**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

----

 

**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, 2007**                                                                                                                                                                  |
| ** **                                                                                                                                                                                                    | ** ** |
| **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**                                                                                                                                                                       |

 

----

 

**RafaellaApparel Group, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                              |   | **20-2745750**       |
|---------------------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of                                          |   | (I.R.S. Employer     |
| incorporation or  organization)                                           |   | Identification  No.) |
|                                                                      |   |                 |
| **1411  Broadway, New York, New York 10018**                              |
| **(212)  403-0300**                                                       |
| (Address,  including zip code, and telephone number, including area code, |
| of registrant’s  principal executive offices)                        |

 

Indicate by checkmark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act   Yes o   No x.

Indicate by checkmark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of theExchange Act.   Yes o   No x.

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.   Yes x   No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): 

| Large accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

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

As of June 30,2007, the registrant had 2,500,000 shares of its common stock, par value $0.01per share, outstanding.

----

 

**RAFAELLA APPAREL GROUP,INC.**

**ANNUAL REPORT**

**JUNE 30, 2007**

**TABLEOF CONTENTS**
|              |       |                                                                                        |       | **PAGE**   |
|--------------|------------|---------------------------------------------------------------------------------------------|------------|------------|
| **PART I**   | ** ** | ** **                                                                                  | ** ** | ** ** |
|         |       |                                                                                        |       |       |
| ITEM 1.      |       | BUSINESS                                                                                    |       | 1          |
| ITEM 1A.     |       | RISK  FACTORS                                                                               |       | 7          |
| ITEM 2.      |       | PROPERTIES                                                                                  |       | 15         |
| ITEM  3.     |       | LEGAL  PROCEEDINGS                                                                          |       | 15         |
| ITEM 4.      |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                         |       | 16         |
| ** **   | ** ** | ** **                                                                                  | ** ** | ** ** |
| **PART II**  | ** ** | ** **                                                                                  | ** ** | ** ** |
|         |       |                                                                                        |       |       |
| ITEM 5.      |       | MARKET FOR THE REPORTING ENTITY’S COMMON STOCK AND  RELATED STOCKHOLDER MATTERS        |       | 17         |
| ITEM 6.      |       | SELECTED FINANCIAL DATA                                                                     |       | 17         |
| ITEM 7.      |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS |       | 19         |
| ITEM 7A.     |       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                  |       | 30         |
| ITEM 8.      |       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                 |       | 30         |
| ITEM 9.      |       | CHANGES IN  AND/OR DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE    |       | 31         |
| ITEM 9A.     |       | CHANGES IN  CONTROLS & PROCEDURES                                                       |       | 31         |
| ** **   | ** ** | ** **                                                                                  | ** ** | ** ** |
| **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                             |       | 46         |
| ITEM 13.     |       | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                  |       | 48         |
| ITEM 14.     |       | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                     |       | 49         |
| ** **   | ** ** | ** **                                                                                  | ** ** | ** ** |
| **PART IV**  | ** ** | ** **                                                                                  | ** ** | ** ** |
|         |       |                                                                                        |       |       |
| ITEM 15.     |       | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                 |       | 49         |

 

i

----

 

# **PART I**

## **Item 1.****                                                           Business**

**STATEMENTREGARDING FORWARD LOOKING STATEMENTS**

Except for the historical information and currentstatements contained in this Annual Report, certain matters discussed herein,including, without limitation, “Item 1 - Business,” “Item 3 - Legal Proceedings”and “Item 7 - Management’s Discussion and Analysis of Financial Condition andResults of Operations,” are forward-looking statements that involve risks anduncertainties. Actual results and timing of certain events could differ materiallyfrom those projected in or contemplated by forward-looking statements due to anumber of factors including, without limitation, changes in industry trends,merchandise and fashion trends, the extent of foreign sourcing andmanufacturing, competition in the apparel industry, changes in general economicconditions, failure to anticipate consumer spending patterns, financial  or political  instability  in any of the nations  in which  our goods  are  manufactured and risks relating to theexecution of management’s business strategy, any of which could cause actualresults to differ materially.

**GENERAL**

Rafaella Apparel Group, Inc. (the “Company”) acquiredsubstantially all of the assets of Rafaella Sportswear, Inc. in an acquisitionconsummated on June 20, 2005.  Except asotherwise indicated, references to “we”, “us”, the Company and Rafaella ApparelGroup, Inc., for periods prior to the acquisition, refer to our predecessor.

**OurCompany**

We are an established designer, sourcer and marketerof a full line of women’s career and casual sportswear separates. We have beenin the women’s apparel business since 1982 and market our products primarilyunder our Rafaella brand. We design, source and market pants, sweaters,blouses, t-shirts, jackets and skirts for all seasons of the year. Our in-housedesign staff develops our lines to include basic styling with updated featuresand colors using a variety of natural and synthetic fabrics. Using our designspecifications, we outsource the production of our clothing line tomanufacturers primarily in Asia, primarily via our agent in Hong Kong, and selldirectly to department, specialty and chain stores and off-price retailers. Wehave over 600 customers, representing over 3,800 individual retail locations.Our customers include some of the larger retailers of women’s clothing in theUnited States.

**OurIndustry**

The retail women’s apparel industry is highlycompetitive, with many providers of the same styles of clothing as are designedand marketed by us. In addition, there is a growing trend toward consolidationin the industry, decreasing the number of retailers and the floor spaceavailable for our products. Finally, manufacturers of women’s apparel aresubject to pricing pressures on both a customer front and a consumer front,stemming from the increased competition for customers and economic cycles thatmay impact the spending of our consumers.

1

----

 

**Products**

Our lines consist of fashionbasics with updated features and colors. We design our products to appeal toour target market of women aged 30 to 55. Our products are divided into threebroad categories based on size: Missy, Petite and Woman. The Missy categorycomprises traditional sized clothing, whereas the Petite and Woman cater tosmaller and larger framed women,respectively. We also categorize our clothing lines as Career or Casual. Careerclothing consists of jackets, pants, skirts, shirts, blouses and sweaters designedto be worn primarily to work. Casual clothing is designed to be worn primarilyas weekend wear and consists of pants, skirts, jackets, shirts and sweatersprincipally made of cotton based fabrics. Recent fashion trends have led to ablurring of the distinctions between these categories, with women wearingCasual separates to work and Career separates for functions outside work.

Our products are priced toretail at the entry level in the “better” sportswear departments of our retailcustomers. Our pants, skirts, blouses and sweaters typically retail for $30 to $50 per item, t-shirts for $15to $40 per item and jackets for $45 to $90 per item. We believe that ourproducts are of an equal or higher quality than those of our competition, butretail in department and specialty stores at a lower price point thancomparable branded products of our competitors.

**Seasonality**

We present seasonal “lines”each year corresponding to the retail selling seasons, Spring, Summer, Fall andHoliday, and from time to time we may offer an additional line as a transitionbetween the Summer and Fall retail selling seasons. Each line consists ofcomplementary styles of pants, sweaters, blouses, t-shirts, jackets and skirts,which are sold as individual items, but which may be coordinated into completeoutfits.  Each style in our lines comesin a variety of colors and/or patterns. Fabrics include cotton and cottonblends, synthetics and synthetic blends, silk and silk blends, wool and wool blendsand linen, depending upon the season and clothing style. Our lines are marketedprincipally under our Rafaella brand.

**Design**

Our design team, operatingout of our headquarters in New York, is responsible for the development of newproducts and our seasonal lines according to our merchandising calendar. The team includes staff designers andassistant designers, with computer aided design capabilities, in addition to acolor and print specialist. Each member of the team has responsibility forcertain products, creating several groupings for a given season.

The design staff interpretsemerging trends in fashion, and receives market feedback from our managementand sales force, in order to stay abreast of new design concepts. Thisinformation is used to develop preliminary expectations for the composition andbasic silhouettes of the next line. With this guidance, the design teamdevelops initial sketches or prototype garments in our New York officereflecting line concepts and style ideas. From these concepts, certain stylesare selected for further development and the design team, in conjunction withmanagement, begins to select colors and fabrics for the line. Fabric samplesare ordered in each pattern and color. Using the sample fabrics, more refinedprototype garments are made, either in our New York office or by contractmanufacturers. These refined prototypes are used for display in the showroomduring the applicable market week. The line is further refined based oncustomer feedback during the market week.

**ProductSourcing and Distribution**

We contract for themanufacture of our products exclusively with third-party manufacturers and donot own or operate any manufacturing facilities. During fiscal 2007, our merchandise purchases were primarilysourced from Asian manufacturing companies. In the future, we may source fromother economically feasible countries. Outsourcing our products allows us tomaximize production flexibility, while avoiding significant capitalexpenditures, work-in-process inventory build-ups and costs associated withmanaging a larger production force.

We utilize individualpurchase orders specifying the price, quantity and design specifications of themerchandise to be produced, mostly secured by letters of credit. We do not havelong-term, formal arrangements

2

----

 

withour manufacturers, and we continually seek additional suppliers for ourproduction needs to provide additional capacity and flexibility as needed.  Because we have been using many of the samemanufacturers for several years, we believe we have established and maintainedexcellent relationships with high-quality manufacturers, fabric suppliers andagents. These relationships facilitate our ability to control the quality ofour products, achieve favorable pricing for production and ensure a reliablesupply of products. Based on our past experience of adding and removingsuppliers, we believe that we are not dependent on any particular supplier and,if necessary, can replace in a timely manner any supplier at a similar cost andquality.

Since 1997, we have workedwith the same principal buying agent based in Hong Kong for the majority of ourproduct sourcing. This agent serves as a non-exclusive buying agent formanufactured goods in Asia, principally China, Hong Kong, Taiwan and Vietnam.This agent identifies and qualifies contract manufacturers, administers andcoordinates production, and manages the quality control process for productionadministered and coordinated by this agent as well as when we utilize certainother agents in Asia. Compensation to our agents is based on a percentage ofthe full cost of the finished garment before shipping costs and customs duties.

We source fabric for many ofour manufacturers. Due to our large annual purchases of our higher volumefabrics, we have been able to negotiate favorable pricing with our fabricsuppliers. We negotiate directly with our suppliers for the purchase ofrequired fabrics, which are purchased either directly by us or by ourmanufacturers under our directions.

We have a comprehensivequality control program that begins overseas to ensure that raw materials andfinished goods meet our specifications for design, fit and quality. Fabricpurchases are inspected upon receipt at the manufacturers’ facilities, andprior to commencement ofproduction. Inspections are handled by representatives of our buying agents aswell as our manufacturers’ staffs. Quality control inspectors also inspectfinished goods before shipment to the U.S., as well as once they reach ourwarehouse and distribution facility located in Bayonne, New Jersey. Managementbelieves that our low return rate on defective merchandise is largely due toour rigorous quality control processes.

We utilize a centralizeddistribution system, under which most merchandise is received, processed anddistributed through our Bayonne, New Jersey facility. From this facility,merchandise is inspected, packed and shipped to our customers via common carriers. To facilitate the distribution process andcontrol warehouse costs, all of our products, other than those ordered tosupport our replenishment programs, are packaged into pre-established packages,or pre-packs, prior to being shipped to our Bayonne facility. Each pre-packcontains four or six garments, in a single style and color, and in a preset rangeof sizes. We offer three pre-pack size ranges in Missy, two in Petite and onein Woman. Management believes the use of pre-packs helps minimize ourdistribution 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 ourcustomers, we confirm that the products and procedures being followed complywith the relevant standards in order to avoid the financial penalties imposedby the customer for non-compliance with their policies and procedures. We use asystem, which was developed to ensure compliance, that includes automation ofcertain components, such as the submission of advance shipping notices to ourcustomers scheduled for several hours in advance of each customer’s deadlinefor such notices. In addition, we monitor each customer’s policies andprocedures guidelines, review all customer manuals on a regular basis, and modifyour systems accordingly.

**Sales,Marketing and Advertising**

We maintain a direct salesforce that operates out of our New York showroom. Our direct sales force iscompensated exclusively on a salaried basis with a discretionary annualperformance bonus. This in-house sales force, together with management,accounted for approximately 95% of our fiscal 2007 sales. We also haveindependent, non-exclusive sales representatives operating in various regions of the U.S. who arecompensated

3

----

 

exclusivelyon a commission basis. These sales representatives accounted for approximately5% of our fiscal 2007 sales.

