,000 and was valid for fabric purchases made through July 31, 2007. The guarantee was terminated at August 19, 2007, when we issued
a $2,000,000 letter of credit to Cone Denim LLC. On January 31, 2008, $200,000 of the standby letter of credit was outstanding.

Effect of New
Accounting Standards

In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections, that applies to all
voluntary changes in accounting principle. This Statement requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects
or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied
to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate
components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to
all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. SFAS 154 will be effective for us for the fiscal year ended January 31, 2008. The
adoption of SFAS No. 154 did not have an impact on our financial condition, results of operations or cash flows.

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 a
companys financial statements and 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. The Interpretation also
provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

We
adopted FIN 48 on February 1, 2007. On the date of adoption there was no impact on our financial statements pertaining to FIN 48. We had no uncertain positions other than the Guatemalan issues noted below and accordingly no unrecognized tax
benefits. We recognize interest and penalties, if any, as part of the provision for income taxes in our Consolidated Statements of Operations.

We are a Delaware corporation and file a Federal Income Tax Return as well as tax returns in the following jurisdictions: California, New York State and New York City. Beginning in 2002, a newly formed Guatemalan subsidiary began filing a
separate Guatemala income tax return. This subsidiary has been granted a tax holiday to December 31, 2012. Another Guatemalan subsidiary, which is now dormant, had been granted a tax holiday which expired on December 31, 2001. A third
Guatemalan subsidiary has no tax holiday and its first tax return was filed for the year ended December 31, 1993.

On March 11,
2008, the Internal Revenue Service (IRS) informed Cygne that it would commence an audit of Cygnes federal tax return for the tax period January 31, 2007; the Company is not currently undergoing any other United States tax
examinations. In 2001, the Guatemalan Internal Revenue Service commenced an audit of the Guatemalan tax returns filed by JMB Internacional, S.A., the Companys 100% owned Guatemalan subsidiary, for its taxable years 1998, 1999, and 2000. The
Guatemalan tax authorities are examining the tax returns of the dormant subsidiary cited above that had been granted a tax holiday, but JMB Internacional, S.A.



52



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was assessed an income tax under a different Guatemala statute. The Company protested this tax and did not pay the tax. However, the Company has established
a reserve for this contingent liability in the amount of $470,000 and has included this reserve on the balance sheet under Income Taxes Payable as of January 31, 2008. The IRS has completed its examinations for the Federal income tax returns
for the tax years January 31, 1985 through January 31, 1996. New York State has completed its examinations for the tax years January 31, 1985 through January 31, 2000. New York City has completed its examinations for the tax
years January 31, 1985 through January 31, 2002.

In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 (SFAS No. 157), Fair Value Measurements, which establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measurements. SFAS
No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. This statement becomes effective for our annual reporting period that begins February 1, 2008. FASB Staff Position FAS
157-2 delays the effective date of SFAS No. 157 for all non-recurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning November 15, 2008. We do not anticipate that the adoption of
SFAS No. 157 will have a material impact on our financial condition, results of operations or cash flows.

In February 2007, the FASB
issued Statement of Financial Accounting Standards Board No. 159 (SFAS No. 159), The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides companies with an option to report
selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and
liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. This statement becomes effective for our annual reporting period that begins February 1, 2008. We do not anticipate that the adoption of SFAS
No. 159 will have an impact on our financial condition, results of operations or cash flows.

In December 2007, the FASB issued SFAS
No. 141 (Revised 2007), Business Combinations(SFAS 141R). SFAS 141R provides additional guidance on improving the relevance, representational faithfulness, and comparability of the financial information that a reporting
entity provides in its financial reports about a business combination and its effects. SFAS 141R applies prospectively to business combination for which the acquisition date is on or after the beginning of the first annual reporting period beginning
after December 15, 2008. We have not yet determined the impact, if any, that the implementation of SFAS No. 141R will have on our results of operations or financial condition as a result of any acquisitions we may consummate.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements(SFAS 160). SFAS
160 applies to all entities that prepare consolidated financial statements and have an outstanding controlling interest in one or more subsidiaries. SFA 160 amends ARB No. 51 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We are in the process of evaluating the effect that the adoption of this standard
will have on our financial statements.

Inflation

We do not believe that the relatively moderate rates of inflation which have been experienced in the United States, where we compete, have had a significant effect on our net sales or profitability.



53



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|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

We are not a party to any derivative financial instruments. We are subject to changes in the prime rate based on the Federal Reserve actions and general market interest fluctuations. We believe that moderate interest rate increases will not
have a material adverse impact on our results of operations, or financial position, in the foreseeable future. For 2007, factor advances and/or bank loans peaked at $12,248,000 and the average amount of factor advances and bank loans were
$10,512,000. An increase of 1% in the interest rate would have increased our interest expense for factor advances and bank loans by approximately $105,000 in the year ended January 31, 2008.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

See
page F-1 for a listing of the consolidated financial statements submitted as part of this annual report.



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

On May 17, 2007, we dismissed Ernst & Young LLP (E & Y) as our independent registered public accounting firm. On the
same date, we engaged Mahoney Cohen & Company, CPA, P.C. (MC) as the Companys independent registered public accounting firm. The decision to change independent registered public accounting firms and the appointment of the
new independent registered public accounting firm was made by the audit committee of our board of directors.

The audit reports of E&Y
on our consolidated financial statements as of and for the fiscal year ended January 31, 2006 and January 31, 2007 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit
scope or accounting principles.

During our fiscal years ended January 31, 2006 and January 31, 2007 and in the subsequent
interim period through May 17, 2007, there were no disagreements between us and E&Y on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to
E&Ys satisfaction, would have caused E&Y to make reference to the subject matter of the disagreement in connection with its reports. There were no reportable events as that term is described in Item 304 (a)(1)(v) of
Regulation S-K, except for material weaknesses reported by management in Item 9A on its January 31, 2006 Annual Report on Form 10-K/A filed December 20, 2006 and its January 31, 2007 Annual Report on Form 10-K filed May 1,
2007. These reports indicate that we did not maintain effective internal controls over financial reporting relating to accounting for our factoring agreement, income taxes and cash receipts and disbursements in the Guatemala subsidiary during the
last two fiscal years ended January 31, 2007. Cygnes Audit Committee discussed the material weaknesses with E & Y and we have authorized E & Y to respond fully to the Companys new accountants concerning the material
weaknesses.



|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------

Conclusion Regarding
the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC,
and that such information is accumulated and communicated to our management timely.

Our management is responsible for establishing and
maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. Under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) as of January 31, 2008.



54



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Based upon that evaluation, our management, including our Chief Executive Officer and our Chief Financial
Officer, has concluded that our internal control over financial reporting was not effective as of January 31, 2008 due to the material weakness described below. A material weakness is a deficiency, or a combination of deficiencies, in internal
control over financial reporting, that results in a more than remote possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

Managements assessment identified the following material weakness in internal control over financial reporting as of January 31, 2008:

Our internal controls over the calculation of accounting adjustments related to the write-down of revenue, cost of sales and gross profit
for the loss sustained with our related party in Mexico were not effective. The lack of effective controls resulted in a material error in the accounting for lost gross profit, lost due to problems at AZT, our related party manufacturer in Mexico.
The error was identified by our external auditors, causing a material audit adjustment which would not have been otherwise identified before being published in the annual filing of the 10-K. As a result, management concluded that this internal
control deficiency constitutes a material weakness in internal control over financial reporting because there is a reasonable possibility that a material misstatement of the annual financial statements would not have been prevented or detected on a
timely basis.

We are currently reviewing our remediation process for the material weakness described above. We may conclude to take one or
more of the following actions:

i. Clearly define roles and responsibilities throughout the accounting/finance organization;

ii. Conducting a review of accounting processes to strengthen the design and operation of controls;

iii. Implement policies to ensure the accuracy of accounting calculations supporting the amounts reflected in our financial statements

These remediation plans will be implemented during the second and third quarters of fiscal 2008. The material weakness will not be considered remediated
until the applicable remedial procedures operate for a period of time, such procedures are tested and management has concluded that the procedures are operating effectively.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during our most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect, our internal control over financial reporting.



55



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PART III



|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------

Directors

The section entitled Proposal No. lElection of Directors in the Companys Proxy Statement for the Annual Meeting
of Stockholders is incorporated herein by reference.

Executive Officers of the Registrant

Our executive officers are as follows:



|                  |  |     |  |                                                                        
|----------------- |  | --- |  | -----------------------------------------------------------------------
|Name              |  | Age |  | Position with the Company                                              
|Bernard M. Manuel |  | 60  |  | Director and Chairman of the Board                                     
|Jay Furrow        |  | 34  |  | President and Chief Executive Officer                                  
|Roy E. Green      |  | 75  |  | Senior Vice President-Chief Financial Officer, Treasurer, and Secretary

Bernard M. Manuel currently serves as the Chairman of the Board and a director. Mr. Manuel
served as our Chief Executive Officer from October 1988, when he joined us, until April 25, 2008, and has served in several additional executive positions since he joined us. Mr. Manuel is a director of several private companies in the
U.S. and Europe. From 1983 until he joined the Company, Mr. Manuel was involved, through Amvent, a company he founded, in the transfer of technology between Europe and the U.S. and related venture capital and merger and acquisition activities,
as well as in the apparel industry. Mr. Manuel earned a Bachelors of Science in Mathematics and several graduate degrees in Mathematics and in Economics from the University of Paris, an M.S. in Political Science from the Institute
dEtudes Politiques in Paris and an M.B.A. with high honors (Baker Scholar) from the Harvard Business School, where he was awarded both the Loeb Rhodes Fellowship for excellence in finance and the Melvin T. Copeland prize for top
performance in marketing.

Jay Furrow joined us as President and Chief Executive Officer on April 25, 2008. He is a principal in the
Furrow Realty Fund, LP, a real estate fund focused on investing in commercial and industrial real estate. Additionally, Mr. Furrow is a founder of and on the board of Regents Secret, Inc., an online fashion retailer, where he has served
as chief executive officer and as chairman of the Board of Directors since its inception in May 2007. Since January 2006, Mr. Furrow has served as managing member and founder of JFJ Holdings LLC, a private equity company. From July 2002 until
January 2006, Mr. Furrow served as Chief Executive Officer, from December 2000 until July 2002 as President, and from April 1999 until March 2003 as Chief Operating Officer of Joes Jeans Inc. (JOEZ), a publicly traded apparel company, in
addition to serving as a member of its Board of Directors from 1999 until July 2007. Mr. Furrow received his J.D. degree from Southern Methodist University School of Law and his B.S. degree in Political Science from Vanderbilt University.

Roy E. Green has served as Chief Financial Officer of the Company, as well as in various additional executive capacities, since October
1987. He currently serves as our Senior Vice President-Chief Financial Officer, Treasurer and Secretary. From 1974 until he joined us, Mr. Green was employed by Cluett Peabody & Co., first as the Chief Financial Officer of its Arrow
Co. division until 1979, then as Vice President and Controller until 1985, and finally as Chief Financial Officer. He has also worked as a certified public accountant for J. K. Lasser & Co. and Hurdman & Cranston. Mr. Green
received a Bachelors degree in Business Administration from Rutgers University. Mr. Green is a certified public accountant.

Code of Ethics

We have adopted a code of ethics applicable to our officers, who include our principal executive officer, principal financial officer
and financial professionals. A copy of our code of ethics has been filed with the Securities and Exchange Commission. We undertake to provide to any person without charge, upon request, a copy of our code of ethics. Requests for such copy should be
made in writing to us at our principal office, which is set forth on the first page of this report, attention Corporate Secretary.



56



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Audit Committee and Financial Reports

The information appearing in the Proxy Statement relating to the members of the Audit Committee and the Audit Committee financial expert under the
captions Board Committees and the information appearing in the Proxy Statement under the caption Section 16(a) Beneficial Ownership Reporting Compliance is incorporated herein by this reference.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The section entitled
Executive Compensation in the Companys Proxy Statement for the Annual Meeting of Stockholders is incorporated herein by reference.



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

The section entitled Beneficial Ownership of Common Stock in the Companys Proxy Statement for the Annual Meeting of Stockholders is
incorporated herein by reference.



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

The sections entitled Related Party Transactions Proposal No. lElection of Directors in the Companys Proxy Statement for the Annual Meeting of Stockholders is incorporated herein by
reference.



|ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES
|-------- | --------------------------------------

The
following table sets forth the aggregate fees billed by our registered independent auditors for services rendered to us for the years ended January 31, 2008 (2007) and January 31, 2007 (2006).

No services were performed by, or fees incurred to, Ernst & Young LLP (E & Y) or in connection with financial information
services design and implementation projects during 2006 or 2007. No services were performed by, or fees incurred to, Mahoney Cohen & Company, CPA, P.C. (MC) in connection with financial information services design and
implementation projects during 2006 or 2007. The fees billed by Mahoney Cohen & Company, CPA, P.C., our independent registered public accounting firm in 2007, and Ernst & Young LLP, our prior independent registered public
accounting firm, for audit and other professional services during 2007 and 2006, respectively, are summarized below. The audit committee has considered whether the provision of these services is compatible with maintaining the principal
accountants independence and has concluded that such services are compatible. All fees paid were reviewed and pre-approved by the audit committee.



|                       |  |        |         |           |   |        
|---------------------- |  | ------ | ------- | --------- | - | -------
|                       |  | MC2007 |         | E & Y2006
|Audit fees (1)         |  | $      | 333,000 |           | $ | 535,000
|Audit related fees (2) |  |        | 0       |           |   | 0      
|Tax planning fees      |  |        | 0       |           |   | 3,000  
|All other fees (3)     |  |        | 9,000   |           |   | 0      
|                       |  |        |         |           |   |        
|Total fees             |  | $      | 342,000 |           | $ | 538,000



|(1) | Includes fees in connection with the audit of our annual consolidated financial statements, the filing of a selling stockholder registration statement, the restatement of our Form
10 K and quarterly reports on Form 10-Q, and reviews of our consolidated financial statements included in our Quarterly Reports on Form 10-Q.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Represents fees billed for professional services rendered on general business matters.
|--- | --------------------------------------------------------------------------------------

|(3) | Fees for S-3 SEC filing.
|--- | ------------------------



57



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PART IV



|ITEM 15. | EXHIBIT, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
|-------- | --------------------------------------------------------------

(a). Financial Statements

(1) and (2) See Index to Consolidated Financial Statements and Financial Statements
Schedule on page F-1.

(3). Exhibits



|            |  |                                                                                                                                                                                                                                                                                                                                      
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                          
|2.1         |  | Asset Purchase Agreement, dated as of July 31, 2005, by and among Commerce Clothing Company LLC, Mr. Guez, 215 GZ Partners, Guez Living Trust dated December 6, 1996, Griffin James Aron Guez
Irrevocable Trust dated January 1, 1996, Stephan Avner Felix Guez Irrevocable Trust dated January 1, 1996 and Cygne Designs, Inc. * (1)
|            | 
|2.2         |  | Asset Purchase Agreement, dated as of March 31, 2006, by and among Innovo Azteca Apparel, Inc., Innoco Group, Inc. and Azteca Production International, Inc. and Cygne Designs, Inc. *
(8)                                                                                                                                           
|            | 
|3.1         |  | Restated Certificate of Incorporation of Cygne Designs, Inc.* (1)                                                                                                                                                                                                                                                                    
|            | 
|3.2         |  | Certificate of Amendment of the Restated Certificate Of Incorporation Of Cygne Designs, Inc. * (7)                                                                                                                                                                                                                                   
|            | 
|3.3         |  | Bylaws of Cygne Designs, Inc. * (1)                                                                                                                                                                                                                                                                                                  
|            | 
|3.4         |  | Amendment to Bylaws of Cygne Designs, Inc., effective as of July 31, 2005. * (1)                                                                                                                                                                                                                                                     
|            | 
|3.5         |  | Form of Warrant issued by Cygne Designs, Inc. pursuant to Securities Agreement. * (17)                                                                                                                                                                                                                                               
|            | 
|10.1        |  | Registration Rights Agreement, dated as of July 31, 2005, by and between Commerce Clothing Company LLC and Cygne Designs, Inc. * (1)                                                                                                                                                                                                 
|            | 
|10.2        |  | Subordinated Secured Promissory Note, dated as of July 31, 2005, to Commerce Clothing Company LLC in an original principal amount of $47,500,000 * (1)                                                                                                                                                                               
|            | 
|10.3        |  | Security Agreement, dated as of July 31, 2005, by and between Commerce Clothing Company LLC and Cygne Designs, Inc. * (1)                                                                                                                                                                                                            
|            | 
|10.4        |  | Stock Transfer Restriction Agreement, dated as of July 31, 2005, by and among Commerce Clothing Company LLC, Bernard Manuel and Cygne Designs, Inc. * (1)                                                                                                                                                                            
|            | 
|10.5        |  | Supply Agreement, dated as of July 31, 2005, by and between AZT International S. de R.L. de C.V. and Cygne Designs, Inc. * (1)                                                                                                                                                                                                       
|            | 
|10.6        |  | Restrictive Covenant Agreement, dated as of July 31, 2005, between Mr. Guez and Cygne Designs, Inc. * (1)                                                                                                                                                                                                                            
|            | 
|10.7        |  | Distribution Agreement, dated as of July 31, 2005, by and between Commerce Clothing Company LLC and Cygne Designs, Inc. * (1)                                                                                                                                                                                                        
|            | 
|10.8        |  | Factoring Agreement, dated as of July 31, 2005, by and between Milberg Factors, Inc., and Cygne Designs, Inc. * (1)                                                                                                                                                                                                                  
|            | 
|10.9        |  | Security AgreementGoods and Chattels, dated as of July 31, 2005, by and between Milberg Factors, Inc. and Cygne Designs, Inc. * (1)                                                                                                                                                                                                 
|            | 
|10.10       |  | Security Interest in Inventory Under Uniform Commercial Code Supplement to Financing or Factoring Contract, dated as of July 31, 2005, by and between Milberg Factors, Inc. and Cygne Designs,
Inc. * (1)                                                                                                                            



