Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

**(Mark One)**

 

| **x**                                                                                                                                                                                                         | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                    | ** **                                                                                               |
| **For the fiscal year ended June 30, 2009**                                                                                                                                                              |
| ** **                                                                                                                                                                                                    |
| **or**                                                                                                                                                                                                        |
| ** **                                                                                                                                                                                                    | ** **                                                                                               |
| **o**                                                                                                                                                                                                         | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                                                                                                                    | ** **                                                                                               |
| **For the transition period  from              to              ** |

 

**Commission File Number:  333-138342**

 

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**RafaellaApparel Group, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                     | ** ** | **20-2745750**       |
|----------------------------------|------------|----------------------|
| (State  or other jurisdiction of |       | (I.R.S.  Employer    |
| incorporation  or organization)  |       | Identification  No.) |

 

**1411Broadway, New York, New York 10018**

**(212)403-0300**

(Address, including zipcode, and telephone number, including area code,****of registrant’s principal executive offices)

 

Indicate by checkmark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.  Yes o   No x.

 

Indicate by checkmark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act.  Yes o   No x.

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x   No o.

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o   No o.

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§ 229.405 of this chapter) is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer or asmaller reporting company.  Seedefinitions of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).   Yes o No x

 

Asof September 28, 2009, the registrant had 2,500,000 shares of its commonstock, par value $0.01 per share, outstanding.

 

 

 

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**Table of Contents**

 

**RAFAELLA APPARELGROUP, INC.**

**ANNUAL REPORT**

**JUNE 30, 2009**

**TABLE OF CONTENTS**

** **
| ** **                                                                                                                                                                                              | ** ** | ** **                                                                                                          | ** ** | **PAGE** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| **PART I**                                                                                                                                                                                         |       |                                                                                                                |       |     |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| ITEM 1.                                                                                                                                                                                                 |       | BUSINESS                                                                                                            |       | 1        |
| ITEM 1A.                                                                                                                                                                                                |       | RISK FACTORS                                                                                                        |       | 6        |
| ITEM 1B.                                                                                                                                                                                                |       | UNRESOLVED  STAFF COMMENTS                                                                                          |       | 14       |
| ITEM 2.                                                                                                                                                                                                 |       | PROPERTIES                                                                                                          |       | 14       |
| ITEM  3.                                                                                                                                                                                                |       | LEGAL  PROCEEDINGS                                                                                                  |       | 14       |
| ITEM 4.                                                                                                                                                                                                 |       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |       | 14       |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| **PART II**                                                                                                                                                                                        |       |                                                                                                                |       |     |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| ITEM 5.                                                                                                                                                                                                 |       | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES |       | 14       |
| ITEM 6.                                                                                                                                                                                                 |       | SELECTED  FINANCIAL DATA                                                                                            |       | 16       |
| ITEM 7.                                                                                                                                                                                                 |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                         |       | 17       |
| ITEM 7A.                                                                                                                                                                                                |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                        |       | 31       |
| ITEM 8.                                                                                                                                                                                                 |       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       | 31       |
| ITEM 9.                                                                                                                                                                                                 |       | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               |       | 31       |
| ITEM  9A(T).                                                                                                                                                                                            |       | CONTROLS &  PROCEDURES                                                                                     |       | 31       |
| ITEM  9B.                                                                                                                                                                                               |       | OTHER  INFORMATION                                                                                                  |       | 32       |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| **PART III**                                                                                                                                                                                       |       |                                                                                                                |       |     |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| ITEM 10.                                                                                                                                                                                                |       | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             |       | 32       |
| ITEM 11.                                                                                                                                                                                                |       | EXECUTIVE COMPENSATION                                                                                              |       | 34       |
| ITEM 12.                                                                                                                                                                                                |       | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                    |       | 45       |
| ITEM 13.                                                                                                                                                                                                |       | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE                                           |       | 46       |
| ITEM 14.                                                                                                                                                                                                |       | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                                             |       | 47       |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| **PART IV**                                                                                                                                                                                        |       |                                                                                                                |       |     |
|                                                                                                                                                                                                    |       |                                                                                                                |       |     |
| ITEM 15.                                                                                                                                                                                                |       | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                                         |       | 48       |
| EXHIBIT INDEX                                                                                                                                                                                           |       | 48                                                                                                                  |
| SIGNATURES                                                                                                                                                                                              |       | 52                                                                                                                  |
| SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS  FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH  HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT |       | 52                                                                                                                  |

 

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**PART I**

 

**ITEM 1.**                                                     BUSINESS

** **

**GENERAL**

** **

Rafaella Apparel Group, Inc. (the “Company”)acquired substantially all of the assets of Rafaella Sportswear, Inc. inan acquisition consummated on June 20, 2005.  The Company, formerly known as RafaellaCorporation, is a Delaware corporation that was formed on April 4,2005.  Except as otherwise indicated, referencesto “we”, “us”, the Company and Rafaella Apparel Group, Inc., for periodsprior to the acquisition, refer to our predecessor.

 

**Our Company**

** **

We are an established wholesaler, designer, sourcer,marketer and distributer of a full line of women’s career and casual sportswearseparates within the United States.  Wehave been in the women’s apparel business since 1982 and market our productsprimarily under the Rafaella brand and private label brands of ourcustomers.  We design, source and marketpants, sweaters, blouses, knits, jackets and skirts for all seasons of theyear.  Our in-house design staff developsour lines to include basic and fashion separates with updated features andcolors using a variety of natural and synthetic fabrics.  Using our design specifications, we outsourcethe manufacturing and production of our clothing line to factories primarily inAsia.  We sell our products directly todepartment, specialty and chain stores and off-price retailers.  We have over 350 customers, representing over4,200 individual retail locations.  Ourcustomers include some of the larger retailers of women’s clothing in theUnited States.

 

**Our Industry**

** **

The retail women’s apparel industry is highlycompetitive, with many providers of similar types of clothing as are designedand marketed by us.  In addition, thereis a growing trend toward consolidation in the industry, decreasing the numberof retailers and the floor space available for our products.  Wholesalers of women’s apparel are subject topricing pressures from both retailers and consumers, stemming from theincreased competition for customers and economic cycles that impacts thespending of our consumers.

 

The women’s apparel industry in which we operate hashistorically been subject to cyclical variations, current general economicconditions, and perceived or anticipated future economic conditions.  The current economic environment,characterized by a dramatic decline in consumer discretionary spending, hasmaterially and adversely affected the retail and wholesale apparelindustry.  Discretionary purchases, suchas women’s apparel, have been especially impacted in the current economicenvironment.

 

**Products**

** **

Our lines consist of basic and fashion separates withupdated features and colors.  We designour products to appeal to our target market of women aged 30 to 55 in theUnited States.  Our products are dividedinto three broad categories based on size: Missy, Petite and Woman.  TheMissy category comprises traditional sized clothing, whereas the Petite andWoman cater to smaller and larger framed women, respectively.  We also categorize our clothing lines asCareer and Casual.  Career clothingconsists of jackets, pants, skirts, shirts, blouses and sweaters designed to beworn primarily to work.  Casual clothingis designed to be worn primarily as weekend wear and consists of pants, skirts,knits, jackets, shirts and sweaters principally made of cotton basedfabrics.  Recent fashion trends have ledto a blurring of the distinctions between these categories, with women wearingCasual separates to work and Career separates for functions outside work.

 

Our products are priced to retail at the entry levelin the “better” sportswear departments of our retail customers.  Our pants, skirts, blouses and sweaterstypically retail for $30 to $50 per item, knits for $15 to $40 per item andjackets for $45 to $90 per item.  Webelieve that our products are of an equal or higher quality than those of ourcompetition.

 

**Seasonality**

** **

We present seasonal “lines” each year corresponding tothe retail selling seasons, Spring, Summer, Fall and Holiday.  Each line consists of complementary styles ofpants, sweaters, blouses, knits, jackets and skirts, which are sold asindividual items, but which may be coordinated into complete outfits.  Each style in our lines comes in a variety ofcolors and/or patterns.  Fabrics includecotton and cotton blends, synthetics and synthetic blends, silk and silkblends, wool and wool blends and linen, depending upon the season and clothingstyle.  Our lines are marketedprincipally under the Rafaella brand and private label brands of our customers.

 

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**Design**

 

Our design team, operating out of our headquarters inNew York, is responsible for the development of new products and our seasonallines according to our merchandising calendar. The team includes a creative director along with staff designers andassistant designers, with computer aided design capabilities, in addition to acolor and print specialist.  Each memberof the team has responsibility for certain products, creating several groupingsfor a given season.

 

The design staff interprets emerging trends in fashionfrom European travel and trend services, and receives market feedback from ourmanagement and sales force, in order to stay abreast of new designconcepts.  This information is used todevelop preliminary expectations for the composition and silhouettes of thenext line.  With this guidance, thedesign team develops initial sketches and design prototype garments reflectingline concepts and style ideas.  Fromthese concepts, certain styles are selected for further development and thedesign team, in conjunction with management, begins to select colors andfabrics for the line.  Fabric samples areordered in each pattern and color.  Usingthe sample fabrics, more refined prototype garments are made by ourmanufacturers.  These refined samples areused for display in the showroom during the applicable market week.  The line is further refined based on customerfeedback during the market week.

 

**Product Sourcingand Distribution**

** **

We contract for the manufacture of our productsexclusively with third-party manufacturers and do not own or operate anymanufacturing facilities.  During fiscal2009, our merchandise purchases were primarily sourced from Asian manufacturers.  In the future, we may source from othereconomically feasible regions of the world. Outsourcing our products allows us to maximize production flexibility,while avoiding significant capital expenditures, work-in-process inventorybuild-ups and costs associated with managing a larger production force.  Over 99% of our goods were manufactured by 18Asian manufacturers.

 

We utilize individual purchase orders specifying theprice, quantity and design specifications of the merchandise to be produced,mostly secured by letters of credit.  Wedo not have long-term, formal arrangements with our manufacturers, and we continually seek additional suppliers forour production needs to provide additional capacity and flexibility asneeded.  Because we have been using manyof the same manufacturers for several years, we believe we have established andmaintained excellent relationships with high-quality manufacturers, fabricsuppliers and agents.  Theserelationships facilitate our ability to control the quality of our products,achieve favorable pricing for production and ensure a reliable supply ofproducts.  Based on our past experienceof adding and removing suppliers, we believe that we are not dependent on anyparticular supplier and, if necessary, can replace in a timely manner anysupplier at a similar cost and quality.

 

From 1997 through the end of October 2008, we workedwith the same principal buying agent based in Hong Kong for the majority of ourproduct sourcing.  Historically, thisagent served as a non-exclusive buying agent for manufactured goods in Asia,principally China, Hong Kong and Vietnam. This agent also identified and qualified contract manufacturers,administered and coordinated production, and managed the quality controlprocess for production administered and coordinated by this agent as well aswhen we utilized certain other agents in Asia. Compensation to our agent was based on a percentage of the full cost ofthe finished garment before shipping costs and customs duties.  During fiscal 2008, we decided to cease ourrelationship with this Hong Kong agent, effective October 31, 2008, and weestablished a subsidiary in Hong Kong to perform these activities in-housebeginning in November 2008.

 

We source fabric for many of our manufacturers.  Due to our large annual purchases of ourhigher volume fabrics, we have been able to negotiate favorable pricing withour fabric suppliers.  We negotiatedirectly with our suppliers for the purchase of required fabrics, which arepurchased either directly by us or by our manufacturers under our directions.

 

We have a comprehensive quality control program thatbegins overseas to ensure that raw materials and finished goods meet ourspecifications for design, fit and quality. Fabric purchases are inspected upon receipt at the manufacturers’facilities, and prior to commencement of production.  Inspections are handled by representatives ofour Hong Kong office as well as our manufacturers’ staffs.  Quality control inspectors also inspectfinished goods before shipment to the United States, as well as once they reachour warehouse and distribution facilities located in Bayonne, New Jersey andany third party distribution facilities that we utilize.  Management believes that our low return rateon defective merchandise is largely due to our rigorous quality controlprocesses.

 

We utilize a centralized distribution system, underwhich most merchandise is received, processed and distributed through ourBayonne, New Jersey facility.  From thesefacilities, merchandise is inspected, packed and shipped to our customers viacommon carriers.  To facilitate thedistribution process and control warehouse costs, all of our products, otherthan those ordered to support our replenishment and private label programs, arepackaged into pre-established packages, or pre-packs, prior to being shipped toour Bayonne facilities.  Each pre-packcontains six, eight or ten garments, in a single style and color, and in apreset range of sizes.  We offer pre-packsize ranges in Missy, Petite and Woman. Management believes the use of pre-packs helps minimize our distribution

 

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costs and reduce shipping errors and reduces our risk of unsoldinventory in an undesirable assortment of sizes that may be difficult to sellat acceptable gross profit margins.

 

Many of our customers have developed their ownextensive individual policies and procedures regarding virtually all aspects ofshipping and product packaging and presentation, including, among others,standards for hangers, shipping boxes,labels, shipping procedures, barcoding and hangtags.  Before we ship orders to our customers, weconfirm that the products and procedures being followed comply with therelevant standards in order to avoid the financial penalties imposed by thecustomer for non-compliance with their policies and procedures.  We use a system, which was developed toensure compliance, which includes automation of certain components, such as thesubmission of advance shipping notices to our customers scheduled for severalhours in advance of each customer’s deadline for such notices.  In addition, we monitor each customer’spolicies and procedures guidelines, review customer manuals on a regular basis,and modify our systems accordingly.

 

**Sales, Marketingand Advertising**

** **

We maintain a direct sales force that operates out ofour New York showroom.  Our direct salesforce is compensated exclusively on a salaried basis with a discretionaryannual performance bonus.  This in-housesales force, together with management, accounted for approximately 98% of ourfiscal 2009 sales.  We also haveindependent, non-exclusive sales representatives operating in various regionsof the United States who are compensated exclusively on a commission basis. These sales representatives accounted for approximately 2% of our fiscal2009 sales.

 

We introduce our products to existing and prospectivecustomers during market weeks, which occur four to six months ahead of thecorresponding retail selling seasons. During market weeks, customers visit our showroom to view our Casual andCareer line of separates for the applicable retail season.  During and shortly following market weeks,many of our customers provide us with non-binding indications as to theirinitial orders for that season. Historically, a very high percentage of these indications havetranslated into actual orders and sales. As a result, we are able to gather information that enables us to refineour production plans to better meet the anticipated demand on a cost-effectivebasis.

 

To date, we have not incurred significant media basedadvertising costs.  We raise awareness ofthe Rafaella brand through a focused, cost effective on-line approach utilizingsocial networking, blogging, e-mail blasts and interactive communityforums.  We maximize media coverage inmajor publications such as Oprah, In Style, WWD and Lucky magazine.

 

**Customers**

** **

Our principal customers are department and specialtystores.  The department and specialtystores channel represented approximately 62% of our total net sales in fiscal2009 and the other approximately 38% of our total net sales in fiscal 2009 wereto off-price retailers and private label customers.  While certain of our customers consist ofseparate department and specialty store chains or off-price retailers withcommon ownership, these customers have separate purchasing departments and aretherefore viewed by us as separate customers. Divisions of Macy’s, Belk, and Kohl’s, our three largest customers (whenviewed on a common ownership basis), accounted for 28%, 20% and 12%,respectively, of our total net sales in fiscal 2009.

 

We believe we have strong relationships with ourcustomers.  We have over 350 customers,representing over 4,200 individual retail store locations.  Our top ten customers (when viewed on commonownership basis) accounted for approximately 96% of net sales for fiscal2009.  It has been our experience thatmany major retailers are continuing to consolidate their women’s apparelsuppliers by purchasing from a select group of established brand name vendors,such as our company.  We are continuingto seek new relationships and expand our presence to new points of sale.

 

**Backlog**

 

As of September 25,2009 and September 26, 2008, we had unfilled customer orders ofapproximately $36.2 million and $55.1 million of merchandise,respectively.  The amount of unfilledcustomer orders at a particular time is affected by a number of factors, includingproduct mix, the timing of receipt and processing of customer orders and theproduct manufacturing and shipping schedule, which is dependent to a certainextent on customer demand.  Accordingly,a comparison of unfilled orders from period to period is not necessarilymeaningful and may not be indicative of eventual actual shipments.

 

**Working Capital**

 

Historically, our salesand operating results fluctuate by quarter, with the greatest sales typicallyoccurring in our first and third quarters of the fiscal year.  It is in these quarters that our Fall andSpring product lines, which traditionally have had the highest volume of netsales, are shipped to customers. As a result, we experience significantvariability in our quarterly results and working 

 

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capital requirements.Moreover, delays in shipping can cause revenues to be recognized in a laterquarter, resulting in further variability in such quarterly results.

 

Working capitalrequirements vary throughout the year. Working capital typically increases during the first and third quartersof the fiscal year as inventory builds to support peak shipping/selling periodsand, accordingly, typically decreases during the second and fourth quarters ofthe fiscal year as inventory is delivered/sold. Cash provided by operating activities is typically higher in the secondand fourth quarters of the fiscal year due to the reduced working capitalrequirements during that period.

 

**Competition**

** **

The United States retail apparel industry is highlycompetitive and fragmented.  Ourcompetitors include numerous apparel designers, manufacturers, importers,licensors and our own customers’ private label programs, many of which arelarger and have greater financial and marketing resources than are available tous.  We believe that the principalcompetitive factors in the industry are:

 

·                  consistent fit;

·                  productquality;

·                  styling;

·                  price;

·                  brandname and brand identity; and

·                  reliability of deliveries.

 

We strive to focus on these points and respond quicklyto customer demand with our range of products and our ability to operate withinthe industry’s production and delivery constraints.  Based on customer feedback, we believe thatour continued dedication to customer service, product assortment andconsistency, quality control and pricing enable us to compete effectively.  We believe that our established brand andrelationships with retailers have resulted in a loyal following of customersand consumers.

 

**Trademarks**

** **

The “Rafaella” and “V Verrazano” (stylized) brandnames, which are our material trademarks, are registered in the United Statesand in certain foreign jurisdictions for use in the women’s sportswearmarket.  We do not have rights to thesemarks for other product categories.  Weregard these trademarks and other proprietary rights as valuable assets andfrom time to time we take action to protect our trademarks againstinfringement.

 

**InformationSystems**

** **

We have a limited information technology team and relyon third-party providers for telecommunications, Electronic Data Interchange (“EDI”)applications and other support.  Ourfinancial and operational information and reporting needs are met by a softwarepackage written primarily for apparel companies and further customized for ourneeds by a third party software development and maintenance firm.  We own substantially all of our computerequipment and contract with third parties to maintain backup systems.

 

Our customers can elect to use EDI to trade andprocess orders with us on a simplified and expedited basis.  We use EDI with certain customers to provideadvance-shipping notices, process orders and conduct billing operations.  In addition, certain other customers use EDIto communicate to us their weekly inventory requirements on a store-by-storebasis.  As of June 30, 2009, we had13 customers that use EDI to communicate with us.  In fiscal 2009, total sales to thesecustomers were approximately 84% of our overall total sales.

 

**Imports, ImportRestrictions and Other Government Regulations**

** **

***Imports and Import Restrictions***

 

Our transactions with our foreign suppliers are subjectto the risks of doing business abroad. Imports into the United States are affected by, among other things, thecost and availability of transportation, and the imposition of import dutiesand restrictions.  The countries that wesource our products from may, from time to time, also impose restrictions ortake various economic actions, which could affect our ability to importproducts from such countries at the current or increased levels.  Imports into the United States can also besubjected to various additional restrictions and the assessment of punitiveantidumping duties or countervailing duties when goods are shipped to the U.S.at less than fair value (dumping) orwith certain countervailing subsidies from the exporting nation.  In 2007, the U.S. Government altered a morethan twenty-year policy by applying its antisubsidy laws to 

 

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certain exports from China.  Inaddition, bills have been introduced in Congress which would hold China andother countries accountable for currency manipulation through the assessment ofpenal duties.  The effect of thesechanges could be an increase to the cost of goods imported by us fromChina.  The pendency of theabove-described actions could have a disruptive effect on imports from theexporting country while the action is pending as a result of the potentiallyresulting uncertainty.  We cannot predictthe likelihood or frequency of any such events occurring.

 

***Other Government Regulation***

 

We are subject tofederal, state and local laws and regulations regarding our business.  These include the Consumer Product SafetyImprovement Act, the Textile Fiber Product Identification Act, the FlammableFabric Act and the rules and regulations of the Federal Trade Commissionand the Consumer Product Safety Commission, or the CPSC, as well as similarlaws and regulations under state requirements. Under the Flammable Fabrics Act, we have elected to file a continuingguaranty with the CPSC and, in connection with this continuing guaranty, we arerequired to maintain written records that show that the guaranty is based ontest results which demonstrate conformance with reasonable and representativetests prescribed by the CPSC.  We believethat we are in compliance in all material respects with all applicablegovernmental regulations.

 

**Employees**

** **

As of June 30, 2009, we had approximately 153employees, of whom approximately 46 were employed in New York, approximately 75were employed in New Jersey, and approximately 32 were employed in HongKong.  We are not a party to any laboragreements and none of our employeesare represented by a union.  We considerour relationship with our employees to be satisfactory and have not experiencedany interruption of our operations due to labor disputes with our employees.

 

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** **

**ITEM 1A.               RISK FACTORS**

** **

**Risks Related toOur Indebtedness**

** **

***Our substantial debt could adversely affect our financial health.***

 

We have a substantial amount of debt.  As of June 30, 2009, we hadapproximately $84.7 million (based upon accreted value at maturity) of seniorsecured notes outstanding, excluding interest accrued thereon and $10.1 millionof letters of credit outstanding under our senior secured revolving creditfacility agreement with HSBC Bank USA, National Association (“HSBC”), as amended(the “Credit Facility”), and the ability to utilize $3.4 million ofavailability under the Credit Facility for letters of credit and loans, subjectto compliance with our financial and other covenants and the terms set forththerein.  Our substantial debt could haveimportant consequences to holders of our senior secured notes.  For example, it could:

 

·                  make us vulnerable to general adverse economic and industry conditions;

·                  limit our ability to refinance or extend the Credit Facility beyond thecurrent maturity date, increase the cost of a refinancing or extension of the CreditFacility or limit our ability to obtain additional financing for future workingcapital, capital expenditures, product development, strategic acquisitions andother general corporate requirements;

·                  expose us to interest rate fluctuations because the interest on thedebt under the Credit Facility is at variable rates;

·                  require us to dedicate a substantial portion of our cash flow fromoperations to payments on our debt, thereby reducing the availability of ourcash flow for operations and other purposes;

·                  limit our flexibility in planning for, or reacting to, changes in ourbusiness and the industry in which we operate; and

·                  place us at a competitive disadvantage compared to our competitors thatmay have proportionately less debt.

 

***Our debt service requires a significant amount of cash.***

 

To service our debt, we require a significant amountof cash.  Our ability to generate cash,make required payments or to refinance our obligations depends on oursuccessful financial and operating performance. We cannot assure you that our operating and financial performance, cashflow and capital resources will be sufficient for payment of our debt in thefuture.  Our financial and operatingperformance, cash flow and capital resources performance depend upon prevailingeconomic conditions, and certain financial, business and other factors, many ofwhich are beyond our control.  Thesefactors include, among others:

 

·                  economic and competitive conditions affecting the market for ourproducts and the women’s apparel market generally;

·                  operating difficulties, increased operating costs or pricing pressureswe may experience; and

·                  increased raw material costs.

 

In addition, the terms of our indenture require thatwe make an offer to repurchase our senior secured notes at 101% of face valuewith 50% of our excess cash flow (as defined) each fiscal year.  To the extent that our noteholders acceptthis offer, we will have less cash to use for working capital or othercorporate purposes.

 

If our cash flow and capital resources areinsufficient to fund our debt service obligations, we may be forced to reduceor delay capacity expansion and capital expenditures, sell material assets oroperations, obtain additional capital or restructure our debt.  In the event that we are required to disposeof material assets or operations or restructure our debt to meet our debtservice and other obligations, there can be no assurances as to the terms ofany such transaction or how soon any such transaction could be completed, if atall.

 

***The terms of our indebtedness impose significant operating andfinancial restrictions on us, which may prevent us from pursuing certainbusiness opportunities and taking certain actions.***

 

The Credit Facility and the indenture governing thenotes impose significant operating and financial restrictions on us.  These restrictions limit or prohibit, amongother things, our ability to:

 

·                  declare dividends orredeem or repurchase capital stock;

·                  prepay, redeem orrepurchase debt (including the senior secured notes);

·                  incur liens;

 

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·                  make loans andinvestments;

·                  guarantee or incuradditional debt;

·                  amend or otherwise alterterms of debt (including the senior secured notes);

·                  engage in mergers,acquisitions and other business combinations;

·                  sell assets;

·                  make capital expenditures;

·                  transact with affiliates;and

·                  alter the business weconduct.

 

In addition, the Credit Facility also includes the followingfinancial covenants:

 

·                  a minimum working capitalrequirement;

·                  a minimum rolling quarterlyperiod net-income (as defined) requirement; and

·                  a cash collateralrequirement.

 

Certain of these financial covenants become morerestrictive over time.

 

A breach of any of these covenants or our inability tocomply with the financial covenants could result in a default under the Credit Facility,which in turn could trigger a default under our senior secured notes.  If any default occurs under the indenture,the holders of the senior secured notes may elect to declare all outstandingborrowings, together with accrued interest and other amounts payablethereunder, to be immediately due and payable. If the debt under the Credit Facility and/or the senior secured noteswere to be accelerated, we cannot assure you that our assets would besufficient to repay in full any indebtedness under the Credit Facility and thesenior secured notes.

 

***Our ability toaccess the credit and capital markets may be adversely affected by factorsbeyond our control, including turmoil in the financial services industry,volatility in financial markets and general economic downturns.***

 

We rely upon access tothe credit markets as a source of liquidity for the portion of our working capitalrequirements not provided by cash from operations. The Credit Facility expireson December 15, 2010 and our senior secured notes mature on June 15, 2011.Market disruptions such as those currently being experienced in the UnitedStates and abroad may increase our cost of borrowing or adversely affect ourability to access sources of liquidity upon which we rely to finance ouroperations and satisfy our obligations as they become due. These disruptionsinclude turmoil in the financial services industry, including substantialuncertainty surrounding particular lending institutions and counterparties withwhich we do business, unprecedented volatility in the markets where ouroutstanding indebtedness trades, and general economic downturns. Managementcurrently does not believe that we will have sufficient cash on hand, based oncurrent cash flow projections, to settle the senior secured notes in June 2011at principal or face value. If we are unable to access credit at competitiverates, or if our short-term or long-term borrowing costs dramatically increase,our ability to finance our operations, meet our short-term obligations andimplement our operating strategy could be adversely affected. Additionally, ifcurrent credit and capital market conditions continue, it could have a materialadverse effect on our ability to refinance all or any portion of our existingdebt, and we may be unable to refinance our existing debt on terms acceptableto us, if at all.

 

**Risks Related toOur Business and Industry**

 

***Slowdowns ingeneral economic activity have detrimentally impacted our customers and havehad an adverse effect on our sales and profitability.***

 

Our business is sensitive to the business cycle of thenational economy. Deterioration in general economic conditions adversely affectdemand for our products, and cause sales of our products to decrease. Many ofour customers, particularly department and specialty stores, have cancelled orscaled back purchases of products such as ours as a result of the dramatic declinein consumer discretionary spending and strategic initiatives by our customersto reduce (carry less) on-hand inventory in stores.  This reduced customer demand has adverselyaffected our results of operations and may continue to do so. ** **Further deteriorationin economic conditions, along with decreasing levels of spending by ourcustomers, will continue to adversely affect our revenues and profits through reducedpurchases of our products. In such circumstances, we may reduce prices oncertain items, which would further adversely affect our profitability.

 

In addition, there could be a number of other effectsfrom the ongoing economic downturn. The inability of key suppliers to accessliquidity, or the insolvency of key suppliers, could lead to delivery delays orfailures. We grant credit to our customers in the normal course of businesswhich subjects us to potential credit risk. Financial difficulties of ourcustomers could adversely impact our results of operations. Finally, othercounterparty failures, including banks and counterparties to other contractualarrangements, could negatively impact our business.

 

***Our business could be negatively impacted by significant changes in thefinancial condition, or bankruptcy, of our customers.***

 

A number of apparel retailers have experiencedsignificant changes and financial difficulties over the past several years,including consolidation of ownership, increased centralization of buyingdecisions, the loss of customers to online retailers, difficulties in implementingonline retailing, restructurings, bankruptcies and liquidations.  Consistent with industry practices, we sellproducts primarily on open account after completing an appropriate creditreview of the customer.  A significantadverse change in a customer or its financial position or a customer’sbankruptcy filing or liquidation could cause us to limit or discontinuebusiness with that customer, require us to assume more credit risk relating tothat customer’s receivables, or limit our ability to collect amounts related toprevious purchases by that customer, all of which could harm our business,financial condition and results of operations by causing a significant declinein revenues attributable to such customers, particularly if our third-party factoris unwilling to assume the credit risk on receivables from such customers orlimits the amount of credit risk it is willing to take from such customers.

 

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***The concentration of our customers could adversely affectour business if a major customer decreases its business with us.***

 

In fiscal 2009, our department and specialty storeschannel accounted for approximately 62% of our total net sales.  The other approximately 38% of our total netsales in fiscal 2009 were to off-price retailers and private label customers.

 

While certain of ourcustomers consist of separate department and specialty store chains oroff-price retailers with common ownership, these customers have separatepurchasing departments and are therefore viewed by us as separatecustomers.  Divisions of Macy’s, Belk,and Kohl’s, our three largest customers (when viewed on a common ownershipbasis), accounted for 28%, 20% and 12%, respectively, of our total net sales infiscal 2009.

 

A decision by any of our major customers, whethermotivated by competitive conditions, financial difficulties, change of ownership,change of management or otherwise, to decrease significantly the amount ofmerchandise purchased from us, to increase the use of their own private labelbrands for which we are not the manufacturer or sourcer, or to change itsmanner of doing business with us, could substantially reduce our revenues andmaterially adversely affect our operations and our ability to generate profits.

 

***Competition in the apparel industry could reduce our salesand our profitability.***

 

As an apparel company, weface competition on many fronts, including the following:

 

·                  establishingand maintaining favorable brand recognition;

 

·                  developingproducts that appeal to consumers;

 

·                  pricing productsappropriately; and

 

·                  obtaining accessto, and sufficient floor space in, retail stores.

 

The United States apparel industry is highlyfragmented and includes a number of very large companies, many of which havegreater financial, technical and marketing resources, greater manufacturingcapacity and more extensive and established customer relationships than wedo.  The competitive responsesencountered from these larger, more established apparel companies may be moreaggressive and comprehensive than we anticipate and we may not be able to competeeffectively.  Additionally, in responseto the continued consolidation of our customers, our competitors mayconsolidate as well in order to increase their ability to servicecustomers.  The competitive nature of theapparel industry may result in lower prices for our products and decreased grossprofit margins, which may materially adversely affect our sales and financialcondition.

 

***Continuedconsolidation among our customers may harm our business***.

 

There has been, and continues to be, consolidationactivity in the U.S. retail women’s apparel industry.  With the growing trend towards consolidation,we are increasingly dependent upon key retailers whose bargaining strength andshare of our business is growing.  It ispossible that these larger retailers may, instead of continuing to purchase women’ssportswear separates from us, decide to manufacture or source such itemsthemselves; or instead of using the Company as their manufacturer or sourcerfor their own private label brands, turn to a competitor or directlymanufacture or source such items.

 

There is also the possibility that customers mayconsolidate with one or more of their other vendors and begin sourcing itemsfrom such vendors.  Consolidation mayalso result in store closures which could adversely impact our sales.

 

In addition, as a result of consolidation, we may facegreater pressure from these larger customers to provide more favorable priceand trade terms, to comply with increasingly more stringent vendor operatingprocedures and policies and to alter our products or product mix to providedifferent items such as exclusive merchandise, private label products or moreupscale goods.  If we are unable toprovide more favorable terms or to develop satisfactory products, programs orsystems to comply with any new product requirements, operating procedures orpolicies, this could adversely affect our operating results.

 

***The apparel industry is subject to pricing pressures thatmay cause us to lower the prices we charge for our products.***

 

Prices in the United States apparel industry have beendeclining over the past several years primarily as a result of the movement ofmanufacturing operations offshore, the growth of the mass market retail channelof distribution, increased competition, consolidation in the retail apparelindustry and the general economic slowdown of recent years.  Products manufactured offshore generally costless to manufacture than those made domestically primarily because labor costsare lower offshore.  Many of ourcompetitors also source their product requirements from developing countries,possibly from developing countries with lower costs than the developingcountries from which we source our products, and those manufacturers may usethese cost savings to reduce prices.  Toremain competitive, we may have to adjust our prices from time to time inresponse to these industry-wide pricing pressures.  Moreover, increasing customer demands forallowances, incentives and other forms of economic support reduce our grossmargins.  Our financial performance maybe materially and adversely affected by these pricing pressures, if we areforced to reduce our prices and we cannot reduce our production costs, or ifour production costs increase and we cannot increase our prices.

 

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***Our profitability may decline as a result of increasing pressure onmargins given that a portion of our operating expenses are fixed.***

 

The apparel industry issubject to significant pricing pressure caused by many factors, includingintense competition, consolidation in the retail industry, pressure fromretailers to reduce the costs of products and changes in consumer spendingpatterns.  These factors may cause us toreduce our sales prices and increase the magnitude and frequency of ourmarkdown allowances to our customers, which could cause our gross margin todecline if we are unable to appropriately manage inventory levels and/orotherwise offset price reductions with comparable reductions in our operatingcosts.  If our sales prices decline andwe fail to sufficiently reduce our variable product costs or operatingexpenses, our profitability will decline. This could have a material adverse effect on our results of operations,liquidity and financial condition.

 

***Our business will suffer if we fail to continuallyanticipate customer tastes.***

 

Customer tastes changerapidly.  We may not be able toanticipate, gauge or respond to these changes in a timely manner.  If we misjudge the market for our products orproduct groups or if we fail to identify and respond appropriately to changingconsumer demands, we may be faced with a significant amount of unsold finishedgoods inventory, which could materially adversely affect our expected operatingresults and financial condition and decrease our sales and gross margins.

 

The United States apparel industry has relatively longlead times for the design and production of products.  Consequently, we must commit in some cases toproduction in advance of orders based on forecasts of consumer demand.  If we fail to forecast consumer demandaccurately, we may underproduce or overproduce a product and encounterdifficulty in filling customer orders or in liquidating excess inventory.  Additionally, if we overproduce a productbased on an aggressive forecast of consumer demand, retailers may not be ableto sell the product in amounts and at prices they deem acceptable and mayexpect sales allowances and cancel future orders.  These outcomes could have a material adverseeffect on our sales, brand image and financial condition seriously affectingour operating results.

 

***We need significant working capital to fund our operations,a substantial portion of which is financed, and our inability to continue tofinance such working capital could affect our marketing and sales effortsbecause our ability to purchase inventory would be curtailed.***

 

We need significantworking capital to purchase inventory and are often required to post letters ofcredit when placing an order with one of our third-party manufacturers orfabric suppliers.  We expect to meet ourworking capital needs primarily through our operating cash flow but we may alsoutilize the Credit Facility, pursuant to which we have been able to obtain aline of credit and letters of credit.  Ifwe are unable to meet the covenants in the Credit Facility and, as a result,are unable to borrow under the facility, or to have letters of credit issued onour behalf, or we are unable to extend or renew or refinance such facility onterms satisfactory to us, our ability to purchase inventory would be curtailedor eliminated, which would significantly affect our marketing and salesefforts, thus significantly harming our business.

 

***Our revenues and operating results are sensitive to consumerconfidence and spending patterns.***

 

The United States apparelindustry has historically been subject to cyclical variations, recessions inthe general economy or uncertainties regarding future economic prospects thataffect consumer spending habits which could negatively impact our businessoverall and specifically our sales, gross margins and profitability.  The success of our operations depends onconsumer spending.  Consumer spending isimpacted by a number of factors, including actual and perceived economicconditions affecting disposable consumer income (such as unemployment, wagesand salaries), business conditions, interest rates, availability of credit andtax rates in the general economy and in the international, regional and localmarkets where our products are sold.  Anysignificant deterioration in general economic conditions, actual or perceived,or increases in interest rates could reduce the level of consumer spending andinhibit consumers’ use of credit.  Inaddition, war, terrorist activity or the threat of either may adversely affectconsumer spending, and thereby have a material adverse effect on our financialcondition and results of operations.

 

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***Fluctuations in the price, availability and quality offabrics could cause production delays and increase costs.***

 

Fluctuations in the price, availability and quality ofthe fabrics or other raw materials used in our manufactured apparel could havea material adverse effect on our cost of sales or our ability to meet customerdemands.  The prices for these fabricsdepend largely on the market prices for the raw materials used to produce them,particularly cotton.  The price andavailability of the raw materials and, in turn, the fabrics used in our apparelmay fluctuate significantly, depending on many factors, including crop yields,weather patterns and changes in oil prices. We may not be able to pass all or any portion of the higher rawmaterials prices and related transportation costs on to our customers.