We introduce our products toexisting and prospective customers during market weeks, which occur four to sixmonths ahead of the corresponding retail selling seasons. During market weeks, customers visit our showroom to view ourCasual and Career lines for the applicable retail season. During and shortlyfollowing market weeks, many of our customers provide us with non-bindingindications as to their initial orders for that season. Historically, a veryhigh percentage of these indications have translated into actual orders andsales. 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 focusedon media based advertising but instead have relied on in-store displays of ourclothing lines, together with our attractive products and strong value proposition, to encourage purchases by our targetend customer. We intend to increase our use of media based advertising,specifically billboard and magazine advertisements.

**Customers**

Our principal customers are departmentand specialty stores. The departmentand specialty stores channel represented approximately 68% of our total netsales in fiscal 2007 and the other approximately 32% of our total net sales infiscal 2007 were to off-price retailers and private label customers. Whilecertain of our customers consist of separate department and specialty storechains or off-price retailers with common ownership, these customers haveseparate purchasing departments and are therefore viewed by us as separatecustomers.  Divisions of Macy’s, Inc.(when viewed on a common ownership basis), Belk and Kohl’s, our three largestcustomers, accounted for 22%, 21% and 11%, respectively, of our total net salesin fiscal 2007.

We believe we have strongrelationships with our customers. We have over 600 customers, representing over3,800 individual retail store locations. Our top ten customers accounted forapproximately 72% of net sales for fiscal 2007. 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 continuing to seek new relationships and expand ourpresence to new points of sale.

**Competition**

The retail apparel industryis highly competitive and fragmented. Our competitors include numerous appareldesigners, manufacturers,importers, licensors and our own customers’ private label programs, many ofwhich are larger and have greater financial and marketing resources than wehave available to us. We believe that the principal competitive factors in theindustry are:

·                  consistent fit;

·                  product quality;

·                  styling;

·                  price;

·                  brand name and brand identity; and

·                  reliability of deliveries.

We strive to focus on thesepoints and respond quickly to customer demands with our range of products andour ability to operate within the industry’s production and delivery constraints. Based on customer feedback, webelieve that our continued dedication to customer service, product assortment and consistency, qualitycontrol and pricing enable us to compete effectively. We believe that ourestablished brand and relationships with retailers have resulted in a loyalfollowing of consumers asevidenced by increased orders from many of our customers.

4

----

 

**Trademarks**

The “Rafaella” and “VVerrazano” (stylized) brand names, which are our material trademarks, areregistered in the United States and in certain foreign jurisdictions for use inthe women’s sportswear market. We do not have rights to these marks for otherproduct categories. We regard these trademarks and other proprietary rights asvaluable assets and from time to time we take action to protect our trademarksagainst infringement.

**InformationSystems**

We have no dedicatedinformation technology team and rely on third-party providers fortelecommunications, Electronic Data Interchange, or EDI, applications and othersupport. Our financial and operational information and reporting needs are met by a software package written exclusivelyfor apparel companies and further customized for our needs by a third partysoftware development and maintenance firm. We lease substantially all of ourcomputer equipment and contract with third parties to maintain backup systems.

Our customers can elect touse EDI to trade and process orders with us on a simplified and expeditedbasis. We use EDI with certain customers to provide advance-shipping notices,process orders and conduct billing operations. In addition, certain othercustomers use EDI to communicate to us their weekly inventory requirements on astore-by-store basis. As of June 30, 2007, we had 47 customers that use EDI tocommunicate with us. In fiscal 2007, total sales to these customers wereapproximately 87% of our overall total sales.

**Imports,Import Restrictions and Other Government Regulations**

***Imports andImport Restrictions***

Our transactions with ourforeign suppliers are subject to the risks of doing business abroad. Importsinto the United States are affected by, among other things, the cost andavailability of transportation of the products and the imposition of importduties and restrictions. The countries that we source our products from may,from time to time, impose new quotas, tariffs, duties or other restrictions oradjust prevailing quota, duty or tariff levels, or take other economic actions,which could affect our ability to import products at the current or increasedlevels. Imports into the United States can also be subjected to variousrestrictions and the assessment of punitive antidumping duties or countervailingduties when goods are shipped to the U.S. at less than fair value (dumping) orwith subsidies from the exporting nation. Bills have been introduced and arepending in Congress which, if enacted, would make it easier for countervailingduty cases to be filed against China. Other bills would hold China 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. Wecannot predict the likelihood or frequency of any such events occurring.

On November 8, 2005, thegovernments of the United States and China entered into a Memorandum ofUnderstanding that took effect on January 1, 2006, and that established agreedquota levels on several textile categories including products imported by us.The quota agreement, which extends to December 31, 2008, allows for annualimport growth in all categories. The bilateral agreement eliminates some of theuncertainty inherent in unilateral safeguard actions. To the extent oursuppliers are not able to acquire sufficient amounts of export quota forcovered products or the cost of acquiring such quota increases, we may belimited or prevented from acquiring products from our foreign suppliers basedin China or the cost of our products imported from China may rise, in whichcase our operations could be seriously disrupted and our business negativelyimpacted until alternative suppliers are found. 

5

----

 

We monitor these and otherduty, tariff and quota related developments and continually seek to minimizeour potential exposure to quota related risks through, among other measures, shifts of productionamong countries and manufacturers.

In addition to the factorsoutlined above, our import operations may be adversely affected by political oreconomic instability resulting in the disruption of trade from exportingcountries, any significant fluctuations in the value of the dollar againstforeign currencies and restrictions on the transfer of funds.

***Other GovernmentRegulation***

We are subject to federal,state and local laws and regulations regarding our business. These include theConsumer Product Safety Act, the Textile Fiber Product Identification Act, theFlammable Fabric Act and the rules and regulations of the Federal Trade Commission and theConsumer Product Safety Commission, or the CPSC. Under the Flammable FabricsAct, we have elected to file a continuing guaranty with the CPSC and, inconnection with this continuing guaranty, we are required to maintain writtenrecords that show that the guaranty is based on test results which demonstrateconformance with reasonable and representative tests prescribed by the CPSC. Webelieve that we are in compliance in all material respects with all applicablegovernmental regulations.

**Employees**

As of June 30, 2007, we hadapproximately 167 employees, of whom approximately 72 were employed in New Yorkand approximately 95 were employed in New Jersey. We are not a party to anylabor agreements and none of our employees are represented by a union. Weconsider our relationship with our employees to be good and have notexperienced any interruption of our operations due to labor disputes with our employees.

**LegalProceedings**

On January 16, 2004, our predecessor, RafaellaSportswear, Inc. (“RSI”) received a letter from U.S. Customs and BorderProtection (“U.S. Customs”) making arrangements for the conduct of a FocusedAssessment audit of RSI.  The audit beganwith a Pre-Assessment Survey (“PAS”) of calendar year 2003 (with a potentialfor extension until June 30, 2004) to determine if the company’s importingprocess was in compliance with U.S. Customs laws and regulations. On September8, 2004, an Entrance Conference was held to discuss the results U.S. Customsreached in its PAS. The PAS report concluded, in part, that “although thecompany demonstrated that operationally they are conducting Customstransactions in an efficient and adequate operating system(s), [from] the lackof written internal controls, policies and procedures [it] appears that thesesystem(s) are weak”.  The PAS cited a fewexamples leading to their conclusion, including:

·                  lackof a formally documented internal control to assure that the value of importsis properly declared;

·                  lackof a formally documented internal control to assure that classification iscorrectly declared;

·                  internalcontrol of value was not periodically tested and results documented; and

·                  internalcontrol over classification was not periodically tested and results documented.

However, the PAS also noted that:

·                  RSIhad not identified any risks related to value and implemented controlmechanisms; and

·                  RSIhad not identified any risks related to classification and implemented controlmechanisms.

In a (Pre-)Exit Conference held on March 28, 2005,U.S. Customs raised many of the same issues and others and recommended that RSIdevelop and implement various internal controls along with a ComplianceImprovement Plan (“CIP”) to address the deficiencies in documentation ofinternal controls identified by U.S.

6

----

 

Customs.  Subsequent to the exit conference, a reportwas issued which indicated areas in which we were found to be deficient. Webelieve that we have addressed these issues and have submitted a comment letterto U.S. Customs stating as such, which we have requested to have appended tothe report. With respect to value, the report found us to be an acceptable riskand determined that no loss of revenue occurred as a result of our valuation ofour products. As part of the CIP, we have prepared and implemented a writtenpolicy and procedures manual which includes documentation of our internalcontrols relating to customs matters, a copy of which was submitted to U.S.Customs.

In light of the issues that had been identified, U.S.Customs conducted a Focused Assessment follow-up review which began with anadvance conference in October of 2006. The objective of the follow-up review (which focused on Rafaella ApparelGroup, Inc. (“RAG”) customs transactions during the period January 1 throughOctober 31, 2006) was to determine whether the follow-up actions developed inthe prior stage of the review were effectively implemented.

After U.S. Customs’ review of additional requestedinformation and specific transactions selected for review, U.S. Customs issueda draft report in May of 2007 in which it concluded, in part, that “[b]ased onthe Follow-up results of the risk areas identified during the initial FocusedAssessment Pre Assessment Survey, we conclude that Rafaella Apparel Group LLChas adequate internal control over its Customs transactions, and is anacceptable risk to U.S. Customs and Border Protection.”  An exit conference was held with U.S. Customson June 28, 2007 to discuss the draft report, the substance of which was agreedto by both RAG and U.S. Customs.  Thefinal report was received on September 20, 2007.

## **Item 1A.****                                                  RiskFactors**

**RisksRelated to Our Business and Industry**

***Continued consolidation among ourcustomers may harm our business***.

There has been, and continues to be, consolidationactivity in the 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 purchasewomen’s sportswear separates from us, decide to manufacture or source such itemsthemselves.  There is also thepossibility that customers may consolidate with one or more of their othervendors and begin sourcing items from such vendors.  For example, May Department Stores Company,formerly our biggest customer, was acquired by Macy’s, Inc. (“Macy’s”), to whomwe did not historically sell a significant amount of our products.  This acquisition had a negative impact on ourbusiness, because of overlap with Macy’s private label product and a decreasein sales as a result of store closures.

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 in any reportingperiod.

***The concentrationof our customers could adversely affect our business.***

In fiscal 2007, our department and specialty storeschannel accounted for approximately 68% of our total net sales.  In that period, our largest customer in thisdistribution channel, when viewed on a common ownership basis, accounted forapproximately 22% of total net sales across its separate department storechains, each of which has a separate purchasing department.  The other approximately 32% of our total netsales in fiscal 2007 were to off-price retailers and private label sales.

A decision by any of our major customers, whethermotivated by competitive conditions, financial difficulties, change ofownership, change of management or otherwise, to decrease significantly theamount of

7

----

 

merchandise purchasedfrom us, or to change its manner of doing business with us, could substantiallyreduce our revenues and materially adversely affect our profitability.

***Wemay be adversely affected by our limited historical books and records and ourlack of formalized internal controls.***

Our predecessor and itsmanagement maintained very limited records of the corporate actions of ourpredecessor and its subsidiaries, including records relating to stock transfersand actions by our predecessor’s Board of Directors.  In addition, our predecessor’s control procedureswere informal and/or undocumented.  Ourpredecessor was not subject to the requirements of Section 404 of theSarbanes-Oxley Act of 2002 and the rules and regulations of the SECthereunder.  As a result, our predecessor’smanagement did not evaluate or assess its internal control over financialreporting.  In addition, we are not yetrequired to comply with Section 404, and we did not perform formalevaluations or assessments of our internal controls following the June 20, 2005acquisition. We are required to comply with Section 404 during fiscal 2008.Any inadequacies in internal controls may lead to financial statements that maynot be reliable.  Any inadequacies couldalso lead to legal liabilities on the part of our company and could give riseto potential regulatory, creditor, noteholder and/or equityholder actions, anyof which could have a material adverse effect on our business and financialcondition.

***Our business couldbe negatively impacted by the significant changes in and financial instabilityof our customers.***

A number of apparel retailers have experiencedsignificant changes and difficulties over the past several years, includingconsolidation of ownership, increased centralization of buying decisions, theloss of customers to online retailers, difficulties in implementing onlineretailing, 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 could cause us to limitor discontinue business with that customer, require us to assume more creditrisk relating to that customer’s receivables, or limit our ability to collectamounts related to previous purchases by that customer, all of which could harmour business, financial condition and results of operations by causing asignificant decline in revenues attributable to such customers, particularly ifour third-party factor is unwilling to assume the credit risk onreceivables from such customers or limits the amount of credit risk it iswilling to take from such customers.