58



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|            |  |                                                                                                                                                                              
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                  
|10.11       |  | Guaranty, dated as of July 31, 2005, by Cygne Designs, Inc. in favor of Milberg Factors, Inc. * (1)                                                                          
|            | 
|10.12       |  | Client Subordination Agreement, dated as of July 31, 2005, by and between Commerce Clothing Company LLC and Cygne Designs, Inc. * (1)                                        
|            | 
|10.13       |  | Letter Agreement, dated as of July 31, 2005, by and between Roy Green and Cygne Designs, Inc. * (1)                                                                          
|            | 
|10.14       |  | Amendment to Supply Agreement, dated October 19, 2005, among Cygne Designs, Inc., Diversified Apparel Resources, LlC, and AZT International S. de R. L. de C.V. * (3)        
|            | 
|10.15       |  | Amendment to Registration Rights Agreement dated October 19, 2005, between Cygne Designs, Inc. and Diversified Apparel Resources, LLC. * (3)                                 
|            | 
|10.16       |  | Lease between Blue River Associates, landlord and Cygne Designs, Inc. * (4)                                                                                                  
|            | 
|10.17       |  | Second Amendment to Supply Agreement, dated December 9, 2005, among Cygne Designs, Inc., Diversified Apparel Resources, LLC, and AZT International S. de R. L. de C.V. * (4) 
|            | 
|10.18       |  | Amendment to the Distribution Agreement, dated December 9, 2005, between Cygne Designs, Inc. and Diversified Apparel Resources, LLC * (4)                                    
|            | 
|10.19       |  | Note Conversion Agreement, dated as of January 3, 2006, by and between Cygne Designs, Inc. and Diversified Apparel Resources LLC * (6)                                       
|            | 
|10.20      |  | Cygne Designs, Inc. 2006 Incentive Plan * (7)                                                                                                                                
|            | 
|10.21      |  | Form of Restricted Stock Agreement for Non-Employee Directors under the 2006 Incentive Plan * (7)                                                                            
|            | 
|10.22       |  | Amendment to Factoring Agreement, dated as of July 31, 2005, by and between Milberg Factors, Inc., and Cygne Designs, Inc. * (8)                                             
|            | 
|10.23       |  | Asset Purchase Agreement, dated March 31,2006, by and among Cygne Designs, Inc. Innovo Group, Inc. Innovo Axteca Apparel, Inc. and Azteca Production International* (9)      
|            | 
|10.24       |  | Letter Agreement dated as of April 24, 2006, by and among Cygne Designs, Inc., Azteca Production International, Inc., Hubert Guez, Paul Guez and Sweet Sportswear, LLC * (10)
|            | 
|10.26       |  | Third Amendment to Supply Agreement, dated April 27, 2006, among Cygne Designs, Inc., Diversified Apparel Resources, LLC, and AZT International S. de R. L. de C.V. * (12)   
|            | 
|10.27       |  | Second Amendment to the Distribution Agreement, dated April 27, 2006, between Cygne Designs, Inc. and Diversified Apparel Resources, LLC * (12)                              
|            | 
|10.28       |  | Fourth Amendment to Supply Agreement, dated August 1, 2006, among Cygne Designs, Inc., Diversified Apparel Resources, LLC, and AZT International S. de R. L. de C.V. * (13)  
|            | 
|10.29       |  | Third Amendment to the Distribution Agreement, dated August 1, 2006, between Cygne Designs, Inc. and Diversified Apparel Resources, LLC * (13)                               
|            | 
|10.30       |  | Amendment to Factoring Agreement, dated as of July 31, 2006, by and between Milberg Factors, Inc., and Cygne Designs, Inc. * (13)                                            
|            | 
|10.31       |  | Amendment to Factoring Agreement, dated as of September 30, 2006, by and between Milberg Factors, Inc., and Cygne Designs, Inc. * (14)                                       
|            | 
|10.32       |  | Waiver to Factoring Agreement, dated as of October 31, 2006, by and between Milberg Factors, Inc., and Cygne Designs, Inc. * (14)                                            
|            | 
|10.33       |  | Waiver to Factoring Agreement, dated as of January 31 2007, by and between Milberg Factors, Inc., and Cygne Designs, Inc. * (15)                                             



59



---

|            |  |                                                                                                                                                                                    
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                        
|10.34       |  | Note Conversion Agreement, dated as of January 31, 2007, by and between Cygne Designs, Inc. and Serge Kraif * (16)                                                                 
|            | 
|10.35       |  | Fifth Amendment to Supply Agreement dated June 12, 2007, among Cygne Designs, Inc., Diversified Apparel Resources, LLC * (16)                                                      
|            | 
|10.36       |  | Loan and Security Agreement, dated as of July 30, 2007, by and between Cygne Designs, Inc. and Comerica Bank. * (17)                                                               
|            | 
|10.37       |  | Master Revolving Note, dated as of July 30, 2007, made by Cygne Designs, Inc. in favor of Comerica Bank * (17)                                                                     
|            | 
|10.38       |  | Form of Warrant issued by Cygne Designs, Inc. pursuant to the Securities Purchase Agreement * (17)                                                                                 
|            | 
|10.39       |  | Form of Securities Purchase Agreement, dated as of August 3, 2007, between Cygne Designs, Inc. and each of the purchasers of the Private Investment in Public Equity. * (17)       
|            | 
|10.40       |  | Note Conversion Agreement, dated as of January 31, 2007, by and between Cygne Designs, Inc. and Serge Kraif, including the form of convertible note and form of warrant. * (18)    
|            | 
|10.41       |  | Amended and Restated Inventory Rider to Loan and Security Agreement with Comerica Bank dated as of November 7, 2007. * (18)                                                        
|            | 
|10.42       |  | Third modification to Loan and Security Agreement dated as of August 27,2007, with Comerica Bank * (20)                                                                            
|            | 
|10.43       |  | Memorandum of Understanding between Shipson, LLC and Cygne Designs, Inc. dated November 14, 2007 concerning fees for use of facilities at 4900 Zambrano Street, Commerce, CA *
(20)
|            | 
|10.46       |  | Amended and Restated Employment Agreement, dated as of January 1, 1995, between Bernard Manuel and Cygne Designs, Inc.* (21)                                                       
|            | 
|10.47       |  | Letter Agreement, dated April 25, 2008, between Bernard Manuel and Cygne Designs, Inc.* (22)                                                                                       
|            | 
|10.48       |  | Fourth modification to Loan and Security Agreement with Comerica Bank dated as of March 22, 2008 * (20)                                                                            
|            | 
|10.49       |  | Fifth modification to Loan and Security Agreement with Comerica Bank dated as of May 5, 2008 * (20)                                                                                
|            | 
|10.50       |  | Second Amended and Restated Inventory Rider to Loan and Security Agreement with Comerica Bank dated as of May 5, 2008. * (20)                                                      
|            | 
|10.51       |  | Consent of Mahoney Cohen & Company, CPA, P.C., Independent Registered Public Accounting Firm dated May 15, 2008* (20)                                                              
|            | 
|10.52       |  | Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm dated May 15, 2008* (20)                                                                               
|            | 
|21.         |  | Subsidiaries of Cygne Designs, Inc. * (20)                                                                                                                                         
|            | 
|31.1        |  | Certification of Chairman of the Board * (20)                                                                                                                                      
|            | 
|31.2        |  | Certification of President and Principal Executive Officer * (20)                                                                                                                  



60



---

|            |  |                                                                                                                                                                                           
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                               
|31.3        |  | Certification of Principal Financial Officer * (20)                                                                                                                                       
|            | 
|32.1        |  | Certification of Chairman of the Board pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of the Sarbanes-Oxley Act of 2002 * (20)                                             
|            | 
|32.2        |  | Certification of President and Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of the Sarbanes-Oxley Act of 2002 * (20)                         
|32.3        |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted to Section 906 of the Sarbanes-Oxley Act of 2002 * (20)                                           
|            | 
|99.1        |  | Revised Audit Committee Charter of the Audit Committee of the Board of Directors of Cygne Designs, Inc., adopted by the Board of Directors of the Company on November 29, 2005 *
(5)      
|            | 
|99.2        |  | Charter of the Compensation and Stock Option Committee of the Board of Directors of Cygne Designs, Inc., adopted by the Board of Directors of the Company on November 29, 2005 *
(5)      
|            | 
|99.3        |  | Charter of the Nominating and Corporate Governance Committee of the Board of Directors of Cygne Designs, Inc., adopted by the Board of Directors of the Company no November 29,
2005 * (5)



|* | Previously filed with the Commission as Exhibits to, and incorporated herein by reference from the following documents:
|- | -----------------------------------------------------------------------------------------------------------------------

| | Management Compensation Arrangement
|- | -----------------------------------



|            |  |                                                               
|----------- |  | --------------------------------------------------------------
|Exhibit No. |  | Description                                                   
|(1)         |  | Companys 8-K filed on August 4, 2005                         
|            | 
|(2)         |  | Companys 8-K filed on September 22, 2005                     
|            | 
|(3)         |  | Companys 8-K filed on October 21, 2005                       
|            | 
|(4)         |  | Companys Form 10-Q filed on December 15, 2005                
|            | 
|(5)         |  | Companys 8-K filed on December 5, 2005                       
|            | 
|(6)         |  | Companys 8-K filed on January 5, 2006                        
|            | 
|(7)         |  | Companys 8-K filed on January 26, 2006                       
|            | 
|(8)         |  | Companys Annual Report on Form 10-K filed May 1, 2006        
|            | 
|(9)         |  | Companys 8-K filed on April 6, 2006                          
|            | 
|(10)        |  | Companys 8-K filed on May 17, 2006                           
|            | 
|(11)        |  | Companys 8-K filed on July 27, 2006                          
|            | 
|(12)        |  | Companys Form 10-Q filed on June 14, 2006                    
|            | 
|(13)        |  | Companys Form 10-Q filed on September 14, 2006               
|            | 
|(14)        |  | Companys Form 10-Q filed on December 19, 2006                
|            | 
|(15)        |  | Companys Form 8-K filed on February 15, 2007                 
|            | 
|(16)        |  | Companys Form 10-Q filed on June 14, 2007                    
|            | 
|(17)        |  | Companys Form 8-K filed on August 3, 2007                    
|            | 
|(18)        |  | Companys Form 8-K filed on August 10, 2007                   
|            | 
|(19)        |  | Companys Form 10-Q/A filed on February 23, 2008              
|            | 
|(20)        |  | Filed herewith                                                
|            | 
|(21)        |  | Company Form 10-K filed for fiscal year ended January 28, 1995
|            | 
|(22)        |  | Companys 8-K filed on April 25, 2008                         



61



---

Exhibits have been included in copies of this Report filed with the Securities and Exchange Commission.
Stockholders of the Company will be provided with copies of these exhibits upon written request to the Company.



|(b) | Reports on Form 8-K
|--- | -------------------



|                  |  |           |  |                                                                                                                          
|----------------- |  | --------- |  | -------------------------------------------------------------------------------------------------------------------------
|Date              |  | Item      |  | Event                                                                                                                    
|November 8, 2007  |  | 2.05      |  | Close of manufacturing facility in Guatemala                                                                             
|                  |  |          
|December 21, 2007 |  | 2.02,9.01 |  | Announcement of financial results for the third quarter and nine month period ended October 31, 2007                     
|                  |  |          
|January 14, 2008  |  | 3.01      |  | NASDAQ notice of potential delisting of Cygne common stock if bid price doesnt meet NASDAQ requirements by July 14, 2008

(c) Exhibits

See (a) (3) above.

(d) Financial Statement Schedule

See Index to Consolidated Financial Statements and Supplemental Schedule appearing on F-1. Schedules not included herein are omitted because they are not applicable or the required information appears in
the Consolidated Financial Statement or notes thereto.



62



---

SIGNATURES

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



Cygne Designs, Inc.(Registrant)By:

/s/    JAY FURROW Jay Furrow(President and Chief Executive Officer)By:

/s/    BERNARD M.
MANUELBernard M. Manuel(Chairman of the Board)


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

KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Bernard M Manuel and Roy E. Green, or either of them, his attorney-in-fact, each with the power of substitution, for him or her in any and all
capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.



|                                             |  |                                                                                                                          |  |             
|-------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------ |  | ------------
|Signature                                    |  | Title                                                                                                                    |  | Date        
|                                             |  |                                                                                                                         
|/s/    BERNARD M.
MANUEL Bernard M. Manuel   |  | Chairman of the Board and Director                                                                                       |  | May 15, 2008
|                                             |  |                                                                                                                         
|/s/    JAY FURROW Jay Furrow                 |  | President and Chief Executive Officer and Director (principal executive officer)                                         |  | May 15, 2008
|                                             |  |                                                                                                                         
|/s/    ROY E. GREEN Roy E. Green             |  | Senior Vice President, Chief Financial Officer, and Treasurer (principal financial and accounting officer) and Secretary |  | May 15, 2008
|                                             |  |                                                                                                                         
|/s/    JAMES G.
GRONINGER James G. Groninger |  | Director                                                                                                                 |  | May 15, 2008
|                                             |  |                                                                                                                         
|/s/    MICHEL COLLET Michel Collet           |  | Director                                                                                                                 |  | May 15, 2008
|                                             |  |                                                                                                                         
|/s/    GUY KINBERG Guy Kinberg               |  | Director                                                                                                                 |  | May 15, 2008



63



---

Cygne Designs, Inc. and Subsidiaries

Consolidated Financial Statements

Index to Consolidated Financial Statements



|                                                                                                                |  |     
|--------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                |  | Page
|                                                                                                                | 
|Reports of Independent Registered Public Accounting Firms                                                       |  | F-2 
|                                                                                                                | 
|Consolidated Balance Sheets as of January 31, 2008 and January 31, 2007                                         |  | F-4 
|                                                                                                                | 
|Consolidated Statements of Operations for Each of the ThreeYears in the Period Ended January 31, 2008           |  | F-5 
|                                                                                                                | 
|Consolidated Statements of Stockholders EquityFor Each of the Three Years in the Period Ended January 31, 2008 |  | F-6 
|                                                                                                                | 
|Consolidated Statements of Cash Flows for Each of the Three YearsIn the Period Ended January 31, 2008           |  | F-7 
|                                                                                                                | 
|Notes to Consolidated Financial Statements                                                                      |  | F-9 
|                                                                                                                | 
|Financial ScheduleSchedule II                                                                                   |  | F-41



F-1



---

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Cygne Designs, Inc.

We have audited the accompanying consolidated balance
sheet of Cygne Designs, Inc. and Subsidiaries as of January 31, 2008, and the related consolidated statement of operations, stockholders equity and cash flows for the year then ended. Our audit also included the financial statement
schedule listed in the Index on page F-1 for the year ended January 31, 2008. These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on
these financial statements and financial statement schedule based on our audits.

We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an
audit of the Companys internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated
financial position of Cygne Designs, Inc. and Subsidiaries as of January 31, 2008, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ MAHONEY COHEN & COMPANY, CPA, P.C.

New York, New York

May 15, 2008



F-2



---

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Cygne Designs, Inc.

We have audited the accompanying consolidated balance sheet of Cygne Designs, Inc. and Subsidiaries as of January 31, 2007, and the related consolidated statement of
operations, stockholders equity and cash flows for each of the two years in the period ended January 31, 2007. Our audits also included the financial statement schedule listed in the Index on page F-1 for the years ended January 31, 2007 and
2006. . These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our
audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Companys internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cygne Designs,
Inc. and Subsidiaries as of January 31, 2007, and the consolidated results of their operations and their cash flows for the year ended January 31, 2007 and 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

Los Angeles,
California

April 25, 2007



F-3



---

Cygne Designs, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share and per share amounts)



|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                                                           |  | January 31, |         
|                                                                                                                                                                                                           |  | 2008        |          |   | 2007 |  
|Assets                                                                                                                                                                                                     |  |             |          |   |      |   |          |  
|Current assets:                                                                                                                                                                                            |  |             |          |   |      |   |          |  
|Cash                                                                                                                                                                                                       |  | $           | 128      |   |      | $ | 1,709    |  
|Trade accounts receivable, net of reserve for allowances for customer chargebacks and trade discount of $1,831 and allowance for doubtful
accounts of $94 at January 31, 2008 and zero at January 31, 2007 |  |             | 9,921    |   |      |   | 1,621    |  
|Due from factor, net of reserve for allowances for customer chargebacks and trade discounts of $1,510 at January 31, 2007                                                                                  |  |             |         |   |      |   | 9,758    |  
|Due from related parties*                                                                                                                                                                                  |  |             | 6,392    |   |      |   | 7,917    |  
|Inventories                                                                                                                                                                                                |  |             | 2,849    |   |      |   | 1,937    |  
|Marketable securities                                                                                                                                                                                      |  |             | 25       |   |      |   | 65       |  
|Other receivables and prepaid expenses                                                                                                                                                                     |  |             | 396      |   |      |   | 175      |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Total current assets                                                                                                                                                                                       |  |             | 19,711   |   |      |   | 23,182   |  
|Property, plant and equipment, net                                                                                                                                                                         |  |             | 663      |   |      |   | 619      |  
|Intangible assets, net of accumulated amortization and impairment of $7,370 at January 31, 2008 and accumulated amortization of $2,832 at
January 31, 2007                                                 |  |             |         |   |      |   | 4,537    |  
|Goodwill                                                                                                                                                                                                   |  |             | 13,677   |   |      |   | 72,877   |  
|Other Assets                                                                                                                                                                                               |  |             | 207      |   |      |   | 68       |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Total assets                                                                                                                                                                                               |  | $           | 34,258   |   |      | $ | 101,283  |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Liabilities and Stockholders Equity                                                                                                                                                                       |  |             |          |   |      |   |          |  
|Current liabilities:                                                                                                                                                                                       |  |             |          |   |      |   |          |  
|Short-term bank borrowings                                                                                                                                                                                 |  | $           | 9,794    |   |      | $ |         |  
|Advances from factor                                                                                                                                                                                       |  |             |         |   |      |   | 9,542    |  
|Current portion of long term note payable                                                                                                                                                                  |  |             |         |   |      |   | 4,715    |  
|Accounts payable*                                                                                                                                                                                          |  |             | 5,045    |   |      |   | 8163     |  
|Due to related parties*                                                                                                                                                                                    |  |             |         |   |      |   | 98       |  
|Accrued expenses                                                                                                                                                                                           |  |             | 1,199    |   |      |   | 982      |  
|Income taxes payable                                                                                                                                                                                       |  |             | 869      |   |      |   | 692      |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                                                  |  |             | 16,907   |   |      |   | 24,192   |  
|Secured subordinated promissory note payable                                                                                                                                                               |  |             |         |   |      |   | 25,202   |  
|Subordinated convertible note payable                                                                                                                                                                      |  |             | 6,111    |   |      |   |         |  
|Deferred taxes                                                                                                                                                                                             |  |             |         |   |      |   | 2,471    |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Total liabilities                                                                                                                                                                                          |  |             | 23,018   |   |      |   | 51,865   |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|                                                                                                                                                                                                           |  |            
|Commitments and contingencies                                                                                                                                                                              |  |             |          |   |      |   |          |  
|                                                                                                                                                                                                           |  |            
|Stockholders equity:                                                                                                                                                                                      |  |             |          |   |      |   |          |  
|Preferred Stock, $0.01 par value; 1,000,000 shares authorized: none issued and outstanding                                                                                                                 |  |             |         |   |      |   |         |  
|Common Stock, $0.01 par value; 100,000,000 shares authorized: 37,917,682 and 26,462,109 shares issued and outstanding, at January 31,
2008 and January 31, 2007, respectively                              |  |             | 379      |   |      |   | 265      |  
|Paid-in capital                                                                                                                                                                                            |  |             | 194,209  |   |      |   | 168,601  |  
|Accumulated other comprehensive (loss) income                                                                                                                                                              |  |             | (15      | ) |      |   | 25       |  
|Accumulated deficit                                                                                                                                                                                        |  |             | (183,333 | ) |      |   | (119,473 | )
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Total stockholders equity                                                                                                                                                                                 |  |             | 11,240   |   |      |   | 49,418   |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                 |  | $           | 34,258   |   |      | $ | 101,283  |  
|                                                                                                                                                                                                           |  |             |          |   |      |   |          |  



|* | Certain reclassifications were made to amounts presented at January 31, 2007 to be consistent with the January 31, 2008 presentation.
|- | -------------------------------------------------------------------------------------------------------------------------------------