 

***Because we sell our products on a purchase order basis andrely on estimated forecasts of our customers’ needs, inaccurate forecasts couldadversely affect our business.***

 

We sell our products pursuant to individual purchaseorders instead of long-term purchase commitments.  We typically do not enter into long-termcontracts with customers.  Therefore, werely on estimated demand forecasts, based upon formal and informal input fromour customers and non-binding indications of our customers’ initial ordersgiven during and shortly following market weeks, to determine how much materialto purchase and product to manufacture. Because our sales are based on purchase orders, our customers maycancel, delay or otherwise modify their purchase commitments with little or noconsequence to them and with little or no notice to us.  In addition, we cannot provide assurance asto the quantities or timing required by our customers for our products. Whetherin response to changes affecting the industry or a customer’s specific businesspressures, any cancellation, delay or other modification in our customers’orders could significantly reduce our revenue, cause our operating results tofluctuate from period to period and make it more difficult for us to predictour revenue.  In addition, if ourforecasts are incorrect, we may have excess unsold inventory, which we may haveto sell at a discount or may not be able to sell at all.

 

***Many of our customers require our compliance with theirvendor operating policies and procedures.***

 

Many of our customers have developed extensivepolicies and procedures regarding virtually all aspects of shipping and productpackaging and presentation, including standards for hangers, shipping boxes,labels, shipping procedures, barcoding and hangtags, among others.  These policies and procedures are oftenextensively documented, very detailed and unique to each customer, requiring usto develop and maintain a system to ensure compliance with each customer’sindividual manual of policies and procedures. Although we have implemented a system that we believe is sufficient toensure compliance with our customer’s shipping and packaging requirements, wecannot assure you that this system or any future system will adequately addresscustomer requirements.  If we do notcomply with these policies and procedures we may be required to pay financialpenalties to our customers, which could become significant if there iswidespread non-compliance.  In addition,our customers may decline to order additional products from us in the event weare consistently unable to comply with the relevant standards and procedures.

 

***The extent of our foreign sourcing and manufacturing mayadversely affect our business.***

 

For fiscal 2009, all ofour products were manufactured outside the United States, including asignificant portion from China, Vietnam and Indonesia.  As a result of the magnitude of our foreignsourcing and manufacturing, our business may be subject to risks, including thefollowing:

 

·                  uncertaintycaused by the elimination of import quotas and the possible imposition ofadditional quotas or antidumping or countervailing duties or other retaliatoryor punitive trade measures;

 

·                  imposition ofduties, taxes and other charges on imports;

 

·                  significantdevaluation of the dollar against foreign currencies;

 

·                  restrictions onthe transfer of funds to or from foreign countries;

 

·                  politicalinstability, military conflict or terrorism involving the United States or anyof the countries where our products are manufactured, which could cause a delayin transportation or an increase in costs of transportation, raw materials orfinished product or otherwise disrupt our business operations;

 

·                  disease,epidemics and health-related concerns, such as swine flu, SARS or the mad cowor hoof and mouth disease outbreaks in recent years, which could result inclosed factories, reduced workforces, scarcity of raw materials and scrutinyand embargoing of goods produced in infected areas; and

 

·                  violations by foreigncontractors of labor and wage standards and resulting adverse publicity.

 

If these risks limit or prevent us from acquiringproducts from foreign suppliers or significantly increase the cost of ourproducts, our operations could be seriously disrupted until alternativesuppliers are found, which could negatively impact our business.

 

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***Our reliance on third-party manufacturers could causedelays, adversely affect operations and damage customer relationships.***

 

We use third-party manufacturers to assemble orproduce all of our products.  We aredependent on the ability of these third-party manufacturers to adequatelyfinance the assembly or production of goods ordered and maintain sufficientmanufacturing capacity.  The use ofthird-party manufacturers to assemble or produce finished goods and theresulting lack of direct control could subject us to difficulty in obtainingtimely delivery of products of acceptable quality.  We do not have long-term contracts with anyof our manufacturers and an unexpected interruption in supply from any of ourmanufacturers could disrupt our operations until a suitable alternate manufacturercan be found and supply restored.  Evenif an alternate manufacturer can be found promptly, such manufacturer may notbe able to provide us with products or manufacturing services of a comparablequality, at an acceptable price or on a timely basis.  As a result, our business relationship withour customers purchasing such products, or any products incorporating suchproducts or services, may be terminated, reduced or otherwise modified by suchcustomer.  There can be no assurance thatthere will not be a disruption in the supply of our products from third-partymanufacturers or, in the event of a disruption, that we would be able tosubstitute suitable alternate third-party manufacturers in a timely manner, orthat a customer will not terminate, reduce or otherwise modify its businessrelationship with us as a result thereof. The failure of any third-party manufacturer to perform, or the loss orreduction of supply from any third-party manufacturer, or the termination,reduction or modification of such customer business relationship, could have amaterial adverse effect on our business, results of operations and financialcondition.

 

In addition, any negative publicity that third-partymanufacturers may receive as a result of the use of labor practices by suchmanufacturers that are inconsistent with labor practices utilized in the UnitedStates, or which are regarded as deficient relative to labor practices utilizedelsewhere in the world, may lead our customers to terminate, reduce or otherwisemodify their business relationships with us. Any such publicity, or resulting change in any of our customer businessrelationships, could also have a material adverse effect on our business,results of operations and financial condition.

 

***Our international operations andthe operations of many of our manufacturers are subject to additional risksthat are beyond our control and that could harm our business.***

 

Due to our operations and our manufacturingrelationships abroad, we are subject to numerous domestic and foreign laws andregulations affecting our business, such as those related to labor, employment,worker health and safety, antitrust and competition, environmental protection,consumer protection, import/export, and anti-corruption, including but notlimited to the Foreign Corrupt Practices Act which prohibits giving anything ofvalue intended to influence the awarding of government contracts. Although wehave put into place policies and procedures aimed at ensuring legal andregulatory compliance, our employees, subcontractors and agents could takeactions that violate these requirements. Violations of these regulations couldsubject us to criminal or civil enforcement actions, any of which could have amaterial adverse effect on our business.

 

***We cannot predict how import restrictions will impact ourbusiness.***

 

Our transactions with our foreign suppliers aresubject to the risks of doing business abroad. Imports into the United States are affected by, among other things, thecost and availability of transportation of the products and the imposition ofimport duties and restrictions.  Thecountries that we source our products from may, from time to time, also imposerestrictions or take various economic actions, which could affect our abilityto import products from such countries at the current or increased levels.  Imports into the United States can also besubjected to various additional restrictions and the assessment of punitiveantidumping duties or countervailing duties when goods are shipped to the U.S.at less than fair value (dumping) orwith certain countervailable subsidies from the exporting nation.  In 2007, the U.S. Government altered a morethan twenty-year policy by applying its antisubsidy laws to certain exportsfrom China.  In addition, bills have beenintroduced in Congress which would hold China and other countries accountablefor currency manipulation through the assessment of penal duties.  The effect of these changes could be anincrease to the cost of goods imported by us from China.  The pendency of the above-described actionscan have a disruptive effect on imports from the exporting country while theaction is pending as a result of the potentially resulting uncertainty.  We cannot predict the likelihood or frequencyof any such events occurring.

 

Various interests haveproposed extending an expired monitoring program covering textile imports fromVietnam and expanding it to cover imports from China. Should these proposals inthe future be adopted and should they result in affirmative determinations ofinjury, they could result in additional restrictions or duties.

 

On November 8, 2005, the governments of theUnited States and China entered into a Memorandum of Understanding that tookeffect on January 1, 2006, and that established agreed quota levels onseveral textile categories including products imported by us.  The now expired quota agreement remained ineffect with respect to goods exported from China through December 31,2008.  The bilateral agreement eliminatedsome of the uncertainty inherent in unilateral safeguard actions.

 

On September 11, 2009, acting under the authorityof the China product safeguard provision (section 421 of the Trade Act of 1974,as amended), the U.S. President proclaimed that certain passenger vehicle andlight truck tires from China are being imported into the United States in suchincreased quantities or under such conditions as to cause or threaten to causemarket disruption to the domestic producers of like or directly competitiveproducts.  The determination furtherprovided for the imposition of additional import duties on such products, for aperiod of three years, as a remedy.  Itis possible that U.S. domestic textile and apparel interests may petition forsimilar relief in the form of additional import duties or other measures suchas quotas.  We cannot predict whethersuch action would be sought or approved.

 

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In addition, various economic factors, including, butnot limited to, the exchange rate between the U.S. and Chinese currencies, andincreased cost for raw materials, labor and transportation, could materiallyimpact the availability or cost at which we could import our products.

 

New and proposed reporting requirements to be made ator prior to the time of entry may also impact the speed and efficiency at whichour goods may enter into the U.S. market. These include, among others, the new “10 + 2” security filing.  Increased time lags for the release ofimported product may also be the case with respect to ongoing governmentalinitiatives in the areas of supply chain security and product safety.

 

We monitor these and other duty, tariff and quotarelated developments and continually seek to minimize our potential exposure toquota related risks through, among other measures, shifts of production amongcountries and manufacturers.

 

In addition to the factors outlined above, our importoperations may be adversely affected by political or economic instabilityresulting in the disruption of trade from exporting countries, any significantfluctuations in the value of the dollar against foreign currencies andrestrictions on the transfer of funds.

 

***We may be unable to protect our trademarks and otherintellectual property rights or expand our use of our trademark outside of thewomen’s sportswear market.***

 

We believe that our trademarks are important to oursuccess and our competitive position due to their name recognition with ourcustomers.  There can be no assurancethat the actions we have taken to establish and protect our trademarks will beadequate to prevent use of our marks or similar marks by others, or imitationof our products by others or to prevent others from seeking to block sales ofour products as a violation of the trademarks and other proprietary rights ofothers.  Also, others may assert rightsin, or ownership of, our trademarks and other proprietary rights, and we may beunable to successfully resolve such disputes to our satisfaction.  Our rights in the Rafaella mark are limitedto use for the women’s sportswear segment of the apparel business.  Other parties are using similar marks inother segments of the apparel business. If we expand outside the women’s sportswear segment of the apparelindustry we may need to market our products under a different trademark.

 

***Our success depends in part on the efforts of our managementteam.***

 

Competition for qualified personnel in the UnitedStates apparel industry is intense and we compete for these individuals withother companies having greater financial and other resources.  Our continued success will depend, insignificant part, upon the continued services of our existing senior managementteam and on our continued ability to attract, retain and motivate qualifiedmanagement, administrative and sales personnel to support our existingoperations and our continued growth.  Theloss of the services of our executive officers could adversely affect ourfuture operating results, which depend to a substantial degree on theirexperience and knowledge of our business and their customer and vendorrelationships.  We may not be able toreplace any of our executive officers with sufficiently experienced andqualified personnel.  The temporary orpermanent loss of the services of any member of our senior management team, orour inability to attract and retain other qualified personnel could have amaterial adverse effect on our business, results of operations and financialcondition.

 

***We rely significantly on a few key shippers to distribute our productsto our customers and any service disruption could have an adverse effect on oursales.***

 

Ourability to both maintain our existing customer base and to attract newcustomers is highly dependent on our ability to deliver products and fulfillorders in a timely and cost-effective manner. To ensure timely delivery of ourproducts to our customers, we rely significantly on a few key shippers to shipthe vast majority of our products to our customers. These shippers may notcontinue to ship our product at its current pricing or its current terms. Ifthere is any disruption in our shippers’ ability to deliver our products,including a disruption caused by a strike by our shippers’ employees, we maylose customers and our sales will be adversely affected. Further, should theseshippers decide to terminate their contracts with us, we may not be able tofind an adequate replacement within a reasonable period of time and at areasonable cost to us. To the extent that our current shippers increase****their prices, we are unable to find a replacement or arerequired to hire a replacement at additional cost, our financial performancecould be materially adversely affected.

 

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***Disruption inour distribution center could adversely affect our results of operations.***

 

We maintain one centraldistribution center.  A seriousdisruption to our distribution center or to the flow of goods in or out of ourcenter due to fire, earthquake, act of terrorism or any other cause coulddamage a significant portion of our inventory and could materially impair ourability to distribute our products to customers in a timely manner or at areasonable cost. We could incur significantly higher costs and longer leadtimes associated with distributing our products to our customers during thetime that it takes for us to reopen or replace our distribution center. As aresult, any such disruption could have a material adverse effect on ourbusiness, results of operations and financial condition.

 

***If ourdistribution facility was to unionize, we would incur increased risk of workstoppages and possibly higher labor costs.***

 

None of our employees areparty to collective bargaining agreements. If employees at our distributioncenter were to unionize, we would incur increased risk of work stoppages andpossibly higher labor costs.  Iforganization efforts at our facility are successful, it could have an adverseeffect on our relationships with employees, labor costs and financialperformance.

 

***We may be adversely affected by ourpredecessor’s limited historical books and records and lack of formalizedinternal controls.***

 

Our predecessor and its management maintained verylimited records of the corporate actions of our predecessor and itssubsidiaries, including records relating to stock transfers and actions by ourpredecessor’s Board of Directors.  Inaddition, our predecessor’s control procedures were informal and/orundocumented.  Our predecessor was notsubject to the requirements of Section 404 of the Sarbanes-Oxley Act of2002 and the rules and regulations of the Securities and ExchangeCommission, or SEC, thereunder.  As aresult, our predecessor’s management did not evaluate or assess its internalcontrol over financial reporting.  Anyinadequacies in internal controls of our predecessor may lead to financialstatements that may not be reliable.  Anyinadequacies could also lead to legal liabilities on the part of our companyand could give rise to potential regulatory, creditor, noteholder and/orequityholder actions, any of which could have a material adverse effect on ourbusiness and financial condition.

 

***The requirements of complying with the Exchange Act and theSarbanes-Oxley Act may strain our resources and distract management.***

 

We are subject to the Securities Exchange Act of1934, as amended, or the Exchange Act, and the Sarbanes-Oxley Act of 2002.  These requirements increase our costs and mayplace a strain on our resources.  TheSarbanes-Oxley Act requires that we maintain and certify that we have effectivedisclosure controls and procedures and internal control over financialreporting.  Pursuant to Section 404of the Sarbanes-Oxley Act, our management is required to deliver a report thatassesses the effectiveness of our internal control over financial reporting,although an attestation report of our registered public accounting firm on theoperating effectiveness of such internal control is temporarily notrequired.  In order to maintain andimprove the effectiveness of our disclosure controls and procedures andinternal control over financial reporting, significant resources and managementoversight will be required as we may need to devote additional time andpersonnel to legal, financial and accounting activities to ensure our ongoingcompliance with the public company reporting requirements.

 

Inaddition, the effort to prepare for these requirements and maintain effectiveinternal controls may divert management’s attention from other businessconcerns, which could adversely affect our business, financial condition andresults of operations.  In addition, wemay need to hire additional accounting and financial staff and might not beable to do so in a timely fashion.  Weare working to identify those areas in which changes should be made to ourfinancial and management control systems to manage our growth and to ensurecompliance with the requirements of the Exchange Act and the Sarbanes-OxleyAct, and to make such changes.  The costsassociated therewith could be significant.

 

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**ITEM1B.**                                       UNRESOLVEDSTAFF COMMENTS

** **

None.

 

**ITEM2.**                                                PROPERTIES

** **

We maintain ourheadquarters in a 30,000 square foot office facility at 1411 Broadway in NewYork, New York.  The headquarters housesour design studio and sales showroom, in addition to our sourcing, finance andadministrative functions.  Our warehouseand distribution facilities occupy approximately 182,000 square feet inBayonne, New Jersey.  Our productsourcing and production facilities occupy approximately 6,000 square feet inKowloon Bay, Kowloon (Hong Kong).  Thefacilities are leased at market rents. The New York office lease expires in January 2013.  The New Jersey leases expire in December 2010and January 2011. The Hong Kong lease expires in November 2011.  In addition, we lease third-party storage anddistribution facilities on a month-to-month basis and pay a fee per itemshipped by the third party on our behalf. We own no real property orfacilities.

 

**ITEM 3.**                                                LEGAL PROCEEDINGS

** **

During April 2009,Kobra International, Ltd. d/b/a Nicole Miller (“Nicole Miller”) commencedarbitration proceedings against the Company alleging that the Company’sdecision to suspend performance as licensee under the parties’ LicenseAgreement (the “License”) constituted an anticipatory breach and/or repudiationof the License.  Nicole Miller seeks $1.5million in purported damages.  On April 29,2009, the Company filed papers denying Nicole Miller’s claims in theirentirety, asserting that the suspension of performance was permitted by theLicense and asserting a counterclaim of $1.0 million alleging that NicoleMiller’s subsequent termination of the License was improper.  While management has denied any liability andintends to vigorously defend against Nicole Miller’s claims and pursue itscounterclaim, at the present time, management believes that a loss isconsidered probable.  In accordance withStatement of Financial Accounting Standards No. 5, Accounting forContingencies, when a loss is considered probable and the loss amount can bereasonably estimated within a range, the Company records the minimum estimatedliability related to the matter if there is no best estimate within therange.  As of June 30, 2009, theCompany has accrued $0.2 million corresponding to the low end of the rangerelated to the potential loss.

 

Additionally, the Company, from time to time, is partyto various legal proceedings.  Whilemanagement, including external counsel, currently believes that the ultimateoutcome of these proceedings, individually and in the aggregate, will not havea material adverse impact on its financial position or results of operations,litigation is subject to inherent uncertainties.

 

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

** **

There were no matterssubmitted to a vote of the security holders during the fourth quarter of thefiscal year.

 

**PART II**

 

**ITEM 5.****                                               ****MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES**

 

There is no established public market for the commonstock of the Company.  All theoutstanding common stock of the Company, consisting of 2,500,000 shares, isowned by RSW 2005, Inc.  RA CerberusAcquisition, LLC, controlled by affiliates of Cerberus Capital Management, L.P.(“Cerberus”), owns 100% of the Company’s convertible preferred stock, which isconvertible at its option into common stock equal to 69.6% of the Company’soutstanding fully-diluted common stock.

 

No dividends have been declared on our common stockduring the two most recent fiscal years or since June 30, 2009.  We do not intend to pay dividends on ourcommon stock in the foreseeable future. Payment of dividends is within the discretion of the Company’s board ofdirectors and depends on various factors, including our net income, financialcondition, cash requirements and other factors deemed relevant by our board ofdirectors.  The amounts available to paydividends are limited by the terms of the 

 

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Financing Agreement,dated June 20, 2005, between the Company and HSBC Bank USA, NationalAssociation (“HSBC”) and the indenture governing our 11 1⁄4% Senior Secured Notesdue 2011.  We must also obtain theaffirmative vote or written consent of the holders of a majority of the thenoutstanding shares of Series APreferred Stock in order (i) to make (or permit any subsidiary to make) any declaration, payment orsetting aside for payment of any dividend or other distribution of any sort inrespect of any of our capital stock other than the Series A PreferredStock or (ii) to repurchase, redeem or acquire any outstanding stock ofthe Corporation other than the Series A Preferred Stock.

 

Subsequent to June 30, 2009, 187,500 options topurchase shares of common stock of the Company were forfeited in connectionwith the departure of a former executive officer of the Company.

 

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**ITEM6.**                                                     SELECTED FINANCIAL DATA

 

The historicalconsolidated financial data included below and elsewhere in this Annual Reportare not necessarily indicative of future performance.  The following selected financial data shouldbe read in conjunction with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations”, and our audited consolidated financialstatements and related notes included elsewhere in this Annual Report.

 

The summary selected historical financial datapresented below is for our predecessor for period from July 1, 2004through June 19, 2005 and, for us, for the period from June 20, 2005through June 30, 2005 and the fiscal years ended June 30, 2009, 2008,2007 and 2006.  This table should be readin conjunction with the Company’s consolidated financial statements and relatednotes appearing elsewhere in this Annual Report.

 

**RAFAELLAAPPAREL GROUP, INC.**

 
| ** **                                                      | ** ** | **Predecessor(1)**                                                       | ** ** | **Successor (1)**                                                         | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **Period from  July 1, 2004  through June 19,** | ** ** | **Period from  June 20, 2005  through June 30,** | ** ** | **Fiscal Year  Ended June 30,** | ** ** |
| ** **                                                      | ** ** | **2005**                                                                 | ** ** | **2005**                                                                  | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** |
| ** **                                                      | ** ** | **(Dollars in thousands)**                                     | ** ** |
| **Income Statement Data:**                                      | ** ** | ** **                                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                       |       | $                                                                        | 225,558    |                                                                      | $          | 4,215 |   | $ | 222,187 |   | $ | 191,284 |   | $ | 177,990 |   | $ | 147,965 |   |
| Cost of sales                                                   |       | 138,883                                                                  |       | 3,074                                                                     |       | 148,555 |   | 127,170 |   | 129,086 |   | 113,037 |   |
| Gross profit                                                    |       | 86,675                                                                   |       | 1,141                                                                     |       | 73,632 |   | 64,114 |   | 48,904 |   | 34,928 |   |
| Selling, general and  administrative expenses (3)               |       | 17,509                                                                   |       | 971                                                                       |       | 29,938 |   | 30,951 |   | 67,017 |   | 56,039 |   |
| Operating income (loss)                                         |       | 69,166                                                                   |       | 170                                                                       |       | 43,694 |   | 33,163 |   | (18,113 | ) | (21,111 | ) |
| Other expense (income):                                         |       |                                                                     |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Interest Expense, net                                           |       | 1,079                                                                    |       | 664                                                                       |       | 22,631 |   | 23,884 |   | 17,964 |   | 13,232 |   |
| Gain on senior secured note  purchases                          |       | —                                                                   |       | —                                                                    |       | — |   | — |   | (3,124 | ) | (25,632 | ) |
| Other                                                           |       | (47                                                                      | )          | —                                                                    |       | — |   | — |   | — |   | — |   |
| Total other expense  (income)                                   |       | 1,032                                                                    |       | 664                                                                       |       | 22,631 |   | 23,884 |   | 14,840 |   | (12,400 | ) |
| Income (loss) before  provision for (benefit from) income taxes |       | 68,134                                                                   |       | (494                                                                      | )          | 21,063 |   | 9,279 |   | (32,953 | ) | (8,711 | ) |
| Provision for (benefit  from) income taxes (2)                  |       | 2,249                                                                    |       | (212                                                                      | )          | 8,463 |   | 2,999 |   | (8,199 | ) | 6,726 |   |
| Net income (loss)                                               |       | 65,885                                                                   |       | (282                                                                      | )          | 12,600 |   | 6,280 |   | (24,754 | ) | (15,437 | ) |
| **Balance Sheet Data (at  end of period):**                     |       |                                                                     |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                       |       | $                                                                        | —     |                                                                      | $          | 52 |   | $ | 27,273 |   | $ | 11,390 |   | $ | 17,131 |   | $ | 17,698 |   |
| Accounts receivable                                             |       | —                                                                   |       | 23,180                                                                    |       | 22,510 |   | 20,785 |   | 15,286 |   | 11,550 |   |
| Inventories                                                     |       | —                                                                   |       | 52,120                                                                    |       | 47,054 |   | 44,375 |   | 33,249 |   | 12,334 |   |
| Total assets                                                    |       | —                                                                   |       | 213,954                                                                   |       | 223,195 |   | 193,804 |   | 148,848 |   | 87,479 |   |
| Current portion of senior  secured notes                        |       | —                                                                   |       | —                                                                    |       | 17,265 |   | 234 |   | 865 |   | — |   |
| Senior secured notes                                            |       | —                                                                   |       | 163,439                                                                   |       | 147,157 |   | 133,144 |   | 119,748 |   | 82,992 |   |
| Total liabilities                                               |       | —                                                                   |       | 200,233                                                                   |       | 196,874 |   | 160,962 |   | 141,118 |   | 95,162 |   |
| Redeemable convertible  preferred stock                         |       | —                                                                   |       | 40,110                                                                    |       | 44,110 |   | 48,110 |   | 52,110 |   | 56,110 |   |
| Total stockholders’ equity  (deficit)                      |       | —                                                                   |       | (26,389                                                                   | )          | (17,789 | ) | (15,268 | ) | (44,380 | ) | (63,793 | ) |
| **Other Financial Data:**                                       |       |                                                                     |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Net cash flows provided by  (used in):                          |       |                                                                     |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Operating activities                                            |       | $                                                                        | 51,201     |                                                                      | $          | 7,739 |   | $ | 36,765 |   | $ | 16,743 |   | $ | 16,872 |   | $ | 13,252 |   |
| Investing activities                                            |       | (5                                                                       | )          | (175,045                                                                  | )          | (283 | ) | (214 | ) | (966 | ) | (1,083 | ) |
| Financing activities                                            |       | (49,366                                                                  | )          | 167,358                                                                   |       | (9,261 | ) | (32,412 | ) | (10,165 | ) | (11,602 | ) |
| Depreciation and  amortization                                  |       | 125                                                                      |       | 71                                                                        |       | 5,453 |   | 4,985 |   | 4,504 |   | 4,671 |   |
| Capital expenditures                                            |       | 5                                                                        |       | —                                                                    |       | 95 |   | 214 |   | 966 |   | 1,083 |   |

 

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(1)        On June 20, 2005, pursuant to a Securities Purchase Agreement datedApril 15, 2005, as amended, Rafaella Apparel Group, Inc. issuedredeemable convertible preferred stock to RA Cerberus Acquisition, LLC for$40.0 million.  Immediately prior to theissuance of the preferred stock, Rafaella Sportswear, Inc. contributedsubstantially all of its assets to Rafaella Apparel Group, Inc. inexchange for 100% of its common stock and the assumption of certain liabilitiesrelated to the contributed assets. Immediately following the issuance of the preferred stock, RafaellaApparel Group, Inc. redeemed 75% of the common stock held by RafaellaSportswear, Inc. for $175.0 million. The June 20, 2005 acquisition was accounted for as a purchase inaccordance with Financial Accounting Standards No. 141, “BusinessCombinations,” and Emerging Issues Task Force 88-16, “Basis in Leveraged BuyoutTransaction.”  As a result of theacquisition and the resulting purchase accounting adjustments, the financialstatements including and after June 20, 2005 are not comparable to thepredecessor periods.

 

(2)        Our predecessor was taxed as an S corporation.  A provision has been made for certain stateand local income taxes applicable to S corporations.

 

(3)        The Company recorded impairment charges of $25.8 million and $34.5million during the years ended June 30, 2009 and 2008, respectively,related to the decline in the fair value of the Rafaella trademark and tradename intangible asset.  The impairmentcharges are reflected within selling, general and administrative expenses.

 

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**ITEM 7.****                                                    ****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following is adiscussion of our results of operations and financial condition.  This discussion should be read in conjunctionwith our audited consolidated financial statements and notes included elsewherein this Annual Report.

 

**NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

*This Annual Report containsstatements that are forward-looking and as such are not**historicalfacts. Rather, these statements constitute projections, forecasts or**forward-looking statements within themeaning of the Private Securities Litigation**Reform Act of 1995. You should not place unduereliance on these statements.**Forward-lookingstatements include information concerning the Company’s liquidity and**possible or assumed future results ofoperations, including descriptions of the**Company’s business strategies. These statements often include wordssuch as**“believe,” “expect,” “anticipate,”“intend,” “plan,” “estimate,” “seek,” “will,” “may”**or similar expressions. These statements are based oncertain assumptions that the**Companyhas made in light of its experience in the industry as well as its**perceptions of the historical trends, currentconditions, expected future**developmentsand other factors the Company believes are appropriate under these**circumstances.*

 

*All such forward-looking statementsspeak only as of the date of this Annual Report.**The Companyexpressly disclaims any obligation or undertaking to release publicly any**updates or revisions to any forward-lookingstatements contained herein to reflect**any change in the Company’s expectations with regard thereto or anychange in events,**conditions orcircumstances on which any such statement is based.*

 

*As you read this Annual Report, youshould understand that these statements are no**guarantees ofperformance or results. They involve risks, uncertainties and**assumptions. You should understand the risks anduncertainties discussed in**“Item 1A —Risk Factors” and elsewhere in this Annual Report, could affect**the Company’s actual financial results and couldcause actual results to differ**materiallyfrom those expressed in the forward-looking statements. Some important**factors include, but are not limited to:*

 

·                  the continued weakening national economy in generaland the consumer retail markets in particular;

 

·                  the financial condition of our customers and continuedconsolidation among our customers in the retail industry;

 

·                  our ability to retain major customers at current orhistorical levels;

 

·                  competition and pricing pressures in apparel industry;

 

·                  our continued ability to anticipate customer andconsumer tastes;

 

·                  ability to accurately forecast customer demand;

 

·                  fluctuations in the price, availability and quality offabrics;

 

·                  our ability to comply with the vendor operatingpolicies and procedures of our customers;

 

·                  our liquidity and the availability and cost ofadditional or continued sources of financing;

 

·                  our ability to generate sufficient cash flow toservice our existing debt service obligations;

 

·                  our ability to satisfy financial and other covenantsof the Credit Facility and senior secured notes indenture;

 

·                  our dependence upon third party sourcing andmanufacturing in foreign countries;

 

·                  changes in export regulations of foreign companies andchanges in U.S. import rules and regulations;

 

·                  protection of our brand and trademarks; and

 

·                  our ability to retain our senior management andattract and retain qualified and experienced employees.

 

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**COMPANY OVERVIEW**

** **

We are an establishedwholesaler, designer, sourcer, marketer and distributer of a full line of women’scareer and casual sportswear separates. We have been in the women’s apparel business since 1982 and market ourproducts primarily under the Rafaella brand and private label brands of ourcustomers.  We design, source and marketpants, sweaters, blouses, knits, jackets and skirts for all seasons of theyear.  Our in-house design staff developsour lines to include basic and fashion separates with updated features andcolors using a variety of natural and synthetic fabrics.  Using our design specifications, we outsourcethe manufacturing and production of our clothing line to factories primarily inAsia.  We sell our products directly todepartment, specialty and chain stores and off-price retailers.  We have over 350 customers, representing over4,200 individual retail locations.  Ourcustomers include some of the larger retailers of women’s clothing in theUnited States.

 

**Critical Trends;Performance Drivers**

** **

***PrimaryRevenue Variables***

*** ***

Our revenues are impacted by the following factors:

 

·                  national andregional economic conditions;

·                  overall levelsof consumer spending for apparel;

·                  demand byretailers for our brand and products;

·                  pricingpressures due to competitive market conditions and buying power of retailers;

·                  the accuracy ofour forecast of demand for our products;

·                  the performanceof our products within the prevailing retail environment;

·                  actions of ourcompetitors;

·                  ability of ourthird-party manufacturers to timely deliver products of acceptable quality; and

·                  the economicimpact of uncontrollable factors, such as terrorism and war.

 

***PrimaryExpense Variables***

*** ***

Variations in our cost of sales are primarily due to:

 

·                  fluctuations inthe price, availability and quality of raw materials;

·                  the length andlevel of variation in the production runs we order from third partymanufacturers;

·                  fluctuations induties, taxes and other charges on imports;

·                  pricingpressures due to competition for manufacturing sources;

·                  reductions inthe value of our unsold inventories;

·                  fluctuations inenergy prices which impact manufacturing costs and inbound transportationcosts; and

·                  internationaleconomic and political conditions.

 

Variations in selling, general and administrativeexpenses are primarily due to:

 

·                  changes inheadcount and salaries and related fringe benefits;

·                  costs associatedwith product development;

·                  changes inwarehousing and distribution expenses associated with sales volumes, outboundtransportation expenses impacted by changes in energy costs, and the need forthird party storage or shipping services;

·                  costs associatedwith legal and accounting professional fees;

·                  changes in PRand marketing expenses;

·                  changes infactoring costs and provisions for customer bad debts;

·                  costs associatedwith enhancing and maintaining an adequate system of internal controls; and

·                  costs associatedwith regulatory compliance.

*** ***

***Consolidation in the Industry***

*** ***

There has been, andcontinues to be, consolidation activity in the United States retail women’sapparel industry.  With the growing trendtowards consolidation, we are increasingly dependent upon key retailers whosebargaining strength and share of our business is growing.  It is possible that these larger retailersmay, instead of continuing to purchase women’s sportswear separates from us, decideto manufacture or source such items themselves. There is also the possibility that customers may consolidate with one 

 

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or more of theirother vendors and begin sourcing items from such vendors.  Consolidation may also result in storeclosures which could adversely impact our sales.

 

In addition, as a result of consolidation, we may facegreater pressure from these larger customers to provide more favorable pricingand trade terms, to comply with increasingly more stringent vendor operatingprocedures and policies and to alter our products or product mix to providedifferent items such as exclusive merchandise, private label products or moreupscale goods.  If we are unable toprovide more favorable terms or to develop satisfactory products, programs orsystems to comply with any new product requirements, operating procedures orpolicies, this could adversely affect our operating results.

 

***ChangingCustomer Tastes***

*** ***

We have designed our products primarily using basicstyling with updated features and colors in order to minimize the impact offashion trends.  However, fabric, colorand other style factors are still critical in determining whether our productsare purchased by consumers and consequently by our direct customers.  Consumer tastes can change rapidly.  We may not be able to anticipate, gauge orrespond to changes in customer tastes in a timely manner.  If we misjudge the market for our products orproduct groups or if we fail to identify and respond appropriately to changingconsumer demands, we may be faced with a significant amount of unsold finishedgoods inventory, which could have a material adverse affect on our expectedoperating results and decrease our sales and gross margins.  Conversely, if we predict consumerpreferences accurately, we could experience increased sales and greateroperating income because our selling, general and administrative expenses wouldremain at or near their current levels even with increased sales.

 

***Competition***

*** ***

As an apparel company, we face competition on manyfronts, including with respect to the following:

 

·                  establishing andmaintaining favorable brand recognition;

·                  developingproducts that appeal to consumers;

·                  pricing productsappropriately; and

·                  obtaining accessto, and sufficient floor space in, retail stores.

 

The United States apparel industry is highlyfragmented and includes a number of very large brands and companies marketingmultiple brands, many of which have greater financial, technical and marketingresources, greater manufacturing capacity and more extensive and establishedcustomer relationships than we do.  Webelieve we have maintained prices for our branded products in department andspecialty stores below comparable products offered by our brandedcompetitors.  However, the futurecompetitive responses encountered from these larger, more established apparelcompanies might be more aggressive and comprehensive than we anticipate and wemay not be able to compete effectively. For example, if our branded competitors were to match our prices forcomparable products, we may be forced to lower our prices or endure lower salesas a result.  The competitive nature ofthe apparel industry may result in lower prices for our products and decreasedgross profit margins, either of which may have a material adverse affect on oursales and results of operations.

 

***Import Restrictions and Regulations***

*** ***

Our transactions with our foreign suppliers aresubject to the risks of doing business abroad. Imports into the United States are affected by, among other things, thecost and availability of transportation of the products and the imposition ofimport duties and restrictions.  Thecountries that we source our products from may, from time to time, also imposerestrictions or take various economic actions, which could affect our abilityto import products from such countries at the current or increased levels.  Imports into the United States can also besubjected to various additional restrictions and the assessment of punitiveantidumping duties or countervailing duties when goods are shipped to the U.S.at less than fair value (dumping) orwith certain countervailable subsidies from the exporting nation.  In 2007, the U.S. Government altered a morethan twenty-year policy by applying its antisubsidy laws to certain exportsfrom China.  In addition, bills have beenintroduced in Congress which would hold China and other countries accountablefor currency manipulation through the assessment of penal duties.  The effect of these changes could be anincrease to the cost of goods imported by us from China.  The pendency of the above-described actionscan have a disruptive effect on imports from the exporting country while theaction is pending as a result of the potentially resulting uncertainty.  We cannot predict the likelihood or frequencyof any such events occurring.

 

Various interests haveproposed extending an expired monitoring program covering textile imports fromVietnam and expanding it to cover imports from China. Should these proposals inthe future be adopted and should they result in affirmative determinations ofinjury, they could result in additional restrictions or duties.

 

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On November 8, 2005, the governments of theUnited States and China entered into a Memorandum of Understanding that tookeffect on January 1, 2006, and that established agreed quota levels onseveral textile categories including products imported by us.  The now expired quota agreement remained ineffect with respect to goods exported from China through December 31,2008.  The bilateral agreement eliminatedsome of the uncertainty inherent in unilateral safeguard actions.

 

On September 11, 2009, acting under the authorityof the China product safeguard provision (section 421 of the Trade Act of 1974,as amended), the U.S. President proclaimed that certain passenger vehicle andlight truck tires from China are being imported into the United States in suchincreased quantities or under such conditions as to cause or threaten to causemarket disruption to the domestic producers of like or directly competitiveproducts.  The determination furtherprovided for the imposition of additional import duties on such products, for aperiod of three years, as a remedy.  Itis possible that U.S. domestic textile and apparel interests may petition forsimilar relief in the form of additional import duties or other measures suchas quotas.  We cannot predict whethersuch action would be sought or approved.