***Our success dependsin part on the efforts of our management team, some of whom are relatively newto our company or their current positions.***

As of June 20, 2006, Ronald Frankel (Chief ExecutiveOfficer of our predecessor and a former advisor to us), Robert Newman (ourformer Vice President - Sales) and Asher Haddad (our former Vice President -Warehouse) are no longer executive officers of our company althoughMr. Frankel remains a member of our board of directors.  Mr. Frankel co-founded our predecessorand had been primarily responsible for our predecessor’s strategic planning andoversight of merchandising, production and sales. Glenn Palmer served as ourChief Executive Officer from June 20, 2005 until his resignation on April 20,2006. Since April 25, 2006, Christa Michalaros has served as our new ChiefExecutive Officer.  Nichole Vowteras hasserved as our Executive Vice President Sourcing and Production since April 25,2006 and Rosemary Mancino has served as our President of Sales & Planningsince August 14, 2006. We cannot assure you that these new members of ourmanagement team will be effectively integrated with our senior managementrapidly or at all.  In addition, even ifwe are able to integrate our new members of management, it is possible that ournew management team may not be able to successfully execute our strategies,which could have a material adverse effect on our business. 

Competition for qualified personnel in the apparelindustry is intense and we compete for these individuals with other companieshaving greater financial and other resources. As described above, we have recently retained several additions to oursenior management team, which we feel are highly qualified.  Our continued success will depend, insignificant part, upon the continued services of this senior management teamand 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 their experienceand knowledge of our business and their customer and vendor relationships.  We may not be able to replace any of ourexecutive officers with

8

----

 

sufficiently experiencedand qualified personnel.  The temporaryor permanent loss of the services of any member of our senior management team,or our inability to attract and retain other qualified personnel could have amaterial adverse effect on our business, results of operations and financialcondition.

***The extent of ourforeign sourcing and manufacturing may adversely affect our business.***

For fiscal 2007, all of our products were manufacturedoutside the United States, including a significant portion from China.  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 with respect to certain countries,particularly China, the reimposition of quotas with respect to certain productsfrom China and the possible imposition of additional quotas or antidumping orcountervailing duties;

·                  impositionof regulations and quotas relating to imports from certain countries, includingquotas imposed by bilateral textile agreements between the United States andforeign countries;

·                  impositionof duties, taxes and other charges on imports;

·                  significantdevaluation of the dollar against foreign currencies;

·                  restrictionson the transfer of funds to or from foreign countries;

·                  politicalinstability, military conflict or terrorism involving the United States or anyof the many countries where our products are manufactured, which could cause adelay in transportation or an increase in costs of transportation, rawmaterials or finished product or otherwise disrupt our business operations;

·                  disease,epidemics and health-related concerns, such as SARS or the mad cow orhoof and mouth disease outbreaks in recent years, which could result in closedfactories, reduced workforces, scarcity of raw materials and scrutiny andembargoing of goods produced in infected areas; and

·                  violationsby foreign contractors of labor and wage standards and resulting adversepublicity.

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.

***Our reliance onthird-party manufacturers could cause delays, adversely affect operationsand 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 of third-partymanufacturers to assemble or produce finished goods and the resulting lack ofdirect control could subject us to difficulty in obtaining timely delivery ofproducts of acceptable quality.  We donot have long-term contracts with any of our manufacturers and an unexpectedinterruption in supply from any of our manufacturers could disrupt ouroperations until a suitable alternate manufacturer can be found and supplyrestored.  Even if an alternatemanufacturer can be found promptly, such manufacturer may not be able toprovide us with products or manufacturing services of a comparable quality, atan acceptable price or on a timely basis. As a result, our business relationship with our customers purchasingsuch products, or any products incorporating such products or services, may beterminated, reduced or otherwise modified by such customer.  There can be no assurance that there will notbe 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 timelymanner, or that a customer will not terminate, reduce or otherwise modify itsbusiness relationship with us as a result thereof.  The failure of any third-partymanufacturer to perform, 

9

----

 

or the loss or reductionof 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 orotherwise modify their business relationships with us.  Any such publicity, or resulting change inany of our customer business relationships, could also have a material adverseeffect on our business, results of operations and financial condition.

***We need significantworking capital to fund our operations, a substantial portion of which isfinanced, and our inability to continue to finance such working capital couldaffect our marketing and sales efforts because our ability to purchaseinventory would be curtailed.***

We need significant working capital to purchaseinventory and are often required to post letters of credit when placing anorder with one of our third-party manufacturers or fabric suppliers.  We expect to meet our working capital needsprimarily through our operating cash flow but we  may also utilize our senior revolving creditfacility, pursuant to which we have been able to obtain a line of credit andletters of credit.  If we are unable tomeet the covenants in our senior revolving 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.

***Competition in theapparel industry could reduce our sales and our profitability.***

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

·                  establishingand maintaining favorable brand recognition;

·                  developingproducts that appeal to consumers;

·                  pricingproducts appropriately; and

·                  obtainingaccess to, and sufficient floor space in, retail stores.

The apparel industry is highly fragmented and includesa number of very large companies, many of which have greater financial,technical and marketing resources, greater manufacturing capacity and moreextensive and established customer relationships than we do.  The competitive responses encountered fromthese larger, more established apparel companies may be more aggressive andcomprehensive than we anticipate and we may not be able to compete effectively.  Additionally, in response to the continuedconsolidation of our customers, our competitors may consolidate as well inorder to increase their ability to service customers.  The competitive nature of the apparelindustry may result in lower prices for our products and decreased gross profitmargins, which may materially adversely affect our sales and profitability.

***The apparelindustry is subject to pricing pressures that may cause us to lower the priceswe charge for our products.***

Prices in the apparel industry have been decliningover 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 

10

----

 

competitive, we may haveto adjust our prices from time to time in response to these industry-widepricing pressures.  Moreover, increasingcustomer demands for allowances, incentives and other forms of economic supportreduce our gross margins.  Our financialperformance may be materially and adversely affected by these pricingpressures, if we are forced to reduce our prices and we cannot reduce ourproduction costs, or if our production costs increase and we cannot increaseour prices.

***Our business willsuffer if we fail to continually anticipate customer tastes.***

Customer tastes change rapidly.  We may not be able to anticipate, gauge orrespond to these changes in a timely manner. If we misjudge the market for our products or product groups or if wefail to identify and respond appropriately to changing consumer demands, we maybe faced with a significant amount of unsold finished goods inventory, whichcould materially adversely affect our expected operating results and financialcondition and decrease our sales, gross margins and profitability.

The apparel industry has relatively long lead timesfor the design and production of products. Consequently, we must commit in some cases to production in advance oforders based on forecasts of consumer demand. If we fail to forecast consumer demand accurately, we may underproduceor overproduce a product and encounter difficulty in filling customer orders orin liquidating excess inventory. Additionally, if we overproduce a product based on an aggressiveforecast of consumer demand, retailers may not be able to sell the product inamounts and at prices they deem acceptable and may expect sales allowances andcancel future orders.  These outcomescould have a material adverse effect on our sales, brand image and financialconditions seriously affecting our profitability.

***Our revenues andprofits are sensitive to consumer confidence and spending patterns.***

The apparel industry has historically been subject tocyclical variations, recessions in the general economy or uncertaintiesregarding future economic prospects that affect consumer spending habits whichcould negatively impact our business overall and specifically our sales, grossmargins and profitability.  The successof our operations depends on consumer spending. Consumer spending is impacted by a number of factors, including actualand perceived economic conditions affecting disposable consumer income (such asunemployment, wages and salaries), business conditions, interest rates,availability of credit and tax rates in the general economy and in theinternational, regional and local markets where our products are sold.  Any significant deterioration in generaleconomic conditions or increases in interest rates could reduce the level ofconsumer spending and inhibit consumers’ use of credit.  In addition, war, terrorist activity or thethreat of either may adversely affect consumer spending, and thereby have amaterial adverse effect on our financial condition and results of operations.

***Fluctuations in theprice, availability and quality of fabrics could cause production delays andincrease 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 a portion of the higher raw materialsprices and related transportation costs on to our customers.

***Because we sell ourproducts on a purchase order basis and rely on estimated forecasts of ourcustomers’ needs, inaccurate forecasts could adversely affect our business.***

We sell our products pursuant to individual purchaseorders instead of long-term purchase commitments.  Therefore, we rely on estimated demandforecasts, based upon formal and informal input from our customers andnon-binding indications of our customers’ initial orders given during andshortly following market weeks, to determine how much material to purchase andproduct to manufacture.  Because oursales are based on purchase orders, our customers may cancel, delay orotherwise modify their purchase commitments with little or no 

11

----

 

consequence to them andwith little or no notice to us.  In addition,we cannot provide assurance as to the quantities or timing required by ourcustomers for our products.  Whether inresponse 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.

***We cannot predicthow import restrictions will impact our business.***

Our transactions with our foreign suppliers aresubject to the risks of doing business abroad. Imports into the United Statesare affected by, among other things, the cost and availability oftransportation of the products and the imposition of import duties andrestrictions. The countries that we source our products from may, from time totime, impose new quotas, tariffs, duties or other restrictions or adjustprevailing quota, duty or tariff levels, or take other economic actions, whichcould affect our ability to import products at the current or increased levels.Imports into the United States can also be subjected to various restrictionsand the assessment of punitive antidumping duties or countervailing duties whengoods are shipped to the U.S. at less than fair value (dumping) or withsubsidies from the exporting nation. Bills have been introduced and are pendingin Congress which, if enacted, would make it easier for countervailing dutycases to be filed against China. Other bills would hold China accountable forcurrency 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. Wecannot predict the likelihood or frequency of any such events occurring.

On November 8, 2005, the governments of the UnitedStates and China entered into a Memorandum of Understanding that took effect onJanuary 1, 2006, and that established agreed quota levels on several textilecategories including products imported by us. The quota agreement, whichextends to December 31, 2008, allows for annual import growth in allcategories. The bilateral agreement eliminates some of the uncertainty inherentin unilateral safeguard actions. To the extent our suppliers are not able toacquire sufficient amounts of export quota for covered products or the cost ofacquiring such quota increases, we may be limited or prevented from acquiringproducts from our foreign suppliers based in China or the cost of our productsimported from China may rise, in which case our operations could be seriouslydisrupted and our business negatively impacted until alternative suppliers arefound.

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.

12

----

 

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 toprotect our trademarks and other intellectual property rights or expand our useof our trademark outside of the women’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.

***The requirements ofcomplying with the Exchange Act and the Sarbanes-Oxley Act may strain ourresources and distract management.***

Weare subject to the Securities Exchange Act of 1934, as amended, or the ExchangeAct, and the Sarbanes-Oxley Act of 2002. These requirements may place a strainon our systems and resources. The Sarbanes-Oxley Act requires that we maintainand certify that we have effective disclosure controls and procedures andinternal control over financial reporting. Pursuant to Section 404 of theSarbanes-Oxley Act, starting with our fiscal 2008 annual report on Form 10-K,our management will be required to deliver a report that assesses theeffectiveness of our internal control over financial reporting and anattestation report of our auditors on the operating effectiveness of suchinternal control. In order to maintain and improve the effectiveness of ourdisclosure controls and procedures and internal control over financialreporting, significant resources and management oversight will be required aswe may need to devote additional time and personnel to legal, financial andaccounting activities to ensure our ongoing compliance with the public companyreporting requirements. Despite these efforts, we may not be able to completethe documentation and management assessment required by Section 404 of theSarbanes-Oxley Act when it becomes applicable to us, which could expose us to legalliabilities on the part of our company and could give rise to potentialregulatory, creditor, noteholder and/or equityholder actions.

Inaddition, the effort to prepare for these obligations 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, we may need to hire additional accountingand financial staff and might not be able to do so in a timely fashion. We areworking to identify those areas in which changes should be made to ourfinancial and management control systems to manage our growth and obligationsunder the Exchange Act and the Sarbanes-Oxley Act, and to make such changes.The costs associated therewith could be significant.

***Many of ourcustomers require our compliance with their vendor operating policies andprocedures.***

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 financial penaltiesto our customers, which could become significant if there is widespreadnon-compliance.  In addition, ourcustomers may decline to order additional products from us in the event we areconsistently unable to comply with the relevant standards and procedures.