See accompanying notes



F-4



---

Cygne Designs, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands except per share amounts)



|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|----------------------------------------------------------------------------- |  | --------------- | ------- | - | --------------- | - | ------- | --------------- |  | - | ------ | -
|                                                                              |  | Year Ended      |        
|                                                                              |  | January 31,2008 |         |   | January 31,2007 |   |         | January 31,2006 | 
|Net sales                                                                     |  | $               | 95,753  |   |                 | $ | 118,816 |                 |  | $ | 58,453 |  
|Cost of goods sold (1)                                                        |  |                 | 79,826  |   |                 |   | 93,342  |                 |  |   | 46,339 |  
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|Gross profit                                                                  |  |                 | 15,927  |   |                 |   | 25,474  |                 |  |   | 12,114 |  
|Selling, general and administrative expenses (1)                              |  |                 | 14,348  |   |                 |   | 16,619  |                 |  |   | 11,174 |  
|Depreciation and amortization                                                 |  |                 | 2,022   |   |                 |   | 2,070   |                 |  |   | 997    |  
|Loss on impairment of goodwill and intangible assets                          |  |                 | 61,850  |   |                 |   |        |                 |  |   |       |  
|Provision for restructuring                                                   |  |                 |        |   |                 |   |        |                 |  |   | 102    |  
|Gain on extinguishment of debt                                                |  |                 | (1,733  | ) |                 |   |        |                 |  |   |       |  
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|(Loss) income from operations before interest, other expense and income taxes |  |                 | (60,560 | ) |                 |   | 6,785   |                 |  |   | (159   | )
|Interest income                                                               |  |                 | (18     | ) |                 |   |        |                 |  |   | (22    | )
|Interest expense including amortization of debt discounts (1)                 |  |                 | 5,359   |   |                 |   | 5,033   |                 |  |   | 5,034  |  
|Other expense                                                                 |  |                 |        |   |                 |   |        |                 |  |   | 175    |  
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|(Loss) income from operations before income taxes                             |  |                 | (65,901 | ) |                 |   | 1,752   |                 |  |   | (5,346 | )
|(Benefit) provision for income taxes                                          |  |                 | (2,041  | ) |                 |   | 1,910   |                 |  |   | 820    |  
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|Net (loss)                                                                    |  | $               | (63,860 | ) |                 | $ | (158    | )               |  | $ | (6,166 | )
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|Net (loss) per share-basic and diluted                                        |  | $               | (2.00   | ) |                 | $ | (0.01   | )               |  | $ | (0.34  | )
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|Weighted average common shares outstanding:                                   |  |                 |         |   |                 |   |         |                 |  |   |        |  
|Basic                                                                         |  |                 | 32,007  |   |                 |   | 25,913  |                 |  |   | 17,861 |  
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  
|Diluted                                                                       |  |                 | 32,007  |   |                 |   | 25,913  |                 |  |   | 17,861 |  
|                                                                              |  |                 |         |   |                 |   |         |                 |  |   |        |  



|(1) | Related Parties amounts include the following line items:
|--- | ---------------------------------------------------------



|                                             |  |                 |        |                 |   |                 |  |   |       
|-------------------------------------------- |  | --------------- | ------ | --------------- | - | --------------- |  | - | ------
|                                             |  | Year Ended     
|                                             |  | January 31,2008 |        | January 31,2007 |   | January 31,2006
|Cost of goods sold                           |  | $               | 60,339 |                 | $ | 85,410          |  | $ | 28,424
|Selling, general and administrative expenses |  | $               | 4,030  |                 | $ | 4,813           |  | $ | 3,766 
|Interest expense                             |  | $               |       |                 | $ | 1,410           |  | $ | 1,120 

See accompanying notes



F-5



---

Cygne Designs, Inc. and Subsidiaries

Consolidated Statements of Stockholders Equity

(In thousands)



|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|---------------------------------------------------------------------------------------------------- |  | -------------------- |  | ------ | --- | -------------- | - | ------- | -------------------- |  | - | ------------------------------------------ | - |  | ------------------ | ---- | - | ----- | - | -------- | - |  | - | ------- | -
|                                                                                                     |  | NumberofCommonShares |  | Amount |     | Paid-InCapital |   |         | DeferredCompensation |  |   | AccumulatedOtherComprehensiveIncome (Loss) |   |  | AccumulatedDeficit |      |   | Total |  
|Balance at January 29, 2005                                                                          |  | 12,438               |  |        | 124 |                |   | 120,918 |                      |  |   |                                           |   |  |                    | (178 | ) |       |   | (113,149 | ) |  |   | 7,715   |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Net (loss)                                                                                           |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   | (6,166   | ) |  |   | (6,166  | )
|Unrealized (loss) on marketable securities                                                           |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    | (14  | ) |       |   |         |   |  |   | (14     | )
|Reclassification adjustment for realized losses included in net income                               |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    | 175  |   |       |   |         |   |  |   | 175     |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Comprehensive (loss)                                                                                 |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | (6,005  | )
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Exercise of stock options                                                                            |  | 28                   |  |        | 2   |                |   | 12      |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 14      |  
|Issuance of common stock as part of acquisition purchase price                                       |  | 10,500               |  |        | 105 |                |   | 32,340  |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 32,445  |  
|Stock issued in conversion of related party note                                                     |  | 1,429                |  |        | 14  |                |   | 7,486   |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 7,500   |  
|Issuance of restricted stock to directors                                                            |  | 60                   |  |        |    |                |   | 290     |                      |  |   | (291                                       | ) |  |                    |     |   |       |   |         |   |  |   | (1      | )
|Amortization of restricted stock                                                                     |  |                     |  |        |    |                |   |        |                      |  |   | 36                                         |   |  |                    |     |   |       |   |         |   |  |   | 36      |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Balance at January 31, 2006                                                                          |  | 24,455               |  |        | 245 |                |   | 161,046 |                      |  |   | (255                                       | ) |  |                    | (17  | ) |       |   | (119,315 | ) |  |   | 41,704  |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Net (loss)                                                                                           |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   | (158     | ) |  |   | (158    | )
|Unrealized gain on marketable securities                                                             |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    | 42   |   |       |   |         |   |  |   | 42      |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Comprehensive (loss)                                                                                 |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | (116    | )
|Issuance of common stock as part of acquisition purchase price                                       |  | 2,000                |  |        | 20  |                |   | 7,660   |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 7,680   |  
|Exercise of stock options                                                                            |  | 7                    |  |        |    |                |   | 1       |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 1       |  
|Stock based compensation                                                                             |  |                     |  |        |    |                |   | 4       |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 4       |  
|Amortization of restricted stock                                                                     |  |                     |  |        |    |                |   | 145     |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 145     |  
|Adoption of FAS 123R                                                                                 |  |                     |  |        |    |                |   | (255    | )                    |  |   | (255                                       | ) |  |                    |     |   |       |   |         |   |  |   |        |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Balance at January 31, 2007                                                                          |  | 26,462               |  | $      | 265 |                | $ | 168,601 |                      |  | $ |                                           |   |  | $                  | 25   |   |       | $ | (119,473 | ) |  | $ | 49,418  |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Net (loss)                                                                                           |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   | (63,860  | ) |  |   | (63,860 | )
|Unrealized (loss) on marketable securities                                                           |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    | (40  | ) |       |   |         |   |  |   | (40     | )
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Comprehensive (loss)                                                                                 |  |                     |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | (63,900 | )
|Sale of common stock, net of issuance costs of $110                                                  |  | 2,655                |  |        | 26  |                |   | 3,528   |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 3,554   |  
|Exercise of stock options                                                                            |  | 1                    |  |        |    |                |   |        |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   |        |  
|Conversion of the secured subordinated promissory note:                                              |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Common Stock and warrants                                                                            |  | 8,800                |  |        | 88  |                |   | 16,712  |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 16,800  |  
|Stock based compensation                                                                             |  |                     |  |        |    |                |   | 109     |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 109     |  
|Grant of restricted stock units                                                                      |  |                     |  |        |    |                |   | 60      |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 60      |  
|Gain on extinguishment of related party debt                                                         |  |                     |  |        |    |                |   | 1,965   |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 1,965   |  
|Contribution attributable to settlement of losses relating to sourcing problems with a related party |  |                     |  |        |    |                |   | 3,234   |                      |  |   |                                           |   |  |                    |     |   |       |   |         |   |  |   | 3,234   |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  
|Balance at January 31, 2008                                                                          |  | 37,918               |  | $      | 379 |                | $ | 194,209 |                      |  | $ |                                           |   |  | $                  | (15  | ) |       | $ | (183,333 | ) |  | $ | 11,240  |  
|                                                                                                     |  |                      |  |        |     |                |   |         |                      |  |   |                                            |   |  |                    |      |   |       |   |          |   |  |   |         |  

See accompanying notes.



F-6



---

Cygne Designs, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)



|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  
|------------------------------------------------------------------------------------------- |  | --------------- | ------- | - | --------------- | - | ------- | --------------- |  | - | ------- | -
|                                                                                            |  | Year Ended      |        
|                                                                                            |  | January 31,2008 |         |   | January 31,2007 |   |         | January 31,2006 | 
|Operating activities                                                                        |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Net (loss)                                                                                  |  | $               | (63,860 | ) |                 | $ | (158    | )               |  | $ | (6,166  | )
|Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities: |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Deferred tax (benefit) provision                                                            |  |                 | (2,471  | ) |                 |   | 1,686   |                 |  |   | 785     |  
|Depreciation and amortization of property, plant and equipment                              |  |                 | 135     |   |                 |   | 132     |                 |  |   | 292     |  
|Amortization of intangible assets                                                           |  |                 | 1,887   |   |                 |   | 1,938   |                 |  |   | 896     |  
|Amortization of debt discounts                                                              |  |                 | 4,352   |   |                 |   | 2,268   |                 |  |   | 3,460   |  
|Amortization of deferred financing costs                                                    |  |                 | 50      |   |                 |   |        |                 |  |   |        |  
|Loss on Mexican inventory                                                                   |  |                 | 2,480   |   |                 |   |         |                 |  |   |         |  
|Loss on impairment of goodwill and long-lived assets                                        |  |                 | 61,850  |   |                 |   |        |                 |  |   | 978     |  
|Write-off of leasehold improvements                                                         |  |                 |        |   |                 |   | 27      |                 |  |   |        |  
|Allowance for doubtful accounts                                                             |  |                 | 94      |   |                 |   |        |                 |  |   |        |  
|Allowance for customer chargebacks and trade discounts                                      |  |                 | 394     |   |                 |   | (452    | )               |  |   | 1,962   |  
|Non-cash stock compensation                                                                 |  |                 | 109     |   |                 |   | 149     |                 |  |   | 36      |  
|Issuance of restricted stock units                                                          |  |                 | 60      |   |                 |   |        |                 |  |   |        |  
|Gain on extinguishment of debt                                                              |  |                 | (1,733  | ) |                 |   |        |                 |  |   |        |  
|Reversal of tax reserves                                                                    |  |                 | (18     | ) |                 |   | (32     | )               |  |   | (11     | )
|Loss on marketable securities                                                               |  |                 |        |   |                 |   |        |                 |  |   | 175     |  
|Changes in operating assets and liabilities:                                                |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Trade accounts receivable                                                                   |  |                 | (10,225 | ) |                 |   | (1,551  | )               |  |   | 767     |  
|Due from factor                                                                             |  |                 | 11,195  |   |                 |   | 6,137   |                 |  |   | (17,405 | )
|Inventories                                                                                 |  |                 | (3,392  | ) |                 |   | 2,552   |                 |  |   | (1,782  | )
|Other receivables, prepaid expenses and other assets                                        |  |                 | (410    | ) |                 |   | 131     |                 |  |   | (14     | )
|Deposits                                                                                    |  |                 |        |   |                 |   |        |                 |  |   | (24     | )
|Due (from) to related parties                                                               |  |                 | (2,965  | ) |                 |   | (4,487  | )               |  |   | 300     |  
|Accounts payable                                                                            |  |                 | (3,151  | ) |                 |   | (993    | )               |  |   | 1,162   |  
|Accrued expenses                                                                            |  |                 | 216     |   |                 |   | 4       |                 |  |   | 417     |  
|Income taxes payable                                                                        |  |                 | 195     |   |                 |   | 139     |                 |  |   | 30      |  
|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Net cash (used in) provided by provided by operating activities                             |  |                 | (5,208  | ) |                 |   | 7,490   |                 |  |   | (14,142 | )
|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Investing activities                                                                        |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Purchase of the denim business from Diversified Apparel Resources LLC                       |  |                 |        |   |                 |   | (250    | )               |  |   | (4,199  | )
|Purchase of private label division from Innovo Group Inc.                                   |  |                 |        |   |                 |   | (110    | )               |  |   |        |  
|Purchase of property, plant and equipment                                                   |  |                 | (179    | ) |                 |   | (54     | )               |  |   | (158    | )
|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Cash used in investing activities                                                           |  |                 | (179    | ) |                 |   | (414    | )               |  |   | (4,357  | )
|                                                                                            |  |                 |        
|Financing activities                                                                        |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Proceeds from exercise of stock options                                                     |  |                 |        |   |                 |   | 1       |                 |  |   | 14      |  
|Proceeds from short-term bank borrowings                                                    |  |                 | 52,345  |   |                 |   |        |                 |  |   |        |  
|Repayment of short-term bank borrowings                                                     |  |                 | (42,551 | ) |                 |   |        |                 |  |   |        |  
|Proceeds from issuance of common stock                                                      |  |                 | 3,664   |   |                 |   |         |                 |  |   |         |  
|Advances from factor                                                                        |  |                 | 30,024  |   |                 |   | 86,928  |                 |  |   | 50,364  |  
|Repayments of advances from factor                                                          |  |                 | (39,566 | ) |                 |   | (93,273 | )               |  |   | (34,477 | )
|Costs incurred in connection with issuance of common stock                                  |  |                 | (110    | ) |                 |   |        |                 |  |   |        |  
|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Net cash provided by (used in) financing activities                                         |  |                 | 3,806   |   |                 |   | (6,344  | )               |  |   | 15,901  |  
|                                                                                            |  |                 |        
|Net (decrease) increase in cash                                                             |  |                 | (1,581  | ) |                 |   | 732     |                 |  |   | (2,598  | )
|Cash at beginning of year                                                                   |  |                 | 1,709   |   |                 |   | 977     |                 |  |   | 3,575   |  
|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  
|Cash at end of year                                                                         |  | $               | 128     |   |                 | $ | 1,709   |                 |  | $ | 977     |  
|                                                                                            |  |                 |         |   |                 |   |         |                 |  |   |         |  

See accompanying notes.



F-7



---

Cygne Designs, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (continued)

(In thousands)



|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------- | ------ | - | --------------- | - | --------------- |  | - | ------
|                                                                                                                                                                                                                      |  | Year Ended     
|                                                                                                                                                                                                                      |  | January 31,2008 |        |   | January 31,2007 |   | January 31,2006
|Supplemental Disclosures of Cash Flow Information                                                                                                                                                                     |  |                 |        |   |                 |   |                 |  |   |       
|Income taxes paid                                                                                                                                                                                                     |  | $               | 247    |   |                 | $ | 120             |  | $ | 16    
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Interest paid                                                                                                                                                                                                         |  | $               | 1,273  |   |                 | $ | 1,355           |  | $ | 455   
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash investing and financing activities                                                                                                                                                                           |  |                 |        |   |                 |   |                 |  |   |       
|Exchange of subordinated promissory note for common stock and warrants                                                                                                                                                |  | $               | 16,800 |   |                 | $ |                |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Note payable offset against the due from related parties                                                                                                                                                              |  | $               | 1,421  |   |                 | $ |                |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Gain on extinguishment of debt with a related party included in Paid in Capital                                                                                                                                       |  | $               | 1,965  |   |                 | $ |                |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash transactions recognized in connection with the acquisition of the private label division of Innovo Group, Inc.:                                                                                              |  |                 |        |   |                 |   |                 |  |   |       
|Issuance of two million shares of common stock                                                                                                                                                                        |  | $               |       |   |                 | $ | 7,680           |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Assumption of debt to related party                                                                                                                                                                                   |  | $               |       |   |                 | $ | 2,500           |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Accrued transaction costs                                                                                                                                                                                             |  | $               |       |   |                 | $ | 11              |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash transactions:                                                                                                                                                                                                |  |                 |        |   |                 |   |                 |  |   |       
|Unrealized gain (loss) on marketable securities                                                                                                                                                                       |  | $               | (40    | ) |                 | $ | 42              |  | $ | 14    
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Issuance of restricted stock                                                                                                                                                                                          |  | $               |       |   |                 | $ |                |  | $ | 291   
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash transactions recognized in connection with the partial payment of the Convertible Note by Diversified Apparel Resources LLC
(Diversified Apparel) Note payable offset against the due from related parties |  | $               | 4,738  |   |                 | $ |                |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash transactions recognized in connection with the sourcing problems with a related party Assumption of loss offset against the due from
related parties                                                         |  | $               | 3,234  |   |                 | $ |                |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash transactions recognized in connection with the payment required by the Secured Subordinated Promissory Note to Diversified Apparel
Principal payment offset against amount due from Diversified Apparel      |  | $               |       |   |                 | $ | 1,500           |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Interest payment offset against amount due from Diversified Apparel                                                                                                                                                   |  | $               |       |   |                 | $ | 2,530           |  | $ |      
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Non-cash transactions recognized in connection with the acquisition of the denim business from Diversified Apparel:                                                                                                   |  |                 |        |   |                 |   |                 |  |   |       
|Issuance of secured promissory note payable, net of discount of $14.2 million                                                                                                                                         |  | $               |       |   |                 | $ |                |  | $ | 33,300
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Note converted to common shares                                                                                                                                                                                       |  | $               |       |   |                 | $ |                |  | $ | 7,500 
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Issuance of 10.5 million shares of common stock                                                                                                                                                                       |  | $               |       |   |                 | $ |                |  | $ | 32,445
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       
|Deferred purchase price consideration, net                                                                                                                                                                            |  | $               |       |   |                 | $ |                |  | $ | 1,639 
|                                                                                                                                                                                                                      |  |                 |        |   |                 |   |                 |  |   |       

See accompanying notes.



F-8



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

January 31, 2008

1. Significant Accounting Policies

Principal Business Activity

Cygne
Designs, Inc. (Cygne) and its subsidiaries (collectively, the Company) are a designer, merchandiser, manufacturer and distributor of branded and private label womens denim, casual and career apparel and mens denim
apparel with sales to retailers located in the United States. The Company has two wholly owned subsidiaries, MBS Internacional, S.A., and Cygne Guatemala, S.A.

Fiscal Year-End

The Companys fiscal year-end is January 31. Fiscal year refers to the year commencing in that
calendar year and ending in January of the following year. The fiscal year ended January 31, 2006 has approximately 52 weeks and 2 days for the year. The fiscal years ended January 31, 2007 and January 31, 2008 have twelve months.

Effective October 31, 2005, the Company changed from a thirteen-week quarterly reporting period to a last day of the month quarterly
reporting period. This change was made to conform to the quarterly accounting periods of other major apparel companies.

The modification
of the fiscal years did not have a material effect on the Companys financial condition, results of operations, or cash flows.

Organization and
Principles of Consolidation

The consolidated financial statements include the accounts of Cygne and its subsidiaries. All inter-company
balances and transactions were eliminated in consolidation.

Income Taxes

The Company follows Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109). Under the
asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. The Company has recorded a valuation allowance against the net deferred tax asset due to the Companys history of losses and near break-even results. However, should the Company conclude that utilization of
deferred tax assets is more likely than not, the value of the deferred tax asset would be increased by eliminating some or all of the valuation allowance. The deferred tax assets are net of deferred tax liabilities except for deferred tax
liabilities originating from the Companys taxable business combinations that resulted in tax-deductible goodwill. In these instances, deferred tax liabilities accumulate over time as goodwill is deducted on tax returns but not amortized for
financial reporting purposes. These deferred tax liabilities will reverse if impairment charges are recognized or when the business is disposed of through sale or otherwise. Because of the uncertainty of the timing of the reversal of the deferred
tax liability related to the goodwill temporary difference at January 31, 2007, these deferred tax liabilities are not netted against the Companys net deferred tax asset in determining the valuation allowance. At January 31, 2008,
the deferred tax liability related to the goodwill was reversed as a result of the goodwill impairment.