 

In addition, various economic factors, including, butnot limited to, the exchange rate between the U.S. and Chinese currencies, andincreased cost for raw materials, labor and transportation, could materiallyimpact the availability or cost at which we could import our products.

 

New and proposed reporting requirements to be made ator prior to the time of entry may also impact the speed and efficiency at whichour goods may enter into the commerce of the United States.  These include, among others, the new “10 + 2”security filing.  Increased time lags forthe release of imported product may also be the case with respect to ongoinggovernmental initiatives in the areas of supply chain security and productsafety.

 

We monitor these and other duty, tariff and quotarelated developments and continually seek to minimize our potential exposure toquota related risks through, among other measures, shifts of production amongcountries and manufacturers.

 

In addition to the factors outlined above, our importoperations may be adversely affected by political or economic instabilityresulting in the disruption of trade from exporting countries, any significantfluctuations in the value of the dollar against foreign currencies andrestrictions on the transfer of funds.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

** **

The methods, estimates and judgments we use inapplying our most critical accounting policies have a significant impact on theresults we report in our consolidated financial statements.  We evaluate our estimates and judgments on anongoing basis.  We base our estimates onhistorical experience and on assumptions that we believe to be reasonable underthe circumstances.  Our experience andassumptions form the basis for our judgments about the carrying value of assetsand liabilities that are not readily apparent from other sources.  Actual results may vary from what weanticipate and different assumptions or estimates could change our reportedresults.

 

We believe the following accounting policies are themost critical to us in that they are important to our financial statements andthey require our most difficult, subjective or complex judgments in thepreparation of our consolidated financial statements.

 

*Revenue Recognition*. Sales are recognized when merchandise is delivered and title and risk ofloss are transferred to customers. Revenue is recorded net of estimated discounts, returns andallowances.  Discounts are based on tradeterms.  Returns and allowances requirepre-approval from management.  On aseasonal basis, we negotiate price allowances with our customers as salesincentives or for the cost of certain promotions.  We estimate these allowances based onhistoric trends, seasonal results, an evaluation of current economic conditionsand retailer performance.

 

*Income Taxes*. We are organized under Delaware law as a corporation and will be treatedas a corporation for United States federal income tax purposes under theInternal Revenue Code of 1986, as amended, or the Code.  Our effective tax rate will vary based on thelevel of business conducted in those states in which we file, as well aschanges made to the tax rates by the state tax authorities.

 

Deferred taxes are provided for the future taxconsequences attributable to differences between the financial statementcarrying amounts of assets and liabilities and their respective tax bases, asmeasured by enacted tax rates in effect in periods when the deferred tax assetsand liabilities are expected to be settled or realized.  We evaluate the probability of realizing ourdeferred tax assets on an on-going basis. This evaluation includes estimating our future taxable income for theyears in which our deferred taxes are expected to reverse, which includesconsideration of tax planning strategies. We provide a valuation allowance if we determine it is more likely thannot that we will not be able to realize our deferred tax assets.  As of June 30, 2009, we concluded that avaluation allowance of approximately $15.0 million relating to certain capitalloss carry forwards was necessary.

 

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We adopted the provisions of FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109” (“FIN 48”), on July 1, 2007.  As a result of this adoption, we recognizedan increase in liabilities for uncertain tax positions of approximately $6.3million with a corresponding increase in the deferred tax asset of $5.9 millionrepresenting the gross unrecognized tax benefits.  Upon adoption, $0.6 million of interest, netof $0.2 million tax benefit, was recorded to retained earnings.  We recognize interest expense related tounrecognized tax benefits in income tax expense.

 

*Receivables*. Receivables consist of trade accounts receivable and receivables thatare assigned to a commercial factor, net of discounts and allowances.  We factor certain trade receivables, on anon-recourse basis with a commercial factor, except that we assume credit riskfor those receivables that do not receive written approval from thefactor.  The factor collects all cashremittances on receivables factored and assumes credit risk on all sales thatare approved in advance by the factor. An allowance for sales discounts, returns, markdowns, co-op advertisingand operational chargebacks is included as a reduction to net sales andreceivables.  Certain of these provisionsresult from seasonal negotiations with customers as well as historic deductiontrends and the evaluation of current market conditions.

 

*Inventories*. Substantially all of the inventory we purchased in fiscal year 2009 wasproduced in Asia.  Inventory costsinclude amounts paid to purchase piece goods and manufacture our products,duty, quota, inbound freight, and costs associated with our Hong Kongsubsidiary (which acts in the capacity of a buying agent).  Inventories are stated at the lower of costor market, with cost being determined at standard costs, which approximate thefirst-in, first-out (FIFO) method. Inventories consist of raw materials (primarily piece goods at ourcontractors), merchandise in transit and finished goods in warehouses.  We take ownership of the finished goods whenthey are shipped and management records the merchandise in transit balancebased on documentation provided by our Hong Kong subsidiary.  For inventory markdowns, we estimate thepercentage of finished goods we will not be able to sell in the normal courseof business and the associated average loss per unit, and write down the valueof these goods to the recovery value expected to be realized through off-pricechannels.

 

*Long-lived Assets*.  Equipmentand leasehold improvements are stated at cost less accumulated depreciation andamortization.  We capitalize improvementsto the extent they increase the economic life of the asset.  Furniture, fixtures, and equipment aredepreciated using the straight-line method over their estimated useful lives of3 to 10 years.  Leasehold improvementsare amortized over the shorter of the remaining lease term or the estimateduseful lives of the assets.  Expendituresfor maintenance and repairs are expensed in the period incurred.

 

Intangible assets consist of the trademark and tradename, customer relationships of the Predecessor, and non-compete agreementswith officers of the Predecessor, acquired on June 20, 2005.  Customer relationships are amortized usingstraight-line and accelerated methods over their estimated useful lives of 7and 15 years, respectively.  Non-competeagreements are amortized using the straight-line method over their estimateduseful lives of 2 and 10 years.  Bothagreements are with Directors of the Company. Owned trademarks have been determined to have indefinite lives and arenot subject to amortization.

 

Our policy is to evaluate depreciable and amortizableassets (fixed assets, customer relationships and non-compete agreements) forimpairment whenever events or changes in circumstances indicate that the carryingamount of such assets may not be recoverable from the undiscounted cash flowsexpected from the use of the asset. These depreciable and amortizable assets are tested for impairment bycomparing the carrying amount of the assets to their fair values.  This approach is dependent upon future growthand trends.  Any impairment loss would bemeasured as the excess of carrying amount over the fair value of the asset,determined on the basis of discounted cash flows from the expected use of theasset.

 

The trademark and trade name, which have beendetermined to be indefinite lived assets, are tested for impairment at leastannually or when changes in circumstances indicate that their carrying amountmay not be recoverable, by comparing the carrying amount of the assets to theirfair value based on an income approach using the relief-from-royaltymethod.  This method assumes that, inlieu of ownership, a firm would be willing to pay a royalty in order to exploitthe related benefits of these assets. This approach is dependent upon a number of factors, including estimatesof future growth and trends, royalty rates for intellectual property, discountrates and other variables.  We base ourfair value estimates on assumptions we believe are reasonable, but which areunpredictable and inherently uncertain. Actual future results may differ from those estimates.  If the estimated fair value of the assets isless than their carrying amount, an impairment loss is recognized equal to suchdifference.

 

*Contingencies and Litigation*. Management evaluates contingent liabilities including threatened orpending litigation in accordance with Statement of Financial AccountingStandards No. 5, “Accounting for Contingencies,” and recordsaccruals when the outcome of these matters is deemed probable and the liabilitymay be reasonably estimated.  Managementmakes these assessments based on the facts and circumstances and in someinstances based in part on the advice of outside legal counsel.

 

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*Stock-based Compensation.*  Effective July 1, 2006, the Companyadopted Statement of Financial Accounting Standards No. 123(R) “ShareBased Payments” (“SFAS 123R”), which revises Statement of Financial AccountingStandards No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”)and requires companies to expense the fair value of employee stock options andother forms of stock based compensation. The computation of the expenses associated with stock based compensationrequires the use of a valuation model. The Company currently uses the Black Scholes option pricing model tocalculate the fair value of its stock options. The Black Scholes model requires assumptions regarding the estimatedlength of time participants will retain their vested stock options beforeexercising them and the estimated volatility of the Company’s common stock overthe expected term.  Changes in theassumptions to reflect future stock price volatility and future stock awardexercise experience could result in a change in the assumptions used to valueawards in the future and may result in a material change to the fair valuecalculation of stock based awards.  Therewas no effect from the change of applying the original provisions of SFAS 123to the Company’s results of operations and cash flows for the year ended June 30,2007, as a result of the Company’s adoption of SFAS 123R, effective July 1,2006.  Compensation expense related tostock-based awards was not significant to the Company’s consolidated statementof operations for the years ended June 30, 2009 and 2008.  Refer to Note 3 of the Company’s consolidatedfinancial statements for further information.

 

**RESULTSOF OPERATIONS**

** **

The following table summarizes the historicaloperations as a percentage of net sales for the years ended June 30, 2009,2008 and 2007.

 
| ** **                                                      | ** ** | **Year Ended  June 30, 2009**          | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                      | ** ** | **(in thousands, except percentages)** | ** ** |
|                                                            |       |                                                  |       |                                         |       |                                         |       |   |   |   |   |   |   |   |   |   |
| Net sales                                                       |       | $                                                     | 147,965    |                                         | 100.0      | %                                            | $          | 177,990 |   | 100.0 | % | $ | 191,284 |   | 100.0 | % |
| Cost of sales                                                   |       | 113,037                                               |       | 76.4                                         |       | 129,086                                      |       | 72.5 |   | 127,170 |   | 66.5 |   |
| Gross profit                                                    |       | 34,928                                                |       | 23.6                                         |       | 48,904                                       |       | 27.5 |   | 64,114 |   | 33.5 |   |
| Selling, general and administrative expenses                    |       | 30,199                                                |       | 20.4                                         |       | 32,513                                       |       | 18.3 |   | 30,951 |   | 16.2 |   |
| Intangible asset impairment                                     |       | 25,840                                                |       | 17.5                                         |       | 34,504                                       |       | 19.4 |   | — |   | — |   |
| Operating income (loss)                                         |       | (21,111                                               | )          | (14.3                                        | )          | (18,113                                      | )          | (10.2 | ) | 33,163 |   | 17.3 |   |
| Interest expense, net                                           |       | 13,232                                                |       | 8.9                                          |       | 17,964                                       |       | 10.4 |   | 23,884 |   | 12.5 |   |
| Gain on senior secured note purchases                           |       | (25,632                                               | )          | (17.3                                        | )          | (3,124                                       | )          | (1.8 | ) | — |   | — |   |
| Interest expense and other financing, net                       |       | (12,400                                               | )          | (8.4                                         | )          | 14,840                                       |       | 8.3 |   | 23,884 |   | 12.5 |   |
| Income (loss) before provision for (benefit from)  income taxes |       | (8,711                                                | )          | (5.9                                         | )          | (32,953                                      | )          | (18.5 | ) | 9,279 |   | 4.9 |   |
| Provision for (benefit from) income taxes                       |       | 6,726                                                 |       | 4.5                                          |       | (8,199                                       | )          | (4.6 | ) | 2,999 |   | 1.6 |   |
|                                                            |       |                                                  |       |                                         |       |                                         |       |   |   |   |   |   |   |
| Net income (loss)                                               |       | $                                                     | (15,437    | )                                            | (10.4      | )%                                           | $          | (24,754 | ) | (13.9 | )% | $ | 6,280 |   | 3.3 | % |

 

***Yearended June 30, 2009 compared to year ended June 30, 2008***

** **

***Net sales***.  Net sales for the year ended June 30, 2009 was$148.0 million.  As compared to net salesof $178.0 million for the year ended June 30, 2008, net sales decreased byapproximately $30.0 million or 16.9%. The reduction of net sales was principally due to a reduction in grosssales of $28.5 million, related to a decrease in volume (approximately 12%) anda decrease in average revenue per unit (approximately 2%).  The decrease in customer volume was primarilyattributed to decreases in department store and private label sales, offset byan increase in off-price sales.  Thedecrease in average revenue per unit was primarily attributed to off-pricesales per unit, offset by an increase in department store sales per unit.

 

***Gross profit***.  Gross profit for the year ended June 30,2009 was $34.9 million.  As a percentageof net sales, gross profit over this period was 23.6%.  As compared to the gross profit of $48.9million for the year ended June 30, 2008 (27.5% of net sales), grossprofit decreased by $14.0 million or 28.6%. The decrease in gross profit was primarily the result of the drop in netsales of $30.0 million.  Gross profit asa percentage of net sales was unfavorably impacted by lower margins associatedwith department store, private label, and off-price sales, partially offset bya decrease in inventory markdowns during the year ended June 30, 2009compared with the prior year.

 

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***Selling, generaland administrative expenses and intangible asset impairment***.  Selling, general and administrative expensesfor the year ended June 30, 2009 was $56.0 million.  As compared to selling, general and administrativeexpenses of $67.0 million for the year ended June 30, 2008, there was adecrease of $11.0 million.  An impairmentcharge of $34.5 million recorded during the year ended June 30, 2008related to the decline in the fair value of the Rafaella trademark and tradename intangible asset versus an impairment charge of $25.8 million recordedduring the year ended June 30, 2009 was the primary contributor to theoverall decrease. The Company performed its annual impairment test of thetrademark and trade name during the fourth quarter of the fiscal year ended June 30,2008 and determined that the trademark and trade name was impairednecessitating a charge of $34.5 million. The Company performed an impairment test of the trademark and trade nameand customer relationships during the second and fourth quarters of the fiscalyear ended June 30, 2009 and determined that the trademark and trade namewas impaired necessitating a charge of $23.4 million and $2.4 million,respectively.  The impairment in bothyears was due to decreased sales and cash flows attributable to the Rafaellabrand as a result of reduced forecasts for future years given the current stateof the U.S. apparel retail environment. Other decreases included advertisingexpenses ($1.3 million), warehouse and distribution costs ($0.8 million),provision for bad debt ($0.4 million), and compensation ($0.6 million).  The decrease in compensation includesseverance costs of approximately $1.1 million incurred during thequarterly period ended March 31, 2009. As of June 30, 2009, $0.6 million of costs (inclusive ofseverance, benefits and outplacement services) remain unpaid and are accruedwithin the accrued expenses and other current liabilities line item of theCompany’s condensed consolidated balance sheet. The severance costs are primarily attributed to two former executiveofficers of the Company. The decrease was partially offset by an increase inrent ($0.4 million).  As a percentage ofnet sales, selling, general and administrative expenses were 37.9% for the yearended June 30, 2009 and 37.7% for the year ended June 30, 2008.

 

***Operating loss***.  Operating loss for the year ended June 30, 2009 was$21.1 million.  As compared to operatingloss of $18.1 million for the year ended June 30, 2008, operating lossincreased by $3.0 million.  The increasewas due to the decrease in gross profit offset by decreases in selling, generaland administrative expenses, as described above.

 

***Interest******expense******(income)******and other financing, net.***  Other financing, net for the year ended June 30, 2009 was $12.4million.  As compared to interest expenseof $14.8 million for the year ended June 30, 2008, interest decreased by$27.2 million or 183.6%.  The decreasewas primarily attributed to a pre-tax gain of approximately $25.6 million and$3.1 million, resulting from the difference between the carrying book value ofthe senior secured notes and the amount paid, net of deferred financing coststhat were written-off, in connection with our open market purchases in fiscal 2009and 2008, respectively; each of the other senior secured note repurchases (pursuantto certain excess cash flow repurchases and restricted payment offers) were at101% of their principal amount at maturity. The decrease in interest expense was also attributed to the reduction inour senior secured notes outstanding period over period.  In November 2008 and November 2007,we repurchased $598,000 and $221,000, respectively, of senior secured notes inconnection with our excess cash flow offers. We purchased $6,000,000 and $8,027,000 of our senior secured notes onthe open market in January 2008 and June 2008, respectively.  We purchased $28,505,000, $2,000,000,$3,991,000 and $4,424,000 of our senior secured notes on the open market in August 2008,March 2009, April 2009, and May 2009, respectively.  As a result of these senior secured notetransactions, interest expense (cash interest and non-cash interest associatedwith original issue discount and deferred financing costs) decreased $5.0million period over period.  Theaggregate decrease of $27.5 million discussed above, was partially offset by areduction in interest income of $0.3 million period over period.  Refer to the “Liquidity and Capital Resources”section below for further discussion surrounding our senior secured notes.

 

***Provision for (benefit from)income taxes***.  Werecorded a provision for income taxes of $6.7 million for the year ended June 30,2009, which represents an effective income tax rate of approximately77.2%.  The difference between the statutoryfederal income tax rate of 34.0% and our effective income tax rate of (77.2)%is primarily attributable to the valuation allowance of $9.9 million that weestablished for the deferred tax asset that resulted from the Rafaellatrademark and trade name intangible asset impairment charge of $25.8 million,as described above.  The underlying taxbasis of the trademark and trade name is capital in nature.  The asset would generate a capital loss forincome tax purposes, which can only be used to offset capital gain income.  We determined that the deferred tax asset isnot more likely than not to be realized as there are no actual or projectedcapital gains available to offset any future capital losses that might begenerated from the Rafaella trademark and trade name deferred tax asset.

 

In addition, the Company does not expect to recognizean income tax benefit from its customer relationship intangible assets andprovided a deferred tax asset valuation allowance of $0.8 million during theyear ended June 30, 2009 because the underlying tax basis of the customerrelationships is capital in nature.

 

The Company remains subject to federal, state andlocal income tax examinations by tax authorities for all tax years, with thestatute of limitations on the initial federal tax year closing as of September 2009.  Examination of the Company’s 2006 federalincome tax return by the Internal Revenue Service was recently completed, aswas a state tax audit for the 2006 and 2005 tax years.  No significantadjustments were proposed in connection with these examinations.  Subsequently, the related unrecognized taxbenefits were recognized.

 

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We recorded a benefit from income taxes of $8.2million for the year ended June 30, 2008, which represents an effectiveincome tax rate benefit of approximately 24.9%. We recorded a net benefit, after valuation allowance, from income taxesprimarily as a result of the $34.5 million impairment charge associated withthe decline in the fair value of the Rafaella trademark and trade nameintangible asset, as described above. The difference between the statutory federal income tax rate of 34.0%and our effective income tax rate of 24.9% is primarily attributable to thevaluation allowance of $4.3 million that we established for the deferred taxasset that resulted from the Rafaella trademark and trade name intangible assetimpairment.  The underlying tax basis ofthe trademark and trade name is capital in nature.  The asset would generate a capital loss forincome tax purposes, which can only be used to offset capital gain income.  We determined that the deferred tax asset isnot more likely than not to be realized as there are no actual or projectedcapital gains available to offset any future capital losses that might begenerated from the Rafaella trademark and trade name deferred tax asset.

 

***Net loss***.  Net loss for the year ended June 30, 2009was $15.4 million.  Net loss as apercentage of net sales for the year ended June 30, 2009 was 10.4%.  As compared to net loss of $24.8 million forthe year ended June 30, 2008, net loss decreased by $9.3 million.  This decrease in net loss was a result of thechanges in operating loss, interest and income taxes, as described above.

 

***Yearended June 30, 2008 compared to year ended June 30, 2007***

** **

***Net sales***.  Net sales for the year ended June 30, 2008 was$178.0 million.  As compared to net salesof $191.3 million for the year ended June 30, 2007, net sales decreased byapproximately $13.3 million or 6.9%.  Thereduction of net sales was principally due to a reduction in gross sales of$14.6 million, related to a decrease in volume (approximately 3%) and adecrease in average revenue per unit (approximately 4%), partially offset by adecrease in allowances ($1.3 million). The decrease in customer volume was primarily attributed to a decreasein anticipated reductions of sales from one customer and decreases indepartment store and off-price sales, partially offset by an increase inprivate label sales.  The decrease inaverage revenue per unit was primarily attributed to off-price sales per unit,and a change in the composition of our sales, driven by an increase in privatelabel sales and a decrease in department store sales.

 

***Gross profit***.  Gross profit for the year ended June 30,2008 was $48.9 million.  As a percentageof net sales, gross profit over this period was 27.5%.  As compared to the gross profit of $64.1million for the year ended June 30, 2007 (33.5% of net sales), grossprofit decreased by $15.2 million or 23.7%. The decrease in gross profit was primarily the result of the drop in netsales of $13.3 million.  Gross profit asa percentage of net sales was unfavorably impacted by higher customerallowances, lower margins associated with off-price customer sales, and anincrease in private label sales (at lower margins than department store sales)and an increase in inventory markdowns during the year ended June 30, 2008compared with the prior year.

 

***Selling, generaland administrative expenses and intangible asset impairment***.  Selling, general and administrative expensesfor the year ended June 30, 2008 was $67.0 million.  As compared to selling, general andadministrative expenses of $31.0 million for the year ended June 30, 2007,there was an increase of $36.1 million. An impairment charge of $34.5 million recorded during the year ended June 30,2008 related to the decline in the fair value of the Rafaella trademark andtrade name intangible asset was the primary contributor to the overallincrease. The Company performed its annual impairment test of the trademark andtrade name during the fourth quarter of the fiscal year ended June 30,2008 and determined that the trademark and trade name was impairednecessitating a charge of $34.5 million. The impairment was due to decreased sales and cash flows attributable tothe Rafaella brand as a result of reduced forecasts for future years given the currentstate of the US apparel retail environment. Other increases included marketingexpenses ($1.8 million), warehouse and distribution costs ($0.9 million), andprovision for bad debt ($0.6 million). The increase was partially offset by a decrease in compensation ($2.0million).  As a percentage of net sales,selling, general and administrative expenses were 37.7% for the year ended June 30,2008 and 16.2% for the year ended June 30, 2007.

 

***Operating loss***.  Operating loss for the year ended June 30, 2008 was$18.1 million.  As compared to operatingincome of $33.2 million for the year ended June 30, 2007, operating incomedecreased by $51.3 million.  The decreasewas due to the decrease in gross profit and increases in selling, general andadministrative expenses, as described above.

 

***Interest******expense******and other financing, net.***  Interest expense for the year ended June 30, 2008 was $14.8million.  As compared to interest expenseof $23.9 million for the year ended June 30, 2007, interest decreased by$9.0 million or 37.9%.  The decrease wasprimarily attributed to a pre-tax gain of approximately $3.1 million, resultingfrom the difference between the carrying book value of the senior secured notesand the amount paid, net of deferred financing costs that were written-off, inconnection with our open market purchases in fiscal 2008; each of the othersenior secured note repurchases (pursuant to certain excess cash flowrepurchases and restricted payment offers) were at 101% of their principalamount at maturity.  The decrease wasalso attributed to the reduction in our senior secured notes outstanding periodover period.  In November 2007 and November 2006,we repurchased $221,000 and $17,429,000, respectively, of senior secured notesin connection with our excess cash flow offers. In June 2007, we repurchased $16,062,000 of senior secured notes inconnection with our restricted payment offer. Finally, we purchased $6,000,000 and $8,027,000 of our senior securednotes on the open market in 

 

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January 2008 and June 2008,respectively.  As a result of thesesenior secured note transactions, interest expense (cash interest and non-cashinterest associated with original issue discount and deferred financing costs)decreased $3.6 million period over period. During fiscal 2007, in connection with the June 2007 and November 2006senior secured note repurchases, we wrote-off approximately $3.1 million ofunamortized original issue discount and deferred financing costs to interestexpense; the November 2007 write-off of unamortized original issuediscount and deferred financing costs was not significant.  The aggregate decrease of $9.8 milliondiscussed above, was partially offset by a reduction in interest income of $0.8million period over period.  Refer to the“Liquidity and Capital Resources” section below for further discussionsurrounding our senior secured notes.

 

***Benefit from income taxes***.  We recorded a benefit from income taxes of$8.2 million for the year ended June 30, 2008, which represents aneffective income tax rate benefit of approximately 24.9%.  We recorded a net benefit, after valuationallowance, from income taxes primarily as a result of the $34.5 millionimpairment charge associated with the decline in the fair value of the Rafaellatrademark and trade name intangible asset, as described above.  The difference between the statutory federalincome tax rate of 34.0% and our effective income tax rate of 24.9% isprimarily attributable to the valuation allowance of $4.3 million that weestablished for the deferred tax asset that resulted from the Rafaellatrademark and trade name intangible asset impairment.  The underlying tax basis of the trademark andtrade name is capital in nature.  Theasset would generate a capital loss for income tax purposes, which can only beused to offset capital gain income.  Wedetermined that the deferred tax asset is not more likely than not to berealized as there are no actual or projected capital gains available to offsetany future capital losses that might be generated from the Rafaella trademarkand trade name deferred tax asset.

 

For the year ended June 30, 2007, we recorded aprovision for income taxes of $3.0 million, which represents an effectiveincome tax rate of approximately 32.3%. The difference between the statutory federal income tax rate of 34.0%and our effective income tax rate of 32.3% is attributable to state and localincome taxes, net of federal benefit.

 

***Net loss***.  Net loss for the year ended June 30,2008 was $24.8 million.  Net loss as apercentage of net sales for the year ended June 30, 2008 was 13.9%.  As compared to net income of $6.3 million forthe year ended June 30, 2007, net income decreased by $31.0 million.  This decrease in net income was a result ofthe decrease in operating income, partially offset by the decrease in interestexpense and the benefit from income taxes, as described above.

 

**LIQUIDITY ANDCAPITAL RESOURCES**

** **

Historically, our primary liquidity and capitalrequirements have been to fund working capital for current operations, whichconsists of funding the buildup of inventories and receivables, and servicingour line of credit.  Our liquidity andcapital requirements also include making interest payments on the seniorsecured notes.  The primary source offunds currently used to meet our liquidity and capital requirements is fundsgenerated from operations, and in the future, may also include directborrowings under the Credit Facility (as defined below).

 

***RevolvingCredit Facility***

 

On June 20, 2005, we entered into a securedrevolving credit facility agreement (as amended, the “Credit Facility”) with HSBCBank USA, National Association (“HSBC”), expiring on June 10, 2010.  Effective September 30, 2008, we enteredinto an amendment of the Credit Facility with HSBC that changed certain termsof the agreement.  The Company sought toamend the Credit Facility as it would not have been in compliance with itsworking capital financial covenant as of September 30, 2008.  On February 10, 2009, we amended theCredit Facility’s positive net income financial covenant as the Company’sforecasts indicated that there was the likelihood that the Company would not bein compliance with the net income financial covenant, at some point, over thenext 12 months.  On September 25,2009, the Company further amended the Credit Facility as it would not have beenin compliance with its working capital financial covenant at any point on orafter June 30, 2010.  The amendmentis effective as of September 25, 2009. The following amendments and modifications to the Credit Facility, amongothers, were effected by the September 25, 2009 amendment: (i) extensionof the term of the Credit Facility from June 20, 2010 to December 15,2010, (ii) a reduction in the maximum loan amount of the Credit Facilityfrom $45.0 million to $30.0 million, (iii) the addition of an affirmativecovenant requiring the Company to maintain certain minimum amounts of cashcollateral, (iv) a modification of a financial covenant to permit negativenet income during certain specified periods after September 30, 2009, (v) anadditional limitation on the undrawn aggregate dollar amounts that werepermitted to be outstanding under standby letters of credit and (vi) theworking capital financial covenant was modified to exclude indebtedness underthe Company’s senior secured notes at any point on or after June 30, 2010 fromthe definition of current liabilities. The amended Credit Facility provides an aggregate maximum availability,if and when the Company has the requisite levels of assets, in the amount of$30.0 million that may be used for direct debt advances plus letters of credit,and is subject to a sub-limit of $20.0 million for direct debt advances and$6.0 million for standby letters of credit through December 31, 2009 and$4.0 million all times thereafter.  TheCredit Facility is collateralized by substantially all of the assets of theCompany.

 

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The Company’s aggregate maximum borrowing availabilityunder the Credit Facility is limited to the sum of (i) 85% of eligiblereceivables, plus (ii) the lesser of (A) the sum of (1) 50% ofeligible inventory and (2) 50% of letters of credit issued for finishedgoods inventory, or (B) an inventory cap of $20.0 million, plus (iii) cashcollateral, reduced by (iv) reserves (as defined).  The Company’s direct debt advance borrowingavailability under the Credit Facility is limited to the lesser of (i) $20.0million, or (ii) the sum of (A) a borrowing base overadvance amount(as defined) and (B) 85% of eligible receivables.  At June 30, 2009, there were no loansand $10.1 million of letters of credit outstanding under the CreditFacility.  The Company’s aggregatemaximum availability for direct debt advances plus letters of creditapproximated $3.4 million as of June 30, 2009.

 

Borrowings under the Credit Facility bear variableinterest at our option at either (i) a base rate or (ii) the Londoninterbank offered rate plus two and three-quarters percent (2.75%) per annum(each as defined).  The Credit Facilityprovides for a monthly commitment fee of 0.25% on the unused portion of theavailable credit under the facility.

 

Under the CreditFacility, the Company is required to maintain working capital in excess of$25.0 million.  Working capital isdefined as the sum of cash, accounts receivable, and inventory, reduced by currentliabilities; the definition of current liabilities excludes indebtedness underthe Company’s senior secured notes at any point on or after June 30,2010.  With the exception of the fiscalquarters ending on March 31, 2009, June 30, 2009, June 30, 2010,and September 30, 2010, the Company is required to maintain positive netincome during each period of two consecutive fiscal quarters.  The Company is permitted to incur up to a netloss of $750,000 during each of the two consecutive fiscal quarters (on arolling basis) ending on March 31, 2009 and June 30, 2009 and up to anet loss of $1,300,000 during each of the two consecutive fiscal quarters (on arolling basis) ending on June 30, 2010 and September 30, 2010.  For purposes of determining compliance withthe net income financial covenant, the definition of net income excludesnoncash expenses associated with (i) amortization of customerrelationships and non-compete agreements, (ii) the accretion of the seniorsecured notes original issue discount, (iii) amortization of deferredfinancing costs, and (iv) impairment charges, if any, resulting from adecline in the value of the Company’s intangible assets.

 

The Company is required to maintain minimum cashcollateral balances at varying times during the term of the Credit Facility asfollows: (a) $6,000,000 from December 31, 2009 through January 31,2010, (b) $0 from February 1, 2010 through April 30, 2010, (c) $3,500,000from May 1, 2010 through July 31, 2010, (d) $0 from August 1,2010 through September 30, 2010, (e) $1,000,000 from October 1,2010 through October 31, 2010, (f) $0 from November 1, 2010through November 30, 2010 and (g) $3,000,000 from December 1,2010 through December 15, 2010.

 

As of June 30, 2009,the Company was in compliance with each of the financial covenants.  The Company expects that it will meet itsfuture debt covenants over the next 12 months. We believe that the covenant with the most sensitivity and risk offuture violation is the net income financial covenant discussed above.  A violation of the financial covenantsconstitutes an event of default under the Credit Facility; such an event ofdefault could result in all debt becoming due and payable, and HSBC having theright to terminate the Credit Facility and its obligation to make advancesthereunder.  If the Company’s operationscontinue to deteriorate beyond its forecasted results, it could result in adebt covenant violation and the Company would need another amendment.  If the Company were unable to amend the termsof the Credit Facility, the Company’s financial condition and results ofoperations may be materially adversely affected.  Due to the inherent uncertainties in makingestimates and assumptions, there can be no assurance that the Company willsatisfy either of its financial covenants in future periods.

 

The Credit Facility includes various other covenantswith which the Company has to comply in order to maintain borrowingavailability including, but not limited to, covenants limiting or restrictingthe Company’s ability to incur indebtedness, incur liens, enter into mergers orconsolidations, dispose of assets, make investments, pay dividends andrepurchase capital stock, enter into transactions with affiliates or prepaycertain indebtedness.  In addition, theCompany is required to report various financial and non-financial informationperiodically to HSBC.  The CreditAgreement also contains customary events of default including, but not limitedto, payment defaults, covenant defaults, cross-defaults to the senior securednotes, material judgment defaults, inaccuracy of representations andwarranties, bankruptcy and insolvency events, defects in HSBC’s securityinterest, change in control events, and material adverse changes.  An event of default could result in all debtbecoming due and payable, and HSBC having the right to terminate the CreditFacility and its obligation to make advances under it.

 

***SeniorSecured Notes***

 

On June 20, 2005, weissued to investors $172.0 million aggregate principal amount at maturity of11.25% senior secured notes due June 2011. These notes were issued at 95% of the face value and netted the Companya total of $163.4 million.  The seniorsecured notes are collateralized by a second priority lien on substantially allof the Company’s assets.

 

The senior securednotes indenture contains various covenants with which the Company has tocomply, including, but not limited to, covenants limiting or restricting theCompany’s ability to incur indebtedness, incur liens, enter into mergersor  consolidations, dispose of assets, make investments, pay dividends andrepurchase capital stock or enter into transactions with 

 

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affiliates.  Inaddition, the Company is required to report various financial and non-financialinformation periodically to the trustee.  The senior secured notesindenture also contains customary events of default including, but not limitedto, payment defaults, cross-defaults to the Credit Facility, material judgmentdefaults, inaccuracy of representations and warranties, bankruptcy andinsolvency events, defects in security interests, change in control events, andmaterial adverse changes.  An event of default could result in all debtbecoming due and payable.

 

At June 30,2009, the senior secured notes principal amount outstanding is $84,743,000 andthe unamortized original issue discount is $1,751,000.  At June 30,2009, debt held in treasury approximated $52,655,000.  The Company’s senior secured notes arerecorded at carrying book value at June 30, 2009.  At June 30,2009, the fair value of the senior secured notes, determined based upon quotedmarket prices, was approximately $16,101,000.

 

Within 100 days after the end of each fiscal year,beginning with the fiscal year ended on June 30, 2006, the Company mustmake an offer to repurchase all or a portion of the notes at 101% of theirprincipal amount at maturity plus accrued and unpaid interest to the date ofpurchase, with 50% of excess cash flow, as defined, from the previous fiscalyear.  Senior secured note aggregateprincipal amounts of $598,000, $221,000 and $17,429,000 were repurchased duringNovember 2008, 2007 and 2006, respectively, in connection with excess cashflow offers made by the Company.  The November 2008,2007 and 2006 repurchases of the notes, which were at 101% of their principalamount at maturity plus accrued and unpaid interest to the date of purchase,approximated $631,000, $234,000 and $18.4 million, respectively.  We wrote-off $1.7 million of unamortizedoriginal issue discount and deferred financing costs to interest expense inconnection with the November 2006 repurchase.  Unamortized original issue discount anddeferred financing costs associated with the November 2007 and 2008repurchases were not significant.

 

An annual excess cash flow payment with respect to thefiscal year ending June 30, 2009 will not be required.  This is basedon the Company’s financial position as of June 30, 2009 and its results ofoperations and cash flows for the year then ended.

 

In addition to the excess cash flow repurchases, theCompany also repurchased $16,062,000 of the senior secured notes at 101% oftheir principal amount at maturity, plus accrued and unpaid interest, forapproximately $16.3 million on June 29, 2007.  We wrote-off $1.4 million of unamortizedoriginal issue discount and deferred financing costs to interest expense inconnection with the June 29, 2007 senior secured note repurchase.

 

The Company purchased, at a discount, $6.0 million and$8.0 million of outstanding senior secured notes on the open market in January 2008and June 2008, respectively.  Apre-tax gain of approximately $3.1 million, resulting from the differencebetween the carrying book value of the senior secured notes and the amountpaid, net of deferred financing costs that were written-off at the time ofpurchase, was recorded to interest expense during the year ended June 30,2008.

 

The Company purchased, at a discount, $28.5 million,$2.0 million, $4.0 million and $4.4 million of outstanding senior secured noteson the open market in August 2008, March 2009, April 2009, and May 2009,respectively.  A pre-tax gain ofapproximately $25.6 million, resulting from the difference between the carryingbook value of the senior secured notes and the amount paid, net of deferredfinancing costs that were written-off at the time of purchase, was recorded tointerest expense during the year ended June 30, 2009.

 

We are exposed to certain known tax contingencies thatmay have a material effect on our liquidity, capital resources or results ofoperations.  Additionally, even where ourreserves are adequate, the incurrence of any of these liabilities may have amaterial effect on our liquidity and the amount of cash available to us forother purposes.  Management believes thatthe amount of cash available to us from our operations, together with cash fromfinancing, will be sufficient for us to pay any known tax contingencies as theybecome due without materially affecting our ability to conduct our operationsand invest in the growth of our business. Refer to Note 11 of our audited consolidated financial statements for furtherinformation.

 

We continually review the capital expenditure needsfor the business as they relate to the business’ information systems,infrastructure, and in-store expenditures and we anticipate that capitalexpenditures may increase in future periods. We also anticipate that we will incur one-time and ongoing expenses,which may be substantial, to improve our infrastructure as a result of being apublic company and support key branding/marketing initiatives.

 

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Based on current salestrends, we believe that our cash flow from operations and available borrowingsunder our senior revolving credit facility will provide us with sufficientfinancial flexibility to fund our operations, debt service requirements, andcapital expenditures over the next twelve months.