13

----

 

**RisksRelated to Our Indebtedness**

***Our substantial debt couldadversely affect our financial health.***

We have a substantial amount of debt. As of June 30,2007, we had approximately $138.5 million at maturity of senior secured notesoutstanding, excluding interest accrued thereon, and the ability to utilize $19.8 millionof availability under our credit facility for letters of credit and loans,subject to compliance with our financial and other covenants and the terms setforth therein. Our substantial debt could have important consequences to holdersof our senior secured notes. For example, it could:

·                  makeus vulnerable to general adverse economic and industry conditions;

·                  limitour ability to obtain additional financing for future working capital, capitalexpenditures, product development efforts, strategic acquisitions and othergeneral corporate requirements;

·                  exposeus to interest rate fluctuations because the interest on the debt under ourrevolving credit facility is at variable rates;

·                  requireus to dedicate a substantial portion of our cash flow from operations topayments on our debt, thereby reducing the availability of our cash flow foroperations and other purposes;

·                  limitour flexibility in planning for, or reacting to, changes in our business andthe industry in which we operate; and

·                  place us at acompetitive disadvantage compared to our competitors that may haveproportionately 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 refinanceour obligations depends on our successful financial and operating performance.We cannot assure you that our operating performance, cash flow and capitalresources will be sufficient for payment of our debt in the future. Ourfinancial and operating performance, cash flow and capital resourcesperformance depend upon prevailing economic conditions, and certain financial,business and other factors, many of which are beyond our control. These factorsinclude, among others:

·                  economicand competitive conditions affecting the market for our products and the women’sapparel market generally;

·                  operatingdifficulties, increased operating costs or pricing pressures we may experience;and

·                  increased rawmaterial 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 eventthat we are required to dispose of material assets or operations or restructureour debt to meet our debt service and other obligations, we cannot assure youas to the terms of any such transaction or how soon any such transaction couldbe completed, if at all.

***Theterms of our indebtedness impose significant operating and financial restrictionson us, which may prevent us from pursuing certain business opportunities andtaking certain actions.***

Our senior revolving creditfacility and the indenture governing the notes impose significant operating andfinancial restrictions on us.  These restrictionslimit or prohibit, among other things, our ability to:

·                  declaredividends or redeem or repurchase capital stock;

14

----

 

·                  prepay,redeem or repurchase debt (including the notes);

·                  incurliens;

·                  makeloans and investments;

·                  guaranteeor incur additional debt;

·                  amendor otherwise alter terms of debt (including the notes);

·                  engagein mergers, acquisitions and other business combinations;

·                  sellassets;

·                  makecapital expenditures;

·                  transactwith affiliates; and

·                  alterthe business we conduct.

In addition, our senior revolving credit facility alsoincludes the following financial covenants:

·                  aminimum working capital requirement; and

·                  arolling six-month period no-loss provision.

Certain of these financial covenants will 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 our seniorrevolving credit facility, which in turn would trigger a default under oursenior secured notes.  If any suchdefault occurs, the holders of the 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 our senior revolving credit facility and/or the noteswere to be accelerated, we cannot assure you that our assets would besufficient to repay in full our senior secured notes and our other debt.

## **ITEM 2.****                                                     PROPERTIES**

We maintain our headquarters in a 30,000 square footoffice facility at 1411 Broadway in New York, New York. The headquarters housesour design studio and sales showroom, in addition to our sourcing, finance andadministrative functions. Our warehouse and distribution facility occupiesapproximately 114,000 square feet in Bayonne, New Jersey. Both facilities areleased at market rents, with the leases in New York and New Jersey expiring inJanuary 2013 and December 2008, respectively. In addition, we lease third-partystorage and distribution facilities on a month-to-month basis and pay a fee peritem shipped by the third party on our behalf. We own no real property orfacilities.

## **ITEM 3.**                                                     **LEGAL PROCEEDINGS**

On January 16, 2004, our predecessor, RafaellaSportswear, Inc. (“RSI”) received a letter from U.S. Customs and Border Protection(“U.S. Customs”) making arrangements for the conduct of a Focused Assessmentaudit of RSI.  The audit began with aPre-Assessment Survey (“PAS”) of calendar year 2003 (with a potential forextension until June 30, 2004) to determine if the company’s importing processwas in compliance with U.S. Customs laws and regulations. On September 8, 2004,an Entrance Conference was held to discuss the results U.S. Customs reached inits PAS. The PAS report concluded, in part, that “although the company demonstratedthat 

15

----

 

operationally they areconducting Customs transactions in an efficient and adequate operatingsystem(s), [from] the lack of written internal controls, policies andprocedures [it] appears that these system(s) are weak”.  The PAS cited a few examples leading to theirconclusion, including:

·                  lackof a formally documented internal control to assure that the value of importsis properly declared;

·                  lackof a formally documented internal control to assure that classification iscorrectly declared;

·                  internalcontrol of value was not periodically tested and results documented; and

·                  internalcontrol over classification was not periodically tested and results documented.

However, the PAS also noted that:

·                  RSIhad not identified any risks related to value and implemented controlmechanisms; and

·                  RSIhad not identified any risks related to classification and implemented controlmechanisms.

In a (Pre-)Exit Conference held on March 28, 2005,U.S. Customs raised many of the same issues and others and recommended that RSIdevelop and implement various internal controls along with a ComplianceImprovement Plan (“CIP”) to address the deficiencies in documentation ofinternal controls identified by U.S. Customs. Subsequent to the exit conference, a report was issued which indicatedareas in which we were found to be deficient. We believe that we have addressedthese issues and have submitted a comment letter to U.S. Customs stating assuch, which we have requested to have appended to the report. With respect tovalue, the report found us to be an acceptable risk and determined that no lossof revenue occurred as a result of our valuation of our products. As part ofthe CIP, we have prepared and implemented a written policy and proceduresmanual which includes documentation of our internal controls relating tocustoms matters, a copy of which was submitted to U.S. Customs.

In light of the issues that had been identified, U.S.Customs conducted a Focused Assessment follow-up review which began with anadvance conference in October of 2006. The objective of the follow-up review (which focused on Rafaella ApparelGroup, Inc. (“RAG”) customs transactions during the period January 1 throughOctober 31, 2006) was to determine whether the follow-up actions developed inthe prior stage of the review were effectively implemented.

After U.S. Customs’ review of additional requestedinformation and specific transactions selected for review, U.S. Customs issueda draft report in May of 2007 in which it concluded, in part, that “[b]ased onthe Follow-up results of the risk areas identified during the initial FocusedAssessment Pre Assessment Survey, we conclude that Rafaella Apparel Group LLChas adequate internal control over its Customs transactions, and is anacceptable risk to U.S. Customs and Border Protection.”  An exit conference was held with U.S. Customson June 28, 2007 to discuss the draft report, the substance of which was agreedto by both RAG and U.S. Customs.  Thefinal report was received on September 20, 2007.

## **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.

16

----

 

# **PART II**

**ITEM 5.****                                                MARKETFOR THE REPORTING ENTITY’S COMMON STOCK AND RELATEDSTOCKHOLDER MATTERS**

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, is ownedby RSW 2005, Inc.  RA CerberusAcquisition, LLC (“Acquisition Co.”), controlled by affiliates of CerberusCapital Management, L.P. (“Cerberus”), owns 100% of the Company’s convertiblepreferred stock, which is convertible at its option into common stock equal to67.5% of the Company’s outstanding fully-diluted common stock.

No dividends have been declared.  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 Financing Agreement, dated June 20,2005, between the Company and HSBC Bank USA, National Association and theindenture governing our 11 1⁄4% Senior Secured Notes due 2011.

The Company has adopted an equity incentive plan.  As of June 30, 2007, 1,111,111 options and awardshave been granted pursuant to this plan.

## **ITEM 6.**                                                     **SELECTED FINANCIAL DATA**

The historical consolidated financial data includedbelow and elsewhere in this Annual Report are not necessarily indicative offuture performance.  The followingselected financial data should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”, andour audited consolidated financial statements and related notes includedelsewhere in this Annual Report.

The summary selected historical financial datapresented below is for our predecessor for the fiscal years ended June 30, 2003and 2004 and for the period from July 1, 2004 through June 19, 2005 and, forus, for the period from June 20, 2005 through June 30, 2005 and the fiscalyears ended June 30, 2007 and 2006.  Thistable should be read in conjunction with the Company’s Consolidated FinancialStatements and Notes appearing elsewhere in this Annual Report.

 

17

----

** **

**RAFAELLAAPPAREL GROUP, INC.**
| ** **                                                      | ** ** | ** **                                     | ** ** | ** **                                                                     | ** ** | **Predecessor**                                                                 | ** ** | **Successor(1)**                               | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                      | ** ** | **Fiscal Year  Ended June 30,** | ** ** | **Period from   July 1, 2004  through June 19,** | ** ** | **Period from   June 20, 2005  through June 30,** | ** ** | **Fiscal Year  Ended June 30,** | ** ** |
| ** **                                                      | ** ** | **2003**                                       | ** ** | **2004**                                                                       | ** ** | **2005**                                                                        | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                                      | ** ** | **(Dollars in thousands)**           | ** ** |
| **Income Statement Data:**                                      | ** ** | ** **                                     | ** ** | ** **                                                                     | ** ** | ** **                                                                      | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                       |       | $                                              | 165,083    |                                                                           | $          | 205,663                                                                         |       | $                                              | 225,558    |   |  $            4,215 |   | $ | 222,187 |   | $ | 191,284 |   |
| Cost of sales                                                   |       | 106,463                                        |       | 127,531                                                                        |       | 138,883                                                                         |       | 3,074                                          |       | 148,555 |   | 127,170 |   |
| Gross profit                                                    |       | 58,620                                         |       | 78,132                                                                         |       | 86,675                                                                          |       | 1,141                                          |       | 73,632 |   | 64,114 |   |
| Selling, general and  administrative expenses                   |       | 16,152                                         |       | 16,795                                                                         |       | 17,509                                                                          |       | 971                                            |       | 29,938 |   | 30,951 |   |
| Operating income                                                |       | 42,468                                         |       | 61,337                                                                         |       | 69,166                                                                          |       | 170                                            |       | 43,694 |   | 33,163 |   |
| Other expense (income):                                         |       |                                           |       |                                                                           |       |                                                                            |       |                                           |       |   |   |   |   |
| Interest                                                        |       | 627                                            |       | 464                                                                            |       | 1,079                                                                           |       | 664                                            |       | 22,631 |   | 23,884 |   |
| Other                                                           |       | —                                         |       | 766                                                                            |       | (47                                                                             | )          | —                                         |       | — |   | — |   |
| Total other expense  (income)                                   |       | 627                                            |       | 1,230                                                                          |       | 1,032                                                                           |       | 664                                            |       | 22,631 |   | 23,884 |   |
| Income (loss) before  provision for (benefit from) income taxes |       | 41,841                                         |       | 60,107                                                                         |       | 68,134                                                                          |       | (494                                           | )          | 21,063 |   | 9,279 |   |
| Provision for (benefit  from) income taxes (2)                  |       | 1,682                                          |       | 2,151                                                                          |       | 2,249                                                                           |       | (212                                           | )          | 8,463 |   | 2,999 |   |
| Net income (loss)                                               |       | 40,159                                         |       | 57,956                                                                         |       | 65,885                                                                          |       | (282                                           | )          | 12,600 |   | 6,280 |   |
| **Balance Sheet Data (at end of  period):**                     |       |                                           |       |                                                                           |       |                                                                            |       |                                           |       |   |   |   |   |
| Cash and cash  equivalents                                      |       | $                                              | 35         |                                                                           | $          | 28                                                                              |       | —                                         |       |  $                 52 |   | $ | 27,273 |   | $ | 11,390 |   |
| Accounts receivable                                             |       | 9,040                                          |       | 18,115                                                                         |       | —                                                                          |       | 23,180                                         |       | 22,510 |   | 20,785 |   |
| Inventories                                                     |       | 34,122                                         |       | 45,717                                                                         |       | —                                                                          |       | 52,120                                         |       | 47,054 |   | 44,375 |   |
| Total assets                                                    |       | 47,042                                         |       | 64,387                                                                         |       | —                                                                          |       | 213,954                                        |       | 223,195 |   | 193,804 |   |
| Current portion of  senior secured notes                        |       | —                                         |       | —                                                                         |       | —                                                                          |       | —                                         |       | 17,265 |   | 234 |   |
| Senior secured notes                                            |       | —                                         |       | —                                                                         |       | —                                                                          |       | 163,439                                        |       | 147,157 |   | 133,144 |   |
| Total liabilities                                               |       | 25,336                                         |       | 33,804                                                                         |       | —                                                                          |       | 200,233                                        |       | 196,874 |   | 160,962 |   |
| Redeemable convertible  preferred stock                         |       | —                                         |       | —                                                                         |       | —                                                                          |       | 40,110                                         |       | 44,110 |   | 48,110 |   |
| Total stockholders’  equity (deficit)                      |       | 21,706                                         |       | 30,583                                                                         |       | —                                                                          |       | (26,389                                        | )          | (17,789 | ) | (15,268 | ) |
| **Other Financial Data:**                                       |       |                                           |       |                                                                           |       |                                                                            |       |                                           |       |   |   |   |   |
| Net cash flows provided  by (used in):                          |       |                                           |       |                                                                           |       |                                                                            |       |                                           |       |   |   |   |   |
| Operating  activities                                           |       | $                                              | 38,125     |                                                                           | $          | 46,186                                                                          |       | $                                              | 51,201     |   |  $            7,739 |   | $ | 36,765 |   | $ | 16,743 |   |
| Investing activities                                            |       | (154                                           | )          | (38                                                                            | )          | (5                                                                              | )          | (175,045                                       | )          | (283 | ) | (214 | ) |
| Financing  activities                                           |       | (37,973                                        | )          | (46,155                                                                        | )          | (49,366                                                                         | )          | 167,358                                        |       | (9,261 | ) | (32,412 | ) |
| Depreciation and  amortization                                  |       | 133                                            |       | 144                                                                            |       | 125                                                                             |       | 71                                             |       | 5,453 |   | 4,985 |   |
| Capital expenditures                                            |       | 154                                            |       | 38                                                                             |       | 5                                                                               |       | —                                         |       | 95 |   | 214 |   |