Contingencies

The Company accounts for contingencies in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies
(SFAS No. 5). SFAS No. 5 requires that the Company record an



F-9



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



estimated loss from a loss contingency when information available prior to issuance of the consolidated financial statements indicates that it is probable
that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated.

Rent Expense

Expenses related to the Companys facility leases are recorded on a straight-line basis over the lease
terms. Differences between the rent expenses incurred and the amounts paid are recorded as deferred rent and are amortized over the lease terms.

Segment Information

Based on the criteria in Statement of Financial Accounting Standards No. 131, Disclosures
about Segments of an Enterprise and Related Information, the Company operates in one segment of the apparel market: womens denim, casual, and career apparel and mens denim apparel.

Use of Estimates

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

Marketable Securities

The Companys marketable securities are comprised of public corporate securities. All
investments are classified as available for sale and are recorded at market using the specific identification method. Realized gains and losses are reflected in other income and expense while unrealized gains and losses are included as a separate
component of stockholders equity, except when a decline in the value of a security is believed to be other than temporary.

Fair Value of
Financial Instruments

Carrying amounts of certain of the Companys financial instruments, including cash, cash equivalents,
marketable securities, accounts receivable, factor advances, accounts payable, and other accrued liabilities, approximate fair value due to their short maturities. The fair values of investments are determined using quoted market prices for those
securities. The fair value of amounts due to/from related parties is not known based on the related party nature of these amounts. The carrying amount of the Companys borrowings under the line of credit and long-term debt approximates fair
value because the interest rate on the instruments fluctuate with market interest rates or represents borrowing rates available with similar terms. The fair value of the Convertible Note is disclosed in Note 7.

Inventories

Inventories are stated at the lower of
cost (determined on a first-in, first-out basis) or market.

Depreciation and Amortization

Depreciation of property, plant and equipment is provided for by the straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized using the straight-line method over the lesser of the useful life or the term of the related lease.

Intangible
assets are amortized over the estimated lives, up to five years, using the straight-line method.



F-10



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Impairment of Long-Lived and Intangible Assets

Long-lived assets consist of property, plant and equipment and intangible assets including goodwill. Intangible assets are comprised of trademarks, costs
to create product lines, and customer relationships. In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, (SFAS No. 142), the Company assesses the impairment of identifiable
intangibles and goodwill at least annually in the case of goodwill, and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers to be important which could trigger an
impairment review include the following:



| |  |  | Significant underperformance relative to expected historical or projected future operating results;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Significant changes in the manner of use of the acquired assets or the strategy for the overall business; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Significant negative industry or economic trends.
| | - |  | -------------------------------------------------

The Company evaluates long-lived assets, including property, plant and equipment and intangible assets other than goodwill, for impairment in accordance with Statement of Financial Accounting Standards No. 144
(SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the estimated future cash
flows (undiscounted and without interest charges) from the use of an asset are less than the carrying value, a write-down would be recorded to reduce the related asset to its estimated fair value.

When the Company determines that the carrying value of long-lived assets and goodwill may not be recoverable based upon the existence of one or more of
the above indicators of impairment and the carrying value of the asset cannot be recovered from projected undiscounted cash flows, the Company records an impairment charge. The Company measures goodwill impairment based on a projected discounted
cash flow method using a discount rate determined by management to be commensurate with the risk inherent in the current business model. Significant management judgment is required in determining whether an indicator of impairment exists and in
projecting cash flows. Based on the Companys annual assessment at January 31, 2008, an impairment of identifiable intangibles and goodwill of $61,850,000 was recorded on the Consolidated Statement of Operations.

The Company measures impairment on long-lived assets on the cash flow method. As of January 31, 2006, the Company performed an impairment test on
the carrying value of the asset group comprised of equipment, land, and building for the Guatemalan plant. Based upon the results of the valuation, the Company took an impairment charge of $978,000 based on estimated market value for the asset group
for the year ended January 31, 2006.

Revenue Recognition

Revenues are recorded at the time of shipment of merchandise, provided that the price is fixed, title has been transferred, collection of the resulting receivable is reasonably assured and the Company has no
significant obligations remaining to be performed. The Company establishes allowances for customer chargebacks, trade discounts and allowance for doubtful accounts. Such reserves amounted to $1,925,000 and $1,510,000, at January 31, 2008 and
January 31, 2007, respectively.

Cost of Goods Sold

Cost of goods sold includes cost of finished products purchased from Diversified Apparel Resources, LLC (Diversified Apparel), cost of imports from its Far East vendors and cost of products manufactured in
the



F-11



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Companys Guatemalan facility. Manufacturing costs of products manufactured in the Companys Guatemala facility are comprised of raw materials, raw
material special treatments, custom duties, freight, direct labor and manufacturing overhead. In 2007, Cygne recorded an inventory loss in connection with a problem in sourcing goods from a related party in Mexico of approximately $2,480,000.

Selling, General and Administrative Expenses

Selling general and administrative expenses (SG&A) include expenses related to compensation, selling commissions, travel and entertainment, samples, rent, office expenses, professional fees, insurance, distribution expenses,
restrictive covenant fees, earn-out fees, factor fees, director fees and other public company expenses. All of the Companys restrictive covenant fees, earn-out fees and distribution expenses during the year ended January 31, 2008 and 2007
were incurred under either the Restrictive Covenant Agreement or the Distribution Agreement with Diversified Apparel as described in Note 10 below or under the Innovo Acquisition Agreement as described in Note 2 to Notes to Consolidated Financial
Statements.

Product Design, Advertising and Sales Promotion Costs

Product design, advertising and sales promotion costs are expensed as incurred and included in the category of SG&A. Product design, advertising and sales promotion costs included in operating expenses in the
accompanying consolidated statements of operations amounted to approximately $1,161,000, $1,036,000 and $650,000 for the years ended January 31, 2008, 2007 and 2006, respectively.

Interest Expense

For the year ended January 31, 2008, interest expense is comprised of interest
on the revolving credit facility, interest on advances from factor, amortization of the discount on the secured subordinated promissory note, amortization of the discount on the Convertible Note and amortization of debt acquisition costs. For the
years ended January 31, 2007 and 2006, interest expense is comprised of interest payable on the secured subordinated promissory note, interest on advances from factor, and amortization of the discount on the secured subordinated promissory note
and, for the year ended January 31, 2006, the deferred acquisition purchase price for the acquisition of the Acquired Business.

Allowances for
Doubtful Accounts and Customer Chargeback and Trade Discounts

The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments. If the financial condition of the Companys customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may
be required. The Company also estimates allowances for customer chargebacks and trade discounts. If market conditions were to decline, the Company may take actions to increase customer incentive offerings possibly resulting in an incremental
allowance at the time the incentive is offered.

Foreign Currency Translation

The functional currency for the Companys foreign operations is the U.S. Dollar. The translation from the applicable foreign currencies to U.S.
dollars is performed for current balance sheet accounts using current exchange rates in effect at the balance sheet date, for fixed asset balance sheet accounts using an historical exchange rate and for revenue and expense accounts using an average
exchange rate.

Net Income (Loss) Per Share

Basic and diluted net income per share information for all periods is presented under the requirements of Statement of Financial Accounting Standards No. 128 (SFAS No. 128) Earnings Per Share. Basic income
per



F-12



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



share is calculated by dividing the net income attributable to common stockholders by the weighted-average common shares outstanding during the period.
Diluted income per share is calculated by dividing net income attributable to common stockholders by the weighted-average common shares outstanding. As the Company had a net loss for the years ended January 31, 2008, 2007 and 2006, stock
options, warrants and stock issuable upon conversion of note payable for 7,426,000 shares at January 31, 2008 and stock options for 500 and 8,150 shares at January 31, 2007 and 2006, respectively are not considered in the calculation of diluted net
loss per share due to their anti-dilutive effect.

Other Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) and unrealized gain (loss) on marketable securities for the years ended January 31,
2008, 2007, and 2006.

Stock Based Compensation

Effective February 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment. SFAS 123R which requires that the compensation cost relating to share-based payment transactions be recognized in financial
statements. The amount of compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. SFAS 123R covers a wide range of share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS 123R replaces SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees. The adoption of SFAS No. 123R did not have a material impact on the Companys financial condition, results of operations or cash flows. However, future periods could be impacted, depending on the number
and nature of grants of equity instruments to employees.

Prior to the adoption of SFAS 123R, the Company accounted for its stock-based
employee compensation plans under the recognition and measurements principles of APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. No stock-based employee compensation cost is reflected in net
income as all options granted under those plans had an exercise price equal to the fair market value of the Common Stock on the date of the grant. No options were granted in the years ended January 31, 2008, 2007 and 2006.

Deferred Financing Cost

The Company incurred costs
of approximately $201,000 for professional services rendered in connection with its revolving credit facility entered into in August 2007. This cost is being amortized on a straight-line basis over twenty-four months, the life of the credit
facility. For the year ended January 31, 2008, amortization expense was approximately $50,000.

Reclassification

Certain reclassifications have been made to the July 31, 2007 Balance Sheet to conform to the January 31, 2008 Balance Sheet, relating to
amounts due from related parties, due to related parties and accounts payable. This reclassification results from the right of offset among the related parties and an unrelated party.

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48
(FIN 48), Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which establishes that the financial statement effects of a tax position taken or expected to be taken in a tax
return are to be recognized in the financial



F-13



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company
adopted FIN 48 on February 1, 2007. On the date of adoption there was no impact on the financial statements pertaining to FIN 48. The Company had no uncertain positions other than the Guatemalan issues noted below and accordingly no
unrecognized tax benefits. The Company recognizes interest and penalties, if any, as part of the provision for income taxes in the Companys Consolidated Statements of Operations.

Cygne Designs, Inc., a Delaware corporation, files a Federal Income Tax Return as well as tax returns in the following jurisdictions: California, New
York State and New York City. Beginning in 2002, a newly formed Guatemalan subsidiary began filing a Guatemala income tax return. This subsidiary has been granted a tax holiday to December 31, 2012. Another Guatemalan subsidiary, which is now
dormant and in the process of being liquidated, had been granted a tax holiday which expired on December 31, 2001. A third Guatemalan subsidiary has no tax holiday and its first tax return was filed for the year ended December 31, 1993.

On March 7, 2008, the Company received a notice from the Internal Revenue Service (IRS) that it would examine the Cygne
tax return for the tax year ended January 31, 2007; the Company is not currently undergoing any other United States tax examinations. However, the Guatemalan tax authorities are examining the tax returns for the years 1998 through 2000 of the
dormant subsidiary cited above that had been granted a tax holiday, but was assessed an income tax under a different Guatemala statute. The Company protested this tax and did not pay the tax. However, the Company has established a reserve for this
contingent liability in the amount of $470,000 and has included this reserve on the balance sheet under Income Taxes Payable as of January 31, 2008 and 2007. The IRS has completed its examinations for the Federal income tax returns for the tax
years January 31, 1985 through January 31, 1996. New York State has completed its examinations for the tax years January 31, 1985 through January 31, 2000. New York City has completed its examinations for the tax years
January 31, 1985 through January 31, 2002.

In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 (SFAS No. 157), Fair Value Measurements, which establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measurements. SFAS
No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. This statement becomes effective for the Companys annual reporting period that begins February 1, 2008. FASB Staff
Position FAS 157-2 delays the effective date of SFAS No. 157 for all non-recurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning November 15, 2008. The Company does not
anticipate that the adoption of SFAS No. 157 will have a material impact on our financial condition, results of operations or cash flows.

In February 2007, the FASB issued Financial Accounting Standards No. 159 (SFAS No. 159), The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides companies with an
option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of
assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. This statement becomes effective for the Companys annual reporting period that begins February 1, 2008. The Company does not
anticipate that the adoption of SFAS No. 159 will have an impact on the Companys financial condition, results of operations or cash flows.



F-14



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (Revised
2007) (SFAS 141R), Business Combinations. SFAS 141R provides additional guidance on improving the relevance, representational faithfulness, and comparability of the financial information that a reporting entity provides in
its financial reports about a business combination and its effects. SFAS 141R applies prospectively to business combination for which the acquisition date is on or after the beginning of the Companys annual reporting period that begins
February 1, 2009. We have not yet determined the impact, if any, that the implementation of SFAS No. 141R will have on our results of operations or financial condition as a result of any acquisitions we may consummate.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160 (SFAS 160), Noncontrolling Interests in
Consolidated Financial Statements. SFAS 160 applies to all entities that prepare consolidated financial statements and have an outstanding controlling interest in one or more subsidiaries. SFAS 160 amends ARB No. 51 to establish
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. This statement becomes effective for the Companys annual reporting period that begins February 1, 2009. The Company does not anticipate that the adoption of SFAS No. 160 will have a material
impact on Cygnes financial condition, results of operations or cash flows.

2. Acquisitions

Acquisition of the Private Label Division from Innovo Group, Inc. (Innovo Acquisition)

On May 12, 2006, Cygne, Innovo Group Inc. (Innovo), and Innovo Azteca Apparel, Inc., a wholly owned subsidiary of Innovo, closed the
transaction contemplated by an Asset Purchase Agreement entered into on March 31, 2006. Azteca Productions International, Inc. (Azteca Productions) was a party to certain ancillary agreements related to the Asset Purchase Agreement
because it was an interested party in the transaction. Innovo is a designer, developer and worldwide marketer of apparel products. Pursuant to the Asset Purchase Agreement, Innovo sold us certain assets related to its private label apparel division.
The purchase price was $10.3 million. Innovo purchased these assets from Azteca Productions in July 2003 pursuant to an asset purchase agreement referred to as the Blue Concept Asset Purchase Agreement.

Cygnes primary purpose for the purchase was to diversify its business. The Company accounted for this transaction as a purchase.

The assets acquired by Cygne included the private label divisions customer list, the assumption of current workforce related to the private label
division, the assumption of all existing purchase orders and inventory related to the private label division, and the assumption of the benefit of a non-compete clause with Azteca Productions. In exchange for the purchased assets, the Company
assumed certain liabilities associated with the private label division, including the remaining obligation under the original promissory note executed by Innovo in favor of Azteca Productions under the Blue Concept Asset Purchase Agreement, all
other liabilities, other than the original promissory note, owed in connection with the private label division to Azteca Productions in excess of $1,500,000, all liabilities associated with the private label divisions outstanding purchase
orders and inventory scheduled in the Asset Purchase Agreement, and the obligations to continue to pay the earn-out under the Blue Concept Asset Purchase Agreement. The aggregate value of the assumed liabilities was $2,500,000, which excluded the
remaining unpaid principal amount of the original promissory note of $7.9 million, which was paid through the issuance of shares of Cygnes common stock, as described below, and any amounts which might be owed under the earn-out. No amounts
were due under the earn-out agreement.

The Asset Purchase Agreement contained customary terms and conditions, including, among other
things, indemnification provisions, representations and warranties and post-closing covenants.



F-15



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



In connection with the Asset Purchase Agreement, the Company entered into a Letter Agreement dated
April 24, 2006 among Azteca Productions, Mr. Hubert Guez, Mr. Paul Guez and Sweet Sportswear, LLC. Pursuant to the Letter Agreement and in connection with the closing of the Innovo Acquisition, on May 12, 2006 the Company issued
1,000,000 shares of its common stock to each of Mr. Hubert Guez and Mr. Paul Guez, for an aggregate issuance of 2,000,000 shares, in lieu of assuming the remaining $7.9 million outstanding balance of the promissory note issued by Innovo to
Azteca Productions. Under the Letter Agreement, the 2,000,000 shares have piggy-back registration rights on any future registration statements on Form S-3 filed by the Company. These shares were registered on Form S-3 dated May 14, 2007.
Messrs. Hubert and Paul Guez also agreed not to offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any such shares until the close of trading on April 23, 2007. In addition, 250,000
of the shares issued to Paul Guez and 250,000 of the shares issued to Hubert Guez were placed in an escrow account until the expiration of the lock-up period, with the escrowed shares being returned to the Company in the event that Cygnes
common stock is traded on Nasdaq (or any other stock exchange, market or trading facility on which the shares are traded) at an average price above $5.00 per share during the one-month period immediately preceding the expiration of the lock-up
period. Cygnes shares did not reach the average target price and the shares were released from escrow to Messrs. Paul Guez and Hubert Guez in April 2007.

As of January 23, 2008, Mr. Hubert Guez has reported in filings with the Securities and Exchange Commission that he beneficially owned, had the power to dispose or direct the disposition of, and to vote or
direct the voting of, shares, personally, through various trusts and Diversified Apparel, representing approximately 21.2% of the shares of the Companys common stock. In addition, on May 12, 2006, Mr. Hubert Guez has advised us that
he (i) owns approximately 47% of Azteca Production International, Inc., (ii) has a 50% membership interest in Sweet Sportswear, LLC and (iii) has approximately a 32% membership interest in Diversified Apparel Resources, LLC. AZT
International, S.A. de C.V is a 100% subsidiary of Azteca Production International, Inc.

As of May 12, 2006, Azteca Production
International, Inc. may be deemed the beneficial owner of approximately 12.7% of Innovo Group Inc. common stock. Mr. Hubert Guez may be deemed to have the sole power to direct the voting and disposition of approximately 5.9% of Innovo Group
Inc. common stock.

The purchase price for the Innovo acquisition is comprised of the following:



|                                                                        |  |                  |       
|----------------------------------------------------------------------- |  | ---------------- | ------
|                                                                        |  | ($ in thousands)
|Issuance of 2,000,000 shares of Cygnes Common Stock at $3.84 per share |  | $                | 7,680 
|Assumption of liability to Diversified Apparel Resources LLC            |  |                  | 2,500 
|Transaction costs                                                       |  |                  | 121   
|                                                                        |  |                  |       
|Total Purchase Price                                                    |  | $                | 10,301
|                                                                        |  |                  |       

The purchase price was allocated as follows:



|                                                                                               |  |                  |       
|---------------------------------------------------------------------------------------------- |  | ---------------- | ------
|                                                                                               |  | ($ in thousands)
|Intangible assetscustomer relationships, $400 amortized over 3 months and $3,600 over 3 years |  | $                | 4,000 
|Excess purchase price allocated to goodwill                                                    |  |                  | 6,301 
|                                                                                               |  |                  |       
|                                                                                               |  | $                | 10,301
|                                                                                               |  |                  |       



F-16



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



The amortization of the Innovo intangible assets for the years ended January 31, 2008 and 2007
was $1,200,000 and $1,253,000, respectively. At January 31, 2008, based on the Companys annual impairment assessment, the Company recorded an impairment of the entire balance of identifiable intangible assets of $1,547,000.

Acquisition of the denim apparel business from Diversified Apparel Resources LLC. (Acquired Business)

On July 31, 2005, Cygne acquired the assets used in the branded and private label denim apparel business, which the Company refers to as the Acquired
Business, of Commerce Clothing (which was later renamed Diversified Apparel Resources, LLC), a privately-held company principally owned by Hubert Guez, Diversified Apparels managing member and Chief Executive Officer, pursuant to an asset
purchase agreement.

The assets Cygne acquired from Diversified Apparel included, among other things, Diversified Apparels:



| |  |  | tangible personal property;
| | - |  | ---------------------------



| |  |  | open purchase orders;
| | - |  | ---------------------



| |  |  | New York showroom leases for the property located on the fourth floor of 215 West 40th Street; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | trademarks and intellectual property associated with the Acquired Business, including the trademarks for Hippie, Hippie Jeans, Hint
Jeans, and Voyou.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

Cygne did not acquire any cash, accounts receivable, prepaid expenses, deposits
(other than the lease deposit for the showrooms), inventories or stock of any subsidiaries from Diversified Apparel.