 

Our senior revolvingcredit facility with HSBC expires on December 15, 2010 and our seniorsecured notes mature on June 15, 2011. Management currently does not believe that we will have sufficient cashon hand, based on our current cash flow projections, to settle the SeniorSecured Notes in June 2011 at principal or face value.  If we are unable to secure additionalfinancing, our business and results of operations may be adverselyaffected.  Consequently, management iscurrently in the process of exploring alternative long-term financing.  There can be no assurance that any suchfinancing will be available with terms favorable to us or at all.

 

We may from time to timeseek to purchase our outstanding senior secured notes in open market purchases,privately negotiated transactions or otherwise. These purchases, if any, will depend on prevailing market conditionsbased on our liquidity requirements, contractual restrictions and otherfactors.  The amount of purchases of oursenior secured notes may be material and may involve significant amounts ofcash and/or financing availability. Under the American Recovery and Reinvestment Act of 2009 (“the Act”),the Company will receive temporary relief under the Delayed Recognition ofCancellation of Debt Income (“CODI”) rules. The Act contains a provision thatallows for a five-year deferral of CODI for debt purchased in 2009 or 2010,followed by recognition of CODI ratably over the succeeding five years. Theprovision applies for specified types of purchases, including the acquisitionof a debt instrument for cash and the exchange of one debt instrument foranother.

 

The following table summarizes our net cash providedby or used in our operating, investing and financing activities for the yearsended June 30, 2009, 2008 and 2007:

 
| ** **                                                | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                | ** ** | **(in thousands)**                      | ** ** |
| Net  cash provided by (used in):                          |       |                                         |       |                                         |       |                                         |       |
| Operating  activities                                     |       | $                                            | 13,252     |                                         | $          | 16,872                                       |       | $ | 16,743 |   |
| Investing  activities                                     |       | (1,083                                       | )          | (966                                         | )          | (214                                         | )          |
| Financing  activities                                     |       | (11,602                                      | )          | (10,165                                      | )          | (32,412                                      | )          |
| **Net increase (decrease) in cash and cash  equivalents** | ** ** | **$**                                        | **567**    | ** **                                   | **$**      | **5,741**                                    | ** ** | **$** | **(15,883** | **)** |

 

***OperatingActivities***

*** ***

Cash flows provided by operating activities for theyears ended June 30, 2009, 2008 and 2007 were $13.3 million, $16.9million, and $16.7 million, respectively. The decrease in cash flows provided by operating activities from 2008 to2009 is the result of the decrease in our operating income (excluding non-cashitems) and income taxes paid in connection with our August 2008 seniorsecured note open market purchase, offset by reductions in payments associatedwith interest, planned reductions in current season inventory purchasesresulting from anticipated reductions in sales and sales of aged inventory tooff-price customers. The change in cash flows provided by operating activitiesbetween 2008 and 2007 was not significant. However, cash flows provided by operating activities was negativelyimpacted period over period as a result of the decrease in our operating income(excluding non-cash items).  The decreasewas primarily offset by reductions in payments associated with interest, incometaxes and inventory purchases.  For eachof the years ended June 30, 2009, 2008 and 2007, significant non-cashitems included amortization of deferred finance charges, accretion of originalissue discount, depreciation and amortization, and the provision for deferredincome taxes.  A non-cash impairmentcharge of $25.8 million and $34.5 million was recorded during 2009 and 2008,respectively related to the decline in the fair value of the Rafaella trademarkand trade name intangible asset.  Inaddition, during 2009 and 2008, a non-cash gain of $25.6 million and $3.1million, respectively was recorded in connection with the senior secured notespurchases.

 

***InvestingActivities***

*** ***

Net cash used in investing activities for the yearsended June 30, 2009, 2008 and 2007 were $1.1 million, $1.0 million, and$0.2 million, respectively.  In 2009, thecash usage was a result of computer and software ($0.4 million) and machineryand equipment ($0.5 million) capital expenditures.  In 2008, the cash usage was a result ofcomputer and software ($0.5 million), machinery and equipment ($0.3 million),and leasehold improvement ($0.2 million) capital expenditures.  Net cash used in investing activities for2007 was not significant.

 

***FinancingActivities***

*** ***

Net cash used in financing activities for the yearsended June 30, 2009, 2008 and 2007 were $11.6 million, $10.2 million, and$32.4 million, respectively.  In 2009,2008 and 2007, the use of cash was primarily for our senior secured noterepurchases and open market purchases discussed above.

 

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**Off-Balance SheetArrangements**

** **

As of June 30, 2009,we had outstanding letters of credit totaling $5.3 million in connection withpurchase orders for merchandise from third-party manufacturers and standbyletters of credit totaling $4.8 million issued by HSBC, which serve as securityfor obligations under certain operating leases, a customs bond and the GMACLetter of Credit (refer to the “Due From Factor” section below for furtherdiscussion).

 

We enter into employment and consulting agreementswith certain of our employees from time to time.  These contracts typically provide forseverance and other benefits. Individually, none of the contracts are expected to be material,although in the aggregate, our obligations under these contracts could besignificant.  Additionally, we havecertain operating leases, which are disclosed in the consolidated financialstatements.

 

The Company has no other off-balance sheetarrangements.

 

**Due From Factor**

** **

Historically,the Company factored a significant portion of its trade receivables, on anon-recourse basis, with GMAC Commercial Finance LLC (“GMAC”), a commercialfactor.  In accordance with the terms of an Amended and RestatedCollection Services Factoring Agreement dated December 16, 2008 betweenGMAC and the Company, all accounts receivable of the Company then held by GMACwere sold back to the Company effective as of such date.  On December 19,2008, the Company delivered to GMAC a notice of termination of the GMACarrangement pursuant to the terms thereof.  On February 5, 2009, aspart of the termination of the GMAC arrangement, the Company arranged for anirrevocable letter of credit in an aggregate amount of $2,000,000 (the “Letterof Credit”) for the benefit of GMAC.  The Letter of Credit permits GMAC todraw amounts equal to amounts collected by GMAC, after January 6, 2009, ifcertain identified customers of the Company file a petition for relief fromcreditors under the United States Bankruptcy Code and claims are made for GMACto return to the customer or its bankruptcy estate amounts GMAC has collectedfrom such customer.  The Letter of Credit was subsequently reduced to$65,000 in September 2009 and expires on February 4, 2010, subject toextension under certain circumstances.

 

On December 19,2008, the Company entered into a factoring agreement with Wells Fargo TradeCapital, LLC (“Wells Fargo”), a commercial factor, pursuant to which theCompany may sell certain of its receivables to Wells Fargo on a non-recoursebasis.  Wells Fargo will assume credit risk on all sales that are approvedin advance.

 

We can not borrow fromWells Fargo and GMAC and the amounts due from Wells Fargo and GMAC are pledgedto our revolving credit facility lenders as security for amounts outstandingunder our revolving credit facility.

 

**Contractual Cash Obligations**

 

The following table sets forth our known contractualcash obligations for the periods specified therein.

 
| ** **                                 | ** ** | **Payment Due by Period** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|
| **Contractual Cash Obligations** | ** ** | **Total**                 | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than 5  Years** | ** ** |
| ** **                                 | ** ** | **(in thousands)**   | ** ** |
| ** **                                 | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Senior  secured notes (1)                  |       | $                         | 84,743     |   | $ | 3,500 |   | $ | 81,243 |   |   |   |   |   |
| Interest  on senior secured notes (1)      |       | 18,319                    |       | 9,179 |   | 9,140 |   |   |   |   |   |
| FIN  48 liabilities and interest           |       | 266                       |       | 70 |   | 196 |   |   |   |   |   |
| Operating  lease obligations               |       | 6,579                     |       | 2,366 |   | 3,392 |   | $ | 821 |   |   |   |
| Purchase  obligations                      |       | 29,540                    |       | 29,540 |   |   |   |   |   |   |   |
| Total  contractual cash obligations        |       | $                         | 139,447    |   | $ | 44,655 |   | $ | 93,971 |   | $ | 821 |   | $ |   |   |
|                                            |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

| (1) | The  payment schedule for the senior secured notes and cash interest on our senior  secured notes reflects a reduction resulting from the July 2009 open  market purchase. Amounts presented are based on the senior secured notes  principal amount outstanding. Actual cash paid in connection with the  July 2009 senior secured note open market purchase of $3.5 million  approximated $0.8 million. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

This table does not reflect up to $30 million ofdirect borrowing availability under our senior revolving credit facility.  The senior revolving credit facility matureson December 15, 2010.

 

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**Effectsof Inflation**

 

Although our purchases from foreign manufacturers are made in U.S. dollars,mitigating any foreign exchange rate risk on purchase commitments, we may besubject to higher prices charged by our manufacturers to compensate forinflation or other market forces in such countries.

 

**Recent AccountingPronouncements**

 

In June 2009, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 167,“Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). The objectiveof this statement is to improve financial reporting by enterprises involvedwith variable interest entities. This statement addresses (1) the effectson certain provisions of FASB Interpretation No. 46 (revised December 2003),“Consolidation of Variable Interest Entities”, as a result of the eliminationof the qualifying special-purpose entity concept in SFAS No. 166,“Accounting for Transfers of Financial Assets-an amendment of FASB Statement No. 140”(“SFAS 166”), and (2) concern about the application of certain keyprovisions of FASB Interpretation No. 46(R), including those in which theaccounting and disclosures under the interpretation do not always providetimely and useful information about an enterprise’s involvement in a variableinterest entity. This statement is effective as of the beginning of eachreporting entity’s first annual reporting period that begins after November 15,2009, for interim periods within that first annual reporting period, and forinterim and annual reporting periods thereafter. Earlier application isprohibited. The Company is evaluating the impact the adoption of SFAS 167 willhave on its consolidated financial statements.

 

In June 2009, the FASB issued SFAS 166. SFAS 166improves the relevance, representational faithfulness, and comparability of theinformation that a reporting entity provides in its financial statements abouta transfer of financial assets; the effects of a transfer on its financialposition, financial performance, and cash flows; and a transferor’s continuinginvolvement, if any, in transferred financial assets. SFAS 166 is effective asof the beginning of each reporting entity’s first annual reporting period thatbegins after November 15, 2009, for interim periods within that firstannual reporting period and for interim and annual reporting periodsthereafter. The Company is evaluating the impact the adoption of SFAS 166 willhave on its consolidated financial statements.

 

In May 2009, the FASB issued SFAS No. 165,“Subsequent Events” (“SFAS 165”).  SFAS 165 requires the disclosure of thedate through which an entity has evaluated subsequent events for potentialrecognition or disclosure in the financial statements and whether that daterepresents the date the financial statements were issued or were available tobe issued.  This standard also provides clarification about circumstancesunder which an entity should recognize events or transactions occurring afterthe balance sheet date in its financial statements and the disclosures that anentity should make about events or transactions that occurred after the balancesheet date.  This standard is effective for interim and annual periodsbeginning with our fiscal year ended June 30, 2009. The Company adoptedSFAS 165 effective June 30, 2009 and has made the appropriate additionaldisclosures in its consolidated financial statements.

 

In April 2008, the FASB issued FASB StaffPosition No. (“FSP”) FAS 142-3, “Determination of the Useful Life ofIntangible Assets.”  This FSP amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder FASB Statement No. 142, “Goodwill and Other Intangible Assets”(“SFAS 142”).  The intent of thisFSP is to improve the consistency between the useful life of a recognizedintangible asset under SFAS 142 and the period of expected cash flows used tomeasure the fair value of the asset under SFAS No. 141(R), “BusinessCombinations” and other U.S. generally accepted accounting principles.  This FSP is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those fiscal years. The Company is currently evaluating the impact of this FSP, if any, onits results of operations and financial position.

 

**On September 15, 2006, theFASB issued FASB Statement No. 157, “Fair Value Measurements” (“SFAS157”).  SFAS 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  SFAS 157 is effective forfiscal years beginning after November 15, 2007.  In February 2008, the FASB issued StaffPositions No. FAS 157-1 and No. FAS 157-2 which delayed the effectivedate of SFAS 157 for one year for certain non financial assets and liabilitiesand removed certain leasing transactions from its scope.  The Company is currently analyzing SFAS 157and its impact on the Company’s financial condition and results of operations.**

 

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

 

Market risk representsthe risk of loss that may impact our financial position, results of operationsor cash flows due to adverse changes in financial product market prices andrates.  We are exposed to market risks,including changes in interest rates and a reduction in the value of the dollar.Market risks related to our operations result primarily from changes ininterest rates.  Our interest rateexposure relates primarily to our variable interest line of credit.  Borrowings under the credit facility bearvariable interest at the Company’s option at either (i) a base rate or (ii) theLondon interbank offered rate plus two and three-quarters percent (2.75%) perannum (each rate as defined in the credit facility).  Loan borrowings and repayments under therevolving credit facility were $13.8 million and $13.8 million, respectivelyduring the year ended June 30, 2009.

 

When purchasing apparel from foreign manufacturers, weuse letters of credit that require the payment in U.S. currency upon receipt ofbills of lading for the products and other documentation.  Prices are fixed in U.S. dollars at the timethe purchase orders and/or letters of credit are issued, which mitigates therisk of a reduction in the value of the dollar. However, purchase prices for the Company’s products may be impacted byfluctuations in the exchange rate between the U.S. dollar and the localcurrencies of the foreign manufacturers, which may have the effect ofincreasing the Company’s cost of goods in the future.  Due to the number of currencies involved andthe fact that not all foreign currencies react in the same manner against theU.S. dollar, the Company cannot quantify in any meaningful way the potentialeffect of such fluctuations on future income. The Company does not engage in hedging activities with respect to suchexchange rate risk.

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

 

Financial statements required by this item appear withan Index to Financial Statements and Schedules, starting on page F-1 ofthis report.

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

 

None.

 
| **ITEM 9A(T).** | **CONTROLS & PROCEDURES** |
|-----------------|------------------------------------|

 

**Management’sEvaluation of Disclosure Controls and Procedures**

 

TheCompany maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act), which are designed to ensure thatinformation required to be disclosed by the Company in the reports we file orsubmit under the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including its Chief Executive Officer and Interim Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

Asof the period ended June 30, 2009 (the “Evaluation Date”), an evaluationof the effectiveness of the Company’s disclosure controls and procedures wasconducted under the supervision of, and reviewed by, our Chief ExecutiveOfficer and Interim Chief Financial Officer. Based on that evaluation, our Chief Executive Officer and Interim ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective at the Evaluation Date.

 

**Management’s Assessment of Internal Control Over Financial Reporting**

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rules 13a-15(f) and15d-15(f).  Our internal control overfinancial reporting includes those policies and procedures that (i) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof our assets that could have a material effect on the financial statements.

 

Internal control over financial reporting is designedto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements prepared for externalpurposes in accordance with generally accepted accounting principles.  Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.  Also, 

 

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projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

Under the supervision and with the participation ofour Chief Executive Officer and  InterimChief Financial Officer, management conducted an evaluation of theeffectiveness of our internal control over financial reporting as of June 30,2009 based on the framework in *Internal Control —Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission and in accordance with theinterpretive guidance issued by the SEC in Release No. 34-55929.  Based on that evaluation, managementconcluded that our internal control over financial reporting was effective asof June 30, 2009.

 

This annual report does not include an attestationreport of our registered public accounting firm regarding internal control overfinancial reporting.  Management’s reportwas not subject to attestation by our registered public accounting firmpursuant to temporary rules of the Securities and Exchange Commission thatpermit the Company to provide only management’s report in this annual report.

 

**Changes in Internal Control OverFinancial Reporting**

 

There have been no changes in our internal controlover financial reporting that have occurred during our fiscal quarter ended June 30,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 
| **ITEM 9B.** | **OTHER INFORMATION** |
|--------------|-----------------------|

 

**None.**

** **

**PART III**

** **
| **ITEM  10.** | **DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE MANAGEMENT** |
|---------------|------------------------------------------------------------------------|

** **

The following table setsforth certain information regarding the members of our board of directors andexecutive officers.  All directors areelected annually and hold office until their successors are elected andqualified, or until their earlier removal or resignation.

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                                                                 |
|--------------------|------------|---------|------------|----------------------------------------------------------------------------------------------|
| Christa Michalaros |       | 48      |       | Chief Executive Officer  and Director                                                        |
| Lance D. Arneson   |       | 34      |       | Vice-President of Finance, Principal Accounting Officer and Interim  Chief Financial Officer |
| Rosemary Mancino   |       | 52      |       | President of  Sales & Planning                                                      |
| Nichole Vowteras   |       | 52      |       | Executive Vice President  Sourcing and Production                                            |
| John Kourakos      |       | 60      |       | Director, Chairman of the  Board                                                             |
| George Kollitides  |       | 39      |       | Director                                                                                     |
| Joel H. Newman     |       | 68      |       | Director                                                                                     |
| Ronald Frankel     |       | 72      |       | Director                                                                                     |
| Robert Newman      |       | 65      |       | Director                                                                                     |

 

**Christa Michalaros**became our Chief Executive Officer and one of our directors on April 25,2006.  From 1999 to 2005, Ms. Michalaros served as the President ofthe Tommy Hilfiger Womenswear Division. Before joining Tommy Hilfiger, Ms. Michalaros was at Liz Claibornefrom 1981 to 1999.  At Liz Claiborne, Ms. Michalaros moved up throughthe sales organization in positions of increasing responsibility in theircasual and career divisions.  Her last position at Liz Claiborne was thePresident of Liz Claiborne Casual, a nearly one billon dollar division. All of the aforementioned companies are principally in the business of women’sapparel.

 

**Lance D. Arneson**has been our Interim Chief Financial Officer and Vice President of Financeeffective as of****April 3, 2009 and prior tothat, was our Controller since December 2006.  Prior to joining Rafaella, Mr. Arnesonwas a Senior Manager with PricewaterhouseCoopers LLP (“PwC”) from September 2004until joining the Company, and prior to that time, Mr. Arneson served as aManager with PwC commencing in 2001.

 

**Rosemary Mancino** became ourPresident of Sales & Planning on August 1, 2006.  Ms. Mancino joined Rafaella with nearly30 years of retail/apparel experience. Prior to joining Rafaella, Ms. Mancino was employed as Senior VicePresident Sales, Retail Planning and In Store Services for five years by TommyHilfiger USA.  Prior to that she wasemployed by Liz Claiborne for ten years, where her last position was serving asVice President/General Manager of Sales for the Liz Claiborne casual division.  All of the aforementioned companies areprincipally in the business of women’s apparel.

 

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**Nichole Vowteras** became ourExecutive Vice President—Sourcing and Production on May 1, 2006.  Prior to her joining Rafaella as VicePresident—Sourcing and Production, Ms. Vowteras was employed as VicePresident of Manufacturing for Garfield Marks for 2.5 years, as Senior VicePresident of Production for Guess, Inc. for one year and with Reebok foreight years, where her last position was serving as Vice President of WorldwideSourcing.  All of the aforementionedcompanies are principally in the business of women’s apparel and footwear.

 

**John Kourakos** is Chairman of theBoard of Directors and was elected as a director in 2007.  Mr. Kourakos has over twenty-five yearsof experience in the apparel industry. Most recently 2002 to 2004, he was Group President of Warnaco’s Sportsweargroup which included the Calvin Klein Jeans, Calvin Klein Underwear and Chapsby Ralph Lauren divisions.  Prior tothat, 1996 to 2001, he was President of the Men’s Sportswear and Tommy Jeansdivisions at Tommy Hilfiger.  Beforejoining Tommy Hilfiger, he was President of Warnaco’s Calvin Klein Men’s andWomen’s Underwear/Calvin Klein Men’s Accessories division from 1994 to1996.  Mr. Kourakos also served in anumber of other key management positions including President of Calvin KleinMenswear at Calvin Klein, Inc., where he managed the men’s lines of CalvinKlein jeans, underwear and sportswear, and as Vice President of Sales for theRalph Lauren Womenswear line and Executive Vice President of Merchandising forthe Calvin Klein line at Bidermann Industries.

 

**George Kollitides**is one of our directors and was elected as a director in 2005.  Mr. Kollitides is a Managing Director atCerberus.  From 2001 to 2003, Mr. Kollitideswas President and Managing Director of TenX Capital Management, a specialsituations investor affiliated with Cerberus, where he was responsible for over$180 million of investments.  Priorto joining TenX, Mr. Kollitides actively invested in numerous privateequity transactions for Catterton Partners, a middle market private equity groupfrom 1998 to 2001.  Prior to joiningCatterton, Mr. Kollitides held various positions of increasingresponsibility at General Electric Capital in the Equity, Corporate Finance,and Corporate Restructuring Groups, focusing on leveraged recapitalizations,reorganizations, change of control transactions and minority equity investmentsfrom 1990 through 1997.  Mr. Kollitidessits on boards of IAP Worldwide Services, Bushmaster Firearms, RemingtonFirearms and LNR Holdings.

 

**Joel H. Newman** was elected as adirector in July 2009.  Mr. Newman most recently servedas Vice Chairman and Chief Operating Officer of Kenneth Cole Productions, Inc.from 2006 until 2007.  Prior to that, Mr. Newman spent more than adecade at Tommy Hilfiger Corporation (“THC”), holding a variety of roles,finally as Executive Vice President of Finance and Operations of THC and ChiefOperating Officer of Tommy Hilfiger U.S.A., Inc., THC’s principal USoperating subsidiary.

 

**Ronald Frankel** is amember of our Board of Directors and was elected as a director in 2005 and hehad been employed by our predecessor since co-founding Rafaella Sportswear, Inc.in 1982.  Prior to founding ourpredecessor, Mr. Frankel worked as an independent sales representativeselling the Booth Bay and Mr. Thompson lines of women’s wear, worked as anin-house sales representative for YSL Sportswear and managed a start-updivision at Bodin Apparel, Inc, a women’s apparel company.  Mr. Frankel has held various positionsin the apparel industry for over 40 years.

 

**Robert Newman**is a member of our Board of Directors and was elected as a director in 2005 andhe had been employed by our predecessor as Vice President-Sales since1992.  Mr. Newman has held salespositions in the apparel industry for over 36 years.  Prior to working with our predecessor, Mr. Newmanwas an outside sales representative for several apparel lines, includingRafaella, from 1984 to 1992.

 

**Code of Business Conduct**

 

The Company has adopted aCode of Business Conduct, which applies to all employees and officers of theCompany and provides that, in the conduct of all corporate activities,integrity and ethical conduct is expected. In addition, the Code of Business Conduct addresses and providesguidance on a number of business-specific issues, including but not limited toconflicts of interest.  You may obtain acopy of the Company’s Code of Ethics, free of charge, by submitting a requestin writing to the attention of the Chief Financial Officer, Rafaella ApparelGroup, Inc., 1411 Broadway, New York, New York 10018.

 

**Audit Committee Financial Expert**

 

Our Board of Directorshas separately designated an audit committee and the functions of a traditionalaudit committee are carried out by three of the members of the Board, Messrs. Kourakos,Kollitides and J. Newman, of whom Mr. Kourakos and Mr. J. Newman areindependent.  Our Board has determinedthat each member of the Board is financially literate but no determination hasbeen made as to the ability of any director to qualify as a “financial expert”within the meaning of the regulations adopted by the Securities and ExchangeCommission.  However, based on theirbackgrounds and their understanding of the Company’s business, the Board ofDirectors believes that the members of the Audit Committee will be able to provideeffective oversight for the Company’s financial reporting process and itsrelationship with its independent accountants.

 

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**ITEM 11.**                          EXECUTIVE COMPENSATION

 

**COMPENSATION DISCUSSION ANDANALYSIS**

 

***Overview***

 

This CompensationDiscussion and Analysis, or CD&A, is intended to provide informationregarding the Company’s executive compensation program and practices.  This CD&A covers a variety of topics,including:  the Company’s compensationphilosophy regarding executive compensation, the role of our CompensationCommittee in setting the compensation of our executive officers, and executivecompensation decisions for fiscal 2009.

 

***Compensation Philosophy***

 

The Company is committedto achieving long-term, sustainable growth and increasing stockholdervalue.  The Company’s compensationprogram for our executive officers is designed to support these objectives andencourage strong financial performance on an annual basis by awarding annualperformance bonuses, and on a long-term basis by linking a portion of ourexecutive officers’ total compensation to Company performance in the form ofequity incentive compensation.  TheCompany’s compensation philosophy is to set our executive officers’compensation, which principally includes base salary, annual performance bonus,and long-term equity incentives, at levels that will attract, motivate, andretain superior executive talent in a highly competitive environment.

 

***Role of the Compensation Committee***

 

Our CompensationCommittee sets the compensation of our executive officers, including the mix ofbase salary, annual performance bonus, and long-term equity incentives.  Our Compensation Committee also sets thefinancial performance targets for our executive officers’ annual performancebonuses.  Our Compensation Committeeconsists of Ms. Michalaros and Messrs. Kourakos, Kollitides andFrankel, of whom Mr. Kourakos is independent.

 

To maintain theeffectiveness of our executive officer compensation program, and keep itconsistent with our compensation philosophy, our Compensation Committee takesinto account the Company’s growth and profitability, individual executiveofficer performance, the nature and scope of each executive officer’sresponsibilities, and each officer’s effectiveness in supporting the Company’slong-term goals.  Our CompensationCommittee also considers the recommendations of our Chief Executive Officerregarding the base salary and annual performance bonus of our executiveofficers, other than her own.

 

***Total Compensation***

 

In setting a totalcompensation target for each executive officer, we consider objective andsubjective factors, such as individual and Company performance, prior equityawards, potential future earnings from equity awards, retention, andmotivation.

 

In 2009, as set forth inmore detail in the Summary Compensation Table, the total compensation of ourChief Executive Officer was $798,405; the total compensation of our formerChief Financial Officer was $326,994; the total compensation of our InterimChief Financial Officer was $223,881; the total compensation of our Presidentof Sales & Planning was $432,475; and the total compensation of ourExecutive Vice President Sourcing and Production was $418,951.

 

***Base Salary***

 

In setting our executiveofficers’ base salaries we take into consideration subjective factors, such asthe relative responsibilities of each executive officer, the cross-functionalleadership roles, business contributions and experience.

 

As discussed furtherbelow under the heading Employment Agreements, our executive officers haveemployment agreements with the Company. These employment agreements were entered into by each of our executiveofficers upon becoming executive officers of the Company between June 2005and June 2009, and provide the executive officers with threshold basesalary levels.  Each year, ourCompensation Committee evaluates whether it is appropriate to approve salariesin excess of the contractual minimums. In 2009, we provided our Chief Executive Officer, former Chief FinancialOfficer, Interim Chief Financial Officer, President of Sales &Planning, and Executive Vice President Sourcing and Production, with basesalaries of $713,462, $307,693, $200,481, $407,693, and $407,693, respectively.

 

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***Annual Performance Bonus***

 

Our practice is to makecash performance bonuses a significant component of our executive officers’total compensation.  We believe thisdesign aligns the interests of our executive officers with the interests of ourstockholders.

 

Our CompensationCommittee approves a target bonus for each executive officer that is based on apercentage of their base salaries.  Inestablishing these bonus targets, the Compensation Committee considers ourexecutive officers’ potential total compensation in light of the Company’scompensation philosophy and market practices. The executive officers can earn their target bonuses based upon theCompany’s achievement of pre-determined financial performance targets.  Our Compensation Committee has the discretionnot to award performance bonuses, even if the Company achieves its financialperformance targets.  Conversely, our CompensationCommittee also has the discretion to award performance bonuses, even if theCompany did not achieve its financial performance targets (e.g., due touncontrollable events or extenuating circumstances as determined by theCompensation Committee).

 

Our executive officerscan earn from 0% to 200% of their target performance bonus based upon theCompany’s achievement of pre-determined Earnings Before Interest, Taxes,Depreciation, and Amortization (“EBITDA”) targets established by theCompensation Committee.  We attempt toestablish the financial performance target(s) at challenging levels thatare reasonably attainable if we meet our performance objectives.  Due to confidentiality and the possibility ofcompetitive harm to the Company, we do not disclose the specific performancetargets necessary for our executive officers to receive the annual performancebonus described in this paragraph.  Basedupon the performance of the Company in 2009, none of our executive officersqualified for performance bonuses (with the exception of Mr. Arneson, whoreceived a performance bonus of $14,000 based upon a determination by ourCompensation Committee independent of any EBITDA targets).** **Based upon the performance of theCompany in 2008, none of our executive officers qualified for performancebonuses.

 

***Equity Incentives***

 

Our Equity Incentive Plan(the “Plan”) allows for various types of equity awards, including stock optionsand restricted stock.  Awards under ourPlan have been granted to attract, motivate, and retain our executive officers.  Such awards have been granted in connectionwith each of the executive officers employment agreements that were enteredinto upon joining the Company between June 2005 and March 2007.  No equity awards were made during fiscal2009.

 

All awards under our Planmust be approved by our Compensation Committee. Our Compensation Committee determines the type, timing, and amount ofequity awards granted to each of our executive officers after considering theirbase salary and target performance bonus in relation to the Company’scompensation philosophy.

 

Awards granted under thePlan have been limited to time-based stock options.  All of the awards vest in annual incrementsof 25% over the first four years of the grant, expire no later than ten yearsafter the grant date, and have an exercise price of $5.33 per share (the June 20,2005 redemption value of the redeemable convertible preferred stock).  No options were exercised during fiscal 2009.

 

***Pension and retirement benefits***

 

Our named executiveofficers do not participate in any deferred benefit retirement plans such as apension plan.

 

***Non-qualified deferredcompensation***

 

We do not have anydeferred compensation programs for our named executive officers.

 

***Other benefits***

 

We provide private healthcare insurance to some of our named executives.

 

***Perquisites and Other Benefits***

 

Pursuant to the Company’s401(k) plan, the Company provides its executives the same level ofmatching contributions available to all eligible employees, which is equal to100% of each executive officer’s first 3% of pre-tax contributions, subject tothe provisions of the 401(k) plan and Internal Revenue Servicelimitations.  The Company also providesour executive officers with a 

 

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medical insurancepolicy that reimburses our executives for certain medical expenses.  Additional information on executive officerperquisites and other benefits can be found in the footnotes to the Fiscal 2009****Summary Compensation Table in this Form 10-K.

 

***Employment Agreements***

 

Employment agreements forsenior management are used by the Company to establish key elements of theagreement between the Company and the executive, including the minimum periodsof employment and the fundamental elements of compensation, as well as thedetails of the individual arrangement that differ from the Company’s standardplans and programs.  The employmentagreements with executive officers are discussed in detail below, in thesection entitled “Compensation of Executive Officers—Employment Agreements andPotential Payouts upon Termination or Change in Control.” Also, detailed inthat section are the potential payouts for each of the officers under thevariety of potential termination scenarios covered by the agreements.

 

**COMPENSATIONOF EXECUTIVE OFFICERS**

 

***Employment Agreements and******PotentialPayments upon a Termination or Change in Control***

 

The following is adescription of the current employment arrangements between us and the namedexecutive officers, including the specific circumstances relating totermination of employment and change in control of the Company that willtrigger payments to each named executive officer and a calculation of theestimated payments to such officers as a result of the occurrence of suchevents had they occurred on June 30, 2009, the end of the Company’s lastfiscal year.

 

**Christa Michalaros**

 

We have entered into anemployment agreement with Christa Michalaros, our Chief Executive Officer,which commenced on April 25, 2006. Under the terms of the agreement, the initial period was from April 25,2006 through June 30, 2007; thereafter, the agreement and the employmentrelationship created thereunder will continue for consecutive one (1) yearperiods commencing on each July 1. The agreement provides for payments to be made to Ms. Michalarosupon certain termination events.  Ms. Michalaroswill also be entitled to certain payments under our Equity Incentive Plan inthe event a “Liquidity Event” occurs, which is defined as (1) any Personwho is (i) not an Affiliate of the Company or (ii) not Cerberus or anAffiliate of Cerberus becomes the beneficial owner, directly or indirectly, offifty percent (50%) or more of the combined voting power of the thenoutstanding voting securities of the Company; (2) the sale, transfer orother disposition of all or substantially all of the business and assets of theCompany, whether by sale of assets, merger or otherwise to a person other thanan Affiliate of Cerberus; (3) if specified by the Board in an AwardAgreement at the time of grant, the consummation of an Initial Public Offering;or (4) the dissolution or liquidation of the Company.

 

Under Ms. Michalaros’employment agreement, the following payments will be made to her or herrepresentatives if (1) she is terminated by the Company for Cause(generally defined as conviction for the commission of a felony; dishonesty;refusal to follow directions of the Board; gross nonfeasance; breach ofconfidentiality or restrictive covenant provisions; or certain other instancesof willful misconduct); (2) her employment terminates due to her death; (3) theCompany terminates her employment due to her disability (meaning adetermination by the Company in accordance with applicable law that as a resultof a physical or mental injury or illness, Ms. Michalaros is unable toperform the essential functions of her job with or without reasonableaccommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) she resigns for any reason:

 

(a)                                  heraccrued but unpaid base salary and benefits in accordance with the agreement,if any, to the date of termination;

 

(b)                                 theunpaid portion of the Bonus, if any, relating to the fiscal year prior to thefiscal year of her disability, resignation or termination by the Company forCause;

 

(c)                                  certainexpenses reimbursable pursuant to the agreement that have been incurred but notyet reimbursed at the date of termination; and

 

(d)                                 anyrights she may have under the Company’s benefit plans and the ConsolidatedOmnibus Budget Reconciliation Act of 1986 (“COBRA”), and any rights she mayhave to indemnification pursuant to the agreement, the by-laws or certificateof incorporation of the Company, or otherwise under law, and any rights she mayhave under any directors and officers liability policies maintained by theCompany or its affiliates.

 

Should Ms. Michalarosterminate her employment by making an election not to renew the term asprovided in the agreement, she shall receive the payments set forth above andthe bonus for the fiscal year ending at the end of the term, determined inaccordance with the terms of the agreement (assuming this occurred on the lastday of fiscal 2009 the amount would have been $0), payable ninety (90) daysafter the end of the fiscal year; provided that the Company in its solediscretion may elect, by written notice given no later 

 

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than fifteen (15)days prior to the end of the term, to pay to the Executive the incrementalseverance payments set forth in sections (a) and (b) of the nextparagraph in exchange for her (i) agreement to be subject to and legallybound by the non-competition and property covenants set forth in the agreementand (ii) execution and nonrevocation of a valid release agreement in aform reasonably acceptable to the Company and Ms. Michalaros.

 

If Ms. Michalaros isterminated by the Company without Cause, or leaves her employ for “Good Reason”as that term is defined in the agreement, or the Company elects not to renewthe term, in addition to the payments upon termination specified in theprevious paragraph, Ms. Michalaros will receive, upon execution withoutrevocation of a valid release agreement in a form reasonably acceptable to theCompany:

 

(a)                                  paymentfor accrued unused vacation days, payable within thirty (30) days after thedate of termination;

 

(b)                                 continuedbase salary for twelve (12) months after the date of termination, payable onthe last business day of the month; and

 

(c)                                  aprorated bonus equal to the bonus earned as of the date of termination based onthe achievement of prorated performance measures derived from the annualbusiness plan for the fiscal year of termination as measured on the date oftermination, payable in a lump sum within thirty (30) days after the date oftermination.

 
| **Component of  Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Executive  for Good  Reason** | ** ** | **Termination  by the  Company  without  Cause or by  Notice of  Intent not to  Renew** | ** ** | **Termination  by the  Executive  by Notice of  Intent not to  Renew** | ** ** | **Termination  upon the  Executive’s  Death or  Disability** | ** ** | **Occurrence  of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                           |       |                                                                                         |       |                                                                        |       |                                                                   |       |                                        |       |
| Cash  Severance (5)                 |       | —                                       | (1)        | —                                                |       | $                                                              | 700,000    |                                                                                         | $          | 700,000                                                                     |       | —                                                                 | (1)        | —                                      |       | — |   |
| Stock  Options                      |       | —                                       | (2)        | —                                                |       | —                                                         | (2)        | —                                                                                       | (2)        | —                                                                      | (2)        | —                                                                 | (3)        | —                                      | (4)        |
|                                     |            |                                              |            |                                                       |            |                                                                |            |                                                                                              |            |                                                                             |            |                                                                        |            |                                             |            |  |  |

 

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(1)   Assumes the Company would not elect to make certain discretionarypayments.

 

(2)   Non-vested options are forfeited. Fair market value is currentlycalculated as below the exercise price, therefore it is assumed options wouldnot be exercised.

 

(3)   Non-vested options are forfeited; vested options may be exercisedby Ms. Michalaros’ representative until one year or expiration. It isassumed options would not be exercised currently due to the issue discussed in(2) above.

 

(4)   While all non-vested options would have vested, fair market valueis below the exercise price.

 

(5)   The cash severance summary assumes the executive did not receive abonus.

 

**Lance D. Arneson**

 

We have entered into anemployment agreement with Lance D. Arneson, our Vice-President of Finance,Principal Accounting Officer and Interim Chief Financial Officer, dated as of April 3,2009.