----

(1)             On June 20, 2005,pursuant to a Securities Purchase Agreement dated April 15, 2005, as amended,Rafaella Apparel Group, Inc. issued redeemable convertible preferred stock toRA Cerberus Acquisition, LLC for $40.0 million. Immediately prior to the issuance of the preferred stock, RafaellaSportswear, Inc. contributed substantially all of its assets to RafaellaApparel Group, Inc. in exchange for 100% of its common stock and the assumptionof certain liabilities related to the contributed assets.  Immediately following the issuance of thepreferred stock, Rafaella Apparel Group, Inc. redeemed 75% of the common stockheld by Rafaella Sportswear, Inc. for $175.0 million.  The June 20, 2005 acquisition was accountedfor as a purchase in accordance with Financial Accounting Standards No. 141,“Business Combinations,” and Emerging Issues Task Force 88-16, “Basis inLeveraged Buyout Transaction.”  As aresult of the acquisition and the resulting purchase accounting adjustments,the financial statements including and after June 20, 2005 are not comparableto the predecessor periods.

(2)             Our predecessor wastaxed as an S corporation.  A provisionhas been made for certain state and local income taxes applicable to Scorporations.

18

----

 

## **ITEM 7.**                                                 **Management’s Discussion and Analysisof Financial Condition andResults of Operations**

The following is a discussion of our results ofoperations and financial condition.  Thisdiscussion should be read in conjunction with our audited consolidatedfinancial statements and notes included elsewhere in this Annual Report.  The discussion of our results of operationsand financial condition includes various forward-looking statements about ourmarkets, the demand for our products, and our future results and is intended toprovide the reader of our audited consolidated financial statements with anarrative discussion about our business. The discussion is presented in the following sections:

·                  CompanyOverview

·                  CriticalAccounting Policies

·                  Resultsof Operations, and

·                  Liquidityand Capital Resources

We based our statements on assumptions or estimatesthat we consider reasonable.  Actualresults may differ materially from those suggested by our forward-lookingstatements for various reasons including those discussed in Item 1A, “RiskFactors” included elsewhere in this Annual Report.

**COMPANYOVERVIEW**

We are an established designer, sourcer and marketerof a full line of women’s career and casual sportswear separates.  We have been in the women’s apparel businesssince 1982 and market our products primarily under our Rafaella brand.  We design, source and market pants, sweaters,blouses, t-shirts, jackets and skirts for all seasons of the year.  Our in-house design staff develops our linesto include basic styling with updated features and colors using a variety ofnatural and synthetic fabrics.  Using ourdesign specifications, we outsource the production of our clothing line tomanufacturers primarily in Asia, primarily via our agent in Hong Kong, and selldirectly to department, specialty and chain stores and off-priceretailers.  We have over 600 customers,representing over 3,800 individual retail locations.  Our customers include some of the largerretailers of women’s clothing in the United States.

**CriticalTrends; Performance Drivers**

***Primary Revenue Variables***

Our revenues are impacted by the following factors:

·                  customeracceptance of our fabrics and designs;

·                  the performanceof our products within the prevailing retail environment;

·                  the accuracy ofour forecast of demand for our products;

·                  actions of ourcompetitors;

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

·                  overall levelsof consumer spending for apparel;

·                  national andregional economic conditions; and

·                  theeconomic impact of uncontrollable factors, such as terrorism and war.

19

----

 

***Primary Expense 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;

·                  internationaleconomic and political conditions;

·                  fluctuations induties, taxes and other charges on imports;

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

·                  reductions inthe value of our unsold inventories; and

·                  pricingpressures due to competition for manufacturing sources.

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

·                  changes inheadcount and salaries and related fringe benefits;

·                  costs associatedwith product development;

·                  increases inwarehousing and distribution expenses associated with higher sales volumes,outbound transportation expenses impacted by changes in energy costs, and theneed for third party storage or shipping services;

·                  increases inadvertising expenses;

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

·                  costsassociated with regulatory compliance.

***Consolidation in the Industry***

There has been, and continues to be, consolidationactivity in the 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 purchasewomen’s sportswear separates from us, decide to manufacture or source such itemsthemselves.  There is also thepossibility that customers may consolidate with one or  more of their other vendors and beginsourcing items from such vendors.  Forexample, May Department Stores Company, formerly our biggest customer, wasacquired by Macy’s, to whom we did not historically sell a significant amountof our products.  This acquisition had anegative impact on our business, because of overlap with Macy’s private labelproduct and a decrease in sales as a result of store closures.

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 operating proceduresand policies and to alter our products or product mix to provide differentitems such as exclusive merchandise, private label products or more upscalegoods. If we are unable to provide more favorable terms or to developsatisfactory products, programs or systems to comply with any new productrequirements, operating procedures or policies, this could adversely affect ouroperating results in any reporting period.

***Changing Customer 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.

20

----

 

***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

·                  obtainingaccess to, and sufficient floor space in, retail stores.

The apparel industry is highly fragmented and includesa number of very large brands and companies marketing multiple brands, many ofwhich have greater financial, technical and marketing resources, greatermanufacturing capacity and more extensive and established customerrelationships than we do.  We believe wehave maintained prices for our branded products in department and specialtystores at more than 20% 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 profitability.

***Import Restrictions and Regulations***

Our transactions with ourforeign suppliers are subject to the risks of doing business abroad. Importsinto the United States are affected by, among other things, the cost andavailability of transportation of the products and the imposition of importduties and restrictions. The countries that we source our products from may,from time to time, impose new quotas, tariffs, duties or other restrictions oradjust prevailing quota, duty or tariff levels, or take other economic actions,which could affect our ability to import products at the current or increasedlevels. Imports into the United States can also be subjected to variousrestrictions and the assessment of punitive antidumping duties orcountervailing duties when goods are shipped to the U.S. at less than fairvalue (dumping) or with subsidies from the exporting nation. Bills have beenintroduced and are pending in Congress which, if enacted, would make it easierfor countervailing duty cases to be filed against China. Other bills would holdChina accountable for currency manipulation through the assessment of penalduties.  The effect of these changescould be an increase 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. Wecannot predict the likelihood or frequency of any such events occurring.

On November 8, 2005, thegovernments of the United States and China entered into a Memorandum ofUnderstanding that took effect on January 1, 2006, and that established agreedquota levels on several textile categories including products imported by us.The quota agreement, which extends to December 31, 2008, allows for annual importgrowth in all categories. The bilateral agreement eliminates some of theuncertainty inherent in unilateral safeguard actions. To the extent oursuppliers are not able to acquire sufficient amounts of export quota forcovered products or the cost of acquiring such quota increases, we may belimited or prevented from acquiring products from our foreign suppliers basedin China or the cost of our products imported from China may rise, in whichcase our operations could be seriously disrupted and our business negativelyimpacted until alternative suppliers are found. 

21

----

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 factorsoutlined above, our import operations may be adversely affected by political oreconomic instability resulting in the disruption of trade from exportingcountries, any significant fluctuations in the value of the dollar againstforeign currencies and restrictions on the transfer of funds.

***Business Trends following June 20, 2005 (the date ofacquisition)***

During the last fiscal year, there continued to beconsolidation in the retail/apparel industry. As of June 20, 2005, our largest customer, May Department StoresCompany, or May Co., was acquired by Macy’s, with whom we historically havedone substantially less business.  As Macy’stook over operations of May Co., a number of the retail stores in which our productswere sold were closed and Macy’s, due to a perceived product overlap of our casuallines with Macy’s private label product, eliminated many of our products throughouta number of Macy’s stores and as a result, we experienced a decrease in thevolume of sales in the second half of fiscal 2006.  While sales to other existing customersmitigated this decline, this trend continued in fiscal 2007.  We have responded to this situation byupdating our product line offering in an effort to provide new fabrics andstyling to offset this perceived product overlap.  We also saw a reduction in sales due toreduced sales in our off-price channel. In addition, we have begun the process of building an infrastructure tosupport our business and comply with the requirements of the SecuritiesExchange Act of 1934 and the Sarbanes Oxley Act of 2002, including Section 404,which is having the resulting effect of adding costs to operations.

**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 ourestimates and judgments on an ongoing basis. We base our estimates onhistorical experience and on assumptions that we believe to be reasonable underthe circumstances. Our experience and assumptions form the basis for ourjudgments about the carrying value of assets and liabilities that are notreadily 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 shipped and title and risk ofloss are transferred to customers. Revenue is recorded net of estimated discounts, returns and allowances.Discounts are based on trade terms. Returns and allowances require pre-approval from management.  On a seasonal basis, we negotiate price allowanceswith our customers as sales incentives or for the cost of certainpromotions.  We estimate these allowancesbased on historic trends, seasonal results, an evaluation of current economicconditions and retailer performance.

*Income Taxes*. We are organized under Delaware lawas a corporation and will be treated as a corporation for United States federalincome tax purposes under the Internal Revenue Code of 1986, as amended, or theCode. Our predecessor filed tax returns as a “Subchapter S” corporation andtreated its subsidiary as a “qualified subchapter S subsidiary” under the Code.Our effective tax rate will vary, as did that of our predecessor, based on

 

22

----

the level of businessconducted in those states in which we file, as well as changes made to the taxrates 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 out 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, 2007, we concluded that avaluation allowance was not necessary.

*Receivables*. Receivables consist of trade accountsreceivable and receivables that are assigned to a commercial factor, net ofdiscounts and allowances.  We factorcertain trade receivables, on a non-recourse basis with a commercial factor,except that we assume credit risk for those receivables that do not receivewritten approval from the factor.  Thefactor collects all cash remittances on receivables factored and assumes creditrisk on all sales that are approved in advance by the factor.  An allowance for sales discounts, returns,allowable customer 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.

*Inventories*. Substantially all of the inventorywe purchased in fiscal year 2007 was produced in Asia. Inventory costs includefinished garments, fabric, contractor labor, duty, freight, and costsassociated with our buying agents (which typically include a buying commissionof 1-3% of the full cost of the finished garment before shipping costs andcustoms duties). Inventories are stated at the lower of cost or market, withcost being determined by the first-in, first-out (FIFO) method. Inventoriesconsist of raw materials (primarily piece goods at our contractors),merchandise in transit and finished goods in warehouses. We take ownership ofthe finished goods when they are shipped from Asia and management records themerchandise in transit balance based on documentation provided by our buyingagents. Slow-moving finished goods inventories are written down to estimatednet realizable value based on estimated sales prices less costs of disposal.