Under the asset
purchase agreement, Cygne assumed the following liabilities of Diversified Apparel:



| |  |  | any and all liabilities, obligations and commitments arising after the closing under the Diversified Apparel agreements included in the assets we acquired
(including the New York showroom leases); and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any liability or obligation arising from the operation of the Acquired Business or ownership of the assets we acquired (including the New York showroom leases)
after the closing date.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In consideration for the assets acquired from Diversified Apparel, Cygne:



| |  |  | issued to Diversified Apparel 10,500,000 shares of our common stock, 7,500,000 of which Diversified Apparel distributed to its members;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | issued to Diversified Apparel a secured subordinated promissory note, which we refer to as the Note, in the principal amount of $47.5 million, subsequently reduced
to $40.0 million through the issuance of 1,428,571 shares of common stock as repayment of $7.5 million of principal, see Note Conversion discussed in Note 7 below;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | paid $2 million in cash to Diversified Apparel on the closing date; and
| | - |  | -----------------------------------------------------------------------



| |  |  | agreed to pay to Diversified Apparel deferred purchase price payments totaling $1,750,000 in seven monthly installments of $250,000 each, without interest, on the
last day of each month commencing with August 2005 and ending February 2006.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-17



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Cygne also entered into several related agreements, including a registration rights agreement, a
supply agreement, a distribution agreement and a restrictive covenant agreement. The supply and distribution arrangements govern purchases of Diversified Apparel products by Cygne, as well as related advances for inventory purchases. The restrictive
covenant agreement sets forth agreed-upon non-competition covenants between Hubert Guez and the Company.

The purchase price consideration
is comprised of the following:



|                                                                                                                                |  |                  |       
|------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ------
|                                                                                                                                |  | ($ in thousands)
|Issuance of 10,500,000 shares of Common Stock, par value $0.01, at the average market price of $3.09 per share at July 31,
2005 |  | $                | 32,445
|Issuance of Note for $47,500,000 net of discount of $14,200,000(1)                                                              |  |                  | 33,300
|Cash at closing                                                                                                                 |  |                  | 2,000 
|Deferred purchase price, net of discount of $111,000                                                                            |  |                  | 1,639 
|Transaction costs                                                                                                               |  |                  | 731   
|                                                                                                                                |  |                  |       
|Total purchase price                                                                                                            |  | $                | 70,115
|                                                                                                                                |  |                  |       

The purchase price was allocated as follows:



|                              |  |                |       
|----------------------------- |  | -------------- | ------
|                              |  | (In thousands)
|Property, plant and equipment |  | $              | 156   
|Lease deposits                |  |                | 13    
|Trademarks                    |  |                | 1,890 
|Product lines                 |  |                | 930   
|Customer relationships        |  |                | 550   
|Goodwill                      |  |                | 66,576
|                              |  |                |       
|                              |  | $              | 70,115
|                              |  |                |       



|(1) | The Company recorded the fair value of the note at $33,300,000, which is a $14,200,000 discount from the $47,500,000 face value of the Note. The discount to the Note was being
amortized to interest expense over the term of the Note. On August 9, 2007, we extinguished the Note and offset the remaining unamortized discount to gain on extinguishment of debt. The Note discount expense for the year ended January 31,
2008, 2007 and 2006 was $1,429,000, $2,268,000 and 3,348,000, respectively.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Goodwill and Intangible Assets

The total amortization for the years ended January 31, 2008, 2007 and 2006 is $686,000, $684,000 and $896,000, respectively.At
January 31, 2008, based on the Companys annual assessment, an impairment of the entire balance of identifiable intangible assets of $1,103,000 was recorded.

Goodwill and Intangible Assets Summary for both Acquisitions

The goodwill at January 31, 2008
before impairment was $72,877,000. At January 31, 2008, based on the Companys annual assessment, an impairment of goodwill of $59,200,000 was recorded and an impairment of the entire balance of identifiable intangible assets, net of
accumulated amortization, of $2,650,000 was recorded.

The amortization of intangible assets for the years ended January 31, 2008,
2007 and 2006 was $1,886,000, $1,937,000 and $896,000, respectively.



F-18



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Registration Rights Agreement

In connection with the acquisition of Diversified Apparel, Cygne entered into a Registration Rights Agreement to register the resale of 10,500,000 shares issued to Diversified Apparel in the connection with the
acquisition of the Acquired Business. The Registration Statement became effective on May 14, 2007.

Pro-forma Statements of Operations

The condensed unaudited pro forma condensed combined statements of operations for the years ended January 31, 2007 and
January 31, 2006 give effect to the July 31, 2005 acquisition of the Acquired Business and the May 12, 2006 consummation of the Innovo Acquisition as if the transactions occurred on February 1, 2005, the first day of Cygnes
fiscal year. Both acquisitions were accounted for using the purchase method of accounting.

The pro forma adjustments to the statement of
operations for the years ended January 31, 2007 and 2006 combine the pro forma Acquired Business adjustments with the pro forma Innovo Acquisition adjustments.

The Acquired Business pro forma adjustments include the adjustment of the historical gross profit to the contractual gross profit which is defined in Cygnes supply agreement with Diversified Apparel, adjustment
of historical distribution and occupancy costs to the contractual cost as defined in Cygnes distribution agreement with Diversified Apparel, the recording of the expense under the restrictive covenant agreement with Hubert Guez, the recording
of the amortization of the intangible assets, recording of the deferred tax liability and the adjustment to reflect the interest expense to include the amortization of debt discount expense on the secured subordinated promissory note issued in
connection with the acquisition of the Acquired Business. The intangible assets include values for trademarks, costs to create product lines and value for customer relationships.

The Innovo Acquisition pro forma adjustments include the elimination of the historical building occupancy costs, the adjustment of the historical
amortization of intangibles to the amortization of Cygnes intangibles, the recording of the deferred tax liability and the elimination of the Innovo Acquisition impairment of goodwill which was recorded on the financial statements of Innovo
Group Inc.

The unaudited pro forma information is presented for illustration purposes only and is not necessarily indicative of the
financial position or results of operations which would actually have been reported had the combinations been in effect during these periods or which might be reported in the future. The unaudited pro forma financial information includes expenses
allocated by Innovo Group Inc. to the Innovo Acquisition which may not be indicative of future results which will include actual expenses.



|                                     |  |                                         |         |   |           |   |         |           |  |   |         |  
|------------------------------------ |  | --------------------------------------- | ------- | - | --------- | - | ------- | --------- |  | - | ------- | -
|                                     |  | (In thousands, except pershare amounts) |        
|                                     |  | Year Ended January 31                   |        
|                                     |  | 2008                                    |         |   | 2007      |   |         | 2006      | 
|                                     |  | Actual                                  |         |   | Pro forma |   |         | Pro forma | 
|Net sales                            |  | $                                       | 95,753  |   |           | $ | 138,796 |           |  |   | 171,522 |  
|Net loss                             |  | $                                       | (63,860 | ) |           | $ | (262    | )         |  | $ | (200    | )
|Net loss per sharebasic and diluted |  | $                                       | (2.00   | ) |           | $ | (0.01   | )         |  | $ | (0.01   | )



F-19



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



3. Marketable Securities

Marketable securities are stated at fair value as determined by quoted market price. The related unrealized holding gains and losses are excluded from operations and recorded in accumulated other comprehensive income
(loss) on the consolidated balance sheets. At January 31, 2008 and 2007, the gross unrealized gain (loss) was approximately ($15,000) and $25,000 respectively. Realized gains and losses and declines in value judged to be other-than-temporary on
marketable securities are included in other expense.

The following table summarizes the marketable securities as of January 31, 2008
and 2007.



|                                        |  |                         |         |                            |   |         |                          |  |   |                     |   |  |   |       
|--------------------------------------- |  | ----------------------- | ------- | -------------------------- | - | ------- | ------------------------ |  | - | ------------------- | - |  | - | ------
|                                        |  | BeginningFair ValueCost |         | GrossUnrealizedGain/(Loss) |   |         | GrossRecordedGain/(Loss) |  |   | EstimatedFair Value
|Marketable securities, January 31, 2008 |  | $                       | 65,000  |                            | $ | (40,000 | )                        |  |   | -0-                 |   |  | $ | 25,000
|Marketable securities, January 31, 2007 |  | $                       | 23,000  |                            | $ | 42,000  |                          |  |   | -0-                 |   |  | $ | 65,000
|Marketable securities, January 31, 2006 |  | $                       | 215,000 |                            | $ | (17,000 | )                        |  | $ | (175,000            | ) |  | $ | 23,000

4. Credit Facilities

Secured Revolving Credit Facility

On August 3, 2007, Cygne entered into a $15 million secured revolving credit
facility with Comerica Bank. The credit facility, which replaced Cygnes expired Factoring Agreement with Milberg Factors, Inc. (Milberg), provides Cygne with a $15 million working capital line of credit, as well as a $2 million
stand-by letter of credit in favor of one of its suppliers. Cygne can borrow up to 80% of eligible receivables with a cap of $15 million. The credit facility terminates on August 31, 2009, although Cygne can terminate it at any time upon 60
days notice and Comerica can terminate at any time upon a default under the credit facility. Borrowings bear interest at prime plus 0.25%. Prime rate at January 31, 2008 was 6.0%. The short-term borrowings under this facility were approximately
$9,794,000 at January 31, 2008. As security for Cygnes obligations under the credit facility, Cygne granted to Comerica Bank a continuing security interest in substantially all of its assets. The Convertible Note is subordinated to
borrowings from Comerica Bank.

The revolving credit facility contains customary covenants, including limitations on, or relating to,
capital expenditures, liens, indebtedness, investments, mergers, acquisitions, and the payment of dividends and other restricted payments. The revolving credit facility also contains working capital, net worth and EBITDA requirements as well as a
debt to net worth ratio requirement to be monitored on a quarterly basis. As of January 31, 2008, the Company was in default with the working capital, net worth, EBITDA and debt to net equity ratio requirements. Comerica Bank issued a notice of
no action to Cygne regarding the default on the covenants at January 31, 2008. The banks decision to not take action to enforce its rights under the agreement does not constitute a waiver of any of the Banks rights, powers and
remedies with respect to the defaults.

On January 31, 2008, $200,000 of the standby letter of credit was outstanding.

On November 7, 2007, Cygne and Comerica Bank amended the credit facility to allow Cygne to borrow from Comerica Bank 50% of eligible finished goods
inventory located at Cygne warehouses, with maximum borrowings of $1.5 million, plus 50% of eligible in-transit inventory with maximum borrowings of $1 million. This amendment did not increase the credit facilitys cap of $15.0 million.

In March 2008, Cygne and Comerica Bank amended the credit facility to allow Cygne to borrow from Comerica Bank 15% of all letters of
credit outstanding in favor of Cygne, with maximum borrowings of $350,000.



F-20



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



On May 5, 2008, Cygne and Comerica Bank amended the credit facility to allow us to borrow from
Comerica Bank 70% of eligible finished goods inventory located at our warehouses with maximum borrowings of $1.25 million plus 80% of eligible in-transit inventory with maximum borrowings of $1.5 million for the period May 5, 2008 through
June 30, 2008. Effective July 1, 2008, the credit facility reverts back to the prior terms allowing the Company to borrow 50% of eligible finished goods inventory located at the Companys warehouses with maximum borrowings of $1.25
million plus 50% of eligible in-transit inventory with maximum borrowings of $1.5 million. The amendment also allows the Company to borrow from Comerica Bank 30% of all letters of credit issued in the Companys favor with maximum borrowings of
$750,000 for the period May 5, 2008 through June 30, 2008.

Factoring Agreement

Effective July 31, 2005, the Company began to use Milberg for credit administration purposes. The Company and Milberg entered into a factoring
agreement effective July 31, 2005 which was amended on January 31, 2006 and July 31, 2006 and renewed through July 31, 2007 (the Factoring Agreement). The Factoring Agreement was replaced by the credit facility on
August 3, 2007.

Under the Factoring Agreement, the Company sold to Milberg without recourse all of Cygnes receivables which
were acceptable to Milberg. Milberg was responsible for collection, assumed all credit risk, and obtained all of the rights and remedies of the Company against the Companys customers for those receivables purchased by Milberg without recourse.
Payment was due from Milberg upon the payment of the receivable to Milberg by Cygnes customer less a Milberg reserve for known future chargebacks from all customers plus a special reserve at July 31, 2007.

The factor fees for the years ended January 31, 2008, 2007 and 2006 were approximately $206,000, $479,000 and $354,000, respectively.

Due from factor, net of factor advances and allowances for customer chargebacks and trade discounts, as shown on the balance sheet at January 31,
2007 is summarized below.



|                                                                                                      |  |                 |       
|----------------------------------------------------------------------------------------------------- |  | --------------- | ------
|                                                                                                      |  | (In thousands) 
|                                                                                                      |  | January 31,2007
|Outstanding factored receivables                                                                      |  | $               | 11,268
|Less, reserve for allowances for chargebacks and trade discounts                                      |  |                 | 1,510 
|                                                                                                      |  |                 |       
|Due from factor, net of reserve for allowances for chargebacks and trade discounts                    |  |                 | 9,758 
|Less, advances from factor                                                                            |  |                 | 9,542 
|                                                                                                      |  |                 |       
|Due from factor net of factor advances and reserve for allowances for chargebacks and trade discounts |  | $               | 216   
|                                                                                                      |  |                 |       



F-21



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



5. Inventories

Inventories consist of the following:



|                                 |  |                 |       |                 |   |      
|-------------------------------- |  | --------------- | ----- | --------------- | - | -----
|                                 |  | (In thousands) 
|                                 |  | January 31,2008 |       | January 31,2007
|Raw material and work-in-process |  | $               | 519   |                 | $ | 389  
|Finished goods                   |  |                 | 2,330 |                 |   | 1,548
|                                 |  |                 |       |                 |   |      
|Total                            |  | $               | 2,849 |                 | $ | 1,937
|                                 |  |                 |       |                 |   |      

6. Property, Plant and Equipment

Property, plant and equipment are stated at cost, less accumulated depreciation and amortization and are summarized below together with estimated useful
lives used in computing depreciation and amortization:



|                                               |  |                 |     |                 |   |                       |  |                 
|---------------------------------------------- |  | --------------- | --- | --------------- | - | --------------------- |  | ----------------
|                                               |  | (In thousands) 
|                                               |  | January 31,2008 |     | January 31,2007 |   | Estimated UsefulLives
|Land                                           |  | $               | 258 |                 | $ | 258                   |  |                 
|Building and building improvements             |  |                 | 117 |                 |   | 117                   |  | At salvage value
|Leasehold improvements                         |  |                 | 336 |                 |   | 231                   |  | Life of lease   
|Equipment, furniture, and fixtures             |  |                 | 230 |                 |   | 295                   |  | 3-7 years       
|                                               |  |                 |     |                 |   |                       |  |                 
|                                               |  |                 | 941 |                 |   | 901                   |  |                 
|Less accumulated depreciation and amortization |  |                 | 278 |                 |   | 282                   |  |                 
|                                               |  |                 |     |                 |   |                       |  |                 
|                                               |  | $               | 663 |                 | $ | 619                   |  |                 
|                                               |  |                 |     |                 |   |                       |  |                 

Depreciation and amortization expense for property, plant and equipment was approximately
$135,000, $132,000 and $292,000 for the years ended January 31, 2008, 2007 and 2006, respectively.

Depreciation of equipment,
furniture and fixtures is provided for by the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the term of the related lease. At January 31, 2006 based
on an appraisal by an independent third party, the Company recorded a 100% impairment charge against its equipment, furniture and fixtures at its Guatemalan facility and established a salvage value, not subject to depreciation, for its building and
building improvements in its Guatemala facility. Personal computers totaling $138,000 which were no longer in use and had been fully reserved were written off during the year ended January 31, 2008. Leasehold improvements in the New York
showroom of $50,000 which are no longer in use were written off resulting in a $27,000 impairment expense during the year ended January 31, 2007.

Impairment of Long-Lived Assets

As of January 31, 2006, the Company performed an impairment test on the carrying value
of the asset group comprised of equipment, land, and building for the Guatemalan plant due to the occurrence of events and changes that require testing for recoverability under Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment of Disposal of Long-Lived Assets. These events included significant adverse changes in the business climate, current and projected cash flow losses for the asset group, and the likelihood that the assets
will be sold or disposed of before the end of their useful lives. The test showed that the carrying value of the asset group exceeded that of undiscounted future cash flows, which indicated that impairment could be present.



F-22



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



In early 2006, the Company retained an independent party to perform a valuation of the fair value of
the asset group. Based upon the results of the valuation, the Company has taken an impairment charge of $978,000 based on estimated market value for the asset group, which results in a net carrying value of $375,000 for the asset group. This charge
is included in the Companys statements of operations in the category of selling, general, and administrative expenses for the year ended January 31, 2006. Cygne believes that there will not be any additional impairment to the value of its
land and buildings as shown on the January 31, 2008 balance sheet.



|                                                           |  |   |          
|---------------------------------------------------------- |  | - | ---------
|Net carrying cost of asset group at January 31, 2006       |  | $ | 1,353,000
|Impairment loss                                            |  |   | 978,000  
|                                                           |  |   |          
|Adjusted carrying value of asset group at January 31, 2006 |  | $ | 375,000  
|                                                           |  |   |          

In connection with the Innovo Acquisition and the acquisition of the Acquired Business, we
recorded goodwill of $72,877,000 and identified intangible assets which included customer relationships, trademarks and product lines, of $4,550,000. At January 31, 2008, Cygne conducted our annual impairment assessment of the value of the
goodwill and identified intangible assets that were recorded in connection with their acquisitions based on a discounted cash flow model of projected earnings. To aid Cygne, the Company retained an independent party to perform the valuation.
Negative trends in sales and gross margins resulted in lower projected future earnings. The negative sales trends were the result of market conditions, the loss of two customers in 2007 which accounted for 49% of the Companys 2007 sales, a
substantial decrease in demand for our branded jeans and our non-denim private label products. The negative trends in gross margins resulted from the loss of guaranteed gross margins under the Supply Agreement. Based on the results of the valuation,
charges of approximately $59,200,000 were recorded for the impairment of goodwill and charges of $2,650,000 were recorded to reflect the impairment of the value of all the remaining identifiable intangible assets.



|                                   |  |          |            |                             |            |                   |              |   |         |  |   |         |  |   |           
|---------------------------------- |  | -------- | ---------- | --------------------------- | ---------- | ----------------- | ------------ | - | ------- |  | - | ------- |  | - | ----------
|                                   |  |          |            | InnovoCustomerRelationships |            | Acquired Business |              |  
|                                   |  | Goodwill |            |                             | Trademarks |                   | ProductLines |   | Total  
|Carrying value at January 31, 2008 |  | $        | 72,877,000 |                             | $          | 1,547,000         |              | $ | 949,000 |  | $ | 154,000 |  | $ | 75,527,000
|Impairment loss                    |  |          | 59,200,000 |                             |            | 1,547,000         |              |   | 949,000 |  |   | 154,000 |  |   | 61,850,000
|                                   |  |          |            |                             |            |                   |              |   |         |  |   |         |  |   |           
|Ending balance at January 31, 2008 |  | $        | 13,677,000 |                             | $          | 0                 |              | $ | 0       |  | $ | 0       |  | $ | 13,677,000
|                                   |  |          |            |                             |            |                   |              |   |         |  |   |         |  |   |           

7. Note Payable

Secured Subordinated Promissory Note (Note)

In connection with the acquisition of Diversified Apparel, the
Company issued a secured subordinated promissory note to Diversified Apparel, a related party. The maturity date of the Note is April 30, 2012 (the Maturity Date). The Note bears interest at 4.7% per annum, compounded annually.
Interest and principal on the Note are payable quarterly commencing October 31, 2006. After giving effect to the conversion of $7,500,000 principal amount of the Note into common stock as described below, the principal amount of the Note was
payable as follows: (i) ten quarterly payments of $1,500,000 commencing on October 31, 2006; and (ii) ten quarterly payments of $2,500,000 commencing on April 30, 2009, with the final payment to be made on July 31, 2011.