 

The agreement providesfor payments to be made to Mr. Arneson upon certain termination events.

 

Under Mr. Arneson’semployment agreement, the following payments will be made to him or hisrepresentatives if (1) he is terminated by us for Cause (generally definedas conviction for the commission of a felony; dishonesty; refusal to followdirections of the Board; gross nonfeasance; breach of confidentiality orrestrictive covenant provisions; or certain other instances of willfulmisconduct); (2) his employment terminates due to his death; (3) theCompany terminates his employment due to his disability (meaning adetermination by the Company in accordance with applicable law that as a resultof a physical or mental injury or illness, Mr. Arneson is unable toperform the essential functions of his job with or without reasonableaccommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) the he resigns for anyreason:

 

(a)                                  hisaccrued but unpaid base salary and benefits in accordance with the agreement,if any, to the date of termination;

 

(b)                                 theunpaid portion of his bonus, if any, relating to the fiscal year prior to thefiscal year of his death, disability, resignation or termination by the Companyfor Cause;

 

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(c)                                  certainexpenses reimbursable pursuant to the agreement that have been incurred but notyet reimbursed at the date of termination; and

 

(d)                                 anyrights he may have under the Company’s benefit plans and COBRA.

 

If we were to terminate Mr. Arnesonwithout Cause, in addition to the payments upon termination specified in (a) through (d),above, Mr. Arneson will receive, upon execution without revocation of avalid release agreement in a form reasonably acceptable to the Companycontinued base salary for six (6) months after the date of termination.

 
| **Component of  Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Company  without  Cause** | ** ** | **Termination  by the  Company  by Notice of  Intent not to  Renew** | ** ** | **Termination  upon the  Executive’s  Death or  Disability** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                  |       |                                                                      |       |                                                                   |       |                                            |       |
| Cash  Severance                     |       | —                                       | (1)        | —                                                |       | $                                                     | 125,000    |                                                                      | $          | 125,000                                                                | (1)        | —                                          |       | — |   |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                           |            |                                                                        |            |                                                 |            |  |  |

 

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(1)   The cash severance summaryassumes the executive did not receive a bonus. However, Mr. Arneson is entitled to a $14,000 performance bonus forfiscal 2009.

 

**Nichole Vowteras**

 

We have entered into anemployment agreement with Nichole Vowteras, our Executive Vice PresidentSourcing and Production, which commenced on May 1, 2006.  Under the terms of the agreement, the term isfrom May 1, 2006 until her employment is terminated by any of the methodsdiscussed below.  Ms. Vowteras willalso be entitled to certain payments under our Equity Incentive Plan in theevent a “Liquidity Event” occurs, which is defined as (1) any Person whois (i) not an Affiliate of the Company or (ii) not Cerberus or anAffiliate of Cerberus becomes the beneficial owner, directly or indirectly, offifty percent (50%) or more of the combined voting power of the thenoutstanding voting securities of the Company; (2) the sale, transfer orother disposition of all or substantially all of the business and assets of theCompany, whether by sale of assets, merger or otherwise to a person other thanan Affiliate of Cerberus; (3) if specified by the Board in an AwardAgreement at the time of grant, the consummation of an Initial Public Offering;or (4) the dissolution or liquidation of the Company.

 

Under Ms. Vowteras’employment agreement, the following payments will be made to her or herrepresentatives if (1) she is terminated by the Company for Cause(generally defined as the commission of a felony; dishonesty; refusal to followdirections of the Board; gross nonfeasance; breach of confidentiality orrestrictive covenant provisions; or certain other instances of willfulmisconduct); (2) her employment terminates due to her death; (3) theCompany terminates her employment due to her disability (meaning adetermination by the Company in accordance with applicable law that as a resultof a physical or mental injury or illness, Ms. Vowteras is unable toperform the essential functions of her job with or without reasonableaccommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) the she resigns for anyreason:

 

(a)                                  heraccrued but unpaid base salary, if any, to the date of termination, payablewithin thirty (30) days after her termination;

 

(b)                                 theunpaid portion of the bonus, if any, relating to the fiscal year prior to thefiscal year of her death, disability, resignation or termination by the Companyfor Cause, payable in accordance with the terms of the agreement;

 

(c)                                  certainexpenses reimbursable pursuant to the agreement that have been incurred but notyet reimbursed at the date of termination; and

 

(d)                                 anyrights she may have under the Company’s benefit plans and COBRA.

 

If Ms. Vowteras isterminated by the Company without Cause, in addition to the benefits describedin the previous paragraph, she will receive, upon execution without revocationof a valid release agreement in a form reasonably acceptable to the Company,continued payment of her base salary for six months following the date oftermination.

 

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| **Component of  Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Company  without  Cause** | ** ** | **Termination  due to the  Executive’s  Disability** | ** ** | **Termination  upon the  Executive’s  Death** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                  |       |                                                                |       |                                                    |       |                                            |       |
| Cash  Severance (base salary)       |       | —                                       |       | —                                                |       | $                                                     | 200,000    |                                                                | —     |                                                    | —     |                                            | —     |   |
| Stock  Options                      |       | —                                       | (1)        | —                                                |       | —                                                | (1)        | —                                                              | (2)        | —                                                  | (2)        | —                                          | (3)        |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                     |            |                                                         |            |                                                 |            |  |

 

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(1)         Non-vested options areforfeited.  Fair market value iscurrently calculated as below the exercise price, therefore it is assumedoptions would not be exercised.

 

(2)         Non-vested options areforfeited; vested options may be exercised by Ms. Vowteras’ representativeuntil one year or expiration.  It isassumed options would not be exercised currently due to the issue discussed in (2) above.

 

(3)         While all non-vested optionswould have vested, fair market value is below the exercise price.

 

**Rosemary Mancino**

 

We have entered into anemployment agreement with Rosemary Mancino, our President of Sales &Planning, which commenced on August 14, 2006.  Under the terms of the agreement, the term isfrom August 14, 2006 until her employment is terminated by any of themethods discussed below.  Ms. Mancinowill also be entitled to certain payments under our Equity Incentive Plan inthe event a “Liquidity Event” occurs, which is defined as (1) any Personwho is (i) not an Affiliate of the Company or (ii) not Cerberus or anAffiliate of Cerberus becomes the beneficial owner, directly or indirectly, offifty percent (50%) or more of the combined voting power of the then outstandingvoting securities of the Company; (2) the sale, transfer or otherdisposition of all or substantially all of the business and assets of theCompany, whether by sale of assets, merger or otherwise to a person other thanan Affiliate of Cerberus; (3) if specified by the Board in an AwardAgreement at the time of grant, the consummation of an Initial Public Offering;or (4) the dissolution or liquidation of the Company.

 

Under Ms. Mancino’semployment agreement, the following payments will be made to her or herrepresentatives if (1) she is terminated by the Company for Cause(generally defined as the commission of a felony; dishonesty; refusal to followdirections of the Board; gross nonfeasance; breach of confidentiality orrestrictive covenant provisions; or certain other instances of willfulmisconduct); (2) her employment terminates due to her death; (3) theCompany terminates her employment due to her disability (meaning adetermination by the Company in accordance with applicable law that as a resultof a physical or mental injury or illness, Ms. Mancino is unable toperform the essential functions of her job with or without reasonableaccommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) the she resigns for anyreason:

 

(a)                                  heraccrued but unpaid base salary, if any, to the date of termination, payablewithin thirty (30) days after her termination;

 

(b)                                 theunpaid portion of the bonus, if any, relating to the fiscal year prior to thefiscal year of her death, disability, resignation or termination by the Companyfor Cause, payable in accordance with the terms of the agreement;

 

(c)                                  certainexpenses reimbursable pursuant to the agreement that have been incurred but notyet reimbursed at the date of termination; and

 

(d)                                 anyrights she may have under the Company’s benefit plans and the ConsolidatedOmnibus Budget Reconciliation Act.

 

If Ms. Mancino isterminated by the Company without Cause, in addition to the benefits describedin the previous paragraph, she will receive, upon execution without revocationof a valid release agreement in a form reasonably acceptable to the Company,continued payment of her base salary for six months following the date oftermination.

 

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| **Component of   Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Company  without  Cause** | ** ** | **Termination  due to the  Executive’s  Disability** | ** ** | **Termination  upon the  Executive’s  Death** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                      |       |                                         |       |                                                  |       |                                                  |       |                                                                |       |                                                    |       |                                            |       |
| Cash Severance (base salary)              |       | —                                       |       | —                                                |       | $                                                     | 200,000    |                                                                | —     |                                                    | —     |                                            | —     |   |
| Stock Options                             |       | —                                       | (1)        | —                                                |       | —                                                | (1)        | —                                                              | (2)        | —                                                  | (2)        | —                                          | (3)        |
|                                           |            |                                              |            |                                                       |            |                                                       |            |                                                                     |            |                                                         |            |                                                 |            |  |

 

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(1)         Non-vested options areforfeited.  Fair market value iscurrently calculated as below the exercise price, therefore it is assumedoptions would not be exercised.

 

(2)         Non-vested options areforfeited; vested options may be exercised by Ms. Mancino’s representativeuntil one year or expiration.  It isassumed options would not be exercised currently due to the issue discussed in (2) above.

 

(3)         While all non-vested optionswould have vested, fair market value is below the exercise price.

 

**Husein Jafferjee**

 

Husein Jafferjee, ourformer Chief Operating Officer, departed the Company as of January 28,2009.  Under the terms of Mr. Jafferjee’semployment agreement, upon termination of his employment with the Company, hewas entitled to the following payments:

 

(a)                                  hisBase Salary at the rate in effect at the time of termination until theeffective date of termination;

 

(b)                                 paymentfor any accrued but unused vacation days;

 

(c)                                  certainexpenses reimbursable pursuant to the agreement that have been incurred but notyet reimbursed at the date of termination;

 

(d)                                 anyrights he may have under the Company’s benefit plans or by law, to the extentthey do not conflict with his employment agreement;

 

(e)                                  paymentof his base salary for the remainder of the term (until January 31, 2010)or twelve (12) months, payable in a lump sum ($600,000);

 

(f)                                    apro-rated annual bonus; and

 

(g)                                 paymentof his COBRA premiums until the earlier of 12 months after the date oftermination or when Mr. Jafferjee first becomes eligible for equivalent insurancecoverage.

 

**Compensation Committee Interlocks and InsiderParticipation**

** **

Our CompensationCommittee (the “Compensation Committee”) presently consists of ChristaMichalaros, John Kourakos, George Kollitides and Ronald Frankel.  Christa Michalaros is our Chief ExecutiveOfficer.  Messrs. Kourakos,Kollitides and Frankel are not under our employ.  None of our executive officers serves as amember of the board of directors or compensation committee of any other entitythat has one or more executive officers serving as a member of our board ofdirectors of our Compensation Committee.

 

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**Summary Compensation Table**

 

Thefollowing table sets forth the compensation of each of our chief executiveofficer, our former chief financial officer, our interim chief financialofficer for fiscal 2009 and our three mostly highly compensated executiveofficers in fiscal 2009 other than the chief executive officer, chief financialofficer and interim chief financial officer for each of fiscal 2007, 2008 and2009, as applicable.

 

**For theYear Ended June 30, 2009**

 
| **Name and Principal Position** | ** ** | **Year** | ** ** | **Salary ($)** | ** ** | **Bonus ($)** | ** ** | **Stock  Awards  ($)** | ** ** | **Option  Awards  ($) (1)** | ** ** | **Non-Equity  Incentive  Plan  Compensation  ($)** | ** ** | **Change in  +  Value and  Nonqualified  Deferred  Compensation  Earnings ($)** | ** ** | **All  Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|------------------------------------------------|------------|----------|------------|---------------------|------------|--------------------|------------|------------------------|------------|-----------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|----------------|------------|
| Christa  Michalaros                            |       | 2009     |       | 713,462             |       | —             |       | —                 |       | 23,264                      |       | —                                             |       | —                                                                                         |       | 61,679                            | (3)        | 798,405        |       |
| *Chief Executive Officer*                      |       | 2008     |       | 700,000             |       | —             |       | —                 |       | 23,263                      |       | —                                             |       | —                                                                                         |       | 63,171                            |       | 786,434        |       |
| * *                                       |       | 2007     |       | 700,000             |       | 700,000            |       | —                 |       | 27,141                      |       | —                                             |       | —                                                                                         |       | 83,370                            |       | 1,510,511      |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
| Lance  Arneson                                 |       | 2009     |       | 200,481             |       | 14,000             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 9,400                             | (2)        | 223,881        |       |
| *Interim Chief Financial Officer*              |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
| Chad  Spooner(4)                               |       | 2009     |       | 307,693             |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 19,301                            | (2)        | 326,994        |       |
| *Former Chief Financial Officer*               |       | 2008     |       | 400,000             |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 26,897                            |       | 426,897        |       |
| * *                                       |       | 2007     |       | 400,000             |       | 300,000            |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 27,039                            |       | 727,039        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
| Nichole  Vowteras                              |       | 2009     |       | 407,693             |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 11,258                            | (2)        | 418,951        |       |
| *Executive Vice President*                     |       | 2008     |       | 400,000             |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 14,482                            |       | 414,482        |       |
| *Sourcing and Production*                      |       | 2007     |       | 400,000             |       | 200,000            |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 14,538                            |       | 614,538        |       |
| * *                                       |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
| Rosemary  Mancino                              |       | 2009     |       | 407,693             |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 24,782                            | (2)        | 432,475        |       |
| *President Sales & Planning*          |       | 2008     |       | 400,000             |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 26,897                            |       | 426,897        |       |
| * *                                       |       | 2007     |       | 353,846             |       | 200,000            |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | 24,875                            |       | 578,721        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                               |       |                                                                                           |       |                              |       |           |       |
| Husein  Jafferjee (5)                          |       | 2009     |       | 366,923             |       | 150,000            |       |                   |       |                        |       |                                               |       |                                                                                           |       | 20,795                            | (2)        | 537,718        |       |
| *Former Chief Operating Officer*               |       | 2008     |       | 230,769             |       | 450,000            | (6)        |                   |       |                        |       |                                               |       |                                                                                           |       | 8,361                             |       | 689,130        |       |
| * *                                       |       | 2007     |       | —              |       | —             |       | —                 |       | —                      |       | —                                             |       | —                                                                                         |       | —                            |       | —         |       |

 

----

(1) Stock option awardforfeitures during the year ended June 30, 2009 were 145,834. Refer toNote 3 of the Company’s consolidated financial statements and the Company’sCritical Accounting Policies and Estimates discussion included withinManagement’s Discussion and Analysis of Financial Condition and Results ofOperations included elsewhere herein for further information on the assumptionsused to fair value the stock option awards.

 

(2) Medical benefitspaid for Mr. Arneson, Mr. Spooner, Ms. Vowteras, Ms. Mancino,and Mr. Jafferjee were $5,669, $16,137, $8,281, $21,805, and $12,357,respectively.

 

(3) Amount shown for Ms. Michalarosincludes the cost of car service ($58,572).

 

(4) Effective April 3,2009, Mr. Spooner resigned as the Company’s Chief Financial Officer. As a consequence thereof, the Company promoted Lance Arneson, the Company’sController, to Vice-President of Finance, Principal Accounting Officer andInterim Chief Financial Officer of the Company, effective April 3, 2009.

 

(5) As of January 28,2009, Mr. Jafferjee was no longer an employee of the Company.

 

(6) Amount shown for Mr. Jafferjeeincludes a $300,000 signing bonus.

 

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**Outstanding Equity Awards at Fiscal Year-End**

 

**As of June 30, 2009**

 
| ** **           | ** ** | **Option Awards**                                                             | ** ** | **Stock Awards**                                                                | ** ** |
|----------------------|------------|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| **Name**             | ** ** | **Number  of  Securities  Underlying  Unexercised  Options (#)  Exercisable** | ** ** | **Number  of  Securities  Underlying  Unexercised  Options (#)  Unexercisable** | ** ** | **Equity Inventive  Plan Awards:  Number of  Securities  Underlying  Unexercised  Unearned  Options (#)** | ** ** | **Option  Exercise  Price ($)** | ** ** | **Option  Expiration  Date** | ** ** | **Number of  Shares or   Units  of Stock  That Have  Not  Vested (#)** | ** ** | **Market Value  of Shares or   Units  of Stock   That Have  Not  Vested ($)** | ** ** | **Equity Inventive  Plan Awards:  Number of  Unearned  Shares,  Units or  Other Rights  That Have   Not  Vested (#)** | ** ** | **Equity Inventive  Plan Awards:  Market or   Payout  Value of  Unearned  Shares, Units  or Other  Rights That   Have Not  Vested ($)** | ** ** |
|                 | ** ** |                                                                               | ** ** |                                                                                 | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   |   |
| Christa  Michalaros  |       | 333,333                                                                            |       | 111,111                                                                              | (1)        | — |   | 5.33 |   | 9/22/2016 |   | — |   | — |   | — |   | — |   |
| Lance  D. Arneson    |       | —                                                                             |       | —                                                                               |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Chad  Spooner (2)    |       | 187,500                                                                            | (3)        | —                                                                               | (1)        | — |   | 5.33 |   | 6/20/2015 |   | — |   | — |   | — |   | — |   |
| Nichole  Vowteras    |       | 83,333                                                                             |       | 27,778                                                                               | (1)        | — |   | 5.33 |   | 9/22/2016 |   | — |   | — |   | — |   | — |   |
| Rosemary  Mancino    |       | 83,333                                                                             |       | 27,778                                                                               | (1)        | — |   | 5.33 |   | 9/22/2016 |   | — |   | — |   | — |   | — |   |
| Husein  Jafferjee(4) |       | —                                                                             |       | —                                                                               |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   |

 

----

(1)         The stock option awards vest annually in increments of 25% for Ms. Michalaros,Mr. Spooner, Ms. Vowteras, and Ms. Mancino, beginning on thefirst anniversary of April 25, 2006, June 20, 2005, June 21,2006, and June 21, 2006, respectively.

 

(2)         Effective April 3, 2009, Mr. Spooner resigned as the Company’sChief Financial Officer.  As a consequence thereof, the Company promotedLance Arneson, the Company’s Controller, to Vice-President of Finance,Principal Accounting Officer and Interim Chief Financial Officer of theCompany, effective April 3, 2009.

 

(3)         Subsequent to June 30, 2009, Mr. Spooner’s 187,500 options topurchase shares of common stock of the Company were forfeited.

 

(4)         As of January 28, 2009, Mr. Jafferjee was no longer anemployee of the Company.

 

**COMPENSATION COMMITTEE REPORT**

 

The CompensationCommittee has reviewed and discussed the Compensation Discussion and Analysisincluded in this annual report on Form 10-K with management and, based onsuch review and discussions, the Compensation Committee recommended to ourBoard of Directors that the Compensation Discussion and Analysis be included inthis annual report.

 

The CompensationCommittee’s Report shall not be deemed incorporated by reference by any generalstatement incorporating by reference this Form 10-K into any filing underthe Securities Act of 1933 or under the Securities Exchange Act of 1934, exceptto the extent that the Company specifically incorporates this CompensationCommittee’s Report by reference, and shall not otherwise be deemed filed undersuch Acts.

 
|   | Compensation  Committee                                   |
|--------|-----------------------------------------------------------|
|   | Christa  Michalaros, Chief Executive Officer and Director |
|   | John  Kourakos, Director                                  |
|   | George  Kollitides, Director                              |
|   | Ronald  Frankel, Director                                 |

 

**Compensation of Directors**

 

Other than Messrs. Kourakosand J. Newman, none of our non employee directors received any fee payments orequity grants.

 

Members of our Board ofDirectors who are either our employees or affiliated with Cerberus receive noseparate compensation for serving on the Board of Directors.  All members of our Board of Directors arereimbursed for actual expenses incurred in connection with attendance at meetingsof the Board of Directors and of committees of the Board of Directors.

 

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In connection withJoel H. Newman’s appointment, the Company and Mr. J. Newman enteredinto a letter agreement dated July 28, 2009 (the “Letter Agreement”). Pursuant to the Letter Agreement, Mr. J. Newman’s total compensation as amember of the Board shall consist solely of a director’s fee of $60,000 perannum, payable quarterly in advance, plus expenses.

 

We have enteredinto an agreement for Chairman of the Board of Directors with John Kourakos which commenced on October 1,2007.  Under the terms of the agreement,the initial period was from October 1, 2007 through September 30,2008; thereafter, the agreement will continue for consecutive twelve (12) monthperiods commencing on each October 1, as long as Mr. Kourakos shallcontinue to be elected as Chairman of the Board.  If Mr. Kourakos’s status as Chairman isterminated under circumstances in which he does not remain a director, theAgreement will terminate, and the Company will pay to Mr. Kourakos allcompensation and benefits to which Mr. Kourakos is entitled up through thedate of termination.

 

Mr. Kourakos’fee was $150,000 on an annualized basis from October 1, 2007 until June 30,2008 and $200,000 per year commencing on July 1, 2008.  For fiscal year 2009, Mr. Kourakos waspaid aggregate fees of $200,000 and was reimbursed $13,842 in the aggregateprimarily attributable to health insurance, auto expenses and legal fees.

 

Mr. Kourakosis entitled, subject to vesting, to receive a transaction bonus in an amountequal to 1.0% of the Appreciated Value in connection with Sale Transactions and1.0% of the Net Dividends paid other than in connection with a SaleTransaction.

 

Calculations ofAppreciated Value or Net Dividends shall be made without duplication inconnection with any Sale Transaction or Dividend payment.

 

A “Sale Transaction” isdefined as:

 

(1) a “Change inControl” (generally defined as (i) a transaction(s) resulting in thesale of all or substantially all of the assets of the Company to a person orentity who is not a stockholder of the Company or an affiliate of such astockholder (such person or entity being a “Third Party”); or (ii) atransaction(s) resulting in the sale by any stockholders of the Company,or any of their affiliates, or a merger or other business combination,involving the Company, resulting in more than fifty percent (50%) of the votingstock of the Company being held by a Third Party);  and

 

(2) other than inconnection with a Change in Control, (A) all transactions by the commonstockholders of the Company or any affiliates of such common stockholdersresulting in the sale of common securities of the Company to one or more ThirdParties and (B) the sale by the Company of its common securities pursuantto an initial public offering.

 

“Appreciated Value” isdefined as:

 

(1) the net value ofall cash, securities and other consideration in any form paid by a Third Partyto the Company and/or the common stockholders in connection with SaleTransactions (including the aggregate amount of any Dividends in connectionwith or in contemplation of a Sale Transaction) and taking into account the NetDividends calculated in connection with any Dividends paid after the EffectiveDate to the Common Stockholders or any affiliates of such common stockholders; minus

 

(ii) in the case ofa Sale Transaction in which the Company receives consideration from the ThirdParty, the sum of (x) the amount of any debt or preferred stock (basedupon its aggregate liquidation preference plus any accrued and unpaid dividendsor other preferred return) assumed, acquired, redeemed or repaid (directly orindirectly) in connection with the Sale Transaction, or which remains on theCompany’s financial statements at the time of the Sale Transaction and (y) $53,333,333(the “Floor Amount”); or

 

(iii) in the case ofa Sale Transaction in which the common stockholders receive consideration fromthe Third Party, the sum of (x) the amount of any preferred stock of theclass or series issued and outstanding on the Effective Date (based upon itsaggregate liquidation preference plus any accrued and unpaid dividends or otherpreferred return) that is issued and outstanding as of the time of such SaleTransaction and (y) the Floor Amount minus (A) the number ofshares of such preferred stock issued and outstanding as of the time of suchSale Transaction multiplied by (B) the original issue price thereof.

 

“Net Dividends” isdefined as:

 

(i) the aggregatevalue of all cash, securities and other consideration paid by the Company tothe Common Stockholders or any affiliates of such Common Stockholders (otherthan in connection with a Sale Transaction) in the form of dividends, otherdistributions or as a repurchase of any common securities of the Company(collectively, “Dividends”) and taking into account the “Appreciated Value”calculated in connection with prior Sale Transactions; minus

 

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(ii) the sum of (x) theamount of any preferred stock of the class or series issued and outstanding(based upon its aggregate liquidation preference plus any accrued and unpaiddividends or other preferred return) that is issued and outstanding as of thetime of such Dividend and (y) the Floor Amount minus (A) thenumber of shares of such preferred stock issued and outstanding as of the timeof such Dividend multiplied by (B) the original issue price thereof.

 

Calculations ofAppreciated Value or Net Dividends shall be made in connection with any SaleTransaction or Dividend payment.

 

In the event aChange in Control is consummated prior to full vesting of his Sale/DividendPayment and provided that Mr. Kourakos’ service has not terminated as ofthe date of such Change in Control, Mr. Kourakos shall be one hundredpercent (100%) vested in the entire Sale/Dividend Payment, which shall bepayable in a lump sum within thirty (30) days of such Change in Control.

 

As of August 31,2009, Mr. Kourakos’ Sale/Dividend payment was 31% vested.  Provided that Mr. Kourakos continues hisservice to the Company or its subsidiaries on each Vesting Date as describedbelow, the Vesting Schedule is as indicated below:

 
| **Vesting Date:********On the following anniversaries of  October 1, 2007:** | ** ** | **The following percent of the  Sale/Dividend Payment shall vest:** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
|                                                                              |       |                                                                |       |
| 12  month                                                                         |       | 4                                                                   | %          |
| 15  month                                                                         |       | 5                                                                   | %          |
| 18  month                                                                         |       | 5                                                                   | %          |
| 21  month                                                                         |       | 5                                                                   | %          |
| 24  month                                                                         |       | 5                                                                   | %          |
| 27  month                                                                         |       | 6                                                                   | %          |
| 30  month                                                                         |       | 6                                                                   | %          |
| 33  month                                                                         |       | 6                                                                   | %          |
| 36  month                                                                         |       | 6                                                                   | %          |
| 39  month                                                                         |       | 10                                                                  | %          |
| 42  month                                                                         |       | 10                                                                  | %          |
| 45  month                                                                         |       | 10                                                                  | %          |
| 48  month                                                                         |       | 10                                                                  | %          |

 

If Mr. Kourakos’ position as Chairman of theBoard terminates for any reason prior to the consummation of a Change inControl, any then-unvested portion of his Sale/Dividend Payment shallimmediately be cancelled, and Mr. Kourakos (and his estate, designatedbeneficiary or other legal representative, as applicable) shall forfeit anyrights or interests in and with respect to any such unvested portion of hisSale/Dividend Payment.

 

In the event any Sale Transaction is consummated, orany Net Dividend is paid, on or prior to the first (1st) anniversary of Mr. Kourakos’termination as Chairman of the Board, Mr. Kourakos shall be entitled tothe portion of his Sale/Dividend Payment that had vested on or prior to theeffective date of termination.  Suchamount shall be payable to Mr. Kourakos in a lump sum within sixty (60)days of the date of such Sale Transaction or Net Dividend payment.

 

In the event any Sale Transaction is consummated, or anyNet Dividend is paid, after such first (1st) anniversary, any rights orinterests in the entire Sale/Dividend Payment shall be cancelled and Mr. Kourakos(and Mr. Kourakos’ estate, designated beneficiary or other legalrepresentative, as applicable) shall forfeit any rights or interests in andwith respect to his entire Sale/Dividend Payment.

 

Director Compensation

 
| **Name**      | ** ** | **Fees Earned** | ** ** | **All Other Compensation(1)** | ** ** |
|---------------|------------|----------------------|------------|-----------------------------------------|------------|
|          |       |                 |       |                                    |       |
| John Kourakos |       | $                    | 200,000    |                                    | $          | 13,842 |   |
| Joel Newman   |       | $                    | 0          |                                    | $          | 0 |   |

 

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(1) Includes reimbursementsprimarily attributable to health insurance, auto expenses and legal fees.

 

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** **

**ITEM12.**               SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS

** **

The followingtable sets forth information as of September 30, 2009 with respect to thebeneficial ownership of our issued and outstanding common stock and convertiblepreferred stock, excluding any grants made under our Equity Incentive Plan,none of which have vested or will vest in the next sixty days, by:

 

·                  eachperson who is known by us to beneficially own 5% or more of our issued andoutstanding common stock and convertible preferred stock;

 

·                  eachmember of our Board of Directors;

 

·                  eachof our executive officers named under “Management—Compensation of ExecutiveOfficers;” and

 

·                  allmembers of our Board of Directors and our named executive officers as a group.

 

Beneficial ownershipis determined in accordance with the rules of the SEC.  To our knowledge, except as set forth in theStockholders’ Agreement where defined or discussed, each holder of our equityinterests listed below has sole voting and investment power as to such equityinterest unless otherwise noted.

** **
| ** **                                                                                | ** ** | **Convertible Preferred  Stock** | ** ** | **Common Stock**         | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------|------------|
| **Name and Address of Beneficial Owner (1)**                     | ** ** | **Number of  Shares**            | ** ** | **Percentage  of Class** | ** ** | **Number of  Shares** | ** ** | **Percentage  of Class** | ** ** |
| Stephen Feinberg(2)(3)                                                                    |       | 7,500,000                             |       | 100                           | %          | 7,500,000 |   | 75 | % |
| RSW 2005, Inc.(7)                                                                    |       | —                                |       | —                        |       | 2,500,000 |   | 100 | % |
| Christa Michalaros(4)                                                                     |       | —                                |       | —                        |       | 333,333 |   | 11.8 | % |
| Lance D. Arneson                                                                          |       | —                                |       | —                        |       | — |   | — |   |
| Chad Spooner (8)                                                                          |       | —                                |       | —                        |       | — |   | — |   |
| Rosemary Mancino(5)                                                                       |       | —                                |       | —                        |       | 83,333 |   | 3.2 | % |
| Nichole Vowteras (6)                                                                      |       | —                                |       | —                        |       | 83,333 |   | 3.2 | % |
| George Kollitides(3)                                                                      |       | —                                |       | —                        |       | — |   | — |   |
| John Kourakos                                                                             |       | —                                |       | —                        |       | — |   | — |   |
| Joel H. Newman                                                                            |       | —                                |       | —                        |       | — |   | — |   |
| Ronald Frankel(7)                                                                         |       | —                                |       | —                        |       | 2,125,000 |   | 85.0 | % |
| Robert Newman(7)                                                                          |       | —                                |       | —                        |       | 125,000 |   | 5.0 | % |
| Asher Haddad (7)                                                                          |       | —                                |       | —                        |       | 250,000 |   | 10.0 | % |
| Husein Jafferjee (9)                                                                      |       | —                                |       | —                        |       | — |   | — |   |
| All members of our Board of  Directors and executive officers as a group (9 persons) |       |                                  |       |                          |       | 2,999,999 |   | 100 | % |

 

----

(1)   The address for each of our officers and,except as otherwise specified below, each of the members of our Board ofDirectors is c/o Rafaella Apparel Group, Inc., 1411 Broadway, 2nd Floor,New York, New York 10018.

 

(2)   Acquisition Co., controlled by Cerberus, owns100% of our convertible preferred stock, which preferred stock is convertibleat its option into common stock equal to 75% of our common stock, orapproximately 69.6% of our outstanding fully-diluted common stock.  Stephen Feinberg exercises sole voting andinvestment authority over all securities of our Company owned by AcquisitionCo. Thus, pursuant to Rule 13d-3 under the Exchange Act, Stephen Feinbergis deemed to beneficially own 100% of our convertible preferred stock and, uponconversion, would beneficially own approximately 69.6% of our common stock(after the exercise of all outstanding options granted pursuant to our EquityIncentive Plan, whether vested or unvested).

 

(3)   The address for each of Stephen Feinberg andGeorge Kollitides is c/o Cerberus Capital Management, L.P., 299 ParkAvenue, New York, New York 10171.

 

(4)   Includes vested options for 333,333 shares ofcommon stock but does not include non-vested options for 111,111****shares of common stock, all of which were granted pursuantto Ms. Michalaros’ employment agreement with us.

 

(5)   Includes vested options for 83,333 shares ofcommon stock but does not include non-vested options for 27,778 shares ofcommon stock, all of which were granted pursuant to Ms. Mancino’semployment agreement with us.

 

(6)   Includes vested options for 83,333 shares ofcommon stock but does not include non-vested options for 27,778 shares ofcommon stock, all of which were granted pursuant to Ms. Vowteras’employment agreement with us.

 

(7)   All of our common stock beneficially owned by Messrs. Frankel,R. Newman and Haddad are held by them indirectly through RSW 2005, Inc.

 

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(8)   Effective April 3, 2009, Mr. Spoonerresigned as the Company’s Chief Financial Officer.  As a consequencethereof, the Company promoted Lance Arneson, the Company’s Controller, toVice-President of Finance, Principal Accounting Officer and Interim ChiefFinancial Officer of the Company, effective April 3, 2009.

 

(9)   As of January 28, 2009, Mr. Jafferjeewas no longer an employee of the Company.

 

**Equity Compensation PlanInformation (1)**

 
| **Plan category**                                           | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities remaining  available for future issuance  under equity compensation plans  (excluding securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                            | ** ** | **(b)**                                                                            | ** ** | **(c)**                                                                                                                                             | ** ** |
|                                                        |       |                                                                                               |       |                                                                               |       |                                                                                                                                                |       |
| Equity compensation plans approved by security  holders     |       | —                                                                                             |       | —                                                                             |       | —                                                                                                                                              |       |
| Equity compensation plans not approved by security  holders |       | 1,111,111                                                                                          |       | $                                                                                  | 5.33       |                                                                                                                                                | —     |   |
| Total                                                       |       | 1,111,111                                                                                          |       | $                                                                                  | 5.33       |                                                                                                                                                | —     |   |

 

----

(1)          A description of the Equity Compensation Plan is set forth under Note 3to the Consolidated Financial Statements.

 

**ITEM13.**                          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

** **

**Controlling Stockholder**

** **

In connection withthe June 20, 2005 acquisition, Acquisition Co., an affiliate of Cerberus,contributed $40.0 million of equity capital to us, acquiring convertiblepreferred stock convertible into approximately 69.6% of our common stock on afully-diluted basis (after the exercise of all outstanding options grantedpursuant to our Equity Incentive Plan, whether vested or unvested).  See “Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters.”

 

*Stockholders’Agreement*

 

In connection withan April 15, 2005 Securities Purchase Agreement, as amended, we enteredinto a Stockholders’ Agreement with Acquisition Co. and our predecessor.  This Stockholders Agreement provides that wewill have a Board of Directors that will consist of seven directors, four ofwhom are designated by Acquisition Co., two of whom are designated by RSW 2005, Inc.,which is controlled by Ronald Frankel, and one of whom is designated jointly byAcquisition Co. and RSW 2005, Inc. Our Board of Directors currentlyconsists of six directors, four of whom were designated by Acquisition Co. andtwo of whom were designated by our predecessor or RSW 2005, Inc.  The Stockholders’ Agreement also containscertain restrictions on transfers by stockholders of their capital stock andtag-along rights, drag-along rights and a right of first refusal with respectto certain permitted transfers.

 

**Related Party Transactions Policy and Procedure**

 

Our financedepartment is primarily responsible for developing and implementing processesand controls to obtain information from our directors, executive officers andsignificant stockholders regarding related party transactions and thendetermining, based on the facts and circumstances, whether we or arelated-party has a direct or indirect material interest in ourtransactions.  Our audit committee doesnot have a written policy regarding the approval of related party transactionsbut will apply its review procedures to potential related-person transactionsas a part of its standard operating procedures. In the course of management’s and the audit committee’s review, thefollowing matters will be considered:

 

·                  the nature ofthe related party’s interest in the transaction;

·                  the materialterms of the transaction, including, the amount involved and type oftransaction;

·                  the importanceof the transaction to the related party and to us;

·                  whether thetransaction would impair the judgment of a director or executive officer to actin our best interest and the best interest of our stockholders; and

·                  any othermatters management or the audit committee deems appropriate.

 

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Since July 1,2008, the beginning of the Company’s most recent fiscal year, we have not beena party to any transaction or series of similar transactions in which theamount involved exceeded or will exceed $120,000 and in which any currentdirector, executive officer, holder of more than 5% of our capital stock, orany member of the immediate family of any of the foregoing, had or will have adirect or indirect material interest.

 

**Director Independence**

 

Our Board of Directorshas not made a determination as to whether each director is “independent”because all of the members of our board have either been appointed by Cerberusor RSW 2005, Inc. The Company has no securities listed for trading on anational securities exchange or in an automated inter-dealer quotation systemof a national securities association, which has requirements that a majority ofits board of directors be independent. The Company believes that Messrs. Kourakos and J. Newman would beconsidered independent under the New York Stock Exchange’s definition ofindependence.

 

**ITEM14.**                                              PRINCIPAL ACCOUNTING FEES AND SERVICES

** **

The followingtable presents fees for services rendered by PricewaterhouseCoopers LLPrelating to the years ended June 30, 2009 and 2008.

 
| ** **            | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|-----------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in thousands)**                      | ** ** |
| Audit fees(1)         |       | $                                            | 446        |                                         | $          | 401 |   |
| Audit-related fees(2) |       | 35                                           |       | 88                                           |       |
| Tax fees(3)           |       | 183                                          |       | 132                                          |       |
| All other fees(4)     |       | 1                                            |       | 2                                            |       |
| Total                 |       | $                                            | 665        |                                         | $          | 623 |   |

 

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(1)    Fees for audit of annual financial statements,statutory audit and review of quarterly financial statements.