*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 7 years.  Leasehold improvements areamortized over the shorter of the remaining lease term or the estimated usefullives of the assets.  Expenditures formaintenance and repairs are expensed in the period incurred.

Intangible assets consist of the trademark and tradename, and customer relationships of the Predecessor, and non-compete agreementswith officers of the Predecessor, acquired on June 20, 2005.  Customer relationships are amortized using anaccelerated method over their estimated useful lives of 15 years.  Non-compete agreements are amortized usingthe straight-line method over their estimated useful lives of 2 and 10years.  Owned trademarks have beendetermined to have indefinite lives and are not subject to amortization.

Our policy is to evaluate depreciable and amortizableassets for impairment whenever events or changes in circumstances indicate thatthe carrying amount of such assets may not be recoverable from the undiscountedcash flows expected from the use of the asset. Any impairment loss would be measured as the excess of carrying amountover the fair value of the asset, determined on the basis of discounted cashflows from the expected use of the asset.

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 

23

----

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 contingentliabilities including threatened or pending litigation in accordance withStatement of Financial Accounting Standards No. 5, “Accounting forContingencies,” and records accruals when the outcome of these mattersis deemed probable and the liability may 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.

*Stock-based Compensation.*  Effective July 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123(R) “Share Based Payments” (“SFAS123R”), which revises Statement of Financial Accounting Standards No. 123, “Accountingfor Stock Based Compensation” (“SFAS 123”) and requires companies to expensethe fair value of employee stock options and other forms of stock basedcompensation. The computation of the expenses associated with stock basedcompensation requires the use of a valuation model. The Company currently usesthe Black Scholes option pricing model to calculate the fair value of its stockoptions. 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.  There was no effect from the change of applying the original provisionsof SFAS 123 to the Company’s results of operations and cash flows for the yearended June 30, 2007, as a result of the Company’s adoption of SFAS 123R,effective July 1, 2006. Compensation expense related to stock-based awards wasnot significant to the Company’s consolidated statement of operations for theyear ended June 30, 2007.  Refer to Note2 of the Company’s consolidated financial statements for further information.

**RESULTSOF OPERATIONS**

For discussion purposes only, our fiscal 2005 resultsdiscussed below represent the mathematical addition of the historical resultsfor the Predecessor period from July 1, 2004 through June 19, 2005 and theSuccessor period from June 20, 2005 through June 30, 2005, or the year endedJune 30, 2005.  This approach is notconsistent with generally accepted accounting principles and yields resultsthat are not comparable on a period-to-period basis due to the new basis ofaccounting established at the acquisition date. However, we believe it is the most meaningful way to comment on theresults of operations for 2005 compared to those of 2006 because a discussionof a partial period from July 1, 2004 through June 19, 2005 (Predecessor)separately from the period from June 20, 2005 through June 30, 2005 (Successor)compared to the succeeding and preceding years, would not be meaningful.

The June 20, 2005 acquisition was accounted for as apurchase in accordance with Statement of Financial Accounting Standards No.141, “Business Combinations,” and Emerging Issues Task Force 88-16, “Basis inLeveraged Buyout Transaction.”  As aresult of the acquisition and the resulting purchase accounting adjustments,the financial statements including and after June 20, 2005 are not comparableto the predecessor periods.

24

----

The following table summarizes the historical operations as apercentage of net sales for the fiscal years ended June 30, 2007 and 2006(Successor), and the period from July 1, 2004 to June 19, 2005 (Predecessor)combined with the period from June 20, 2005 to June 30, 2005 (Successor).
| ** **                                    | ** ** | **Year   Ended  June 30, 2007**        | ** ** | **Year  Ended  June 30, 2006** | ** ** | **Combined Year  Ended  June 30, 2005** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                    | ** ** | **(in thousands, except percentages)** | ** ** |
| Net sales                                     |       | $                                                     | 191,284    |                                     | 100.0      | %                                                      | $          | 222,187 |   | 100 | % | $ | 229,773 |   | 100 | % |
| Cost of sales                                 |       | 127,170                                               |       | 66.5                                     |       | 148,555                                                |       | 66.9 |   | 141,957 |   | 61.8 |   |
| Gross profit                                  |       | 64,114                                                |       | 33.5                                     |       | 73,632                                                 |       | 33.1 |   | 87,816 |   | 38.2 |   |
| Selling, general  and administrative expenses |       | 30,951                                                |       | 16.2                                     |       | 29,938                                                 |       | 13.5 |   | 18,480 |   | 8.0 |   |
| Operating income                              |       | 33,163                                                |       | 17.3                                     |       | 43,694                                                 |       | 19.7 |   | 69,336 |   | 30.2 |   |
| Other expenses                                |       |                                                  |       |                                     |       |                                                   |       |   |   |   |   |   |   |
| Interest expense, net                         |       | 23,884                                                |       | 12.5                                     |       | 22,631                                                 |       | 10.2 |   | 1,743 |   | — |   |
| Other income                                  |       | —                                                |       | —                                   |       | —                                                 |       | — |   | (47 | ) | — |   |
| Income before  provision for income taxes     |       | 9,279                                                 |       | 4.9                                      |       | 21,063                                                 |       | 9.5 |   | 67,640 |   | 29.4 |   |
| Provision for  income taxes                   |       | 2,999                                                 |       | 1.6                                      |       | 8,463                                                  |       | 3.8 |   | 2,037 |   | 0.9 |   |
| Net income                                    |       | $                                                     | 6,280      |                                     | 3.3        | %                                                      | $          | 12,600 |   | 5.7 | % | $ | 65,603 |   | 28.6 | % |

 

***Year ended June 30, 2007 compared to year endedJune 30, 2006***

***Netsales***.  Net salesfor the year ended June 30, 2007 was $191.3 million.  As compared to net sales of $222.2 millionfor the year ended June 30, 2006, net sales decreased by approximately $30.9million or 13.9%.  The decrease in netsales was principally due to an increase in customer allowances given ($3.2 million),a decrease in volume (approximately 10%), and a slight decrease in averagerevenue per unit (approximately 1%). The decrease in customer sales wasprimarily attributed to reductions in net sales of approximately $38.7 millionrelated to four customers offset by increases in customer net sales of $5.5million related to three customers.

***Grossprofit***.  Grossprofit for the year ended June 30, 2007 was $64.1 million.  As a percentage of net sales, gross profitover this period was 33.5%.  As comparedto the gross profit of $73.6 million for the year ended June 30, 2006 (33.1% ofnet sales), gross profit decreased by $9.5 million or 12.9%.  The decrease in gross profit was primarilythe result of the impact from reduced gross sales ($28.7 million) andincreased customer discounts, returns and allowances ($2.2 million), inaddition to a $0.9 million charge related to inventory recorded at fairvalue in connection with the acquisition and sold during the period ended June30, 2007 compared with a $9.4 million charge recorded during the period endedJune 30, 2006.

*** Selling, general and administrative expenses***.  Selling, general and administrative expensesfor the year ended June 30, 2007 was $31.0 million.  As compared to selling, general andadministrative expenses of $29.9 million for the year ended June 30, 2006,there was an increase of $1.0 million or 3.4%. Increases in professional fees ($1.8 million) and salaries ($0.4million) were partially offset by decreases in employment fees ($0.5 million),amortization of intangible assets ($0.4 million), and insurance ($0.2million).  As a percentage of net sales,selling, general and administrative expenses was 16.2% for the year ended June30, 2007 and 13.5% for the year ended June 30, 2006.

***Operatingincome***. Operating income for the year ended June 30, 2007 was $33.2million.  As compared to operating incomeof $43.7 million for the year ended June 30, 2006, operating income decreasedby $10.5 million or 24.1%.  The decreasewas due to the decreased gross profit and increases in selling, general andadministrative expenses, as described above.

***Interest******expense, net.***  Interest expense for the year ended June30, 2007 was $23.9 million.  As compared tointerest of $22.6 million for the year ended June 30, 2006, interest increasedby $1.3 million.  The increase ininterest expense resulted from $3.2 million attributed to the write-off ofunamortized original issue discount and deferred financing costs and purchaseconsideration paid in connection with our November 2006 and June 2007 seniorsecured notes repurchases (as further discussed within the “Liquidity andCapital Resources” section below), partially offset by increased interestincome of $0.8 million, and a reduction in interest expense incurred of $1.3million due to our repurchase of senior secured notes and reduced borrowingsunder our line of credit compared with the prior year.

25

----

***Provisionfor income taxes***.  We recorded a provision for income taxes of $3.0million for the year ended June 30, 2007, which represents an effective incometax rate of approximately 32.3%.  For theyear ended June 30, 2006, we recorded a provision for income taxes of$8.5 million, which represents an effective income tax rate of approximately40.2%. The decrease in our effective rate in 2007 is principally due to achange in estimate regarding the allocation of taxable income in certainjurisdictions in 2006.

***Netincome***.  Netincome for the year ended June 30, 2007 was $6.3 million.  Net income as a percentage of net sales forthe full year period ended June 30, 2007 was 3.3%.  As compared to net income of $12.6 millionfor the year ended June 30, 2006, net income decreased by $6.3 million or 50.2%.  This decrease in net income was a result ofthe decrease in operating income, the increase in interest expense and thedecrease in the provision for income taxes, as described above.

***Year ended June 30, 2006 compared to combined yearended June 30, 2005***

***Netsales***.  Net salesfor the year ended June 30, 2006 was $222.2 million.  As compared to net sales of $229.8 millionfor the combined year ended June 30, 2005, net sales decreased by approximately$7.6 million or 3.3%.  The decrease innet sales was principally due to an increase in customer allowances given ($4.3million) and a decrease in volume (approximately 6%), partially offset by aslight increase in average revenue per unit (approximately 5%).

***Grossprofit***.  Grossprofit for the year ended June 30, 2006 was $73.6 million.  As a percentage of net sales, gross profitover this period was 33.1%.  As comparedto the gross profit of $87.8 million for the combined year ended June 30, 2005(38.2% of net sales), gross profit decreased by $14.2 million or 16.2%.  Decreases in gross profit were primarily theresult of the $9.4 million charge related to inventory recorded at fair valuein connection with the acquisition and sold during the current period, inaddition to the impact from reduced net sales dollars.

***Selling,general and administrative expenses***.  Selling, general and administrative expensesfor the year ended June 30, 2006 was $29.9 million.  As compared to selling, general andadministrative expenses of $18.5 million for the combined year ended June 30,2005, there was an increase of $11.4 million or 61.6%.  Amortization of intangible assets ($5.4million), established as a part of the purchase accounting for the acquisition,along with planned additions and increases to salaries ($4.5 million), andinsurance ($0.4 million), were the primary contributors to the overallincreases.  As a percentage of net sales,selling, general and administrative expenses was 13.5% for the year ended June30, 2006 and 8.0% for the combined year ended June 30, 2005.

***Operatingincome***. Operating income for the year ended June 30, 2006 was $43.7million.  As compared to operating incomeof $69.3 million for the combined year ended June 30, 2005, operating incomedecreased by $25.6 million or 36.9%.  Thedecrease was due to the decreased gross profit and increases in selling,general and administrative expenses, as described above.

***Interest******expense, net.***  Interest expense for the year ended June30, 2006 was $22.6 million.  As comparedto interest of $1.7 million for the combined year ended June 30, 2005, interestincreased by $20.9 million.  Increases ininterest were a result of interest recorded for the senior secured notes issuedin connection with the June 20, 2005 acquisition and interest recognized forthe amortization of deferred financing charges in conjunction with the issuanceof those notes.

***Provisionfor income taxes***.  We recorded a provision for income taxes of$8.5 million for the year ended June 30, 2006, which represents an effectiveincome tax rate of approximately 40.2%. For the combined year ended June 30, 2005, we recorded a provision forincome taxes of $2.0 million, which represents an effectiveincome tax rate of approximately 3.0%. The lower effective tax rate for the combined year ended June 30, 2005is a result of our predecessor being an S corporation and the successor companybeing a C corporation.

***Netincome***.  Netincome for the year ended June 30, 2006 was $12.6 million.  Net income as a percentage of net sales forthe full year period ended June 30, 2006 was 5.7%.  As compared to net income of $65.6 millionfor the combined year ended June 30, 2005, net income decreased by $53.0million or 80.8%.  This decrease in netincome was a result of the decrease in operating income, the increase ininterest expense and the increase in the provision for income taxes, asdescribed above.