Prior to the transfer of the Note by Diversified Apparel to an unrelated third party with an effective date of November 1, 2006,
Cygnes obligations under the Note were secured by a pledge of the trademarks purchased by Cygne under the Agreement, pursuant to a Security Agreement entered into with Diversified Apparel. The Note Transfer Agreement is described below.



F-23



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Note Conversion Agreement

On January 3, 2006, the Company and Diversified Apparel Resources, LLC entered into a Note Conversion Agreement providing for the conversion of $7,500,000 principal amount of the Note to Diversified Apparel into
1,428,571 shares of the Companys common stock at the rate of $5.25 per share. Accordingly, the Company canceled the principal payments due October 31, 2011, January 31, 2012 and April 30, 2012. In connection with the
conversion of the $7,500,000 of the Note, the amortization of the debt discount was increased by approximately $2,063,000 which represented the pro-rata unamortized discount.

On October 31, 2006, Cygne made a principal payment of $1.5 million due on the Note through reduction of the amounts owed by Diversified Apparel.

Note Transfer Agreement

Effective
November 1, 2006, Diversified Apparel transferred the Note to Mr. Serge Kraif, a third party not related to the Company at the time of transfer. Effective January 31, 2007, the Company entered into an agreement with Mr. Kraif
(the Conversion Agreement) which was approved by the Companys stockholders on August 9, 2007, pursuant to which, immediately following the stockholder approval:



| |  |  | Cygne issued 8,800,000 shares of the Companys common stock to Mr. Kraif in payment of $22.0 million of the Note;
| | - |  | -----------------------------------------------------------------------------------------------------------------





| |  |  | Cygne issued a convertible note in the principal amount of $15.0 million (the Convertible Note) that is convertible into shares of the Companys
common stock at a conversion price of $3.50 per share in payment of $15.0 million of the Note; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cygne issued to Mr. Kraif a warrant to purchase up to 4,400,000 shares of the Companys common stock at a price of $3.00 per share (the
Warrant).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

The total value of the Companys common stock, its Convertible Note and warrant issued to Mr. Kraif was
approximately $28.3 million.

In addition, effective January 31, 2007, Mr. Kraif agreed that (i) the $1.5 million principal
payment on the Note originally due on January 31, 2007 would be postponed and paid by Cygne from time to time when it had available funds and (ii) all accrued but unpaid interest at January 31, 2007 was waived. This waiver was
recorded as a reduction of interest expense in the year ended January 31, 2007. The holder of the Note has also waived the interest payment due from February 1, 2007 through August 9, 2007 which was also recorded as a reduction of
interest expense for the year ended January 31, 2008.

Effective April 30, 2007, Mr. Kraif agreed that the $1.5 million
principal payments on the Note due on April 30, 2007 and July 31, 2007 could be delayed pending stockholder consideration of the Note conversion proposal discussed above. Cygnes stockholders approved the Note Conversion on
August 9, 2007, and this $3.0 million principal payment was satisfied through the issuance of the common stock, Convertible Note and warrant discussed above.

As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $1.5 million principal payment on the Note originally due on January 31, 2007. This payment was offset against related party
receivables.

The gain on extinguishment of the Note of $1,733,000 is the change between the carrying value of the Note against the fair
value of the Convertible Note of $11,380,000 and the fair value of the warrants of $3,248,000. The fair value of the warrants was determined using the closing price of the common stock on August 9, 2007,



F-24



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



the date that the Conversion Agreement was approved by the stockholders, using the Black-Scholes option pricing model with the following assumptions: stock
price at the approval date of the Conversion Agreement of $1.54; exercise price of $3.00; term of 5 years; volatility factor of 71.2%; dividend yield of zero; discount rate of 4.64%.

The Convertible Note bears interest at the annual rate of 4.7%. Twenty-four (24) quarterly principal payments of $625,000 will be payable on the
Convertible Note beginning April 30, 2008 and ending on the maturity date of January 31, 2014. Interest is due quarterly. Any principal outstanding on the Convertible Note will be convertible at the conversion price of $3.50 a share. The
Company, at its option, may prepay the principal balance outstanding at any time with payment discount rates ranging from 24.19% if prepayment occurred before January 31, 2008 declining to 3.43% if payment occurs between February 1, 2013
and January 31, 2014. The Convertible Note is subordinated to borrowings from Comerica Bank. In the event of default on borrowings from Comerica Bank, Mr. Kraif has the right to accelerate principal and interest payments on the Convertible
Note. At January 31, 2008, Mr. Kraif agreed not to accelerate payment of interest or principal in the event of default.

The Warrant
is exercisable at any time between February 15, 2009 and January 31, 2012.

Cygne recorded the gain on the Conversion Agreement
of $1,733,000 on its Consolidated Statements of Operations as an extinguishment of debt since the exchange occurred prior to Mr. Kraif becoming a shareholder.

As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $625,000 principal payments on the Convertible Note due April 30, 2008, July 31, 2008 and October 31, 2008
totaling $1,875,000. As of October 31, 2007, Diversified Apparel agreed to accept $1,422,000 in exchange for immediate payment of these three payments, which was offset against the related party receivable. Cygne recorded the $453,000
prepayment gain on its Consolidated Statement of Stockholders Equity as a contribution to capital since the pre-payment was to a related party.

As of January 31, 2008, Mr. Serge Kraif assigned to Diversified Apparel the $625,000 principal payments on the Convertible Note due January 31, 2009, April 30, 2009, July 31,
2009, October 31, 2009, January 31, 2010, April 30, 2010, July 31, 2010, October 31, 2010, January 31, 2011, and April 30, 2011, totaling $6,250,000. As of January 31, 2008,
Diversified Apparel agreed to accept $4,738,125 in exchange for prepayment of these ten payments, which was offset against the related party receivable. Cygne recorded the $1,512,000 prepayment gain on its Consolidated Statement of
Stockholders Equity as a contribution to capital since the pre-payment was to a related party. The remaining principal balance of $6,875,000 on the Convertible Note matures on January 31, 2014 with payments of $1,875,000 due in the year
ended January 31, 2012, and $2,500,000 due in each of the years ended January 31, 2013 and 2014.

In addition, Mr. Serge
Kraif has waived all the accrued but unpaid interest for the period August 9, 2007 through January 31, 2008 in the amount of $315,801.

All shares of the Companys common stock issued pursuant to the Conversion Agreement, upon conversion of the Convertible Note or upon exercise of the Warrant have been registered for resale under the Securities Act.

Debt discount

Based on a third party
valuation, the Company determined the fair value of the $15,000,000 Convertible Note. As a result, the Company recorded a debt discount of $3,620,000 to reduce the carrying value of the $15,000,000 Convertible Note to its face value of $11,380,000.
The discount is being amortized to interest



F-25



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



expense over 6.5 years using the effective interest method. During the year ended January 31, 2008, $2,856,000 of debt discount amortization was
recorded. The normal amortization was $418,000 and the amortization caused by the partial pre-payment of the Convertible Note was $2,438,000. Debt discount to be recorded over the remaining life of the Convertible Note is as follows:



|                       |  |                  |    
|---------------------- |  | ---------------- | ---
|Year Ended January 31: |  | ($ in thousands)
|2009                   |  |                  | 126
|2010                   |  |                  | 135
|2011                   |  |                  | 145
|2012                   |  |                  | 166
|Thereafter             |  |                  | 191
|                       |  |                  |    
|                       |  | $                | 763

8. Stockholders Equity

On January 20, 2006, the stockholders of Cygne approved the Companys 2006 Incentive Plan (the Plan) to enable the Company to attract, motivate, reward, and retain key personnel through the use
of equity-based and cash incentive compensation awards. Subject to adjustment for recapitalization events, a total of 3,000,000 shares of the Companys Common Stock may be issued under the Plan, exclusive of shares repurchased, forfeited or
otherwise canceled. No employee may be granted options to purchase more than 600,000 shares under the Plan in a single calendar year. With respect to performance-based awards not valued by reference to the Companys Common Stock at date of
grant, the maximum amount that may be earned by any employee during any calendar year is $1,000,000.

Stock Options

Any unused portion of the annual limitations on awards that may be earned by an employee shall be carried forward on a cumulative basis. No options were
granted under the Plan during the year 2006. During the quarter ended July 31, 2007, a director exercised 500 options under the Companys 1993 Stock Option Plan for Non-Employee Directors. This plan expired on April 15, 2003 and there
are no outstanding options left under this plan.

The stock option transactions are summarized for the periods shown below:



|                                        |  |                             |   |                       |                     |            |                               |   |      |  |        |  
|--------------------------------------- |  | --------------------------- | - | --------------------- | ------------------- | ---------- | ----------------------------- | - | ---- |  | ------ | -
|                                        |  | Non-Employee Directors Plan |   | Total Numberof Shares |                    
|                                        |  | Number ofShares             |   |                       | ExercisePrice Range |            | Weighted-AverageExercisePrice |  
|Options outstanding at January 31, 2006 |  | 8,150                       |   |                       | $                   | 0.08-$0.23 |                               | $ | 0.13 |  | 8,150  |  
|Options exercised in 2006               |  | (7,650                      | ) |                       | $                   | 0.08-$0.23 |                               | $ | 0.15 |  | (7,650 | )
|                                        |  |                             |   |                       |                     |            |                               |   |      |  |        |  
|Options outstanding at January 31, 2007 |  | 500                         |   |                       |                     |            |                               |   |      |  | 500    |  
|Options exercised in 2007               |  | (500                        | ) |                       |                     |            |                               |   |      |  | (500   | )
|                                        |  |                             |   |                       |                     |            |                               |   |      |  |        |  
|Options outstanding at January 31, 2008 |  |                            |   |                       |                     |            |                               |   |      |  |       |  
|                                        |  |                             |   |                       |                     |            |                               |   |      |  |        |  



F-26



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Restricted Stock Units

Under the Plan, an annual restricted stock unit ("RSU") compensation amount of $60,000 will be credited to each member of our Board of Directors who is not an employee. An RSU is a unit of measurement equivalent to
one share of Common Stock, but with none of the attendant rights of a stockholder of a share of Common Stock. The annual RSU compensation amount will vest with the director while he is serving as a non-employee director of the Company in quarterly
installments as of the last business day of the calendar quarter to which it applies, subject to earlier vesting under certain circumstances. Payment of a directors RSU account will be made in a lump sum in shares of common stock equal to the
number of RSUs in the RSU account as soon as practicable after the directors Board service terminates. The RSU expense recognized in the year ended January 31, 2008 was $60,000.

Stock Issuances

On July 31, 2005, the Company
issued 10,500,000 shares as part of the purchase price for the acquisition of the assets used in the branded and private label denim apparel business from Diversified Apparel. The shares were valued at $3.09 a share.

On January 3, 2006, the Company issued 1,428,571 shares of its Common Stock to a related party in a conversion of $7,500,000 of the secured
subordinated note payable. The shares were valued at $5.25 a share.

On January 20, 2006, the Company filed an amended and restated
certificate of incorporation to increase the aggregate authorized shares to 101,000,000 shares, including 100,000,000 authorized shares of $0.01 par value Common Stock and 1,000,000 authorized shares of Preferred Stock, par value of $0.01 per share.

On January 20, 2006, the Company issued 60,000 shares of restricted Common Stock under the Plan to directors, subject to vesting over
a period of eight quarters of continued service, beginning with the quarter ended January 31, 2006. The shares were valued at $4.85 a share. The shares will also vest in full upon a Change in Control, as defined in the Plan, or upon the
termination of the directors service due to death or disability. In connection therewith, the Company recorded deferred compensation of $291,000, representing the fair value of the shares, which was being amortized over the vesting period.
During the year ended January 31, 2006 and 2007, approximately $36,000 and $145,000, respectively, were amortized upon adoption of SFAS 123R. The unamortized balance of the deferred compensation was reversed into paid-in-capital.

On May 12, 2006, we issued 2,000,000 shares of our common stock as part of the purchase price for the acquisition of the private label division of
Innovo Group Inc. The shares were valued at $3.84 a share,

Cygne has filed a registration statement which was declared effective on
May 14, 2007 for resale by certain of its stockholders of an aggregate of 13,928,571 shares of Cygnes common stock. 11,928,571 shares were acquired by Diversified Apparel directly from Cygne in connection with Cygnes acquisition of
the branded and private label denim apparel business from Diversified Apparel and the subsequent conversion of $7,500,000 principal amount of the Note, and 2,000,000 shares were acquired by Hubert Guez and Paul Guez from Cygne in connection with
Cygnes acquisition of certain assets of the private label apparel division of Innovo Group, Inc. on May 12, 2006. The selling stockholders (other than Diversified Apparel and Paul Guez) are members of Diversified Apparel who acquired the
shares of common stock by distribution from Diversified Apparel. The 13,928,571 shares offered constitute, in the aggregate, approximately 36.7% of Cygnes shares outstanding as of January 31, 2008.



F-27



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Private Equity Placement

On August 3, 2007, in a private equity placement, Cygne issued 2,655,073 shares of Common Stock at a price of $1.38 per share, representing a 15% discount to the average closing price of the Common Stock on the
10 consecutive trading days ended July 20, 2007 for $3,554,000, net of issuance costs of $110,000. In addition, Cygne issued to the purchasers warrants to purchase an aggregate of 1,062,030 shares of Common Stock at an exercise price of $1.95
per share. The $1.95 exercise price per share of the warrant represents a 20% premium to the average closing price of the common stock on the 10 consecutive trading days ended July 20, 2007. The warrants are exercisable at any time during the
period beginning November 2007 and ending July 2012.

Note Transfer Agreement

Effective November 1, 2006, Diversified Apparel transferred the Note to Mr. Serge Kraif, a third party not related to the Company at the time
of transfer. Effective January 31, 2007, the Company entered into an agreement with Mr. Kraif (the Conversion Agreement) which was approved by the Companys stockholders on August 9, 2007, pursuant to which,
immediately following stockholder approval:



| |  |  | Cygne issued 8,800,000 shares of the Companys common stock to Mr. Kraif in payment of $22.0 million of the Note;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | Cygne issued a convertible note in the principal amount of $15.0 million (the Convertible Note) that is convertible into shares of the Companys
common stock at a conversion price of $3.50 per share in payment of $15.0 million of the Note; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cygne issued to Mr. Kraif a warrant to purchase up to 4,400,000 shares of the Companys common stock at a price of $3.00 per share (the
Warrant).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

Cygne has filed a registration statement which was declared effective on January 11, 2008 for
resale by certain of its stockholders of an aggregate of 25,674,078 shares of Cygnes common stock. 16,950,000 shares were acquired by Mr. Kraif in exchange for $37.0 million principal amount of an outstanding promissory note, 3,717,103
shares were acquired by certain of the selling stockholders in a private placement consummated in August 2007 in connection with Cygnes entering into a new credit arrangement and 60,000 shares were acquired by non-employee directors pursuant
to grants of restricted stock under our 2006 Incentive Plan. The remaining 4,946,975 shares are owned by Mr. Manuel, our Chairman and Chief Executive Officer.

9. Concentrations of Risk

For the year ended January 31, 2008, sales to JC Penney, Kohls, Target Stores and
American Eagle Outfitters accounted for 23%, 17%, 16% and 33%, respectively, of Cygnes net sales. American Eagle Outfitters ceased to be a customer in December 2007. For the year ended January 31, 2007, sales to JC Penney, Kohls, Target
Stores and American Eagle Outfitters accounted for 16%, 14%, 15% and 27%, respectively, of Cygnes net sales. For the year ended January 31, 2006, sales to JC Penney, Kohls and New York & Company, accounted for 21%, 18% and
32%, respectively, of Cygnes net sales.

Foreign manufacturing is subject to a number of risks, including work stoppages,
transportation delays and interruptions, political instability, foreign currency fluctuations, economic disruptions, expropriation, nationalization, the imposition of tariffs and import and export controls, changes in governmental policies
(including U.S. policy toward these countries). The occurrence of certain of these factors in Guatemala, where Cygne owns a manufacturing facility, resulted in the impairment of the Companys investment located in this country. In the year
ended January 31, 2006, Cygne recorded a 100% impairment charge with respect to its



F-28



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



equipment, furniture and fixtures at its Guatemalan facility and established a salvage value of $375,000 for the building and building improvements. The
Guatemalan manufacturing facility was closed in November 2007 and Cygne is seeking a buyer for the building. Cygne cannot assure you that it will be able to realize the salvage value recorded.

10. Related Party Transactions

In connection with
the acquisition of the Acquired Business, Cygne entered into agreements at July 31, 2005, as subsequently amended, with companies controlled by Hubert Guez.

The Supply Agreement: Prior to July 31, 2007, AZT International S. de R.L. de C.V. (AZT), an affiliate of Hubert Guez, manufactured on a non-exclusive basis branded and private label denim apparel for
Cygne in Mexico at specified gross margins to Cygne. Pursuant to the Supply Agreement, AZT shipped its manufactured apparel to the United States and invoiced Diversified Apparel, an affiliate of Hubert Guez. Diversified Apparel invoiced Cygne for
the apparel when it was shipped to Cygne customers. At the end of each month, Diversified Apparel invoiced Cygne for the apparel it had on hand that Cygne estimated that it would ship to its customers in the subsequent month. Cygne renewed the
Supply Agreement for one year until July 31, 2008. Cygne ceased sourcing products from AZT on December 18, 2007. The Supply Agreement specified that the guarantee of Cygnes gross margins for products manufactured by AZT for Target
and American Eagle Outfitters (AEO) expired on January 31, 2008. Cygne ceased doing business with AZT in December 2007.

On July 31, 2007 Cygne purchased from Diversified Apparel all of the fabric located at AZT allocated to Cygne production. Starting August 1, 2007, Cygne purchased all of the fabric for the garments to be manufactured for Cygne in
the AZT facilities. In addition, on July 31, 2007, Cygne purchased from Diversified Apparel the entire finished stock inventory located in the warehouse located in Commerce, California, which was not included in the contractual month-end
inventory purchases.

Under the Supply Agreement, Cygne was obligated to advance to Diversified Apparel up to 50% of the amount of purchase
orders outstanding, if Diversified Apparel requests such advance in writing. The repayment terms for the outstanding advances were to deduct the advances from the payments made in connection with future inventory purchases. At January 31, 2008
and 2007, outstanding advances to Diversified Apparel were zero and $7,917,000, respectively.

The apparel purchased under the Supply
Agreement from Diversified Apparel for the year ended January 31, 2008 and 2007 was approximately $32,224,000 and $64,246,000, respectively. There was no inventory manufactured under the Supply Agreement at January 31, 2008. The purchases
for the year ended January 31, 2008 exclude the fabric purchased at July 31, 2007.

On December 18, 2007, a creditor company
of AZT, a related party to Cygne and the Mexican contractor for the Companys vendor, Diversified Apparel, which is also a related party to Cygne, obtained a court decree against AZT which allowed this creditor company to obtain possession of
all of Cygnes fabric, trim, work-in-process and finished goods located at the AZT manufacturing facility in Mexico. Mr. Manuel, Cygnes CEO, immediately entered into intensive discussion with the creditor company as well as
Cygnes two customers serviced by the AZT Mexican manufacturing facility. The court decree to AZT was not due to any wrongdoing of the Company but a claim by the creditor company against AZT.