 

(2)    Fees for professional services forconsultations.  The fees in fiscal 2008related to the Company’s implementation of FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”and Section 404 of the Sarbanes-Oxley Act of 2002.  The fees in fiscal 2009 related to theCompany’s implementation of FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes — an interpretation of FASB Statement No. 109.”

 

(3)    Fees related to professional services for taxcompliance, tax advice and tax planning. These services include tax return preparation services, technical taxadvice on U.S. and international tax matters and assistance with tax auditdefense matters.

 

(4)    Fees for permissible work provided byPricewaterhouseCoopers LLP that do not meet any of the above-categorydescriptions.  The fees relate to the useof Comperio, PricewaterhouseCoopers LLP’s accounting research software.

 

Under the AuditCommittee’s Charter, the committee has the sole authority for appointing,compensating, retaining and overseeing the work of the Company’s independentauditors.  In addition, the committee hasthe sole authority to approve all engagement fees and terms and all permissiblenon-audit services to be provided by the independent auditors. Subsequent tothe Company’s Registration Statement on Form S-4 filed February 9,2007, the committee has approved each such audit and non-audit service to beprovided by the Company’s independent auditors. The committee has also adopted polices and procedures for pre-approvingcertain services performed by the independent auditors.  The committee has pre-approved the use of theindependent auditors for specific types of services that fall within categoriesof non-audit services, including various tax services.  The percentage of fees paid for audit-related,tax and all other fees that were approved by the Audit Committee was 100% infiscal 2009.  Management of the Companyreviews the nature of the professional services to be rendered by theindependent auditors with the committee during each committee meeting.

 

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** **

**PART IV**

** **

**ITEM15.**                                              EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

** **

**(a) Documents filed as partof this report:**

 

(1)    Financial Statements

 
| ** **                                                                                                              | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report  of Independent Registered Public Accounting Firm                                                                |       | F-2      |
| Consolidated  Balance Sheets at June 30, 2009 and 2008                                                             |       | F-3      |
| Consolidated  Statements of Operations for the years ended June 30, 2009, 2008, and  2007                          |       | F-4      |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the years ended  June 30, 2009, 2008, and 2007 |       | F-5      |
| Consolidated  Statements of Cash Flows for the years ended June 30, 2009, 2008, and  2007                          |       | F-6      |
| Notes  to Consolidated Financial Statements                                                                             |       | F-7      |

 

(2)    Financial Statement Schedules

 

None.

 

(3)   List of Exhibits

 

The exhibits listed in the Exhibit Index,which appears immediately following and is incorporated herein by reference,are filed as part of this annual report on Form 10-K.

 

**(b) Exhibits**

 

See the Exhibit Indexbelow.

 

**(c) Separate FinancialStatements and Schedules**

 

None.

 

**EXHIBIT INDEX**

** **

**Form 10-K for Fiscal Year Ended June 30, 2009**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                             |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                        |
| 2.1*             |       | Securities  Purchase Agreement, dated April 15, 2005, among RA Cerberus  Acquisition, LLC, Rafaella Sportswear, Inc., Verrazano, Inc.,  Ronald Frankel and Rafaella Corporation                         |
|             |       |                                                                                                                                                                                                                        |
| 2.2*             |       | Amendment  No. 1 to the Securities Purchase Agreement, dated May 27, 2005                                                                                                                                         |
|             |       |                                                                                                                                                                                                                        |
| 2.3*             |       | Contribution  Agreement, dated June 20, 2005, among Rafaella Sportswear, Inc. and  Rafaella Apparel Group, Inc.                                                                                              |
|             |       |                                                                                                                                                                                                                        |
| 3.1*             |       | Amended  and Restated Certificate of Incorporation of Rafaella Apparel  Group, Inc.                                                                                                                                    |
|             |       |                                                                                                                                                                                                                        |
| 3.2*             |       | Bylaws  of Rafaella Corporation                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                        |
| 3.3*             |       | Certificate  of Incorporation of Verrazano, Inc.                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                        |
| 3.4*             |       | Bylaws  of Verrazano, Inc.                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                        |
| 4.1*             |       | Stockholder’s  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  RA Cerberus Acquisition, LLC, Rafaella Sportswear, Inc. and  the principals set forth therein             |
|             |       |                                                                                                                                                                                                                        |
| 4.2*             |       | Indenture  for the 11 1/4% Senior Secured Notes  due 2011, dated June 20, 2005, among Rafaella Apparel  Group, Inc., the guarantors named therein and The Bank of New York, as  trustee and collateral agent |

 

48

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                 |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.3*             |       | First  Supplemental Indenture, dated July 12, 2006, among Rafaella Apparel  Group, Inc., the guarantors named therein and the Bank of New York, as  trustee and collateral agent                      |
|             |       |                                                                                                                                                                                                            |
| 4.4*             |       | Form of  111¤4% Senior Secured Notes  due 2011 (included in Exhibit 4.2)                                                                                                                    |
|             |       |                                                                                                                                                                                                            |
| 4.5*             |       | Form of  Guarantee (included in Exhibit 4.2)                                                                                                                                                          |
|             |       |                                                                                                                                                                                                            |
| 4.6*             |       | Registration  Rights Agreement, dated June 20, 2005, among Rafaella Apparel  Group, Inc., Jeffries & Company, Inc. and the guarantors  named therein                                    |
|             |       |                                                                                                                                                                                                            |
| 4.7*             |       | Intercreditor  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  Verrazano, Inc., HSBC Bank USA, National Association, The Bank of New  York, as trustee and collateral agent |
|             |       |                                                                                                                                                                                                            |
| 4.8*             |       | Second  Lien Security Agreement, dated June 20, 2005, in favor of The Bank of  New York, among Rafaella Apparel Group, Inc., the additional grantors  listed therein and The Bank of New York         |
|             |       |                                                                                                                                                                                                            |
| 10.1*            |       | Note  Purchase Agreement, dated June 13, 2005, among the Company,  Jeffries & Company, Inc. and the guarantors named therein                                                                 |
|             |       |                                                                                                                                                                                                            |
| 10.2*            |       | Escrow  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  RA Cerberus Acquisition, LLC, Ronald Frankel, and JPMorgan Chase  Bank, N.A., as escrow agent             |
|             |       |                                                                                                                                                                                                            |
| 10.3*            |       | Redemption  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  Rafaella Sportswear, Inc. and RA Cerberus Acquisition, LLC                                            |
|             |       |                                                                                                                                                                                                            |
| 10.4*            |       | Financing  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  Verrazano, Inc., HSBC Bank USA, National Association and Israel Discount  Bank of New York                       |
|             |       |                                                                                                                                                                                                            |
| 10.5*            |       | Continuing  Indemnity Agreement, dated June 20, 2005, between Rafaella Apparel  Group, Inc. and HSBC Bank USA, National Association                                                                   |
|             |       |                                                                                                                                                                                                            |
| 10.6*            |       | Pledge  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.  and HSBC Bank USA, National Association, as Agent                                                                         |
|             |       |                                                                                                                                                                                                            |
| 10.7*            |       | Continuing  Letter of Credit Agreement, dated June 20, 2005, among Rafaella Apparel  Group, Inc. and HSBC Bank USA, National Association                                                              |
|             |       |                                                                                                                                                                                                            |
| 10.8*            |       | Deposit  Account Control Agreement, dated June 20, 2005, among Rafaella Apparel  Group, Inc., The Bank of New York and HSBC Bank USA, National  Association                                           |
|             |       |                                                                                                                                                                                                            |
| 10.9*            |       | Trademark  Collateral Security Agreement, dated June 20, 2005, among Rafaella  Apparel Group, Inc. and HSBC Bank USA, National Association                                                            |
|             |       |                                                                                                                                                                                                            |
| 10.10*           |       | Factoring  Agreement, dated June 20, 2005, among GMAC Commercial Finance LLC  and Rafaella Apparel Group, Inc.                                                                                   |
|             |       |                                                                                                                                                                                                            |
| 10.11*           |       | Rafaella  Apparel Group, Inc. Equity Incentive Plan, dated June 20, 2005                                                                                                                              |
|             |       |                                                                                                                                                                                                            |
| 10.12*           |       | Employment  Agreement, dated June 20, 2005, between Rafaella Apparel  Group, Inc. and Chad J. Spooner                                                                                            |
|             |       |                                                                                                                                                                                                            |
| 10.13*           |       | Amendment  to the Employment Agreement, dated June 20, 2005 between Rafaella  Apparel Group, Inc. and Chad J. Spooner                                                                            |
|             |       |                                                                                                                                                                                                            |
| 10.14*           |       | Employment  Agreement, dated as of April 24, 2006, between Rafaella Apparel  Group, Inc. and Christa Michalaros                                                                                       |
|             |       |                                                                                                                                                                                                            |
| 10.15*           |       | Consulting  Agreement and General Release, effective as of April 25, 2006, among  Rafaella Apparel Group, Inc. and Glenn S. Palmer                                                               |
|             |       |                                                                                                                                                                                                            |
| 10.16*           |       | Employment  Agreement dated as of May 1, 2006, between Rafaella Apparel  Group, Inc. and Nichole Vowteras                                                                                             |
|             |       |                                                                                                                                                                                                            |
| 10.17*           |       | Amendment  to the Employment Agreement, dated as of June 20, 2006, between Rafaella  Apparel Group, Inc. and Nichole Vowteras                                                                         |

 

49

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18*           |       | Employment  Agreement, dated as of June 20, 2006, between Rafaella Apparel  Group, Inc. and Rosemary Mancino                                                                                                                                                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.19            |       | Employment  Agreement, dated as of January 22, 2007, between Rafaella Apparel  Group, Inc. and Jason W. Epstein, previously filed as  Exhibit 10.19 to Rafaella’s Quarterly Report on Form 10-Q for the  quarterly period ending March 31, 2007, filed May 15, 2007, and  herein incorporated by reference.                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.20            |       | Employment  Agreement, dated as of January 8, 2008, between Rafaella Apparel  Group, Inc. and Husein Jafferjee, previously filed as Exhibit 10.20  to Rafaella’s Current Report on Form 8-K, filed January 14, 2008,  and herein incorporated by reference.                                                                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.21            |       | Consent  and Amendment No. 3 to Financing Agreement, dated March 4, 2008,  among Rafaella Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA,  National Association and Israel Discount Bank of New York, previously filed  as Exhibit 10.21 to Rafaella’s Quarterly Report on Form 10-Q for  the quarterly period ending March 31, 2008, filed May 15, 2008, and  herein incorporated by reference. |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.22            |       | Amendment  No. 4 to Financing Agreement, dated March 28, 2008, among Rafaella  Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA, National  Association and Israel Discount Bank of New York, previously filed as  Exhibit 10.22 to Rafaella’s Quarterly Report on Form 10-Q for the  quarterly period ending March 31, 2008, filed May 15, 2008, and  herein incorporated by reference.            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.23            |       | Amendment  No. 5 to Financing Agreement, dated May 14, 2008, among Rafaella  Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA, National  Association and Israel Discount Bank of New York, previously filed as  Exhibit 10.23 to Rafaella’s Quarterly Report on Form 10-Q for the  quarterly period ending March 31, 2008, filed May 15, 2008, and  herein incorporated by reference.              |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.24            |       | Amendment  to Employment Agreement, dated as of August 28, 2008, between Rafaella  Apparel Group, Inc. and Husein Jafferjee, previously filed as  Exhibit 10.24 to Rafaella’s Current Report on Form 8-K, filed  September 3, 2008, and herein incorporated by reference.                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.25            |       | Agreement  for Chairman of Board of Directors, dated as of October 1, 2007, between  Rafaella Apparel Group, Inc. and John Kourakos, previously filed as  Exhibit 10.25 to Rafaella’s Current Report on Form 8-K, filed  September 3, 2008, and herein incorporated by reference.                                                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.26            |       | Amendment  No. 1 to Financing Agreement, dated March 31, 2006, among Rafaella  Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA, National  Association and Israel Discount Bank of New York.                                                                                                                                                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.27            |       | Amendment  No. 2 to Financing Agreement, dated December 31, 2006, among  Rafaella Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA,  National Association and Israel Discount Bank of New York.                                                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.28            |       | Amendment No. 6 to Financing Agreement, dated September 30,  2008, among Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC  Bank USA, National Association, previously filed as Exhibit 10.28 to  Rafaella’s Quarterly Report on Form 10-Q for the quarterly period ending  September 30, 2008, and herein incorporated by reference.                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.29            |       | Amended and Restated Collection Services Factoring Agreement, dated  as of December 16, 2008, between Rafaella Apparel Group, Inc. and  GMAC Commercial Finance LLC, previously filed as Exhibit 10.29 to  Rafaella’s Current Report on Form 8-K, filed December 16, 2008, and  herein incorporated by reference.                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.30            |       | Factoring Agreement (Collection), dated December 19, 2008,  between Rafaella Apparel Group, Inc. and Wells Fargo Trade Capital, LLC,  previously filed as Exhibit 10.29 to Rafaella’s Current Report on  Form 8-K, filed December 16, 2008, and herein incorporated by  reference.                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.31            |       | Factoring Agreement (Collection), dated December 19, 2008,  between Verrazano, Inc. and Wells Fargo Trade Capital, LLC, previously  filed as Exhibit 10.29 to Rafaella’s Current Report on Form 8-K,  filed December 16, 2008, and herein incorporated by reference.                                                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.32            |       | Amendment No. 7 to Financing Agreement, dated December 16,  2008, among Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC  Bank USA, National Association, previously filed as Exhibit 10.32 to  Rafaella’s Quarterly Report on Form 10-Q for the quarterly period ending  December 31, 2008, and herein incorporated by reference.                                                                   |

 

50

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                  |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.33            |       | Amendment No. 8 to Financing Agreement, dated February 10,  2009, among Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC  Bank USA, National Association, previously filed as Exhibit 10.33 to  Rafaella’s Quarterly Report on Form 10-Q for the quarterly period ending  December 31, 2008, and herein incorporated by reference. |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.34            |       | Amendment No. 9 to Financing Agreement, dated September 25,  2009, among Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC  Bank USA, National Association, previously filed as Exhibit 99.1 to  Rafaella’s Current Report on Form 8-K filed October 1, 2009, and  herein incorporated by reference.                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.35            |       | Employment Agreement dated as of April 3, 2009, between Rafaella  Apparel Group, Inc. and Lance Arneson, previously filed as  Exhibit 99.1 to Rafaella’s Current Report on Form 8-K, filed  June 9, 2009, and herein incorporated by reference.                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 10.36            |       | Letter Agreement dated as of July 28, 2009, between Rafaella  Apparel Group, Inc. and Joel H. Newman, previously filed as  Exhibit 99.1 to Rafaella’s Current Report on Form 8-K, filed  July 28, 2009, and herein incorporated by reference.                                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 21.1**           |       | List  of subsidiaries of Rafaella Apparel Group, Inc.                                                                                                                                                                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1**           |       | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2**           |       | Certification  of Interim Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                           |
|             |       |                                                                                                                                                                                                                                                                                                                                                                             |
| 32.1**           |       | Certification  of Chief Executive Officer and Interim Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                               |

 

----

*                                 Previously filed as an exhibit to theRegistration Statement on Form S-4 (Reg. No.: 333-138342) originallyfiled with the SEC on November 1, 2006.

 

**                          Filed herewith.

 

51

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**Table of Contents**

** **

**SIGNATURES**

** **

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| October 13, 2009 | **RAFAELLA APPAREL GROUP, INC****.** |
|-----------------------|--------------------------------------|
|                  |                                 |   |
|                  |                                 |   |
|                  | By:                                  | /s/ Christa Michalaros |
|                  |                                 | Christa Michalaros |
|                  |                                 | Chief Executive Officer and Director |
|                  |                                 | (Principal Executive Officer) |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 

 
| **Signature**               | ** ** | **Title**                                                                                                                                  | ** ** | **Date**              |
|-----------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|
| ** **                  |       |                                                                                                                                       |       |                  |
| **/s/  Christa Michalaros** |       | Chief Executive Officer and Director                                                                                                       |       | October 13, 2009 |
| ** **                  |       | (Principal Executive Officer)                                                                                                              |       |                  |
| **Christa  Michalaros**     | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| ** **                  | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| **/s/  Lance D. Arneson**   |       | Vice-President of Finance, Principal Accounting Officer and Interim  Chief Financial Officer  (Principal Financial and Accounting Officer) |       | October 13, 2009 |
| ** **                  |       |                                                                                                                                       |       |                  |
| **Lance  D. Arneson**       | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| ** **                  | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| **/s/ John Kourakos**       |       | Director, Chairman of the Board                                                                                                            |       | October 13, 2009 |
| ** **                  |       |                                                                                                                                       |       |                  |
| **John Kourakos**           | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| ** **                  | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| **/s/George  Kollitides**   |       | Director                                                                                                                                   |       | October 13, 2009 |
| ** **                  |       |                                                                                                                                       |       |                  |
| **George  Kollitides**      | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| ** **                  | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| **/s/ Joel Newman**         |       | Director                                                                                                                                   |       | October 13, 2009 |
| ** **                  |       |                                                                                                                                       |       |                  |
| **Joel Newman**             | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| ** **                  | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| **/s/  Ronald Frankel**     |       | Director                                                                                                                                   |       | October 13, 2009 |
| ** **                  |       |                                                                                                                                       |       |                  |
| **Ronald  Frankel**         | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| ** **                  | ** ** | ** **                                                                                                                                 | ** ** | ** **            |
| **/s/ Robert Newman**       |       | Director                                                                                                                                   |       | October 13, 2009 |
| ** **                  |       |                                                                                                                                       |       |                  |
| **Robert Newman**           | ** ** | ** **                                                                                                                                 | ** ** | ** **            |

 

**SUPPLEMENTAL INFORMATION TOBE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACTBY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12OF THE ACT**

** **

No annual reportor proxy material has been or will be distributed to the shareholders.

 

52

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**RafaellaApparel Group, Inc. and SubsidiariesConsolidated Financial Statements**

 

**Table ofContents**

 
| ** **                                                                                                              | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Audited Financial Statements                                                                                            |       |     |
|                                                                                                                    |       |     |
| Report of  Independent Registered Public Accounting Firm                                                                |       | F-2      |
| Consolidated  Balance Sheets at June 30, 2009 and 2008                                                             |       | F-3      |
| Consolidated  Statements of Operations for the years ended June 30, 2009, 2008, and  2007                          |       | F-4      |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the years ended  June 30, 2009, 2008, and 2007 |       | F-5      |
| Consolidated  Statements of Cash Flows for the years ended June 30, 2009, 2008, and  2007                          |       | F-6      |
| Notes  to Consolidated Financial Statements                                                                             |       | F-7      |

 

F-1

----

### Table of Contents

 

### **Report ofIndependent Registered Public Accounting Firm**

###  

To the Board of Directorsand Stockholders of Rafaella Apparel Group, Inc.:

 

In our opinion, theaccompanying consolidated balance sheets and the related consolidatedstatements of operations, stockholders’ equity and cash flows present fairly,in all material respects, the financial position of Rafaella Apparel Group, Inc.and its subsidiaries (the “Company”)****at June 30,2009 and June 30, 2008, and the results of their operations and their cashflows for each of the three years in the period ended June 30, 2009****in conformity with accounting principles generally acceptedin the United States of America.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.  We conducted our audits of these statementsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

As discussed in Note 2 tothe consolidated financial statements, the Company changed the manner in whichit accounts for uncertain tax positions in 2008. The Company adopted theprovisions of FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes - an Interpretation of FASB Statement No. 109” on July 1,2007.

 

 

PricewaterhouseCoopersLLP

New York, NY

 

 

October 13, 2009

 

F-2

----

Table of Contents

 

**RafaellaApparel Group, Inc. and SubsidiariesConsolidated Balance Sheets**

**(Inthousands, except number of shares)**

 
| ** **                                                                                                                                                                              | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Assets**                                                                                                                                                                              |       |                    |       |                    |       |
| Current assets:                                                                                                                                                                         |       |                    |       |                    |       |
| Cash and cash equivalents                                                                                                                                                               |       | $                       | 17,698     |                    | $          | 17,131 |   |
| Receivables, net                                                                                                                                                                        |       | 11,550                  |       | 15,286                  |       |
| Inventories                                                                                                                                                                             |       | 12,334                  |       | 33,249                  |       |
| Deferred income taxes                                                                                                                                                                   |       | 1,080                   |       | 3,578                   |       |
| Other current assets                                                                                                                                                                    |       | 5,557                   |       | 1,023                   |       |
| Total current assets                                                                                                                                                                    |       | 48,219                  |       | 70,267                  |       |
| Equipment and leasehold  improvements, net                                                                                                                                              |       | 1,703                   |       | 1,082                   |       |
| Intangible assets, net                                                                                                                                                                  |       | 35,265                  |       | 65,314                  |       |
| Deferred financing costs,  net                                                                                                                                                          |       | 2,199                   |       | 4,807                   |       |
| Other assets                                                                                                                                                                            |       | 93                      |       | 47                      |       |
| Deferred income taxes                                                                                                                                                                   |       |                    |       | 7,331                   |       |
| Total assets                                                                                                                                                                            |       | $                       | 87,479     |                    | $          | 148,848 |   |
|                                                                                                                                                                                    |       |                    |       |                    |       |
| **Liabilities and Stockholders’  Equity (Deficit)**                                                                                                                                |       |                    |       |                    |       |
| Current liabilities:                                                                                                                                                                    |       |                    |       |                    |       |
| Accounts payable                                                                                                                                                                        |       | $                       | 7,810      |                    | $          | 10,549 |   |
| Accrued expenses and other  current liabilities                                                                                                                                         |       | 2,168                   |       | 2,278                   |       |
| Current portion of senior  secured notes                                                                                                                                                |       |                    |       | 865                     |       |
| Total current liabilities                                                                                                                                                               |       | 9,978                   |       | 13,692                  |       |
| Senior secured notes                                                                                                                                                                    |       | 82,992                  |       | 119,748                 |       |
| Income taxes                                                                                                                                                                            |       | 1,770                   |       | 7,294                   |       |
| Deferred rent                                                                                                                                                                           |       | 422                     |       | 384                     |       |
| Total liabilities                                                                                                                                                                       |       | 95,162                  |       | 141,118                 |       |
| Commitments and  contingencies                                                                                                                                                          |       |                    |       |                    |       |
| Redeemable convertible  preferred stock—$.01 par value; redemption value $5.33 per share plus 10% per  annum; 7,500,000 shares authorized; 7,500,000 shares issued and outstanding |       | 56,110                  |       | 52,110                  |       |
| Stockholders’ equity  (deficit):                                                                                                                                                   |       |                    |       |                    |       |
| Common stock—$.01 par  value; 11,111,111 shares authorized; 2,500,000 shares issued and outstanding                                                                                |       | 25                      |       | 25                      |       |
| Additional paid in capital                                                                                                                                                              |       | 288                     |       | 264                     |       |
| Deemed dividend, in excess  of predecessor basis                                                                                                                                        |       | (26,022                 | )          | (26,022                 | )          |
| Retained earnings  (deficit)                                                                                                                                                            |       | (38,084                 | )          | (18,647                 | )          |
| Total stockholders’ equity  (deficit)                                                                                                                                              |       | (63,793                 | )          | (44,380                 | )          |
| Total liabilities and  stockholders’ equity (deficit)                                                                                                                              |       | $                       | 87,479     |                    | $          | 148,848 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

F-3

----

Table ofContents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**ConsolidatedStatements of Operations**

**(Inthousands)**

 
| ** **                                                      | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                            |       |                                         |       |                                         |       |                                         |       |
| Net sales                                                       |       | $                                            | 147,965    |                                         | $          | 177,990                                      |       | $ | 191,284 |   |
| Cost of sales                                                   |       | 113,037                                      |       | 129,086                                      |       | 127,170                                      |       |
| Gross profit                                                    |       | 34,928                                       |       | 48,904                                       |       | 64,114                                       |       |
| Selling, general and  administrative expenses                   |       | 30,199                                       |       | 32,513                                       |       | 30,951                                       |       |
| Intangible asset  impairment                                    |       | 25,840                                       |       | 34,504                                       |       |                                         |       |
| Operating income (loss)                                         |       | (21,111                                      | )          | (18,113                                      | )          | 33,163                                       |       |
| Interest expense, net                                           |       | 13,232                                       |       | 17,964                                       |       | 23,884                                       |       |
| Gain on senior secured  note purchases                          |       | (25,632                                      | )          | (3,124                                       | )          |                                         |       |
| Interest expense and other  financing, net                      |       | (12,400                                      | )          | 14,840                                       |       | 23,884                                       |       |
| Income (loss) before  provision for (benefit from) income taxes |       | (8,711                                       | )          | (32,953                                      | )          | 9,279                                        |       |
| Provision for (benefit  from) income taxes                      |       | 6,726                                        |       | (8,199                                       | )          | 2,999                                        |       |
| Net income (loss)                                               |       | (15,437                                      | )          | (24,754                                      | )          | 6,280                                        |       |
| Dividends accrued on  redeemable convertible preferred stock    |       | 4,000                                        |       | 4,000                                        |       | 4,000                                        |       |
| Net income (loss)  available to common stockholders             |       | $                                            | (19,437    | )                                            | $          | (28,754                                      | )          | $ | 2,280 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

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**RafaellaApparel Group, Inc. and Subsidiaries**

**ConsolidatedStatements of Stockholders’ Equity (Deficit)**

**(Inthousands, except number of shares)**

 
| ** **                                        | ** ** | **Common Stock** | ** ** | **Additional  Paid in** | ** ** | **Deemed  Dividend, in  excess of  predecessor** | ** ** | **Retained  Earnings  (Accumulated** | ** ** | ** **   | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------|------------|--------------|------------|
| ** **                                        | ** ** | **Shares**            | ** ** | **Amount**                   | ** ** | **Capital**                                                | ** ** | **basis**                            | ** ** | **Deficit)** | ** ** | **Total** | ** ** |
| Balance at June 30,  2006                    |       | 2,500,000             |       | $                            | 25         |                                                       |       |                                 | $          | (26,022      | )          | $ | 8,208 |   | $ | (17,789 | ) |
| Net income                                        |       |                  |       |                         |       |                                                       |       |                                 |       | 6,280        |       | 6,280 |   |
| Accretion of preferred  stock to redemption value |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| Stock-based compensation  expense                 |       |                  |       |                         |       | $                                                          | 241        |                                 |       |         |       |   | 241 |   |
| Balance at June 30,  2007                    |       | 2,500,000             |       | 25                           |       | 241                                                        |       | (26,022                              | )          | 10,488       |       | (15,268 | ) |
| Net loss                                          |       |                  |       |                         |       |                                                       |       |                                 |       | (24,754      | )          | (24,754 | ) |
| Accretion of preferred  stock to redemption value |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| Stock-based compensation  expense                 |       |                  |       |                         |       | 23                                                         |       |                                 |       |         |       | 23 |   |
| Adoption of FIN 48                                |       |                  |       |                         |       |                                                       |       |                                 |       | (381         | )          | (381 | ) |
| Balance at June 30,  2008                    |       | 2,500,000             |       | 25                           |       | 264                                                        |       | (26,022                              | )          | (18,647      | )          | (44,380 | ) |
| Net loss                                          |       |                  |       |                         |       |                                                       |       |                                 |       | (15,437      | )          | (15,437 | ) |
| Accretion of preferred  stock to redemption value |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| Stock-based compensation  expense                 |       |                  |       |                         |       | 24                                                         |       |                                 | ** ** | ** **   |       | 24 |   |
| Balance at June 30,  2009                    |       | 2,500,000             |       | $                            | 25         |                                                       | $          | 288                                  |       | $            | (26,022    | ) | $ | (38,084 | ) | $ | (63,793 | ) |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

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**RafaellaApparel Group, Inc. and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Inthousands)**

 
| ** **                                                                                | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                                                      |       |                                         |       |                                         |       |                                         |       |
| Cash flows provided by  operating activities:                                             |       |                                         |       |                                         |       |                                         |       |
| Net income (loss)                                                                         |       | $                                            | (15,437    | )                                            | $          | (24,754                                      | )          | $ | 6,280 |   |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |                                         |       |                                         |       |                                         |       |
| Amortization of deferred  finance charges                                                 |       | 1,386                                        |       | 1,755                                        |       | 3,849                                        |       |
| Accretion of original  issue discount                                                     |       | 835                                          |       | 1,041                                        |       | 772                                          |       |
| Depreciation and  amortization                                                            |       | 4,671                                        |       | 4,504                                        |       | 4,985                                        |       |
| Stock-based compensation  expense                                                         |       | 24                                           |       | 23                                           |       | 241                                          |       |
| Income taxes                                                                              |       | 4,305                                        |       | (10,236                                      | )          | (2,364                                       | )          |
| Deferred rent                                                                             |       | 38                                           |       | 64                                           |       | 191                                          |       |
| Gain on senior secured  note purchases                                                    |       | (25,632                                      | )          | (3,124                                       | )          |                                         |       |
| Intangible asset impairment                                                               |       | 25,840                                       |       | 34,504                                       |       |                                         |       |
| Changes in operating  assets and liabilities:                                             |       |                                         |       |                                         |       |                                         |       |
| Accounts receivable                                                                       |       | 3,736                                        |       | 5,499                                        |       | 1,725                                        |       |
| Inventories                                                                               |       | 20,915                                       |       | 11,126                                       |       | 2,679                                        |       |
| Other current assets                                                                      |       | (4,534                                       | )          | 1,163                                        |       | (46                                          | )          |
| Accounts payable                                                                          |       | (2,739                                       | )          | (3,336                                       | )          | (2,440                                       | )          |
| Accrued expenses and other  current liabilities                                           |       | (110                                         | )          | (1,351                                       | )          | 871                                          |       |
| Other assets                                                                              |       | (46                                          | )          | (6                                           | )          |                                         |       |
| Net cash provided by  operating activities                                                |       | 13,252                                       |       | 16,872                                       |       | 16,743                                       |       |
| Cash flows used in  investing activities:                                                 |       |                                         |       |                                         |       |                                         |       |
| Purchase of equipment and  leasehold improvements                                         |       | (1,083                                       | )          | (966                                         | )          | (214                                         | )          |
| Net cash used in investing  activities                                                    |       | (1,083                                       | )          | (966                                         | )          | (214                                         | )          |
| Cash flows used in financing  activities:                                                 |       |                                         |       |                                         |       |                                         |       |
| Repurchase of senior  secured notes                                                       |       | (11,552                                      | )          | (10,135                                      | )          | (31,816                                      | )          |
| Deferred financing costs                                                                  |       | (50                                          | )          | (30                                          | )          |                                         |       |
| Change in book overdraft                                                                  |       |                                         |       |                                         |       | (596                                         | )          |
| Net cash used in financing  activities                                                    |       | (11,602                                      | )          | (10,165                                      | )          | (32,412                                      | )          |
| Net increase (decrease) in  cash and cash equivalents                                     |       | 567                                          |       | 5,741                                        |       | (15,883                                      | )          |
| Cash and cash equivalents,  beginning of period                                           |       | 17,131                                       |       | 11,390                                       |       | 27,273                                       |       |
| Cash and cash equivalents,  end of period                                                 |       | $                                            | 17,698     |                                         | $          | 17,131                                       |       | $ | 11,390 |   |
| Supplemental disclosures  of cash flow information:                                       |       |                                         |       |                                         |       |                                         |       |
| Cash paid during the  period for:                                                         |       |                                         |       |                                         |       |                                         |       |
| Interest                                                                                  |       | $                                            | 11,232     |                                         | $          | 15,538                                       |       | $ | 20,104 |   |
| Income taxes                                                                              |       | 7,203                                        |       | 548                                          |       | 7,326                                        |       |
| Supplemental disclosures  of non-cash financing activities:                               |       |                                         |       |                                         |       |                                         |       |
| Accretion of preferred  stock to redemption value                                         |       | $                                            | 4,000      |                                         | $          | 4,000                                        |       | $ | 4,000 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

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**RafaellaApparel Group, Inc.Notes to Consolidated Financial Statements**

 

**1.  Descriptionof Business and Acquisition**

 

Rafaella Apparel Group, Inc.,together with its subsidiaries (the “Company”), is a wholesaler, designer,sourcer, marketer and distributer of a full line of women’s career and casualsportswear separates sold primarily under the Rafaella brand and private labelbrands of our customers.  The Company’sproducts are sold to department and specialty stores and off-price retailerslocated throughout the United States of America.

 

The Company, a Delawarecorporation, was formed to effect the acquisition of Rafaella Sportswear, Inc.(the “Predecessor”) by RA Cerberus Acquisition, LLC.  On June 20, 2005, pursuant to aSecurities Purchase Agreement dated April 15, 2005, as amended, theCompany issued redeemable convertible preferred stock (the “Preferred Stock”)to RA Cerberus Acquisition, LLC for $40,000,000 (note 10).  Immediately prior to the issuance of thePreferred Stock, the Predecessor contributed substantially all of its assets tothe Company in exchange for 100% of the Company’s common stock (10,000,000shares) and the assumption of certain liabilities related to the contributedassets.  Immediately following theissuance of the Preferred Stock, the Company issued $172,000,000 Senior SecuredNotes (note 9) and entered into a $62,500,000 revolving credit facility (note8).  Proceeds from the Preferred Stock,Senior Secured Notes issuance and borrowings under the revolving creditfacility were used to redeem 7,500,000 shares of common stock, pay transactioncosts, pay debt issuance costs, and retire short term borrowings of thePredecessor.

 

The June 20, 2005transaction was accounted for as a purchase of the Predecessor’s business inaccordance with Statement of Financial Accounting Standards No. 141, “BusinessCombinations,” and the Emerging Issues Task Force Issue No. 88-16, “Basisin Leveraged Buyout Transactions”.  Asthe stockholders of the Predecessor (“Continuing Stockholders”) retained a 25%interest in the Company through the Predecessor’s ownership of the commonstock, the assets and liabilities of the Company were assigned new values,which are part carryover basis (25%) and part fair value basis (75%).  The Continuing Stockholders’ residualinterest in the Company applied to the incremental debt resulting from theacquisition was accounted for as a deemed dividend and recognized as areduction of stockholders’ equity (deficit).

 

FASB Statement No. 131,“Disclosures about Segments of an Enterprise and Related Information”,established standards for reporting information about operating segments.  Operating segments are defined as componentsof an enterprise for which separate financial information is available andevaluated regularly by the chief operating decision-maker, or decision-makinggroup, in deciding how to allocate resources and in assessing performance.  The Company is organized as, and operates in,one reportable segment:  the designing,sourcing, and marketing of a full line of women’s career and casual sportswearseparates.  The Company’s chief operatingdecision-maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial informationpresented on a consolidated basis, accompanied by information about revenue bycustomer, for purposes of evaluating financial performance and allocatingresources.  The Company’s operations andassets are primarily located in the United States of America.

 

The classification ofcertain prior year’s amounts have been revised to conform with the currentyear’s presentation.

 

**2.  SignificantAccounting Policies**

 

**Basis of consolidation**

 

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries.  Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.

 

**Use of estimates**

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the consolidated financial statements andthe reported amounts of revenues and expenses during the reporting period.  Estimates by their nature are based onjudgments and available information. Therefore, actual results could differ materially from those estimatesunder different assumptions and conditions. The most significant assumptions and estimates involved in preparing thefinancial statements include, among other things, income taxes, customerallowances for discounts, returns, markdowns, co-op advertising and operationalchargebacks, lower of cost or market estimates related to inventory, and theestimated useful lives and fair values of intangible assets.

 

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**Cash and cash equivalents**

 

Cash and cash equivalentsinclude overnight deposits with banks, which are unrestricted as to withdrawalor use, and have an original maturity of three months or less.  Interest income, included within interestexpense, net that was earned on the Company’s cash and cash equivalentsamounted to $54,000, $310,000, and $1,079,000, for the years ended June 30,2009, 2008 and 2007, respectively.

 

**Receivables**

 

The Company assigns andsells certain of its accounts receivable pursuant to an agreement with a largecommercial financial institution (the “factor”) whereby the factor pays theCompany after the factor receives payment from the Company’s customer.  The factor will assume credit risk on allassigned accounts receivable for which it has provided written creditapproval.  An allowance for salesdiscounts, returns, markdowns, co-op advertising and operational chargebacks isincluded as a reduction to net sales and receivables.  Certain of these provisions result fromseasonal negotiations with customers, as well as historic deduction trends andthe evaluation of current market conditions. The Company also grants credit directly to certain customers in thenormal course of business without participation by the factor.  An allowance for doubtful accounts isdetermined through an analysis of the aging of accounts receivable at the dateof the financial statements, assessments of collectability based on anevaluation of historic and anticipated trends, the financial condition of theCompany’s customers, and an evaluation of the impact of economicconditions.  The Company’s historicalestimates of these costs have not differed materially from actual results.