26

----

**Liquidity and Capital Resources**

Historically, our primaryliquidity and capital requirements have been to fund working capital forcurrent operations, which consists of funding the buildup of inventories andreceivables, and servicing our line of credit. Our liquidity and capital requirements also include making interestpayments on the senior secured notes. The primary source of funds currently used to meet our liquidity andcapital requirements is funds generated from operations, and in the future, mayalso include direct borrowings under our revolving credit facility.

Effective June 20, 2005,we entered into a revolving credit facility with two banks.  The credit facility provides us with arevolving line of credit, which can be used for loans and letters of credit ofup to $62.5 million, with a sublimit for loans of $45.0 million.  Under the credit facility, the aggregatecredit available to us is equal to specified percentages of eligiblereceivables and inventory, plus letters of credit issued for finished goods,subject to adjustment by the banks.  Borrowingsunder the credit facility bear variable interest at the Company’s option ateither (i) the prime rate minus one-half of one percent (0.50%) per annumor (ii) the London interbank offered rate plus two and one-quarter percent(2.25%) per annum (each rate as defined in the credit facility).  The credit facility requires a monthlycommitment fee of 0.25% on the unused portion of the available credit under thecredit facility.  At June 30, 2007, therewere no loans under the revolving credit facility and $18.1 million of lettersof credit outstanding under the credit facility. We had credit availability ofapproximately $19.8 million.

On June 20, 2005, weissued to investors $172.0 million aggregate principal amount at maturity of11.25% senior secured notes due 2011. These notes were issued at 95% of the face value and netted the Companya total of $163.4 million.

The credit facility iscollateralized by substantially all of our assets and expires on June 20,2010.  The senior secured notes arecollateralized by a second priority lien on substantially all of ourassets.  The revolving credit agreementand the indenture to the notes contain various covenants that, among otherthings, place limitations on dividends and repurchases of capital stock,investments, asset sales, incurrence of additional indebtedness and havecross-default provisions.  Further, therevolving credit agreement also contains covenants that require us to reportnet income in quarterly periods subsequent to September 30, 2005 and maintain aminimum level of working capital, which escalates during the term of theagreement.  We amended the net incomecovenant during the year ended June 30, 2007 to require net income on a rollingsix-month period for the periods ended September 30, December 31, March 31 andJune 30.  The working capital covenantwas $40.0 million as of June 30, 2007. As of June 30, 2007, we were in compliance with the financial covenantsincluded in the credit facility and the notes.

Within 100 days after theend of each fiscal year, beginning with the fiscal year ended on June 30, 2006,we must make an offer to repurchase all or a portion of the senior secured notesat 101% of their principal amount at maturity plus accrued and unpaid interestto the date of purchase, with 50% of excess cash flow, as defined, from theprevious fiscal year.  In connection withthe fiscal year ended June 30, 2006, we repurchased $17,429,000 of the seniorsecured notes at 101% of their principal amount at maturity, plus accrued andunpaid interest, for approximately $18.4 million on November 8, 2006.  The Company wrote-off $1.7 million of unamortizedoriginal issue discount and deferred financing costs to interest expense inconnection with the November 8, 2006 excess cash flow repurchase.

We repurchased$16,062,000 of the senior secured notes at 101% of their principal amount atmaturity, plus accrued and unpaid interest, for approximately $16.3 million onJune 29, 2007.  The Company wrote-off$1.4 million of unamortized original issue discount and deferred financingcosts to interest expense in connection with the June 29, 2007 senior securednote repurchase.

We currently estimatethat the annual excess cash flow payment with respect to the fiscal year endedJune 30, 2007, payable on or before November 6, 2007, will be approximately $234,000and have classified this amount in the current portion of senior secured notesin the consolidated balance sheet as of June 30, 2007.

We continue to review thecapital expenditure needs for the business as they relate to informationsystems and infrastructure.  As a result,capital expenditures may increase in future periods; however, we have notfinalized plans for any significant capital expenditure at the presenttime.  We anticipate that we will incurone-time and ongoing expenses, which may be substantial, to improve ourinfrastructure to position us more competitively.  These expenditures will include the hiring ofadditional personnel and improved information technology.

Management believes thatcash flow from operations and available borrowings under our senior revolvingcredit facility will provide adequate resources to meet our capitalrequirements and operational needs for the foreseeable future.

27

----

The following table summarizes our net cash providedby or used in our operating activities, investing activities and financingactivities for the fiscal years ended June30, 2007 and 2006 (Successor), and for the period from July 1, 2004 to June 19,2005 (Predecessor) combined with the period from June 20, 2005 to June 30, 2005(Successor):
| ** **                                                | ** ** | **Year Ended  June 30, 2007** | ** **  | **Year Ended   June 30, 2006** | ** ** | **Combined   Year Ended   June 30, 2005** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|-------------|----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **(in thousands)**                      | ** **  |
| Net cash  provided by (used in):                          |       |                                         |        |                                               |       |                                                               |       |
| Operating  activities                                     |       | $                                            | 16,743      |                                               | $          | 36,765                                                             |       | $ | 58,940 |   |
| Investing  activities                                     |       | (214                                         | )           | (283                                               | )          | (175,050                                                           | )          |
| Financing  activities                                     |       | (32,412                                      | )           | (9,261                                             | )          | 117,992                                                            |       |
| **Net (decrease) increase in cash  and cash equivalents** | ** ** | **$**                                        | **(15,883** | **)**                                              | **$**      | **27,221**                                                         | ** ** | **$** | **1,882** | ** ** |

 

For discussion purposes only, our fiscal 2005 resultsdiscussed below represent the mathematical addition of the historical resultsfor the Predecessor period from July 1, 2004 through June 19, 2005 and theSuccessor period from June 20, 2005 through June 30, 2005, or the year endedJune 30, 2005.  This approach is notconsistent with generally accepted accounting principles and yields resultsthat are not comparable on a period-to-period basis due to the new basis ofaccounting established at the acquisition date. However, we believe it is the most meaningful way to comment on the cashflows for 2005 because a discussion of a partial period consisting of ten daysis not meaningful.

***Operating Activities***

Cash flows provided by operating activities for theyears ended June 30, 2007, 2006 and 2005 were $16.7 million, $36.8 million and$58.9 million, respectively.  Thedecrease in cash flows provided by operating activities from 2006 to 2007 isthe result of lower net income, changes in deferred income taxes, and decreasesin cash flows from working capital related to accounts payable andinventories.  The decrease in cash flowsprovided by operating activities from 2005 to 2006 is the result of lower netincome, net of non-cash charges, principally as a result of the June 20, 2005acquisition, partially offset by decreased working capital requirements.  In 2006, non-cash charges includeddepreciation and amortization of intangible assets and financing costs and theprovision for deferred income taxes. Non-cash charges were not significant in 2005.  Decreased working capital requirementsresulted from a reduction in inventory as prior season merchandise was sold offprior to the acquisition, and an increase in accounts payable and accruedexpenses reflecting changes in our infrastructure.

***Investing Activities***

Net cash used in investing activities for the yearsended June 30, 2007, 2006 and 2005 were $0.2 million, $0.3 million and $175.1million, respectively.  Net cash used ininvesting activities for 2005 principally related to the acquisition, net ofcash acquired.  In 2006, the Companyrecorded a purchase price adjustment of $0.2 million.  Capital expenditures were not significant forany of the periods presented.

***Financing Activities***

Net cash used in financing activities for the yearsended June 30, 2007 and 2006 were $32.4 million and $9.3 million,respectively.  In 2007, cash wasprimarily used to repurchase senior secured notes (discussed in the “Liquidityand Reserves” section above) in the amount of $31.8 million.  In 2006, we repaid borrowings outstandingunder our credit facility totaling $9.3 million.  Net cash provided by financing activities forthe year ended June 30, 2005 was $118.0 million.  Prior to the acquisition, we madedistributions to stockholders of $73.8 million and increased our credit lineborrowings by $24.5 million.  Subsequentto the acquisition, we raised $163.4 million through the issuance of seniorsecured notes, and received $40.0 million for the issuance of redeemableconvertible preferred stock, which was partially offset by the payment of $13.0million for costs related to the issuance of the senior secured notes.  In addition, we repaid $23.0 million of creditline borrowings.

28

----

**Off-BalanceSheet Arrangements**

As of June 30, 2007, we hadoutstanding letters of credit totaling $17.6 million in connection withpurchase orders for merchandise fromthird-party manufacturers and a standby letter of credit in the amount of$450,000 issued by HSBC in favor of the landlord of our New York offices, whichserves as security for our obligations under our lease.

We enter into employment andconsulting agreements with certain of our employees from time to time.  These contracts typically provide for severance and other benefits.  Individually, none of the contracts areexpected to be material, although in the aggregate, our obligations under thesecontracts could be significant.  Additionally,  we have certain operating leases, which aredisclosed in the consolidated financial statements.  The Company has no other off-balance sheetarrangements.

**DueFrom Factor**

We factor certain of ourreceivables to GMAC Commercial Finance LLC, a commercial factor.  The receivables are sold to GMAC on anon-recourse basis, subject to adjustment for sales discounts, sales returns,markdown allowances, miscellaneous charges and disputes.  Upon a sale, GMAC assumes the credit andcollection risk.  We do not borrow fromour factor and the amount due from the factor is pledged to our revolvingcredit facility lenders as security for amounts outstanding under our revolvingcredit facility.

**ContractualCash 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)                  |       | $                                        | 138,509    |   | $ | 221 |   | $ |   |   | $ | 138,288 |   | $ |   |   |
| Interest on  senior secured notes (1)      |       | 62,242                                   |       | 15,570 |   | 31,115 |   | 15,557 |   |   |   |
| Operating lease  obligations               |       | 8,235                                    |       | 1,770 |   | 2,887 |   | 2,757 |   | 821 |   |
| Purchase  obligations                      |       | 30,965                                   |       | 30,965 |   |   |   |   |   |   |   |
| Total contractual cash  obligations        |       | $                                        | 239,951    |   | $ | 48,526 |   | $ | 34,002 |   | $ | 156,602 |   | $ | 821 |   |

----

(1)             Thepayment schedule for the senior secured notes and cash interest on our seniorsecured notes does not reflect any reductions in principal from the repurchaseoffer we are required to make from 50% of our excess cash flow (as defined) inthe indenture governing our senior secured notes.

This table does not reflect up to$45 million of direct borrowing availability under our senior revolving creditfacility. The senior revolving credit facility matures on June 20, 2010.

**Effects of Inflation**

 

Althoughour purchases from foreign manufacturers are made in dollars, mitigating any foreign exchange raterisk on purchase commitments, we may be subject to higher prices charged by ourmanufacturers to compensate for inflation or other market forces in suchcountries.

**RecentAccounting Pronouncements**

In June 2006, the Financial Accounting Standards Board(the “FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with FASB Statement No. 109, “Accountingfor Income Taxes”. FIN 48 prescribes a recognition threshold and measurementattribute for financial statement recognition and measurement of a tax positiontaken or expected to be taken in a tax return. FIN 48 also provides guidance onderecognition, classification, interest and

29

----

 

penalties, accounting ininterim periods, disclosure and transition. FIN 48 is effective for fiscalyears beginning after December 15, 2006. The Company is currently analyzing FIN48 and its impact on the Company’s financial condition and results of operations.

On September 13, 2006, the SEC staff issued StaffAccounting Bulletin No. 108, “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements” (“SAB 108”).  SAB 108 wasissued in order to eliminate the diversity of practice surrounding how publiccompanies quantify financial statement misstatements. The adoption of SAB 108did not have an impact on the Company’s financial position or results ofoperations.

On September 15, 2006, the FASB issued FASB StatementNo. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. SFAS 157 is effectivefor fiscal years beginning after November 15, 2007. The Company is currentlyanalyzing SFAS 157 and its impact on the Company’s financial condition andresults of operations.

## **ITEM 7A.****                                            QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT****MARKET RISK**

Market risk represents the risk of loss that mayimpact our financial position, results of operations or cash flows due toadverse changes in financial product market prices and rates. We are exposed tomarket risks, including changes in interest rates and a reduction in the valueof the dollar.

Market risks related to our operations resultprimarily from changes in interest rates. Our interest rate exposure relatesprimarily to our variable interest line of credit. Borrowings under the creditfacility bear variable interest at the Company’s option at either (i) the primerate minus one-half of one percent (0.50%) per annum or (ii) the Londoninterbank offered rate plus two and one-quarter percent (2.25%) per annum (eachrate as defined in the credit facility). There were no loan borrowings orrepayments under the revolving credit facility during the year ended June 30,2007.