American Eagle Outfitters (AEO), one of the customers, response was to cancel all orders issued to us and to issue new orders for the
same garments to the creditor company. Shipments to AEO are estimated to be $2,700,000. We no longer have AEO as a customer.



F-29



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Mr. Manuel negotiated an agreement with the creditor company whereby the creditor company would
continue to ship to Cygne the second customers garments with sales estimated at $2,600,000 and invoice us his costs for the garments shipped which shipment was completed in April 2008. We, in turn, invoiced our customer for these garments. We
agreed to pay the creditor company thirty days after shipment of garments. At January 31, 2008, we owed the creditor company $954,000.

Diversified Apparel agreed to reimburse us for the cost of the lost fabric and the normal gross profit lost on the sales to AEO and our second customer. The cost of the fabric of $2,480,000, which is included in our cost of goods sold, and
the lost gross profit of $754,000, are shown on the financial statements as an increase to Due from Related Parties and an increase to paid-in-capital of $3,234,000. Had we not had this situation with our vendor, we would have shipped to our
customers and collected trade receivables of $5,000,000. Although Diversified Apparel agreed to reimburse us at wholesale prices for the lost shipments, the reimbursement was included in the Due from Related Parties account on the balance sheet. The
Due from Related Parties already included advances made to Diversified Apparel under the Supply Agreement for costs to make the product. The net financial result of the transaction is that we did recoup our losses through reductions in amounts owed
by Cygne on the Convertible Note which was assigned to Diversified Apparel. We have not received any cash reimbursement from Diversified Apparel in relation to our losses which adversely affected our cash flows.

We no longer source goods from AZT.

The
Distribution Agreement: Diversified Apparel provides distribution and operating services including building occupancy costs for Cygne. Cygne renewed the Distribution Agreement, which had an expiration date of July 31, 2007, for a one-year
period until July 31, 2008. The distribution agreement cost for the years ended January 31, 2008, 2007 and 2006 was $2,493,000, $2,934,000 and $1,672,000, respectively. Cygne and Diversified Apparel cancelled this agreement effective
February 1, 2008.

In addition, the cost of the packing materials purchased from Diversified Apparel for the years ended
January 31, 2008, 2007 and 2006 was $248,000, $284,000 and $193,000, respectively. All amounts are included in Selling, General and Administrative expenses in the statement of operations.

Pursuant to the Distribution Agreement, Cygne purchased all of its denim apparel manufactured outside of Mexico from Diversified Apparel. Diversified
Apparel received this apparel in its United States warehouse and retained the physical risk of loss while the inventory is in its possession. The Distribution Agreement provided that at the end of each month, Diversified Apparel invoiced Cygne for
the apparel it had on hand that Cygne estimated that it would ship to its customers in the subsequent month.

On July 31, 2007, Cygne
purchased from Diversified Apparel the entire finished stock inventory located in the warehouse located in Commerce, California which was not included in the contractual month-end inventory purchases. Cygne is invoiced by Diversified Apparel for all
finished garment inventory on the date that the finished garments are delivered to the warehouse. Effective December 5, 2007, Cygne notified Diversified Apparel that all its purchase orders to Diversified Apparel for Far East vendors would be
cancelled and replaced by Cygne purchase orders made directly with the Far East vendors.

Under the Distribution Agreement, prior to
December 5, 2007, Cygne was obligated to advance to Diversified Apparel up to 50% of the amount of purchase orders outstanding, if Diversified Apparel requested such advance in writing. The repayment terms for the outstanding advances were to
deduct the advances from the payments made in connection with future inventory purchases.

The apparel purchased from Diversified Apparel
under the Distribution Agreement for the years ended January 31, 2008, 2007 and 2006 was approximately $26,459,000, $19,462,000 and $10,536,000, respectively.



F-30



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Restrictive Covenant Agreement: Cygne and Hubert Guez entered into a restrictive covenant agreement
whereby Cygne pays Hubert Guez one percent (1%) of net sales, not including non-denim sales to New York & Company, and not including sales of denim apparel resulting from subsequent business acquisitions. The Company recorded an
expense of $466,000 for the year ended January 31, 2008, $626,000 for the year ended January 31, 2007 and $386,000 for the year ended January 31, 2006. All amounts expensed are included in Selling, General and Administrative expenses
in the statement of operations. Cash payments made under this agreement during the years ended January 31, 2008, 2007 and 2006 were zero, $500,000 and zero, respectively. Cygnes payable to Hubert Guez at January 31, 2008 and 2007 was
approximately $980,000 and $514,000, respectively. This payable is included in due to (due from) Related Parties.

Secured Subordinated
Promissory Note: In connection with the acquisition of the denim business from Diversified Apparel, Cygne issued to Diversified Apparel a $47.5 million note bearing interest at 4.7% per annum. On January 3, 2006, the Company and
Diversified Apparel entered into a Note Conversion Agreement providing for the conversion of $7,500,000 of principal due under the Note to Diversified Apparel into 1,428,571 shares of the Companys common stock. Accordingly, Cygne canceled the
principal payments due October 31, 2011, January 31, 2012 and April 30, 2012. On October 31, 2006, the Company made a principal payment of $1,500,000 due on the Note and interest payment due of $2,530,000 through reduction
of the amounts owed by Diversified Apparel. Effective November 1, 2006, Diversified Apparel transferred the Note to Mr. Serge Kraif. See Note 7 above.

The Company recorded interest expense to Diversified Apparel for the years ended January 31, 2008, 2007 and 2006 of zero, $1,410,000 and $1,120,000, respectively.

Cygne filed a registration statement which was declared effective on May 14, 2007 for resale by certain of its stockholders of an aggregate of
13,928,571 shares of Cygnes common stock. 11,928,571 shares were acquired by Diversified Apparel directly from Cygne in connection with Cygnes acquisition of the branded and private label denim apparel business from Diversified Apparel
and the subsequent conversion of $7,500,000 principal amount of the Note, and 2,000,000 shares were acquired by Hubert Guez and Paul Guez from Cygne in connection with Cygnes acquisition of certain assets of the private label apparel division
of Innovo Group, Inc. on May 12, 2006. The selling stockholders (other than Diversified Apparel and Paul Guez) are members of Diversified Apparel who acquired the shares of common stock by distribution from Diversified Apparel. The 13,928,571
shares offered constitute, in the aggregate, approximately 36.7% of Cygnes shares outstanding as of January 31, 2008.

First
Finish Inc., an affiliate of Hubert Guez up to June 30, 2007, operates a fabric finishing testing and development facility in California. The cost for services rendered to Cygne by First Finish Inc. for the five months ended June 30, 2007
was approximately $58,000, compared to $177,000 during the year ended January 31, 2007. Payments to reduce prior amounts due to First Finish, Inc. during the five months ended June 30, 2007 and the year ended January 31, 2008 were
$87,000 and $96,000, respectively. The amount due to First Finish as a related party at January 31, 2008 was zero as compared to $34,000 at January 31, 2007.

In connection with the Innovo Acquisition, Cygne assumed the obligations under an earn-out agreement with Paul and Hubert Guez for sales to American Eagle Outfitters. The Company pays to each of Paul Guez and Hubert
Guez 1.25% of sales to American Eagle Outfitters. The Company recorded an expense of $771,000 for the year ended January 31, 2008, and an expense of $792,000 for the year ended January 31, 2007. Cygne ceased doing business with American
Eagle Outfitters in December 2007. All amounts expensed are included in Selling, General and Administrative expenses in the statement of operations.



F-31



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Cash payments made under this agreement to Paul Guez during the year ended January 31, 2008 and
2007 were zero and $330,000, respectively. Cygnes payable to Paul Guez at January 31, 2008 and 2007 was approximately $450,000 and $64,000, respectively. Cash payments made under this agreement to Hubert Guez during the year ended
January 31, 2008 and 2007 were zero. Cygnes payable to Hubert Guez at January 31, 2008 and 2007 was approximately $780,000 and $394,000, respectively. These payables are included in due to (due from) Related Parties.

Cygne guaranteed payment to American Eagle Outfitters for purchases of fabric to AZT, a related party, from Cone Denim LLC to fulfill purchase orders
from American Eagle Outfitters for finished product. The guarantee limit was $3,500,000 and was valid for fabric purchases made through July 31, 2007. The amount of the guarantee at July 31, 2007 was approximately $2,333,000. The guarantee
was terminated at August 19, 2007 when Cygne issued a $2,000,000 letter of credit to Cone Denim LLC. On January 31, 2008, $200,000 of the standby letter of credit was outstanding

Payments to Cygne employees: As part of the Agreement, Cygne, on July 31, 2005, hired approximately fifty employees who worked for Diversified
Apparel. On January 1, 2006, the employees had been transferred onto the payroll of Cygne. Cygne reimbursed Diversified Apparel $1,393,000 during the year ended January 31, 2006 for all costs associated with this group of employees for the
period following the acquisition and before the payroll transfer.

Due to/(due from) Related Parties with the right of offset is comprised of the following
amounts:



|                                                                                         |  |                 |         |   |                 |   |         |  
|---------------------------------------------------------------------------------------- |  | --------------- | ------- | - | --------------- | - | ------- | -
|                                                                                         |  | (In thousands)  |        
|                                                                                         |  | January 31,2008 |         |   | January 31,2007 |  
|Due from Diversified Apparel under the Supply Agreement*                                 |  | $               | (18,004 | ) |                 | $ | (11,325 | )
|Due from Diversified Apparelsettlement of sourcing problem from related party in Mexico |  |                 | (3,234  | ) |                 |   |        |  
|Due to Diversified Apparelassumption of liability under Innovo Acquisition Agreement    |  |                 | 2,500   |   |                 |   | 2,500   |  
|Due to Mr. Hubert Guezrestricted covenant                                               |  |                 | 980     |   |                 |   | 514     |  
|Due to Mr. Hubert Guezearn-out agreement                                                |  |                 | 780     |   |                 |   | 394     |  
|Due to Mr. Paul Guezearn-out agreement                                                  |  |                 | 450     |   |                 |   |        |  
|Due to Diversified Apparelassumption of vendor liabilities                              |  |                 | 2,477   |   |                 |   |        |  
|Due to Diversified Apparelassumption of Secured Promissory Note Payable                 |  |                 | 1,500   |   |                 |   |        |  
|Due to Diversified Apparelassumption of Convertible Note Payable                        |  |                 | 6,159   |   |                 |   |        |  
|                                                                                         |  |                 |         |   |                 |   |         |  
|Due from Related Parties with the right of offset                                        |  | $               | (6,392  | ) |                 | $ | (7,917  | )
|                                                                                         |  |                 |         |   |                 |   |         |  

Due to Related Parties with no right of offset is comprised of the following amounts:



|                                        |  |                 |   |                 |   |   
|--------------------------------------- |  | --------------- | - | --------------- | - | --
|                                        |  | (In thousands) 
|                                        |  | January 31,2008 |   | January 31,2007
|Due to First Finish Inc                 |  | $               |  |                 | $ | 34
|Due to Mr. Paul Guezearn-out agreement |  |                 |  |                 |   | 64
|                                        |  |                 |   |                 |   |   
|                                        |  | $               |  |                 | $ | 98
|                                        |  |                 |   |                 |   |   

Diversified Apparel assumed our liability to two of our vendors totaling $3,177,000 in 2007. These
liabilities were offset against related party receivable.



F-32



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



As of October 31, 2007, Mr. Serge Kraif assigned to Diversified Apparel the $1,500,000
principal payment on the Note originally due January 31, 2007. This payment was offset against related party receivable.

As of
October 31, 2007, Diversified Apparel agreed to accept $1,421,000 in exchange for payments on the Convertible Note. This payment was offset against related party receivable.

As of January 31, 2008, Diversified Apparel agreed to accept $4,738,000 in exchange for payments on the Convertible Note. This payment was offset
against related party receivable.

The categories of the related party charges are (in thousands):



|                            |  |                                                                                                             |  |                           |        |                           |   |                           |  |   |       
|--------------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------ | ------------------------- | - | ------------------------- |  | - | ------
|                            |  |                                                                                                             |  | (In thousands)           
|StatementPlacementSee below |  |                                                                                                             |  | Year EndedJanuary 31,2008 |        | Year EndedJanuary 31,2007 |   | Year EndedJanuary 31,2006
|1                           |  | Supply Agreement, net of inventory shown in Item 4                                                          |  | $                         | 34,208 |                           | $ | 64,498                    |  | $ | 20,002
|1                           |  | Distribution Agreement relating to purchase of Far East imported products, net of inventory shown in Item 4 |  |                           | 27,787 |                           |   | 20,912                    |  |   | 8,422 
|2                           |  | Distribution Agreement relating to distribution expense                                                     |  |                           | 2,493  |                           |   | 2,934                     |  |   | 1,672 
|2                           |  | Distribution Agreement relating to packing material expense                                                 |  |                           | 248    |                           |   | 284                       |  |   | 193   
|2                           |  | Restrictive Covenant Agreement                                                                              |  |                           | 460    |                           |   | 626                       |  |   | 386   
|2                           |  | Earn-out under Innovo Acquisition Agreement                                                                 |  |                           | 771    |                           |   | 792                       |  |   |      
|2                           |  | First Finish, Inc.                                                                                          |  |                           | 58     |                           |   | 177                       |  |   | 122   
|2                           |  | Charges by Diversified Apparel for employees performing services for Cygne                                  |  |                           |       |                           |   |                          |  |   | 1,393 
|3                           |  | Interest on Secured Subordinated Promissory Note                                                            |  |                           |       |                           |   | 1,410                     |  |   | 1,120 
|                            |  |                                                                                                             |  |                           |        |                           |   |                           |  |   |       
|                            |  | Total                                                                                                       |  | $                         | 64,369 |                           | $ | 88,275                    |  | $ | 33,310
|                            |  |                                                                                                             |  |                           |        |                           |   |                           |  |   |       

The categories identified above are shown in the financial statement under the following captions:



|                    |  |                                             
|------------------- |  | --------------------------------------------
|Statement Placement |  |                                             
|1                   |  | Cost of goods sold *                        
|2                   |  | Selling, general and administrative expenses
|3                   |  | Interest expense                            



|* | Certain reclassifications were made to amounts presented for the year ended January 31, 2007 to be consistent with the January 31, 2008 presentation.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------

Related party charges included in inventory are (in thousands):



|     |  |                                  |  |                 |   |                 |   |                 |  |   |      
|---- |  | -------------------------------- |  | --------------- | - | --------------- | - | --------------- |  | - | -----
|Item |  |                                  |  | January 31,2008 |   | January 31,2007 |   | January 31,2006
|4    |  | Supply Agreement inventory       |  | $               |  |                 | $ | 992             |  | $ | 1,244
|4    |  | Distribution Agreement inventory |  |                 |  |                 |   | 664             |  |   | 2,114
|     |  |                                  |  |                 |   |                 |   |                 |  |   |      
|     |  |                                  |  | $               |  |                 | $ | 1,656           |  | $ | 3,358

As of January 31, 2008 and 2007, the Company had outstanding short-term purchase order
commitments to Diversified Apparel, a related party, for zero and $31,768,000, respectively.



F-33



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



11. Commitments and Contingencies

Leases

The Company entered into a lease for office space with an expiration date of October 31,
2008. The Company also leases showroom space under two operating leases expiring through October 31, 2008 and miscellaneous equipment through July 2009.

Minimum future payments under the above leases are as follows:



|                       |  |   |        
|---------------------- |  | - | -------
|Year Ended January 31, |  |  
|2009                   |  |   | 254,000
|2010                   |  |   | 2,000  
|                       |  |   |        
|                       |  | $ | 256,000
|                       |  |   |        

Total rent expense under the operating leases for the years ended January 31, 2008, 2007 and
2006 was approximately $375,000, $388,000 and $270,000, respectively. Pursuant to the Companys lease, rent expense charged to operations differs from rent paid because of the effect of free rent periods, landlord reimbursement of leasehold
improvement costs and scheduled rent increases. Accordingly, the Company has recorded deferred rent payable of approximately $8,000 and $61,000, respectively, at January 31, 2008 and 2007, which is included in accrued expenses. Rent expense is
calculated by allocating total rental payments, including those attributable to scheduled rent increases, on a straight-line basis over the leased term.

On November 14, 2007, Cygne entered into a memorandum of understanding with Shipson, LLC (Shipson). Pursuant to the memo of understanding, Shipson will allow the use of 25,000 square feet of leased
space for warehousing and shipping purposes as well as office space located in Commerce, California to Cygne beginning January 1, 2008. Cygne can terminate this agreement at any time with 90 days prior notice.

Commitments

The Company has an employment agreement
(Agreement) with an officer through April 30, 2008. The agreement is automatically renewed ninety days before the employee termination date on April 30, 2008. On February 1, 2008, the Agreement was renewed until
April 30, 2009. On April 25, 2008, the Company and the officer entered into a letter agreement terminating the employment agreement and providing, among other things, that the officer will remain an employee through January 31, 2010,
advising our senior executive officers with respect to international sourcing, and for which he will receive a salary of $12,500 per month, and will be entitled to continue to participate, at our expense, in our health insurance plan; and in
recognition of his past services to Cygne and his agreement to forego bonuses and contractually mandated annual salary increases for over ten years, upon termination of his employment we will pay him severance in the amount of $1,200,000, payable in
12 equal quarterly installments of $100,000, with the first payment commencing on February 15, 2010. See Note 15 of the Notes to the Consolidated Financial Statements.

The officer may receive a bonus which would be determined by the Board of Directors. The officer has not received a bonus.

As of January 31, 2008, the Company has outstanding short-term purchase order commitments with its vendors of approximately $23,668,000.



F-34



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



Litigation

The Company is involved in various legal proceedings that are incidental to the conduct of its business, none of which the Company believes could reasonably be expected to have a material adverse effect on the
Companys financial condition, results of operations or cash flows.

On March 21, 2008, Cygne received a letter from Weltman,
Weinberg & Reis Co., LPA informing Cygne that they had been retained by China Export & Credit Corporation aka Sinosure (Sinosure) to investigate a collection claim by Evolve International Trading (Shanghai) Co. Ltd.
(Evolve). Evolve claims that it shipped certain goods to Cygne and that Cygne owes it $1,519,822 in unpaid invoices for those goods. This letter and the supporting documents were forwarded to Hubert Guez and Diversified Apparel
Resources, LLC (DAR). DAR and Hubert Guez have examined the documents and informed us that Cygne has no liability concerning these amounts. Therefore, we consider it remote that we will have to pay this amount and that it is not a
liability.

On April 11, 2008, Cygne received a summons and complaint on behalf of M.Y. Accessories Ltd. (M.Y.). M.Y.
claims that it sold and delivered certain goods to Diversified Apparel Resources, LLC (DAR) and Cygne. In the complaint, M.Y. claims that DAR and Cygne are responsible for the $311,373 in unpaid invoices for those goods. This letter and
the supporting documents were forwarded to Hubert Guez and DAR. DAR and Hubert Guez have examined the documents and informed us that Cygne has no liability concerning these amounts. Therefore, we consider it remote that we will have to pay this
amount and that it is not a liability. In addition, in the above complaint, M.Y. claims that it sold and delivered goods to Cygne and that Cygne owes it $27,012 in unpaid invoices for those goods. We have examined the documents and we believe that
it is probable that we will have to pay this amount. Therefore, we have included this claim at the stated amount as a liability in our financial statements.