 

**Inventories**

 

Inventories are stated atthe lower of cost or market, with cost being determined at standard costs,which approximate the FIFO (First-in, First-out) method.  Cost includes amounts paid to purchase piecegoods and manufacture the Company’s products, plus duty, quota, inbound freightand costs associated with the Company’s Hong Kong subsidiary.

 

**Long-lived assets**

 

Equipment and leaseholdimprovements are stated at cost less accumulated depreciation andamortization.  The Company capitalizesimprovements to the extent they increase the economic life of the asset.  Furniture, fixtures, and equipment aredepreciated using the straight-line method over their estimated useful lives of3 to 10 years.  Leaseholdimprovements are amortized over the shorter of the remaining lease term or theestimated useful lives of the assets. Depreciation and amortization expense is included in selling, generaland administrative expenses. Expenditures for maintenance and repairs are expensed in the periodincurred.

 

Intangible assets consistof the trademark and trade name, customer relationships of the Predecessor, andnon-compete agreements with officers of the Predecessor, acquired on June 20,2005.  Customer relationships areamortized using straight-line and accelerated methods over their estimateduseful lives of 7 and 15 years, respectively.  Non-compete agreements are amortized usingthe straight-line method over their estimated useful lives of 2 and10 years.  Owned trademarks havebeen determined to have indefinite lives and are not subject to amortization.

 

The Company’s policy isto evaluate depreciable and amortizable assets (fixed assets, customerrelationships and non-compete agreements) for impairment whenever events orchanges in circumstances indicate that the carrying amount of such assets maynot be recoverable from the undiscounted cash flows expected from the use ofthe asset.  These depreciable andamortizable assets are tested for impairment by comparing the carrying amountof the assets to their fair values.  Thisapproach is dependent upon future growth and trends.  Any impairment loss would be measured as theexcess of carrying amount over the fair value of the asset, determined on thebasis of discounted cash flows from the expected use of the asset.

 

The trademark andtrade name, which have been determined to be indefinite lived assets, aretested for impairment at least annually or when changes in circumstancesindicate that their carrying amount may not be recoverable, by comparing thecarrying amount of the assets to their fair values based on an income approachusing the relief-from-royalty method. This method assumes that, in lieu of ownership, a firm would be willingto pay a royalty in order to exploit the related benefits of these assets.  This approach is dependent upon a number offactors, including estimates of future growth and trends, royalty rates forintellectual property, discount rates and other variables.  The Company bases its fair value estimates onassumptions it believes are reasonable, but which are unpredictable andinherently uncertain.  Actual futureresults may differ from those estimates. If the estimated fair value of the assets is less than their carryingamount, an impairment loss is recognized equal to such difference.

 

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**Deferred financing costs**

 

Costs associated withobtaining long-term financing are deferred and amortized, under the effectiveinterest method, over the terms of the related debt.  Amortization of these costs is included ininterest expense.

 

**Revenue recognition**

 

Sales are recognized whenmerchandise is delivered and title and risk of loss are transferred tocustomers.  Revenue is recorded net ofestimated discounts, returns and allowances. Discounts are based on trade terms. Returns and allowances require pre-approval from management.  On a seasonal basis, the Company negotiatesprice allowances with its customers as sales incentives or for the cost ofcertain promotions.  These allowances areestimated based on historic trends, seasonal results, an evaluation of currenteconomic conditions, and retailer performance.

 

**Cost of sales**

 

Cost of sales includesexpenses to acquire and produce goods for sale, including product costs,freight, import costs, third party inspection activity, and provisions forshrinkage, excess and obsolete inventory. Warehousing activities, including receiving, storing, picking, packingand general warehousing costs, are included in selling, general andadministrative expenses.

 

**Advertising**

 

The Company recordsadvertising expense as incurred. Cooperative advertising expenses without specific performance guidelinesare reflected as a reduction of net sales and for the years ended June 30,2009, 2008 and 2007 were approximately $1,643,000, $2,302,000, and $1,478,000,respectively.  Non cooperativeadvertising expenses approximated $132,000 and $225,000 for the years ended June 30,2009 and 2008.  Non cooperativeadvertising for the year ended June 30, 2007 was not significant.

 

**Shipping and handling costs**

 

The Company includesshipping and handling costs associated with inbound freight in cost ofsales.  Shipping and handling costsassociated with outbound freight are included in selling, general andadministrative expenses and for the years ended June 30, 2009, 2008 and2007 amounted to approximately $300,000, $332,000, and $470,000, respectively.

 

**Income taxes**

 

Deferred taxes areprovided for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of assets and liabilities and theirrespective tax bases, as measured by enacted tax rates in effect in periodswhen the deferred tax assets and liabilities are expected to be settled orrealized.  A valuation allowance isprovided on deferred tax assets when it is more likely than not that suchdeferred tax asset will not be realized.

 

The Company adopted the provisions of FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes — aninterpretation of FASB Statement No. 109” (“FIN 48”), on July 1,2007.  As a result of this adoption, theCompany recognized an increase in liabilities for uncertain tax positions ofapproximately $6.3 million with a corresponding increase in the deferred taxasset of $5.9 million representing the gross unrecognized tax benefits.  Upon adoption, $0.6 million of interest, netof $0.2 million tax benefit, was recorded to retained earnings.  The Company recognizes interest expenserelated to unrecognized tax benefits in income tax expense.

 

**Recent accounting pronouncements**

 

In June 2009, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 167, “Amendments to FASB Interpretation No. 46(R)”(“SFAS 167”). The objective of this statement is to improve financial reportingby enterprises involved with variable interest entities. This statementaddresses (1) the effects on certain provisions of FASB Interpretation No. 46(revised December 2003), “Consolidation of Variable Interest Entities”, asa result of the elimination of the qualifying special-purpose entity concept inSFAS No. 166, “Accounting for Transfers of Financial Assets-an amendmentof FASB Statement No. 140” (“SFAS 166”), and (2) concern about theapplication of certain key provisions of FASB 

 

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Interpretation No. 46(R),including those in which the accounting and disclosures under theinterpretation do not always provide timely and useful information about anenterprise’s involvement in a variable interest entity. This statement iseffective as of the beginning of each reporting entity’s first annual reportingperiod that begins after November 15, 2009, for interim periods withinthat first annual reporting period, and for interim and annual reportingperiods thereafter. Earlier application is prohibited. The Company isevaluating the impact the adoption of SFAS 167 will have on its consolidatedfinancial statements.

 

In June 2009, theFASB issued SFAS 166. SFAS 166 improves the relevance, representationalfaithfulness, and comparability of the information that a reporting entityprovides in its financial statements about a transfer of financial assets; theeffects of a transfer on its financial position, financial performance, andcash flows; and a transferor’s continuing involvement, if any, in transferredfinancial assets. SFAS 166 is effective as of the beginning of each reportingentity’s first annual reporting period that begins after November 15,2009, for interim periods within that first annual reporting period and forinterim and annual reporting periods thereafter. The Company is evaluating theimpact the adoption of SFAS 166 will have on its consolidated financialstatements.

 

In May 2009, theFASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”).  SFAS 165requires the disclosure of the date through which an entity has evaluatedsubsequent events for potential recognition or disclosure in the financialstatements and whether that date represents the date the financial statementswere issued or were available to be issued.  This standard also providesclarification about circumstances under which an entity should recognize eventsor transactions occurring after the balance sheet date in its financialstatements and the disclosures that an entity should make about events ortransactions that occurred after the balance sheet date.  This standard iseffective for interim and annual periods beginning with our fiscal year ended June 30,2009. The Company adopted SFAS 165 effective June 30, 2009 and has madethe appropriate additional disclosures in its consolidated financialstatements.

 

In April 2008, the FASBissued FASB Staff Position No. (“FSP”) FAS 142-3, “Determination of theUseful Life of Intangible Assets.”  ThisFSP amends the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset under FASB Statement No. 142, “Goodwill and OtherIntangible Assets” (“SFAS 142”). The intent of this FSP is to improve the consistency between the usefullife of a recognized intangible asset under SFAS 142 and the period of expectedcash flows used to measure the fair value of the asset under SFAS No. 141(R),“Business Combinations” and other U.S. generally accepted accountingprinciples.  This FSP is effective forfinancial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years.  The Company is currently evaluating theimpact of this FSP, if any, on its results of operations and financialposition.

 

On September 15,2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements” (“SFAS157”).  SFAS 157 defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  SFAS 157 is effective forfiscal years beginning after November 15, 2007.  In February 2008, the FASB issued StaffPositions No. FAS 157-1 and No. FAS 157-2 which delayed the effectivedate of SFAS 157 for one year for certain non financial assets and liabilitiesand removed certain leasing transactions from its scope.  The Company is currently analyzing SFAS 157and its impact on the Company’s financial condition and results of operations.

 

**3.  Stock-basedcompensation**

 

Stock-based compensationawards are accounted for in accordance with Statement of Financial AccountingStandards No. 123R, “Share-Based Payments.”  The Rafaella Apparel Group, Inc. EquityIncentive Plan (the “Plan”) provides for the issuance of stock option andrestricted stock-based compensation awards to senior management, other key employees,and consultants to the Company.  TheCompany has reserved 1,111,111 shares of common stock for issuance pursuant tothe terms of the Plan.  While the termsof individual awards may vary, employee stock options granted to-date vest inannual increments of 25% over the first four years of the grant, expire nolater than ten years after the grant date, and have an exercise price of $5.33per share.

 

Under the Plan, unvestedawards become immediately vested upon the occurrence of a Liquidity Event.  A Liquidity Event, as defined in the Plan, is(i) a change in control, (ii) the sale, transfer or other dispositionof all or substantially all of the business and assets, (iii) theconsummation of an initial public offering, or (iv) the dissolution or liquidationof the Company.  Common stock acquiredthrough the exercise of stock option grants or vesting of restricted stockissued under the Plan may not be sold, disposed of or otherwise transferred bya participant of the Plan prior to a Liquidity Event without the consent ofCerberus Capital Management, L.P. (“Cerberus”), a shareholder of the Company.

 

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Under the Plan, prior toa Liquidity Event, the Company has the right, but not the obligation, topurchase from a participant and to cause the participant to sell to theCompany, common stock acquired through the exercise of stock option grants orvesting of restricted stock issued following the participant’s (i) death, (ii) terminationof employment with the Company as a result of disability, (iii) terminationof employment by the Company without cause, (iv) termination of employmentby the Company for cause, or (v) termination of employment with theCompany for any other reason.  Thepurchase price for shares under clauses (i), (ii), or (iii) above is thegreater of (a) the purchase price paid for such shares by the participantand (b) the fair market value of such shares.  The purchase price for shares under clauses (iv) and(v) above is the lesser of (a) the purchase price, if any, paid forsuch shares by the participant, or if no price was paid, one dollar ($1.00) and(b) 50% of the fair market value of such shares.  If at any time after an initial publicoffering, a participant’s employment or relationship is terminated for cause,the Company has the right, but not the obligation, to purchase from theparticipant and to cause the participant to sell to the Company, all commonstock acquired through the exercise of stock option grants or vesting ofrestricted stock issued for the same purchase price as that of clauses (iv) and(v) above.  In the event that theCompany does not exercise its repurchase rights above, Cerberus may also electto repurchase the shares under the same terms and conditions.

 

The Company uses theBlack-Scholes option pricing model to determine the fair value of stock-optionawards. The weighted-average estimated fair value of stock options grantedduring the year ended June 30, 2007 was $1.82.  Fair value was estimated using theBlack-Scholes option pricing model with the following assumptions: (i) dividendyield - 0%, (ii) expected volatility - range of 40% to 50%, (iii) risk-freeinterest rate - range of 4.76% to 4.92%, and (iv) expected life - 4 to 5years.  There were no stock optionsgranted during the years ended June 30, 2009 and 2008.

 

A summary of stock optionplan activity during the year ended June 30, 2009 is presented below:

 
| ** **                              | ** ** | **Shares** | ** ** | **Weighted********Average********Remaining********Contractual  Life********(in  years)** | ** ** |
|-----------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------|------------|
| Options outstanding, July 1, 2008  |       | 1,111,111  |       |                                                                                     |       |
| Forfeited                               |       | (145,834   | )          |                                                                                     |       |
| Options outstanding, June 30, 2009 |       | 965,277    |       | 7.2                                                                                      |       |
| Options exercisable, June 30, 2009 |       | 798,610    |       | 7.2                                                                                      |       |

 

As of June 30, 2009,common stock that could be acquired through the exercise of 409,722 stockoptions are subject to the call right provisions described above.  Subsequent to a Liquidity Event, the callright provisions lapse, except for employees terminated for cause.  As a result of the call right provisions, thestock option awards do not substantively vest prior to the occurrence of aLiquidity Event.  Accordingly,stock-based compensation expense will not be recognized until it is probablethat a Liquidity Event will occur.  As ofJune 30, 2009, it was not probable that a Liquidity Event will occur.  Unrecognized compensation costs related tothese options approximated $240,000 at June 30, 2009.

 

The Company recordedcompensation expense related to 555,555 stock options, not subject to the callright provisions described above, of approximately $24,000, $23,000 and$241,000 during the years ended June 30, 2009, 2008 and 2007,respectively.  As of June 30, 2009,there was an additional $19,000 of unrecognized compensation cost related tothese options, which will be recognized ratably as compensation expense over aweighted average vesting period of 0.8 years. Subsequent to June 30, 2009, 187,500 options to purchase shares ofcommon stock of the Company were forfeited in connection with the departure of aformer executive of the Company.

 

TheCompany is obligated to pay certain cash payments equal to one and three-tenthspercent (1.3%) of the Appreciated Value of the Company in connection with SaleTransactions and one and three-tenths percent (1.3%) of the Net Dividends paidother than in connection with a Sale Transaction (each term as defined) inconnection with two separate agreements entered into among the Company and aformer employee and a member of the Company’s board of directors during theyear ended June 30, 2008.  As thecash payments are contingent in nature, compensation expense will not berecognized until it is probable that such payments will occur.  As of June 30, 2009, it was not probablethat a Sale Transaction or a Net Dividend payment will occur.

 

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**4.  Receivables**

 

Receivables consist of (in thousands):

 
| ** **                                                  | ** ** | **June 30, 2009** | ** ** | **June 30, 2008** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
|                                                        |       |                   |       |                   |       |
| Due from factor                                             |       | $                      | 18,260     |                   | $          | 12,732 |   |
| Trade receivables                                           |       | 1,712                  |       | 10,000                 |       |
|                                                        |       | 19,972                 |       | 22,732                 |       |
| Less: Allowances for sales  returns, discounts, and credits |       | (8,422                 | )          | (7,446                 | )          |
|                                                        |       | $                      | 11,550     |                   | $          | 15,286 |   |

 

Historically,the Company factored a significant portion of its trade receivables, on anon-recourse basis, with GMAC Commercial Finance LLC (“GMAC”), a commercialfactor.  In accordance with the terms of an Amended and RestatedCollection Services Factoring Agreement dated December 16, 2008 betweenGMAC and the Company, all accounts receivable of the Company then held by GMACwere sold back to the Company effective as of such date.  On December 19,2008, the Company delivered to GMAC a notice of termination of the GMACarrangement pursuant to the terms thereof.  On February 5, 2009, aspart of the termination of the GMAC arrangement, the Company arranged for anirrevocable letter of credit in an aggregate amount of $2,000,000 (the “Letterof Credit”) for the benefit of GMAC.  The Letter of Credit permits GMAC todraw amounts equal to amounts collected by GMAC, after January 6, 2009, ifcertain identified customers of the Company file a petition for relief fromcreditors under the United States Bankruptcy Code and claims are made for GMACto return to the customer or its bankruptcy estate amounts GMAC has collectedfrom such customer.  The Letter of Credit was subsequently reduced to$65,000 in September 2009 and expires on February 4, 2010, subject toextension under certain circumstances.

 

On December 19,2008, the Company entered into a factoring agreement with Wells Fargo TradeCapital, LLC (“Wells Fargo”), a commercial factor, pursuant to which theCompany may sell certain of its receivables to Wells Fargo on a non-recoursebasis.  Wells Fargo will assume credit risk on all sales that are approvedin advance.

 

Anallowance for sales discounts, returns, markdowns, co-op advertising andoperational chargebacks is included as a reduction to net sales andreceivables.  These provisions result from seasonal negotiations withcustomers, as well as historic deduction trends and the evaluation of currentmarket conditions.

 

For the years ended June 30,2009, 2008 and 2007, the provision for sales returns, discounts and creditscharged to earnings was $35,223,000, $34,364,000, and $35,141,000,respectively, and decreased by authorized deductions taken by customers of$34,247,000, $33,836,000, and $35,830,000, respectively.

 

**5.  Inventories**

 

Inventories are summarized as follows (in thousands):

 
| ** **                         | ** ** | **June 30, 2009** | ** ** | **June 30, 2008** | ** ** |
|------------------------------------|------------|------------------------|------------|------------------------|------------|
|                               |       |                   |       |                   |       |
| Piece goods (held by  contractors) |       | $                      | 266        |                   | $          | 1,544 |   |
| Finished goods:                    |       |                   |       |                   |       |
| In warehouse                       |       | 6,761                  |       | 20,170                 |       |
| In transit                         |       | 5,307                  |       | 11,535                 |       |
|                               |       | $                      | 12,334     |                   | $          | 33,249 |   |

 

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**6.  Equipmentand Leasehold Improvements**

 

Equipment and leasehold improvements consist of thefollowing (in thousands):

 
| ** **                                       | ** ** | **June 30, 2009** | ** ** | **June 30, 2008** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                             |       |                        |       |                        |       |
| Furniture, fixtures and  equipment               |       | $                           | 2,083      |                        | $          | 1,136 |   |
| Leasehold improvements                           |       | 375                         |       | 239                         |       |
|                                             |       | 2,458                       |       | 1,375                       |       |
| Less: Accumulated  depreciation and amortization |       | (755                        | )          | (293                        | )          |
|                                             |       | $                           | 1,703      |                        | $          | 1,082 |   |

 

Depreciation andamortization expense of equipment and leasehold improvements for the yearsended June 30, 2009, 2008 and 2007 were approximately $462,000, $168,000,and $45,000, respectively.

 

**7.  IntangibleAssets**

 

Intangible assetsresulting from the June 20, 2005 acquisition, consist of the following asof June 30, 2009 and 2008 (in thousands):

 
| ** **                      | ** ** | **Estimated  Lives** | ** ** | **2009** | ** ** | **2008** | ** ** |
|---------------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Customer relationships          |       | 7, 15 years          |       | $        | 43,525     |     | $          | 43,525 |   |
| Less: Accumulated  amortization |       |                 |       | (17,359  | )          | (13,406  | )          |
|                            |       |                 |       | 26,166   |       | 30,119   |       |
|                            |       |                 |       |     |       |     |       |
| Non-compete agreements          |       | 2, 10 years          |       | 3,067    |       | 3,067    |       |
| Less: Accumulated  amortization |       |                 |       | (1,525   | )          | (1,269   | )          |
|                            |       |                 |       | 1,542    |       | 1,798    |       |
|                            |       |                 |       |     |       |     |       |
| Trademark and trade name        |       | Indefinite life      |       | 7,557    |       | 33,397   |       |
| Total intangible assets         |       |                 |       | $        | 35,265     |     | $          | 65,314 |   |

 

The Company’sindefinite-lived intangible assets consist of the Rafaella trademark and tradename, as the Company believes these assets will contribute to cash flowsindefinitely.  These assets have been inexistence since the Company’s inception 25 years ago, and there is noforeseeable limit on the period of time over which they are expected tocontribute to cash flows.  In accordancewith SFAS No. 142, the Company’s trademark and trade name are reviewed atleast annually for impairment.  TheCompany performed an impairment test of the trademark and trade name during thesecond and fourth quarters of the fiscal year ended June 30, 2009 and thefourth quarter of the fiscal year ended June 30, 2008 and determined thatthe trademark and trade name was impaired necessitating a charge of $23.4million, $2.4 million and $34.5 million, respectively.  The impairment resulted from decreased salesand cash flows attributed to the Rafaella brand and reductions to managementforecasts resulting from the continuing adverse economic conditions and currentstate of the US retail apparel environment. The impairment charges of $25.8 million and $34.5 million are reflectedwithin selling, general and administrative expenses for the years ended June 30,2009 and 2008.  There were no impairmentsor impairment indicators present and therefore no impairment loss was recordedduring the fiscal year ended June 30, 2007.  The Company re-evaluated the useful lives ofthe trademark and tradename and customer relationships as of June 30, 2009and determined that the impairment and other circumstances did not warrantrevised estimates of useful lives.  Bothnon-compete agreements are with Directors of the Company.  The amortization expense related tointangible assets for the years ended June 30, 2009, 2008 and 2007 wasapproximately $4,209,000, $4,336,000, and $4,940,000, respectively.

 

Estimated amortization expense for the next fiveyears is as follows:

 
| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2010       |       | $                       | 3,934      |   |
| 2011       |       | 3,661                   |       |
| 2012       |       | 3,401                   |       |
| 2013       |       | 2,874                   |       |
| 2014       |       | 2,661                   |       |
|            |            |                         |            |  |

 

Webase our fair value estimates on assumptions we believe are reasonable, butwhich are unpredictable and inherently uncertain.  Actual future results may differ from thoseestimates.  If the estimated fair valueof the assets is less than their carrying amount, an impairment loss isrecognized equal to such difference.

 

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**8.  Short-termBorrowings**

 

On June 20,2005, the Company entered into a secured revolving credit facility agreement(as amended, the “Credit Facility”) with HSBC Bank USA, National Association (“HSBC”),expiring on June 10, 2010. Effective September 30, 2008, the Company entered into an amendmentof the Credit Facility with HSBC that changed certain terms of theagreement.  The Company sought to amendthe Credit Facility as it would not have been in compliance with its workingcapital financial covenant as of September 30, 2008.  On February 10, 2009, the Companyamended the Credit Facility’s positive net income financial covenant as theCompany’s forecasts indicated that there was the likelihood that the Companywould not be in compliance with the net income financial covenant, at somepoint, over the next 12 months.  On September 25,2009, the Company further amended the Credit Facility as it would not have beenin compliance with its working capital financial covenant at any point on orafter June 30, 2010.  The amendmentis effective as of September 25, 2009. The following amendments and modifications to the Credit Facility, amongothers, were effected by the September 25, 2009 amendment: (i) extensionof the term of the Credit Facility from June 20, 2010 to December 15,2010, (ii) a reduction in the maximum loan amount of the Credit Facilityfrom $45.0 million to $30.0 million, (iii) the addition of an affirmativecovenant requiring the Company to maintain certain minimum amounts of cashcollateral, (iv) a modification of a financial covenant to permit negativenet income during certain specified periods after September 30, 2009, (v) anadditional limitation on the undrawn aggregate dollar amounts that werepermitted to be outstanding under standby letters of credit and (vi) theworking capital financial covenant was modified to exclude indebtedness underthe Company’s senior secured notes at any point on or after June 30, 2010from the definition of current liabilities. The amended Credit Facility provides an aggregate maximum availability,if and when the Company has the requisite levels of assets, in the amount of$30.0 million that may be used for direct debt advances plus letters of credit,and is subject to a sub-limit of $20.0 million for direct debt advances and$6.0 million for standby letters of credit through December 31, 2009 and$4.0 million at all times thereafter. The Credit Facility is collateralized by substantially all of the assetsof the Company.

 

The Company’s aggregatemaximum borrowing availability under the Credit Facility is limited to the sumof (i) 85% of eligible receivables, plus (ii) the lesser of (A) thesum of (1) 50% of eligible inventory and (2) 50% of letters of creditissued for finished goods inventory, or (B) an inventory cap of $20.0million, plus (iii) cash collateral, reduced by (iv) reserves (asdefined).  The Company’s direct debtadvance borrowing availability under the Credit Facility is limited to thelesser of (i) $20.0 million, or (ii) the sum of (A) a borrowingbase overadvance amount (as defined) and (B) 85% of eligiblereceivables.  At June 30, 2009,there were no loans and $10.1 million of letters of credit outstanding underthe Credit Facility.  The Company’saggregate maximum availability for direct debt advances plus letters of creditapproximated $3.4 million as of June 30, 2009.

 

Borrowings under the CreditFacility bear variable interest at the Company’s option at either (i) abase rate or (ii) the London interbank offered rate plus two andthree-quarters percent (2.75%) per annum (each as defined).  The Credit Facility provides for a monthlycommitment fee of 0.25% on the unused portion of the available credit under thefacility.

 

Under the CreditFacility, the Company is required to maintain working capital in excess of$25.0 million.  Working capital isdefined as the sum of cash, accounts receivable, and inventory, reduced bycurrent liabilities; the definition of current liabilities excludesindebtedness under the Company’s senior secured notes at any point on or after June 30,2010.  With the exception of the fiscalquarters ending on March 31, 2009, June 30, 2009, June 30, 2010,and September 30, 2010, the Company is required to maintain positive netincome during each period of two consecutive fiscal quarters.  The Company is permitted to incur up to a netloss of $750,000 during each of the two consecutive fiscal quarters (on arolling basis) ending on March 31, 2009 and June 30, 2009 and up to anet loss of $1,300,000 during each of the two consecutive fiscal quarters (on arolling basis) ending on June 30, 2010 and September 30, 2010.  For purposes of determining compliance withthe net income financial covenant, the definition of net income excludesnoncash expenses associated with (i) amortization of customerrelationships and non-compete agreements, (ii) the accretion of the seniorsecured notes original issue discount, (iii) amortization of deferredfinancing costs, and (iv) impairment charges, if any, resulting from adecline in the value of the Company’s intangible assets.

 

The Company is required to maintain minimum cashcollateral balances at varying times during the term of the Credit Facility asfollows: (a) $6,000,000 from December 31, 2009 through January 31,2010, (b) $0 from February 1, 2010 through April 30, 2010, (c) $3,500,000from May 1, 2010 through July 31, 2010, (d) $0 from August 1,2010 through September 30, 2010, (e) $1,000,000 from October 1,2010 through October 31, 2010, (f) $0 from November 1, 2010through November 30, 2010 and (g) $3,000,000 from December 1,2010 through December 15, 2010.

 

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As of June 30, 2009,the Company was in compliance with each of the financial covenants.  The Company expects that it will meet itsfuture debt covenants over the next 12 months. Management believes that thecovenant with the most sensitivity and risk of future violation is the netincome financial covenant discussed above. A violation of the financialcovenants constitutes an event of default under the Credit Facility; such anevent of default could result in all debt becoming due and payable, and HSBChaving the right to terminate the Credit Facility and its obligation to makeadvances thereunder.  If the Company’soperations continue to deteriorate beyond its forecasted results, it couldresult in a debt covenant violation and the Company would need anotheramendment.  If the Company were unable toamend the terms of the Credit Facility, the Company’s financial condition andresults of operations may be materially adversely affected.  Due to the inherent uncertainties in makingestimates and assumptions, there can be no assurance that the Company willsatisfy either of its financial covenants in future periods.

 

The Credit Facilityincludes various other covenants with which the Company has to comply in orderto maintain borrowing availability including, but not limited to, covenantslimiting or restricting the Company’s ability to incur indebtedness, incurliens, enter into mergers or consolidations, dispose of assets, makeinvestments, pay dividends and repurchase capital stock, enter intotransactions with affiliates or prepay certain indebtedness.  In addition, the Company is required toreport various financial and non-financial information periodically toHSBC.  The Credit Agreement also containscustomary events of default including, but not limited to, payment defaults,covenant defaults, cross-defaults to the senior secured notes, material judgmentdefaults, inaccuracy of representations and warranties, bankruptcy andinsolvency events, defects in HSBC’s security interest, change in controlevents, and material adverse changes.  Anevent of default could result in all debt becoming due and payable, and HSBChaving the right to terminate the Credit Facility and its obligation to makeadvances under it.

 

Pursuant to the CreditFacility, the Company remits funds from the collection of receivables to paydown borrowings outstanding under the Credit Facility.  Under the Company’s factoring agreement, theCompany directs its customers to remit payments on accounts receivable to itsfactor.  At the request of HSBC, theCompany has directed its factor to remit the funds from the collection ofreceivables directly to an HSBC account to reduce borrowings outstanding underthe Credit Facility.  Payments fromcustomers in connection with the Company’s factoring arrangement are reflectedin operating cash flows as collections of receivables.  Funds remitted under this arrangement toreduce short-term borrowings are reflected in cash flows from financingactivities in the statement of cash flows.

 

Loan borrowings andrepayments under the Credit Facility were $13.8 million and $13.8 million,respectively, during the year ended June 30, 2009.  Loan borrowings and repayments under theCredit Facility were $12.8 million and $12.8 million, respectively, during theyear ended June 30, 2008.  Therewere no loan borrowings or repayments under the Credit Facility during the yearended June 30, 2007.

 

**9.  Senior SecuredNotes**

 

On June 20, 2005, the Company received aggregateproceeds of $163,400,000 from the issuance of 11.25% senior secured notes, facevalue $172,000,000.  The notes wereissued at 95% of face value, resulting in an original issue discount of $8,600,000that is being amortized under the effective interest method over the term ofthe notes.  Senior secured notesprincipal amount outstanding at June 30, 2009 and 2008 is $84,743,000 and$124,261,000, respectively.  At June 30,2009 and 2008, debt held in treasury approximated $52,655,000 and $14,027,000,respectively.  At June 30, 2009 and2008, the unamortized original issue discount is $1,751,000 and $3,648,000,respectively.  The Company’s seniorsecured notes are recorded at carrying book value at June 30, 2009 and2008.  At June 30, 2009 and 2008, the fair value of the seniorsecured notes, determined based upon quoted market prices, was approximately$16,101,000, and $73,159,000, respectively.  The notes bear cash interestat 11.25%.  After giving effect to theoriginal issue discount and costs associated with the issuance, the notes havean effective interest rate of approximately 13.7%.  The notes mature on June 15, 2011 andcash interest is payable semiannually on June 15 and December 15 ofeach year, commencing December 15, 2005. The notes are collateralized by a second priority lien on substantiallyall of the assets of the Company.  Thenotes are subordinated to amounts outstanding under the revolving creditfacility.

 

Within 100 days after the end of each fiscal year,beginning with the fiscal year ended on June 30, 2006, the Company mustmake an offer to repurchase all or a portion of the notes at 101% of theirprincipal amount at maturity plus accrued and unpaid interest to the date ofpurchase, with 50% of excess cash flow, as defined, from the previous fiscalyear.  Senior secured note aggregateprincipal amounts of $598,000, $221,000 and $17,429,000 were repurchased duringNovember 2008, 2007 and 2006, respectively, in connection with excess cashflow offers made by the Company.  The November 2008,2007 and 2006 repurchases of the notes, which were at 101% of their principalamount at maturity plus accrued and unpaid interest to the date of purchase,approximated $631,000, $234,000 and $18.4 million, respectively.  The Company wrote-off $1.7 million ofunamortized original issue discount and 

 

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deferred financing coststo interest expense in connection with the November 2006 repurchase.  Unamortized original issue discount anddeferred financing costs associated with the November 2008 and 2007repurchases were not significant.

 

An annual excess cash flow payment with respect to thefiscal year ending June 30, 2009 will not be required.  This  is based on the Company’s financial positionas of June 30, 2009 and its results of operations and cash flows for theyear then ended.

 

In addition to the excess cash flow repurchases, theCompany also repurchased $16,062,000 of the senior secured notes at 101% oftheir principal amount at maturity, plus accrued and unpaid interest, forapproximately $16.3 million on June 29, 2007.  The Company wrote-off $1.4 million ofunamortized original issue discount and deferred financing costs to interestexpense in connection with the June 29, 2007 senior secured noterepurchase.

 

The Company purchased, at a discount, $6.0 million and$8.0 million of outstanding senior secured notes on the open market in January 2008and June 2008, respectively.  Apre-tax gain of approximately $3.1 million, resulting from the differencebetween the carrying book value of the senior secured notes and the amountpaid, net of deferred financing costs that were written-off at the time ofpurchase, was recorded to interest expense during the year ended June 30,2008.

 

The Company purchased, at a discount, $28.5 million,$2.0 million, $4.0 million and $4.4 million of outstanding senior secured noteson the open market in August 2008, March 2009, April 2009, and May 2009,respectively.  A pre-tax gain ofapproximately $25.6 million, resulting from the difference between the carryingbook value of the senior secured notes and the amount paid, net of deferredfinancing costs that were written-off at the time of purchase, was recorded tointerest expense during the year ended June 30, 2009.

 

In July 2009, the Company purchased, at adiscount, $3.5 million of outstanding senior secured notes on the open market.  A pre-tax gain of approximately $2.5 million,resulting from the difference between the carrying book value of the seniorsecured notes and the amount paid, net of deferred financing costs that werewritten-off at the time of purchase, will be recorded to interest expenseduring the year ended June 30, 2010.

 

The senior secured notes indenture contains variouscovenants with which the Company has to comply, including, but not limited to,covenants limiting or restricting the Company’s ability to incur indebtedness,incur liens, enter into mergers or consolidations, dispose of assets, makeinvestments, pay dividends and repurchase capital stock or enter intotransactions with affiliates.  In addition, the Company is required toreport various financial and non-financial information periodically to thetrustee.  The senior secured notes indenture also contains customaryevents of default including, but not limited to, payment defaults,cross-defaults to the Credit Facility, material judgment defaults, inaccuracyof representations and warranties, bankruptcy and insolvency events, defects insecurity interests, change in control events, and material adversechanges.  An event of default could result in all debt becoming due andpayable.

 

**10.  Redeemable ConvertiblePreferred Stock**

 

On June 20, 2005, the Company issued 7,500,000shares of redeemable convertible preferred stock (the “Preferred Stock”) for$40,000,000.  The holders of thePreferred Stock vote with the common stockholders as a single voting class,have certain veto rights and the right to designate the majority of the membersof the board of directors.  The holdersof the Preferred Stock are not entitled to dividends, unless a dividend isdeclared with respect to the common stockholders.

 

The Preferred Stock is redeemable at the option of theholder upon the earlier of (i) a change in control of the Company, asdefined in the certificate of incorporation, (ii) June 20, 2010, ifno principal amounts of the senior secured notes are outstanding, and (iii) December 20,2011, if principal amounts of the senior secured notes are outstanding.  The Preferred Stock is redeemable at itsoriginal purchase price, plus a return of 10% per annum, which is beingaccreted through a charge to retained earnings.  Since the redemption of the Preferred Stock isoutside the control of the Company, the Preferred Stock is classified outsideof stockholders’ equity (deficit) on the consolidated balance sheets.  For each of the years ended June 30,2009, 2008 and 2007, the Company accreted $4,000,000 towards the PreferredStock.

 

The Preferred Stock is convertible into common stockon a one for one basis.  Such conversionratio is subject to adjustment in the event of additional issuances of commonstock at prices less than the original conversion price.

 

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**11.  Income Taxes**

** **

The provision for (benefit from) income taxesconsists of the following (in thousands):

 
| ** **      | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-----------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **      | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** |
| Current:        |       |                                         |       |                                         |       |                                         |       |
| Federal         |       | $                                            | 1,664      |                                         | $          | 1,714                                        |       | $ | 5,106 |   |
| State and local |       | 644                                          |       | 322                                          |       | 257                                          |       |
|            |       | 2,308                                        |       | 2,036                                        |       | 5,363                                        |       |
| Deferred:       |       |                                         |       |                                         |       |                                         |       |
| Federal         |       | 4,000                                        |       | (9,462                                       | )          | (1,939                                       | )          |
| State and local |       | 418                                          |       | (773                                         | )          | (425                                         | )          |
|            |       | 4,418                                        |       | (10,235                                      | )          | (2,364                                       | )          |
|            |       | $                                            | 6,726      |                                         | $          | (8,199                                       | )          | $ | 2,999 |   |

 

Theeffective income tax rate differs from the statutory income tax rate asfollows:

 
| ** **                                            | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                            | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** |
| Statutory federal income tax rate                     |       | 34.0                                         | %          | 34.0                                         | %          | 34.0                                         | %          |
| State and local income taxes, net of federal  benefit |       | (9.1                                         | )          | 3.5                                          |       | (1.7                                         | )          |
| Valuation allowance                                   |       | (109.5                                       | )          | (11.2                                        | )          |                                         |       |
| FIN 48 interest and liabilities                       |       | 7.4                                          |       | (1.4                                         | )          |                                         |       |
| Effective tax rate                                    |       | (77.2                                        | )%         | 24.9                                         | %          | 32.3                                         | %          |

 

Deferred income taxes reflect the net tax effects oftemporary differences between the carrying amounts of assets and liabilitiesfor financial reporting purposes and the amount used for income tax purposes.