On March 20, 2008, received a summons and complaint on behalf of Copen Associates, Inc. (Copen). Copen claims that it sold and delivered certain goods to Cygne on January 18, 2007 and
November 1, 2007 as agreed upon and that Cygne owes it $55,871 in unpaid invoices for those goods. We have examined the documents and we believe that it is probable that we will have to pay this amount. Therefore, we have included this claim at
the stated amount as a liability in our financial statements.

12. Income Taxes

Deferred income taxes are provided using the liability method. Under this method, deferred income taxes reflect tax carryforwards and the net tax effects
of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. The financial effect of changes in tax laws or rates is accounted for in
the period of enactment. Significant components of the Companys deferred tax assets and liabilities are as follows.



F-35



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



|                                                                                        |  |                       |         |   |      |   |         |  
|--------------------------------------------------------------------------------------- |  | --------------------- | ------- | - | ---- | - | ------- | -
|                                                                                        |  | (In thousands)        |        
|                                                                                        |  | Year Ended January 31 |        
|                                                                                        |  | 2008                  |         |   | 2007 |  
|Deferred tax assets:                                                                    |  |                       |         |   |      |   |         |  
|Net operating loss carryforwards                                                        |  | $                     | 17,257  |   |      | $ | 19,097  |  
|Difference between book and tax basis of goodwill                                       |  |                       | 16,378  |   |      |   |         |  
|Investment in subsidiaries not currently deductible                                     |  |                       | 362     |   |      |   | 1,069   |  
|Unrealized loss on marketable securities                                                |  |                       | 70      |   |      |   | 70      |  
|                                                                                        |  |                       |         |   |      |   |         |  
|                                                                                        |  |                       | 34,067  |   |      |   | 20,236  |  
|Deferred tax liabilities:                                                               |  |                       |         |   |      |   |         |  
|Difference between book and tax basis of intangible assets                              |  |                       | 0       |   |      |   | 4,155   |  
|                                                                                        |  |                       |         |   |      |   |         |  
|Net deferred tax asset                                                                  |  |                       | 34,067  |   |      |   | 16,081  |  
|Valuation allowances                                                                    |  |                       | (34,067 | ) |      |   | (16,081 | )
|                                                                                        |  |                       |         |   |      |   |         |  
|Net deferred tax asset after valuation allowances                                       |  | $                     | 0       |   |      | $ | 0       |  
|                                                                                        |  |                       |         |   |      |   |         |  
|Deferred tax liability resulting from difference between book and tax basis of goodwill |  | $                     | 0       |   |      | $ | (2,471  | )
|                                                                                        |  |                       |         |   |      |   |         |  

For financial reporting purposes, income (loss) before income taxes includes the following
components:



|                     |  |                 |         |   |                 |   |        |                 |  |   |        |  
|-------------------- |  | --------------- | ------- | - | --------------- | - | ------ | --------------- |  | - | ------ | -
|                     |  | (In thousands)  |        
|                     |  | Year Ended      |        
|                     |  | January 31,2008 |         |   | January 31,2007 |   |        | January 31,2006 | 
|Pretax (loss) income |  |                 |         |   |                 |   |        |                 |  |   |        |  
|United States        |  | $               | (64,611 | ) |                 | $ | 3,357  |                 |  | $ | (3,947 | )
|Foreign              |  |                 | (1,290  | ) |                 |   | (1,605 | )               |  |   | (1,399 | )
|                     |  |                 |         |   |                 |   |        |                 |  |   |        |  
|Total                |  | $               | (65,901 | ) |                 | $ | 1,752  |                 |  | $ | (5,346 | )
|                     |  |                 |         |   |                 |   |        |                 |  |   |        |  

Significant components of the (benefit from) provision for income taxes are as follows:



|                    |  |                 |        |   |                 |   |                 |  |   |    
|------------------- |  | --------------- | ------ | - | --------------- | - | --------------- |  | - | ---
|                    |  | (In thousands) 
|                    |  | Year Ended     
|                    |  | January 31,2008 |        |   | January 31,2007 |   | January 31,2006
|Current:            |  |                 |        |   |                 |   |                 |  |   |    
|Federal             |  | $               | 92     |   |                 | $ | 56              |  | $ | 0  
|Foreign             |  |                 | 0      |   |                 |   | 0               |  |   | 0  
|State and local     |  |                 | 338    |   |                 |   | 168             |  |   | 35 
|                    |  |                 |        |   |                 |   |                 |  |   |    
|Total current       |  | $               | 430    |   |                 | $ | 224             |  | $ | 35 
|                    |  |                 |        |   |                 |   |                 |  |   |    
|Deferred taxes      |  |                 |        |   |                 |   |                 |  |   |    
|Federal             |  | $               | (2,100 | ) |                 | $ | 1,433           |  | $ | 667
|State               |  |                 | (371   | ) |                 |   | 253             |  |   | 118
|                    |  |                 |        |   |                 |   |                 |  |   |    
|Total               |  | $               | (2,471 | ) |                 | $ | 1,686           |  | $ | 785
|                    |  |                 |        |   |                 |   |                 |  |   |    
|Total tax provision |  | $               | (2,041 | ) |                 | $ | 1,910           |  | $ | 820
|                    |  |                 |        |   |                 |   |                 |  |   |    



F-36



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Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



The reconciliation of income tax at U.S. federal statutory tax rates to income tax expense is as follows:



|                                                               |  |                  |         |   |                 |       |    |                 |   |        |   |  |       |   |  |   |        |   |  |       |   
|-------------------------------------------------------------- |  | ---------------- | ------- | - | --------------- | ----- | -- | --------------- | - | ------ | - |  | ----- | - |  | - | ------ | - |  | ----- | --
|                                                               |  | $( in thousands) |        
|                                                               |  | Year Ended       |        
|                                                               |  | January 31,2008  |         |   | January 31,2007 |       |    | January 31,2006 |  
|Tax at U.S. statutory rates                                    |  | $                | (22,406 | ) |                 | (34.0 | )% |                 | $ | 596    |   |  | 34.0  | % |  | $ | (1,817 | ) |  | (34.0 | )%
|U.S. loss, no benefit provided                                 |  |                  | 20,027  |   |                 | 30.0  |    |                 |   |       |   |  |      |   |  |   | 1,342  |   |  | 25.1  |   
|Utilization of U.S. net operating loss carryforwards           |  |                  | (1,469  | ) |                 | (2.0  | )  |                 |   | (1,085 | ) |  | (62.0 | ) |  |   |       |   |  |      |   
|Foreign loss (income) not subject to tax (benefit)             |  |                  | 439     |   |                 | 1.0   |    |                 |   | 545    |   |  | 31.1  |   |  |   | 475    |   |  | 8.8   |   
|Tax amortization of goodwill without benefit for book purposes |  |                  | (2,471  | ) |                 | (1.0  | )  |                 |   | 1,686  |   |  | 96.2  |   |  |   | 785    |   |  | 14.7  |   
|Gain on debt conversion and debt amortization                  |  |                  | 2,658   |   |                 | 4.0   |    |                 |   |       |   |  |      |   |  |   |       |   |  |      |   
|Loss of inventory                                              |  |                  | 843     |   |                 | 1.0   |    |                 |   |       |   |  |      |   |  |   |       |   |  |      |   
|Reversal of state tax accrual                                  |  |                  | (18     | ) |                 | (0    | )  |                 |   | (32    | ) |  | (1.8  | ) |  |   | (11    | ) |  | (0.2  | ) 
|Foreign and state income taxes                                 |  |                  | 356     |   |                 | 1.0   |    |                 |   | 200    |   |  | 11.4  |   |  |   | 46     |   |  | 0.9   |   
|                                                               |  |                  |         |   |                 |       |    |                 |   |        |   |  |       |   |  |   |        |   |  |       |   
|                                                               |  | $                | (2,041  | ) |                 | 3.1   | %  |                 | $ | 1,910  |   |  | 109.0 | % |  | $ | 820    |   |  | 15.3  | % 
|                                                               |  |                  |         |   |                 |       |    |                 |   |        |   |  |       |   |  |   |        |   |  |       |   

As of January 31, 2008, based upon tax returns filed and to be filed, the Company expects to
report a net operating loss carryforward for U.S. Federal income tax purposes of approximately $45,000,000. This carryforward amount reflects the fact that an ownership change with respect to the Companys shares took place on
January 3, 2006 for purposes of Section 382 of the U.S. Internal Revenue Code. Based upon the ownership change, the Company estimates that net operating loss carryforwards will be limited to approximately $5,303,000 per year. This
ownership change caused a forfeiture of approximately $63 million of net operating loss carryforwards for U.S. federal income taxes. If unused, the remaining loss carryforwards will expire in the Companys taxable years ending in 2011 through
2026. Approximately $19,000,000 of the federal net loss carryforwards will expire as of the end of the taxable year January 2011. The following table sets forth federal net operating loss carryforwards, as adjusted:



|               |  |                   |  |                                        |       
|-------------- |  | ----------------- |  | -------------------------------------- | ------
|Year Generated |  | Year ofExpiration |  | Federal Net OperatingLoss
Carryforward
|               |  |                   |  | (In thousands)                        
|1996           |  | 2011              |  | $                                      | 19,000
|1997           |  | 2012              |  |                                        | 3,000 
|1998           |  | 2013              |  |                                        | 8,000 
|1999           |  | 2019              |  |                                        | 3,000 
|2000           |  | 2020              |  |                                        | 1,000 
|2003           |  | 2023              |  |                                        | 2,000 
|2005           |  | 2025              |  |                                        | 7,000 
|2006           |  | 2026              |  |                                        | 2,000 
|               |  |                   |  |                                        |       
|               |  |                   |  | $                                      | 45,000
|               |  |                   |  |                                        |       

As of January 31, 2008, based upon tax returns filed and to be filed, the Company expects to
report net operating loss carryforwards for New York State and New York City tax purposes (on a separate company basis) of approximately $33 million. If unused, these loss carryforwards will expire as of the end of the Companys taxable years
ending in 2011 through 2026. Approximately $19,000,000 of the Companys net operating loss carryforwards for New York State and New York City purposes (on a separate company basis) will expire in the



F-37



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



taxable year ending January 2011. The ownership change with respect to the Companys shares which took place on January 3, 2006, caused
a forfeiture of approximately $25.0 million of net operating loss carryforwards for state and local income tax purposes.

The Company has
recorded a valuation allowance against the entire deferred tax asset due to the Companys history of losses and near break-even results. However, should the Company conclude that recoverability is reasonably certain, the value of the deferred
tax asset would be increased by eliminating some or all of the valuation allowance.

Tax Audits

The Internal Revenue Service (IRS) has completed its examinations for the Federal income tax returns for the tax years January 31, 1985
through January 31, 1996. New York State has completed its examinations for the tax years January 31, 1985 through January 31, 2000. New York City has completed its examinations for the tax years January 31, 1985 through
January 31, 2002.

On March 11, 2008, the IRS informed the Company that it would commence an audit of Cygnes federal tax
return for the tax period January 31, 2007; the Company is not currently undergoing any other United States tax examinations.

In
2001, the Guatemalan Internal Revenue Service commenced an audit of the Guatemalan tax returns filed by JMB Internacional, S.A., the Companys 100% owned Guatemalan subsidiary, for its taxable years 1998, 1999, and 2000. The Guatemalan tax
authorities are examining the tax returns of this subsidiary, which had been granted a tax holiday, but JMB Internacional, S.A. was assessed an income tax under a different Guatemala statute. The Company protested this tax and did not pay the tax.
However, the Company has established a reserve for this contingent liability in the amount of $470,000 and has included this reserve on the balance sheet under Income Taxes Payable.

In May 2005, the Israeli Internal Revenue Service (IIRS) orally informed the Companys Israeli tax representative that it would commence
an audit for the years prior to December 31, 2004 of the Companys 100% owned dormant Israeli subsidiary, M.T.G.I.-Textile Manufacturers Group (Israel) Ltd. There has been no further communication with the IIRS since May 2005.

The Company is subject to other ongoing tax audits in several jurisdictions. Although there can be no assurances, the Company believes any adjustments
that may arise as a result of these other audits will not have a material adverse effect on the Companys financial condition, results of operations, and cash flows.

13. Employee Benefit Plans

On January 1, 2006 the Company implemented a 401(k) plan (the
2006 401(k) plan) that permits U.S. employees to make contributions up to the maximum permitted by law. The 2006 401(k) plan contains an employer contribution provision that provides for a Companys contribution of 10% of the
employees contribution. The Companys contribution to the plan for the years ended January 31, 2008 and 2007 was approximately $15,000 and $12,000, respectively.



F-38



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



14. Closed Manufacturing Facility

Guatemalan Manufacturing Facility

On November 8, 2007, the management of Cygne Designs, Inc.
made the decision to close its manufacturing facility located in Guatemala. The planned closure of the Guatemalan facility was completed in November 2007. We made this decision as the competitiveness of the product categories manufactured in
Guatemala was adversely affected by the discontinuance of textile import quotas by the United States on January 1, 2005. The Guatemala Apparel Agency, which has been in business since 1999 and coordinates buying merchandise and supplying it to
retailers, was not closed.

In the year ended January 31, 2006, based on an appraisal by an independent third party, Cygne recorded a
100% impairment charge with respect to its equipment, furniture and fixtures at its Guatemalan facility and established a salvage value of $375,000 for the land, building and building improvements. Cygne incurred severance costs related to the
closure of this facility of $275,000 which was recorded as an expense and paid during the three months ended January 31, 2008. Cygne believes that there will not be any additional impairment to the value of its land and buildings as shown on
the January 31, 2008 balance sheet. The land and building is currently for sale.

15. Quarterly Financial Data (Unaudited)

The following table sets forth the quarterly financial data for the years ended January 31, 2008 (2007) and 2007 (2006).



|                                                              |  |                                         |        |   |       |   |          |  |       |        |  |       |         |   |       |   |        |   |       |   |        |  |   |        |  |   |        |  
|------------------------------------------------------------- |  | --------------------------------------- | ------ | - | ----- | - | -------- |  | ----- | ------ |  | ----- | ------- | - | ----- | - | ------ | - | ----- | - | ------ |  | - | ------ |  | - | ------ | -
|                                                              |  | (In thousands except per share amounts) |       
|                                                              |  | 2007                                    |        |   | 2006  |  
|                                                              |  | Qtr.1                                   |        |   | Qtr.2 |   | Qtr.3(2) |  | Qtr.4 |        |  | Qtr.1 |         |   | Qtr.2 |   | Qtr.3  |   | Qtr.4 |  
|Net sales                                                     |  | $                                       | 20,863 |   |       | $ | 33,189   |  | $     | 22,905 |  | $     | 18,796  |   |       | $ | 20,895 |   |       | $ | 45,116 |  | $ | 32,980 |  | $ | 19,825 |  
|Gross profit (loss)                                           |  |                                         | 4,173  |   |       |   | 7,818    |  |       | 4,208  |  |       | (272    | ) |       |   | 4,964  |   |       |   | 9,976  |  |   | 6,379  |  |   | 4,155  |  
|Loss on impairment of goodwill and intangible assets          |  |                                         |       |   |       |   |         |  |       |       |  |       | 61,850  |   |       |   |       |   |       |   |       |  |   |       |  |   |       |  
|(Loss) income before interest, other expense and income taxes |  |                                         | 65     |   |       |   | 3,105    |  |       | 2,636  |  |       | (66,366 | ) |       |   | 724    |   |       |   | 3,723  |  |   | 2.645  |  |   | (307   | )
|Interest expense(1)                                           |  |                                         | 957    |   |       |   | 947      |  |       | 1,132  |  |       | 2,305   |   |       |   | 1,290  |   |       |   | 1,293  |  |   | 1,436  |  |   | 1,014  |  
|Provision for (benefit from) income taxes                     |  |                                         | 480    |   |       |   | 577      |  |       | 797    |  |       | (3,895  | ) |       |   | 410    |   |       |   | 440    |  |   | 444    |  |   | 616    |  
|Net (loss) income                                             |  |                                         | (1,372 | ) |       |   | 1,581    |  |       | 707    |  |       | (64,776 | ) |       |   | (976   | ) |       |   | 1,990  |  |   | 765    |  |   | (1,937 | )
|Net (loss) income per share-basic and diluted                 |  | $                                       | (0.05  | ) |       | $ | 0.06     |  | $     | 0.02   |  | $     | (1.71   | ) |       | $ | (0.04  | ) |       | $ | 0.08   |  | $ | 0.03   |  | $ | (0.07  | )
|                                                              |  |                                         |        |   |       |   |          |  |       |        |  |       |         |   |       |   |        |   |       |   |        |  |   |        |  |   |        |  



|(1) | Including amortization of debt discount.
|--- | ----------------------------------------

|(2) | Per amended 10-Q filed on May 15, 2008
|--- | --------------------------------------

Quarterly
computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters may not agree with the year shown elsewhere in the Annual Report on Form 10-K.



F-39



---

Cygne Designs, Inc. and Subsidiaries

Notes to Consolidated Financial Statements(Continued)



16. Subsequent Event

On April 25, 2008, Cygne appointed Jay Furrow as President and Chief Executive Officer of Cygne. Bernard Manuel, who was Chairman, President and Chief Executive Officer, will continue to serve as Chairman of
Cygne. Mr. Furrow will receive an annual salary of $400,000 per year, and will participate in all employee benefit programs offered by Cygne to its executives. In connection with the appointment of Jay Furrow as President and CEO, the Company
granted to Mr. Furrow a fully vested 10-year option to purchase one million shares of the Companys common stock at a price of $0.30 per share.

In connection with the appointment of Mr. Furrow as President and Chief Executive Officer, on April 25, 2008 Cygne and Mr. Manuel entered into a letter agreement terminating his employment agreement and
providing, among other things, that: Mr. Manuel will remain an employee through January 31, 2010, advising senior executive officers with respect to international sourcing, and for which Mr. Manuel will receive a salary of $12,500 per
month, and will be entitled to continue to participate, at Cygnes expense, in the Companys health insurance plan; and in recognition of Mr. Manuels past services to Cygne and his agreement to forego bonuses and contractually
mandated annual salary increases for over ten years, upon termination of his employment Cygne will pay him severance in the amount of $1,200,000, payable in 12 equal quarterly installments of $100,000, with the first payment commencing on
February 15, 2010.



F-40



---

Cygne Designs, Inc. and Subsidiaries

Schedule II-Valuation and Qualifying Accounts

January 31, 2008



|                                     |  |                              |  |                            |  |                     |   |  |                        
|------------------------------------ |  | ---------------------------- |  | -------------------------- |  | ------------------- | - |  | -----------------------
|Description                          |  | Balance atBeginning ofPeriod |  | Charged toCost andExpenses |  | Change inAllowances |   |  | Balance atEnd of Period
|                                     |  | (In thousands)              
|Reserves for returns and allowances: |  |                              |  |                            |  |                     |   |  |                        
|Year ended January 31, 2006          |  | 0                            |  | 3,894                      |  | 1,932               |   |  | 1,962                  
|Year ended January 31, 2007          |  | 1,962                        |  | 8,798                      |  | (9,250              | ) |  | 1,510                  
|Year ended January 31, 2008          |  | 1,510                        |  | 1,831                      |  | (1,510              | ) |  | 1,831                  
|                                     |  |                              |  |                           
|Reserve for other receivables:       |  |                              |  |                            |  |                     |   |  |                        
|Year ended January 31, 2006          |  | 433                          |  | 0                          |  | 433                 |   |  | 0                      
|Year ended January 31, 2008          |  | 0                            |  | 94                         |  | 0                   |   |  | 94                     



F-41