 

The components ofdeferred taxes as of June 30, 2009 and 2008, relating primarily totemporary differences arising as a result of the acquisition, are as follows(in thousands):

 
| ** **                                 | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | ** **              | ** ** | ** **              | ** ** |
| Deferred tax assets:                       |       |                    |       |                    |       |
| Accounts receivable                        |       | $                       |       |                    | $          | 192 |   |
| Inventories                                |       | 728                     |       | 3,052                   |       |
| Accrued expenses and other liabilities     |       | 508                     |       | 484                     |       |
| Interest                                   |       | 15                      |       | 493                     |       |
| Deferred financing costs and other assets  |       | 262                     |       | 426                     |       |
| Intangible assets                          |       | 15,917                  |       | 10,460                  |       |
| Stock-based compensation                   |       | 111                     |       | 105                     |       |
| Other                                      |       | 81                      |       | 70                      |       |
| Total deferred tax assets                  |       | 17,622                  |       | 15,282                  |       |
| Valuation allowance on deferred tax assets |       | (14,995                 | )          | (4,300                  | )          |
| Deferred tax liabilities:                  |       |                    |       |                    |       |
| Senior secured notes                       |       | (2,950                  | )          |                    |       |
| Depreciation                               |       | (169                    | )          | (73                     | )          |
| Total deferred tax liabilities             |       | (3,119                  | )          | (73                     | )          |
| Net deferred taxes                         |       | $                       | (492       | )                       | $          | 10,909 |   |

 

During the years ended June 30,2009 and 2008, the Company established a valuation allowance of $9.9 millionand $4.3 million, respectively, for the deferred tax asset that resulted fromthe Rafaella trademark and trade name intangible asset impairments (note 7).  The underlying tax basis of the trademark andtrade name is capital in nature.  Theasset would generate a capital loss for income tax purposes, which can only beused to offset capital gain income.  TheCompany determined that the deferred tax asset is not more likely than not tobe realized as there are no actual or projected capital gains available tooffset any future capital losses that 

 

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might be generated fromthe Rafaella trademark and trade name deferred tax asset.  In addition, the Company does not expect torecognize an income tax benefit from its customer relationship intangibleassets and provided a deferred tax asset valuation allowance of $0.8 millionduring the year ended June 30, 2009 because the underlying tax basis ofthe customer relationships is capital in nature. Any federal operating lossesgenerated for the period ended June 30, 2009 may be carried back, the benefitof which is reflected in current taxes receivable. Current taxes receivableapproximated $5.4 million and $0.6 million as of June 30, 2009 and 2008,respectively, and are included in other assets on the balance sheet.  During the year ended June 30, 2007, theCompany used $0.1 million of federal net operating loss carryforwards.  State net operating loss carryforwards of$6.2 million were used during the year ended June 30, 2007.  As of June 30, 2009 and 2008, there wereno federal operating loss carryforwards. As of June 30, 2009 there werestate operating loss carryforwards of $5.2 million, which will expire in 2029.

 

The Company remainssubject to federal, state and local income tax examinations by tax authoritiesfor all tax years, with the statute of limitations on the initial federal taxyear closing as of September 2009. Examination of the Company’s 2006 federal income tax return by theInternal Revenue Service was recently completed, as was a state tax audit forthe 2006 and 2005 tax years.  No significant adjustments were proposed inconnection with these examinations.  Subsequently,the related unrecognized tax benefits were recognized. The Companyrecognizes interest expense related to unrecognized tax benefits in income taxexpense.  As of June 30, 2009 and2008, accrued interest approximated $27,000 and $1.2 million,respectively.  For the year ended June 30,2009, interest income related to the reversal of unrecognized tax benefitsrecorded in income tax expense approximated $0.7 million.  For the year ended June 30, 2008,interest expense related to unrecognized tax benefits recorded in income taxexpense approximated $0.3 million.

 

Areconciliation of the beginning and ending amount of unrecognized tax benefitsfor the years ended June 30, 2009 and 2008 is as follows:

 

**FIN 48 Tabular Reconciliation(in thousands)**

 
| ** **                                           | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross unrecognized tax benefits at July 1,      |       | $          | 6,091      |       | $          | 5,893 |   |
| Gross increases related to prior year tax  positions |       | 31         |       | 198        |       |
| Gross decreases related to prior year tax  positions |       | (5,953     | )          |       |       |
| Gross unrecognized tax benefits at June 30,     |       | $          | 169        |       | $          | 6,091 |   |

 

As of June 30, 2009and 2008, the Company had approximately $0.2 million of unrecognized taxbenefits that, if recognized, would affect the effective tax rate. The Companydoes not believe it is reasonably possible the unrecognized tax benefits willsignificantly increase or decrease within the next twelve months.

 

**12.  Concentration of Credit Risk and MajorCustomers**

** **

The Company maintains its cash accounts in onecommercial bank located in New York.  Thecash balances are insured by the Federal Deposit Insurance Corporation (FDIC)up to $250,000 per bank.

 

Receivables arise in the normal course ofbusiness.  Management minimizes itscredit risk with respect to trade receivables sold to its factor.  For trade receivables not factored,management monitors the creditworthiness of such customers and reviews theoutstanding receivables at period end, as well as uncollected accountexperience and establishes an allowance for doubtful accounts as deemednecessary.  Bad debt expense approximated$0.1 million and $0.6 million for the years ended June 30, 2009 and2008.  Bad debt expense was notsignificant for the year ended June 30, 2007.

 

For the year ended June 30, 2009, sales to threecustomers approximated $42.0 million, $29.2 million, and $18.5 million of theCompany’s consolidated net sales.  Forthe year ended June 30, 2008, sales to three customers approximated $37.3million, $35.9 million, and $32.4 million of the Company’s consolidated netsales.  For the year ended June 30,2007, sales to three customers approximated $41.2 million,$40.8 million, and $21.8 million of the Company’s consolidated netsales.  Accounts receivable, net ofallowances, from two customers approximated $2.5 million and $1.8 million at June 30,2009.  Accounts receivable, net ofallowances, from four customers approximated $3.0 million, $2.8 million, $2.5million, and $1.7 million at June 30, 2008.

 

**13.  Commitments and Contingencies**

** **

DuringApril 2009, Kobra International, Ltd. d/b/a Nicole Miller (“Nicole Miller”)commenced arbitration proceedings against the Company alleging that the Company’sdecision to suspend performance as licensee under the parties’ LicenseAgreement (the “License”) constituted an anticipatory breach and/or repudiationof the License.  Nicole Miller seeks $1.5million in purported 

 

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damages.  On April 29, 2009, the Company filedpapers denying Nicole Miller’s claims in their entirety, asserting that thesuspension of performance was permitted by the License and asserting acounterclaim of $1.0 million alleging that Nicole Miller’s subsequenttermination of the License was improper. While management has denied any liability and intends to vigorouslydefend against Nicole Miller’s claims and pursue its counterclaim, at thepresent time, management believes that a loss is considered probable.  In accordance with Statement of FinancialAccounting Standards No. 5, Accounting for Contingencies, when a loss isconsidered probable and the loss amount can be reasonably estimated within arange, the Company records the minimum estimated liability related to thematter if there is no best estimate within the range.  As of June 30, 2009, the Company hasaccrued $0.2 million corresponding to the low end of the range related to thepotential loss.

 

Additionally, the Company, from time to time, is partyto various legal proceedings.  Whilemanagement, including external counsel, currently believes that the ultimateoutcome of these proceedings, individually and in the aggregate, will not havea material adverse impact on its financial position or results of operations,litigation is subject to inherent uncertainties.

 

The Company enters into employment and consultingagreements with certain of its employees from time to time.  Thesecontracts typically provide for severance and other benefits.  During theyear ended June 30, 2009, the Company incurred severance costs ofapproximately $1.1 million.  The severance costs are primarily attributedto two former executive officers of the Company.

 

The Company is obligated to pay minimum rental paymentsunder non-cancellable operating leases for showroom, office, and warehousespace expiring at various dates through January 2013.  The lease agreements provide for fixed rentescalations over their terms.  TheCompany recognizes such minimum rental commitments as rent expense on astraight-line basis.  The Company is alsoresponsible for additional rent based on increases in certain costs of theleased premises.  Minimum rentalcommitments, in the aggregate and for each of the next five years, are as follows:

 
| **Years ending June 30,** | ** ** | **(in thousands)** | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| 2010                                     |       | $                       | 2,366      |   |
| 2011                                     |       | 1,948                   |       |
| 2012                                     |       | 1,444                   |       |
| 2013                                     |       | 821                     |       |
| 2014                                     |       | —                  |       |
| Thereafter                               |       | —                  |       |
|                                     |       | $                       | 6,579      |   |

 

Rent expense for the years ended June 30, 2009,2008 and 2007 was approximately $2,625,000, $2,188,000, and $1,915,000,respectively.

 

The Company was contingently liable for open lettersof credit of approximately $10.1 million and $16.9 million as of June 30,2009, and 2008, respectively.

 

**14.  Retirement Plan**

 

The Company has a defined contribution retirement planwhich covers all employees and provides for eligible employees to make electivecontributions of up to 15% of their salary. Company matching contributions to the plan for the years ended June 30,2009, 2008 and 2007, were approximately $132,000, $198,000, and $181,000,respectively.

 

**15.  Fair Value of Financial Instruments**

** **

The fair value of cash and cash equivalents,receivables and accounts payable approximate their carrying value due to theirshort-term maturities.  At June 30,2009 and 2008, the fair value of the senior secured notes, determined basedupon quoted market prices, was approximately $16,101,000 and $73,159,000,respectively.

 

**16.  Subsequent Events**

 

The Company has performedan evaluation of subsequent events through October 13, 2009, which is thedate the consolidated financial statements were issued.  See Note 8 fordiscussion of amendment to the Credit Facility, Note 9 for discussion ofrepurchase of senior secured notes, Note 3 for discussion of forfeiture ofoptions, and Note 4 for discussion of GMAC Letter of Credit.

 

F-19

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**Tableof Contents**

 

**17.  Accrued Expenses and Other CurrentLiabilities**

** **

Accrued expenses and other current liabilitiesconsist of (in thousands):

 
| ** **                        | ** ** | **June 30, 2009** | ** ** | **June 30, 2008** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Accrued interest expense          |       | $                           | 424        |                        | $          | 621 |   |
| Accrued compensation and benefits |       | 1,109                       |       | 1,152                       |       |
| Other accrued liabilities         |       | 635                         |       | 505                         |       |
|                              |       | $                           | 2,168      |                        | $          | 2,278 |   |

 

**18.  QuarterlyFinancial Data (unaudited) (in thousands)**

 
| ** **        | ** ** | **Quarter ended**        | ** ** |
|-------------------|------------|-------------------------------|------------|
| ** **        | ** ** | **June 30,  2009(2)(4)** | ** ** | **March 31,  2009(2)** | ** ** | **December 31,  2008(4)** | ** ** | **September 30,  2008(2)** | ** ** |
| ** **        | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales         |       | $                             | 23,838     |   | $ | 34,555 |   | $ | 40,675 |   | $ | 48,897 |   |
| Gross profit      |       | 5,524                         |       | 9,802 |   | 7,419 |   | 12,183 |   |
| Net income (loss) |       | 132                           |       | (276 | ) | (25,444 | ) | 10,151 |   |
|                   |            |                               |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **        | ** ** | **Quarter ended**        | ** ** |
|-------------------|------------|-------------------------------|------------|
| ** **        | ** ** | **June 30,  2008(1)(3)** | ** ** | **March 31,  2008(1)** | ** ** | **December 31,  2007** | ** ** | **September 30,  2007** | ** ** |
| ** **        | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales         |       | $                             | 41,621     |   | $ | 46,394 |   | $ | 42,563 |   | $ | 47,412 |   |
| Gross profit      |       | 10,652                        |       | 12,960 |   | 9,266 |   | 16,026 |   |
| Net income (loss) |       | (26,212                       | )          | 995 |   | (1,899 | ) | 2,362 |   |
|                   |            |                               |            |  |  |  |  |  |  |  |  |  |  |

 

----

(1)             The Company recordedgains of approximately $1.7 million and $0.4 million, net of tax, in connectionwith the senior secured note purchases (described in Note 9) during thequarterly periods ended June 30, 2008 and March 31, 2008,respectively.

 

(2)             The Company recordedgains of approximately $3.9 million, $1.0 million, and $10.6 million, net oftax, in connection with the senior secured note purchases (described in Note 9)during the quarterly periods ended June 30, 2009, March 31, 2009 and September 30,2008, respectively.

 

(3)             The Company recordedan impairment charge of $34.5 million during the quarter ended June 30,2008 related to the decline in the fair value of the Rafaella trademark andtrade name intangible asset.  Theimpairment charge is reflected within selling, general and administrativeexpenses.

 

(4)             The Company recordedimpairment charges of $2.4 million and $23.4 million during the quarters ended June 30,2009 and December 31, 2008, respectively related to the decline in thefair value of the Rafaella trademark and trade name intangible asset (describedin Note 7).  The impairment charge isreflected within selling, general and administrative expenses.

 

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**19.  ConsolidatingFinancial Statements**

 

In June 2005, the Company issued 11.25% SeniorSecured Notes that are fully, unconditionally, jointly and severally guaranteedon a senior secured basis by Verrazano, Inc. (“Verrazano”), a wholly-ownedsubsidiary of the Company.  Verrazano wasformed in 2004 and commenced operations in 2005.  The following condensed consolidatingfinancial information as of June 30, 2009 and 2008, and for the yearsended June 30, 2009, 2008 and 2007 is provided in lieu of separatefinancial statements for the Company and Verrazano.

 

**Rafaella Apparel Group, Inc. and Subsidiaries**

**Condensed Consolidating Balance Sheet**

**As of June 30, 2009**

**(In thousands)**

 
| ** **                                                 | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                 | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| **Assets**                                                 | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Current assets:                                            |       |                             |       |          |       |                                                 |       |       |       |
| Cash and equivalents                                       |       | $                                | 17,440     |          | $          | 230                                                  |       | $          | 28         |   | $ | 17,698 |   |
| Receivables, net                                           |       | 9,014                            |       | 2,536         |       |                                                 |       | 11,550     |       |
| Inventories                                                |       | 11,297                           |       | 1,037         |       |                                                 |       | 12,334     |       |
| Deferred income taxes                                      |       | 1,040                            |       | 40            |       |                                                 |       | 1,080      |       |
| Other current assets                                       |       | 6,864                            |       | 15,925        |       | (17,232                                              | )          | 5,557      |       |
| Total current assets                                       |       | 45,655                           |       | 19,768        |       | (17,204                                              | )          | 48,219     |       |
| Equipment and leasehold improvements, net                  |       | 1,534                            |       |          |       | 169                                                  |       | 1,703      |       |
| Intangible assets, net                                     |       | 34,291                           |       | 974           |       |                                                 |       | 35,265     |       |
| Deferred financing costs, net                              |       | 2,199                            |       |          |       |                                                 |       | 2,199      |       |
| Investment in subsidiaries                                 |       | 17,476                           |       |          |       | (17,476                                              | )          |       |       |
| Other assets                                               |       | 47                               |       |          |       | 46                                                   |       | 93         |       |
| Total assets                                               |       | $                                | 101,202    |          | $          | 20,742                                               |       | $          | (34,465    | ) | $ | 87,479 |   |
|                                                       |       |                             |       |          |       |                                                 |       |       |       |
| **Liabilities and Stockholders’  Equity (Deficit)**   | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Current liabilities:                                       |       |                             |       |          |       |                                                 |       |       |       |
| Accounts payable                                           |       | $                                | 5,805      |          | $          | 1,977                                                |       | $          | 28         |   | $ | 7,810 |   |
| Accrued expenses and other liabilities                     |       | 17,933                           |       | 92            |       | (15,857                                              | )          | 2,168      |       |
| Total current liabilities                                  |       | 23,738                           |       | 2,069         |       | (15,829                                              | )          | 9,978      |       |
| Senior secured notes                                       |       | 82,992                           |       |          |       |                                                 |       | 82,992     |       |
| Income taxes                                               |       | 1,770                            |       |          |       |                                                 |       | 1,770      |       |
| Deferred rent                                              |       | 385                              |       |          |       | 37                                                   |       | 422        |       |
| Total liabilities                                          |       | 108,885                          |       | 2,069         |       | (15,792                                              | )          | 95,162     |       |
| Commitments and contingencies                              |       |                             |       |          |       |                                                 |       |       |       |
| Redeemable convertible stock                               |       | 56,110                           |       |          |       |                                                 |       | 56,110     |       |
| Stockholders’ equity (deficit):                       |       |                             |       |          |       |                                                 |       |       |       |
| Common stock                                               |       | 25                               |       |          |       |                                                 |       | 25         |       |
| Additional paid in capital                                 |       | 288                              |       | 8,741         |       | (8,741                                               | )          | 288        |       |
| Deemed dividend, in excess of predecessor basis            |       | (26,022                          | )          |          |       |                                                 |       | (26,022    | )          |
| Retained earnings (deficit)                                |       | (38,084                          | )          | 9,932         |       | (9,932                                               | )          | (38,084    | )          |
| Total stockholders’ equity (deficit)                  |       | (63,793                          | )          | 18,673        |       | (18,673                                              | )          | (63,793    | )          |
| Total liabilities and stockholders’ equity  (deficit) |       | $                                | 101,202    |          | $          | 20,742                                               |       | $          | (34,465    | ) | $ | 87,479 |   |

 

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Table ofContents

 

**Rafaella Apparel Group, Inc. and Subsidiaries**

**Condensed Consolidating Balance Sheet**

**As of June 30, 2008**

**(In thousands)**

 
| ** **                                                 | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                 | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| **Assets**                                                 | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Current assets:                                            |       |                             |       |          |       |                                                 |       |       |       |
| Cash and equivalents                                       |       | $                                | 17,154     |          | $          |                                                 |       | $          | (23        | ) | $ | 17,131 |   |
| Receivables, net                                           |       | 13,685                           |       | 1,601         |       |                                                 |       | 15,286     |       |
| Inventories                                                |       | 31,467                           |       | 1,782         |       |                                                 |       | 33,249     |       |
| Deferred income taxes                                      |       | 3,510                            |       | 68            |       |                                                 |       | 3,578      |       |
| Other current assets                                       |       | 1,086                            |       | 14,611        |       | (14,674                                              | )          | 1,023      |       |
| Total current assets                                       |       | 66,902                           |       | 18,062        |       | (14,697                                              | )          | 70,267     |       |
| Equipment and leasehold improvements, net                  |       | 1,080                            |       |          |       | 2                                                    |       | 1,082      |       |
| Intangible assets, net                                     |       | 64,010                           |       | 1,304         |       |                                                 |       | 65,314     |       |
| Deferred financing costs, net                              |       | 4,807                            |       |          |       |                                                 |       | 4,807      |       |
| Investment in subsidiaries                                 |       | 18,235                           |       |          |       | (18,235                                              | )          |       |       |
| Other assets                                               |       | 47                               |       |          |       |                                                 |       | 47         |       |
| Deferred income taxes                                      |       | 7,029                            |       | 302           |       |                                                 |       | 7,331      |       |
| Total assets                                               |       | $                                | 162,110    |          | $          | 19,668                                               |       | $          | (32,930    | ) | $ | 148,848 |   |
|                                                       |       |                             |       |          |       |                                                 |       |       |       |
| **Liabilities and Stockholders’  Equity (Deficit)**   | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Current liabilities:                                       |       |                             |       |          |       |                                                 |       |       |       |
| Accounts payable                                           |       | $                                | 9,478      |          | $          | 1,094                                                |       | $          | (23        | ) | $ | 10,549 |   |
| Accrued expenses and other liabilities                     |       | 16,750                           |       | 104           |       | (14,576                                              | )          | 2,278      |       |
| Current portion of senior secured notes                    |       | 865                              |       |          |       |                                                 |       | 865        |       |
| Total current liabilities                                  |       | 27,093                           |       | 1,198         |       | (14,599                                              | )          | 13,692     |       |
| Senior secured notes                                       |       | 119,748                          |       |          |       |                                                 |       | 119,748    |       |
| Income taxes                                               |       | 7,155                            |       | 139           |       |                                                 |       | 7,294      |       |
| Deferred rent                                              |       | 384                              |       |          |       |                                                 |       | 384        |       |
| Total liabilities                                          |       | 154,380                          |       | 1,337         |       | (14,599                                              | )          | 141,118    |       |
| Commitments and contingencies                              |       |                             |       |          |       |                                                 |       |       |       |
| Redeemable convertible stock                               |       | 52,110                           |       |          |       |                                                 |       | 52,110     |       |
| Stockholders’ equity (deficit):                       |       |                             |       |          |       |                                                 |       |       |       |
| Common stock                                               |       | 25                               |       |          |       |                                                 |       | 25         |       |
| Additional paid in capital                                 |       | 264                              |       | 8,741         |       | (8,741                                               | )          | 264        |       |
| Deemed dividend, in excess of predecessor basis            |       | (26,022                          | )          |          |       |                                                 |       | (26,022    | )          |
| Retained earnings (deficit)                                |       | (18,647                          | )          | 9,590         |       | (9,590                                               | )          | (18,647    | )          |
| Total stockholders’ equity (deficit)                  |       | (44,380                          | )          | 18,331        |       | (18,331                                              | )          | (44,380    | )          |
| Total liabilities and stockholders’ equity  (deficit) |       | $                                | 162,110    |          | $          | 19,668                                               |       | $          | (32,930    | ) | $ | 148,848 |   |

 

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Table ofContents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Operations**

**Year ended June 30,2009**

**(Inthousands)**

 
| ** **                                                      | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net sales                                                       |       | $                                | 129,503    |          | $          | 18,462                                               |       |       |       | $ | 147,965 |   |
| Cost of sales                                                   |       | 96,238                           |       | 15,824        |       | $                                                    | 975        |       | 113,037    |   |
| Gross profit                                                    |       | 33,265                           |       | 2,638         |       | (975                                                 | )          | 34,928     |       |
| Selling, general and administrative expenses                    |       | 28,032                           |       | 2,041         |       | 126                                                  |       | 30,199     |       |
| Intangible asset impairment                                     |       | 25,840                           |       |          |       |                                                 |       | 25,840     |       |
| Operating income (loss)                                         |       | (20,607                          | )          | 597           |       | (1,101                                               | )          | (21,111    | )          |
| Interest expense, net                                           |       | 13,232                           |       |          |       |                                                 |       | 13,232     |       |
| Gain on senior secured note purchases                           |       | (25,632                          | )          |          |       |                                                 |       | (25,632    | )          |
| Interest expense and other financing, net                       |       | (12,400                          | )          |          |       |                                                 |       | (12,400    | )          |
| Income (loss) before provision for (benefit from)  income taxes |       | (8,207                           | )          | 597           |       | (1,101                                               | )          | (8,711     | )          |
| Provision for (benefit from) income taxes                       |       | 6,471                            |       | 255           |       |                                                 |       | 6,726      |       |
| Equity in earnings of subsidiaries                              |       | (759                             | )          |          |       | 759                                                  |       |       |       |
| Net income (loss)                                               |       | $                                | (15,437    | )             | $          | 342                                                  |       | $          | (342       | ) | $ | (15,437 | ) |

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Operations**

**Year ended June 30,2008**

**(Inthousands)**

 
| ** **                                                      | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net sales                                                       |       | $                                | 145,561    |          | $          | 32,429                                               |       |       |       |   | $ | 177,990 |   |
| Cost of sales                                                   |       | 105,034                          |       | 23,977        |       | $                                                    | 75         |       | 129,086    |   |
| Gross profit                                                    |       | 40,527                           |       | 8,452         |       | (75                                                  | )          | 48,904     |       |
| Selling, general and administrative expenses                    |       | 29,059                           |       | 3,433         |       | 21                                                   |       | 32,513     |       |
| Intangible asset impairment                                     |       | 34,504                           |       |          |       |                                                 |       | 34,504     |       |
| Operating income (loss)                                         |       | (23,036                          | )          | 5,019         |       | (96                                                  | )          | (18,113    | )          |
| Interest expense, net                                           |       | 17,964                           |       |          |       |                                                 |       | 17,964     |       |
| Gain on senior secured note purchases                           |       | (3,124                           | )          |          |       |                                                 |       | (3,124     | )          |
| Interest expense and other financing, net                       |       | 14,840                           |       |          |       |                                                 |       | 14,840     |       |
| Income (loss) before provision for (benefit from)  income taxes |       | (37,876                          | )          | 5,019         |       | (96                                                  | )          | (32,953    | )          |
| Provision for (benefit from) income taxes                       |       | (10,013                          | )          | 1,814         |       |                                                 |       | (8,199     | )          |
| Equity in earnings of subsidiaries                              |       | 3,109                            |       |          |       | (3,109                                               | )          |       |       |
| Net income (loss)                                               |       | $                                | (24,754    | )             | $          | 3,205                                                |       | $          | (3,205     | ) | $ | (24,754 | ) |

 

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Table ofContents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Operations**

**Year ended June 30,2007**

**(Inthousands)**

 
| ** **                                   | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                   | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net sales                                    |       | $                                | 169,478    |          | $          | 21,806                                               |       |       |       | $ | 191,284 |   |
| Cost of sales                                |       | 110,748                          |       | 16,422        |       |                                                 |       | 127,170    |       |
| Gross profit                                 |       | 58,730                           |       | 5,384         |       |                                                 |       | 64,114     |       |
| Selling, general and administrative expenses |       | 28,618                           |       | 2,333         |       |                                                 |       | 30,951     |       |
| Operating income                             |       | 30,112                           |       | 3,051         |       |                                                 |       | 33,163     |       |
| Interest expense and other financing, net    |       | 23,885                           |       | (1            | )          |                                                 |       | 23,884     |       |
| Income before provision for income taxes     |       | 6,227                            |       | 3,052         |       |                                                 |       | 9,279      |       |
| Provision for income taxes                   |       | 1,883                            |       | 1,116         |       |                                                 |       | 2,999      |       |
| Equity in earnings of subsidiaries           |       | (1,936                           | )          |          |       | $                                                    | 1,936      |       |       |   |
| Net income                                   |       | $                                | 6,280      |          | $          | 1,936                                                |       | $          | (1,936     | ) | $ | 6,280 |   |

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Cash Flows**

**Year ended June 30,2009**

**(Inthousands)**

 
| ** **                                                                                          | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Non-  guarantor  Subsidiary  and  Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                                                                                          | ** ** | ** **                   | ** ** | ** **    | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Cash flows provided by (used in) operating  activities:                                             |       |                         |       |          |       |                                               |       |       |       |
| Net income (loss)                                                                                   |       | $                            | (15,437    | )             | $          | 342                                                |       | $          | (342       | ) | $ | (15,437 | ) |
| Adjustments to reconcile net income (loss) to net cash  provided by (used in) operating activities: |       |                         |       |          |       |                                               |       |       |       |
| Amortization of deferred finance charges                                                            |       | 1,386                        |       |          |       |                                               |       | 1,386      |       |
| Accretion of original issue discount                                                                |       | 835                          |       |          |       |                                               |       | 835        |       |
| Depreciation and amortization                                                                       |       | 4,313                        |       | 330           |       | 28                                                 |       | 4,671      |       |
| Equity in earnings of subsidiaries                                                                  |       | 759                          |       |          |       | (759                                               | )          |       |       |
| Stock-based compensation expense                                                                    |       | 24                           |       |          |       |                                               |       | 24         |       |
| Income taxes                                                                                        |       | 4,114                        |       | 191           |       |                                               |       | 4,305      |       |
| Deferred rent                                                                                       |       | 1                            |       |          |       | 37                                                 |       | 38         |       |
| Gain on senior secured note purchases                                                               |       | (25,632                      | )          |          |       |                                               |       | (25,632    | )          |
| Intangible asset impairment                                                                         |       | 25,840                       |       |          |       |                                               |       | 25,840     |       |
| Changes in operating assets and liabilities:                                                        |       |                         |       |          |       |                                               |       |       |       |
| Accounts receivable                                                                                 |       | 4,671                        |       | (935          | )          |                                               |       | 3,736      |       |
| Inventories                                                                                         |       | 20,170                       |       | 745           |       |                                               |       | 20,915     |       |
| Other current assets                                                                                |       | (5,778                       | )          | (1,314        | )          | 2,558                                              |       | (4,534     | )          |
| Accounts payable                                                                                    |       | (3,673                       | )          | 906           |       | 28                                                 |       | (2,739     | )          |
| Accrued expenses and other current liabilities                                                      |       | 1,183                        |       | (12           | )          | (1,281                                             | )          | (110       | )          |
| Other assets                                                                                        |       |                         |       |          |       | (46                                                | )          | (46        | )          |
| Net cash provided by (used in) operating  activities                                                |       | 12,776                       |       | 253           |       | 223                                                |       | 13,252     |       |
| Cash flows used in investing activities:                                                            |       |                         |       |          |       |                                               |       |       |       |
| Purchase of equipment and leasehold improvements                                                    |       | (888                         | )          |          |       | (195                                               | )          | (1,083     | )          |
| Net cash used in investing activities                                                               |       | (888                         | )          |          |       | (195                                               | )          | (1,083     | )          |
| Cash flows (used in) provided by financing  activities:                                             |       |                         |       |          |       |                                               |       |       |       |
| Change in book overdraft                                                                            |       |                         |       | (23           | )          | 23                                                 |       |       |       |
| Repurchase of senior secured notes                                                                  |       | (11,552                      | )          |          |       |                                               |       | (11,552    | )          |
| Deferred financing costs                                                                            |       | (50                          | )          |          |       |                                               |       | (50        | )          |
| Net cash (used in) provided by financing  activities                                                |       | (11,602                      | )          | (23           | )          | 23                                                 |       | (11,602    | )          |
| Net increase in cash and cash equivalents                                                           |       | 286                          |       | 230           |       | 51                                                 |       | 567        |       |
| Cash and cash equivalents, beginning of period                                                      |       | 17,154                       |       |          |       | (23                                                | )          | 17,131     |       |
| Cash and cash equivalents, end of period                                                            |       | $                            | 17,440     |          | $          | 230                                                |       | $          | 28         |   | $ | 17,698 |   |

 

F-24

----

Table ofContents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Cash Flows**

**Year ended June 30,2008**

**(Inthousands)**

 
| ** **                                                                                          | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Non-  guarantor  Subsidiary  and  Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                                                                                          | ** ** | ** **                   | ** ** | ** **    | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Cash flows provided by (used in) operating  activities:                                             |       |                         |       |          |       |                                               |       |       |       |
| Net income (loss)                                                                                   |       | $                            | (24,754    | )             | $          | 3,205                                              |       | $          | (3,205     | ) | $ | (24,754 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                         |       |          |       |                                               |       |       |       |
| Amortization of deferred finance charges                                                            |       | 1,755                        |       |          |       |                                               |       | 1,755      |       |
| Accretion of original issue discount                                                                |       | 1,041                        |       |          |       |                                               |       | 1,041      |       |
| Depreciation and amortization                                                                       |       | 4,173                        |       | 331           |       |                                               |       | 4,504      |       |
| Equity in earnings of subsidiaries                                                                  |       | (3,109                       | )          |          |       | 3,109                                              |       |       |       |
| Stock-based compensation expense                                                                    |       | 23                           |       |          |       |                                               |       | 23         |       |
| Income taxes                                                                                        |       | (10,121                      | )          | (115          | )          |                                               |       | (10,236    | )          |
| Deferred rent                                                                                       |       | 64                           |       |          |       |                                               |       | 64         |       |
| Gain on senior secured note purchases                                                               |       | (3,124                       | )          |          |       |                                               |       | (3,124     | )          |
| Intangible asset impairment                                                                         |       | 34,504                       |       |          |       |                                               |       | 34,504     |       |
| Changes in operating assets and liabilities:                                                        |       |                         |       |          |       |                                               |       |       |       |
| Accounts receivable                                                                                 |       | 3,497                        |       | 2,002         |       |                                               |       | 5,499      |       |
| Inventories                                                                                         |       | 7,545                        |       | 3,581         |       |                                               |       | 11,126     |       |
| Other current assets                                                                                |       | 1,045                        |       | (5,557        | )          | 5,675                                              |       | 1,163      |       |
| Accounts payable                                                                                    |       | 178                          |       | (3,515        | )          | 1                                                  |       | (3,336     | )          |
| Accrued expenses and other current liabilities                                                      |       | 4,182                        |       | 45            |       | (5,578                                             | )          | (1,351     | )          |
| Other assets                                                                                        |       | (6                           | )          |          |       |                                               |       | (6         | )          |
| Net cash provided by (used in) operating  activities                                                |       | 16,893                       |       | (23           | )          | 2                                                  |       | 16,872     |       |
| Cash flows used in investing activities:                                                            |       |                         |       |          |       |                                               |       |       |       |
| Purchase of equipment and leasehold improvements                                                    |       | (964                         | )          |          |       | (2                                                 | )          | (966       | )          |
| Net cash used in investing activities                                                               |       | (964                         | )          |          |       | (2                                                 | )          | (966       | )          |
| Cash flows (used in) provided by financing  activities:                                             |       |                         |       |          |       |                                               |       |       |       |
| Change in book overdraft                                                                            |       |                         |       | 23            |       | (23                                                | )          |       |       |
| Repurchase of senior secured notes                                                                  |       | (10,135                      | )          |          |       |                                               |       | (10,135    | )          |
| Deferred financing costs                                                                            |       | (30                          | )          |          |       |                                               |       | (30        | )          |
| Net cash (used in) provided by financing activities                                                 |       | (10,165                      | )          | 23            |       | (23                                                | )          | (10,165    | )          |
| Net increase in cash and cash equivalents                                                           |       | 5,764                        |       |          |       | (23                                                | )          | 5,741      |       |
| Cash and cash equivalents, beginning of period                                                      |       | 11,390                       |       |          |       |                                               |       | 11,390     |       |
| Cash and cash equivalents, end of period                                                            |       | $                            | 17,154     |          | $          |                                               |       | $          | (23        | ) | $ | 17,131 |   |

 

F-25

----

Table ofContents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Cash Flows**

**Year ended June 30,2007**

**(Inthousands)**

 
| ** **                                                                         | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Non-  guarantor  Subsidiary  and  Eliminations** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|----------------------------------------------------|------------|-----------|------------|
|                                                                               |       |                         |       |          |       |                                               |       |      |       |
| Cash flows provided by operating activities:                                       |       |                         |       |          |       |                                               |       |      |       |
| Net income                                                                         |       | $                            | 6,280      |          | $          | 1,936                                              |       | $         | (1,936     | ) | $ | 6,280 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                         |       |          |       |                                               |       |      |       |
| Amortization of deferred finance charges                                           |       | 3,849                        |       |          |       |                                               |       | 3,849     |       |
| Accretion of original issue discount                                               |       | 772                          |       |          |       |                                               |       | 772       |       |
| Depreciation and amortization                                                      |       | 4,600                        |       | 385           |       |                                               |       | 4,985     |       |
| Equity in earnings of subsidiaries                                                 |       | (1,936                       | )          |          |       | 1,936                                              |       |      |       |
| Stock-based compensation expense                                                   |       | 241                          |       |          |       |                                               |       | 241       |       |
| Income taxes                                                                       |       | (2,185                       | )          | (179          | )          |                                               |       | (2,364    | )          |
| Deferred rent                                                                      |       | 191                          |       |          |       |                                               |       | 191       |       |
| Changes in operating assets and liabilities:                                       |       |                         |       |          |       |                                               |       |      |       |
| Accounts receivable                                                                |       | 3,467                        |       | (1,742        | )          |                                               |       | 1,725     |       |
| Inventories                                                                        |       | 1,652                        |       | 1,027         |       |                                               |       | 2,679     |       |
| Other current assets                                                               |       | 1,383                        |       | (4,137        | )          | 2,708                                              |       | (46       | )          |
| Accounts payable                                                                   |       | (5,132                       | )          | 2,692         |       |                                               |       | (2,440    | )          |
| Accrued expenses and other current liabilities                                     |       | 3,519                        |       | 60            |       | (2,708                                             | )          | 871       |       |
| Net cash provided by operating activities                                          |       | 16,701                       |       | 42            |       |                                               |       | 16,743    |       |
| Cash flows used in investing activities:                                           |       |                         |       |          |       |                                               |       |      |       |
| Purchase of equipment and leasehold improvements                                   |       | (214                         | )          |          |       |                                               |       | (214      | )          |
| Net cash used in investing activities                                              |       | (214                         | )          |          |       |                                               |       | (214      | )          |
| Cash flows used in financing activities:                                           |       |                         |       |          |       |                                               |       |      |       |
| Decrease in book overdraft                                                         |       | (554                         | )          | (42           | )          |                                               |       | (596      | )          |
| Repurchase of senior secured notes                                                 |       | (31,816                      | )          |          |       |                                               |       | (31,816   | )          |
| Net cash used in financing activities                                              |       | (32,370                      | )          | (42           | )          |                                               |       | (32,412   | )          |
| Net decrease in cash and cash equivalents                                          |       | (15,883                      | )          |          |       |                                               |       | (15,883   | )          |
| Cash and cash equivalents, beginning of period                                     |       | 27,273                       |       |          |       |                                               |       | 27,273    |       |
| Cash and cash equivalents, end of period                                           |       | $                            | 11,390     |          | $          |                                               |       | $         |       |   | $ | 11,390 |   |

 

F-26

----