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 inU.S. dollars at the time the purchase orders and/or letters of credit areissued, which mitigates the risk of a reduction in the value of thedollar.  However, purchase prices for theCompany’s products may be impacted by fluctuations in the exchange rate betweenthe U.S. dollar and the local currencies of the foreign manufacturers, whichmay have the effect of increasing the Company’s cost of goods in the future.Due to the number of currencies involved and the fact that not all foreigncurrencies react in the same manner against the U.S. dollar, the Company cannotquantify in any meaningful way the potential effect of such fluctuations onfuture income. The Company does not engage in hedging activities with respectto such exchange rate risk.

## **ITEM 8.****                                                     FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

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

30

----

## **ITEM 9.****                                              CHANGESIN AND/OR DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE**

None.

## **ITEM 9A.****                                        CHANGESIN CONTROLS & PROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

 

Our management, with the participation of our ChiefExecutive Officer and our Chief Financial Officer, has evaluated our disclosurecontrols and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act).  Based onthat evaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures were effective to ensure that informationrequired to be disclosed in reports that we file or submit under the ExchangeAct are: (1) recorded, processed, summarized and reported within the timeperiods specified in the SEC's rules and forms; and (2) accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

**Changes in Internal Controls**

 

There have been no changes in our internal controlover financial reporting that have occurred during our fiscal quarter endedJune 30, 2007 that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

31

----

**PARTIII**

**ITEM10.**             DIRECTORSAND OFFICERS OF THE REGISTRANT

**MANAGEMENT**

The following table sets forth certain information regardingthe members of our board of directors and executive officers, as of June 30, 2007.
| Name               | ** ** | ** ** | ** ** | **Age**                                                       | ** ** | **Position** | ** ** | ** ** |
|--------------------|------------|------------|------------|---------------------------------------------------------------|------------|--------------|------------|------------|
| Christa Michalaros |       | 46         |       | Chief Executive Officer  and Director                         |
| Chad Spooner       |       | 35         |       | Chief Financial Officer                                       |
| Rosemary Mancino   |       | 50         |       | President of Sales &  Planning                            |
| Nichole Vowteras   |       | 50         |       | Executive Vice  President Sourcing and Production             |
| Jason Epstein      |       | 33         |       | Chief Information  Officer, Vice President Strategic Planning |
| George Kollitides  |       | 37         |       | Director                                                      |
| Kurt Larsen        |       | 43         |       | Director                                                      |
| Ronald Frankel     |       | 70         |       | Director                                                      |
| Robert Newman      |       | 63         |       | Director                                                      |

 

**ChristaMichalaros**became our Chief Executive Officer and one of ourdirectors on April 25, 2006.  From 1999 to 2005, Ms. Michalaros served asthe President of the Tommy Hilfiger Womenswear Division. Before joining TommyHilfiger, Ms. Michalaros was at Liz Claiborne from 1981 to 1999.  At LizClaiborne, Ms. Michalaros moved up through the sales organization in positionsof increasing responsibility in their casual and career divisions.  Herlast position at Liz Claiborne was the President of Liz Claiborne Casual, anearly one billon dollar division.  All of the aforementioned companiesare principally in the business of women’s apparel.

**Chad Spooner**has been our Chief Financial Officer sinceJune 20, 2005 and prior to that, was part of the Cerberus operations team since2004.  Prior to joining Cerberus,Mr. Spooner was employed by GE, from 1993 to 2004.  During his tenure at GE, Mr. Spoonerheld various positions in manufacturing and finance.  Mr. Spooner held assignments insourcing, engineering and manufacturing in GE’s Manufacturing ManagementProgram.  Subsequent to that,Mr. Spooner spent several years on GE’s Corporate Audit Staff, where heaudited numerous GE industrial and financial services businesses.  He then went on to serve as a Finance Managerfor GE Healthcare Europe in Paris, France. Mr. Spooner was then promoted to GE’s Corporate Financial Planningand Analysis Group, where he covered the financial performance of numerous GEbusinesses.  Following that role,Mr. Spooner became the CFO for GE Energy’s Contractual Service business, aglobal multi-billion dollar turbine maintenance business.

**Rosemary Mancino**became our President of Sales & Planning on June23, 2006.  Ms. Mancino joined Rafaellawith nearly 30 years of retail/apparel experience.  Prior to joining the Rafaella, Ms. Mancinowas employed as Senior Vice President Sales, Retail Planning and In StoreServices for five years by Tommy Hilfiger USA. Prior to that she was employed by Liz Claiborne for ten years, where herlast position was serving as Vice President/General Manager of Sales for theLiz Claiborne casual division.  All ofthe aforementioned companies are principally in the business of women’sapparel.

**Nichole Vowteras**became our Executive Vice President Sourcing andProduction on May 1, 2006.  Prior to herjoining Rafaella as Vice President - Sourcing and Production, Ms. Vowteras wasemployed as Vice President of Manufacturing for Garfield Marks for 21¤2 years, as Senior Vice President of Production forGuess, Inc.  for one year and with Reebokfor eight years, where her last position was serving as Vice President ofWorldwide Sourcing.  All of theaforementioned companies are principally in the business of women’s apparel andfootwear.

**Jason Epstein** became our ChiefInformation Officer, Vice President Strategic Planning on March 19, 2007.  Mr. Epstein joined Rafaella with more than 14years of experience in technology, management, operations and businessdevelopment.  Prior to joining Rafaella, Mr.Epstein was the Chief Technology Officer & Vice President of Supply ChainManagement at Elie Tahari Limited. While at Elie Tahari, he was responsible forBusiness Applications, Business Intelligence, and Network Operations.  Before his appointment as Chief TechnologyOfficer at Elie Tahari, Mr. Epstein was one of the founding partners andDirector of Business Development at Bind Networks Solutions, LLC as well asworked as a systems engineer at NCR (AT&T) Corporation.

32

----

 

**George Kollitides**is one of our directors.  Mr. Kollitides is a Managing Director atCerberus.  From 2001 to 2003,Mr. Kollitides was President and Managing Director of TenX CapitalManagement, a special situations investor affiliated with Cerberus, where hewas responsible for over $180 million of investments.  Prior to joining TenX, Mr. Kollitidesactively invested in numerous private equity transactions for CattertonPartners, a middle market private equity group from 1998 to 2001.  Prior to joining Catterton,Mr. Kollitides held various positions of increasing responsibility atGeneral Electric Capital in the Equity, Corporate Finance, and CorporateRestructuring Groups, focusing on leveraged recapitalizations, reorganizations,change of control transactions and minority equity investments from 1990through 1997.  Mr. Kollitides sitson boards of IAP Worldwide Services, Bushmaster Firearms, Remington Firearmsand LNR Holdings.

**Kurt Larsen**is one of our directors.  Mr. Larsen is currently a ManagingDirector at Cerberus.  Prior to joiningCerberus in 2003, Mr. Larsen served as the Managing Partner of BlackDiamond Capital Partners, a private equity firm which he founded, and directedthe investment of over $245 million of private equity capital in sixcompanies.  Prior to founding BlackDiamond Capital Partners in 1997, Mr. Larsen was a Principal at AuroraCapital Group where he worked from 1992 to 1997.  Prior to his experience at Aurora CapitalGroup, Mr. Larsen worked as an Associate at both WSGP Partners, a privateequity firm founded by William E. Simon, and Drexel Burnham Lambert Inc.in Beverly Hills, CA.

**Ronald Frankel**is a member of our Board of Directors and hasbeen employed by our predecessor since co-founding RafaellaSportswear, Inc. in 1982.  Prior tofounding our predecessor, Mr. Frankel worked as an independent salesrepresentative selling the Booth Bay and Mr. Thompson lines of women’swear, worked as an in-house sales representative for YSL Sportswear and manageda start-up division 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 hasbeen employed by our predecessor as Vice President-Sales since 1992.  Mr. Newman has held sales positions in theapparel industry for over 36 years. Prior to working with our predecessor, Mr. Newman was an outsidesales representative for several apparel lines, including Rafaella, from 1984to 1992.

33

----

**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 provides guidanceon a number of business-specific issues, including but not limited to conflictsof interest.  You may obtain a copy of theCompany’s Code of Ethics, free of charge, by submitting a request in writing tothe attention of Chad Spooner, Rafaella Apparel Group, Inc., 1411 Broadway, NewYork, New York 10018.

 

**Audit Committee Financial Expert**

 

Our Board of Directors has separately designated anaudit committee and the functions of a traditional audit committee are carriedout by two of the members of the Board. Our Board has determined that eachmember of the Board is financially literate but no determination has been madeas to the ability of any director to qualify as a “financial expert” within themeaning 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 toprovide effective oversight for the Company's financial reporting process andits relationship with its independent accountants.  Neither of our directors who serve on theAudit Committee is independent due to their affiliations with the Company.

 

**ITEM 11.   EXECUTIVE COMPENSATION**

** **

**COMPENSATION DISCUSSION AND ANALYSIS**

 

***Overview***

 

ThisCompensation Discussion and Analysis, or CD&A, is intended to provideinformation regarding the Company’s executive compensation program andpractices. This CD&A covers a variety of topics, including: the Company’scompensation philosophy regarding executive compensation, the role of ourCompensation Committee in setting the compensation of our executive officers,and executive compensation decisions for fiscal 2007.

 

***Compensation Philosophy***

 

The Company iscommitted to achieving long-term, sustainable growth and increasing stockholdervalue. The Company’s compensation program for our executive officers is designedto support these objectives and encourage strong financial performance on anannual and long-term basis by linking a portion of our executive officers’total compensation to Company performance in the form of equity incentivecompensation. The principal elements of our executive compensation structureare base salary, annual performance bonus, and long-term equity incentives.

 

The Company’scompensation philosophy is to set our executive officers’ compensation,including base salary, annual performance bonus, and long-term equityincentives, at levels that will attract, motivate, and retain superiorexecutive talent in a highly competitive environment.

 

***Role of the CompensationCommittee***

 

OurCompensation Committee sets the compensation of our executive officers,including the mix of base salary, annual performance bonus, and long-termequity incentives. Our Compensation Committee also sets the financialperformance targets for our executive officers’ annual performance bonuses.

 

To maintainthe effectiveness 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 Compensation Committee also considers the recommendationsof our Chief Executive Officer regarding the base salary and annual performancebonus of our executive officers.

 

***Total Compensation***

 

In setting atotal compensation 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 2007, asset forth in more detail in the Summary Compensation Table, the totalcompensation of our Chief Executive Officer was $1,510,511; the totalcompensation of our Chief Financial Officer was $727,039; the totalcompensation of our Executive Vice President Sourcing and Production was$614,538; the total compensation of our President of Sales & Planning was$578,721; and the total compensation of our Chief Information Officer, VicePresident Strategic Planning was $229,604. In 2007, none of our directorsreceived compensation for their services.

 

***Base Salary***

 

In setting ourexecutive officers’ base salaries we take into consideration subjectivefactors, such as the relative responsibilities of each executive officer andthe cross-functional leadership roles and business contributions.

 

In 2007, weprovided our Chief Executive Officer, Chief Financial Officer, Executive VicePresident Sourcing and Production, President of Sales & Planning, and ChiefInformation Officer, Vice President Strategic Planning, with base salaries paidof $700,000, $400,000, $400,000, $353,846, and $115,385, respectively. Ourexecutive officers have employment agreements that provide them with thresholdbase salary levels.  These employmentagreements were entered into by each of our executive officers upon joining theCompany between June 2005 and March 2007.

 

***Annual Performance Bonus***

 

Our practiceis to make cash performance bonuses a significant component of our executiveofficers’ total compensation. We believe this design aligns the interests ofour executive officers with the interests of our stockholders.

34

----

OurCompensation Committee approves a target bonus for each executive officer thatis based on a percentage of their base salaries. In establishing these bonustargets, the Compensation Committee considers our executive officers’ potentialtotal compensation in light of the Company’s compensation philosophy and marketpractices. The executive officers can earn their target bonuses based upon theCompany’s achievement of pre-determined financial performance targets. OurCompensation Committee has the discretion not to award performance bonuses,even if the Company achieves its financial performance targets.  Conversely, our Compensation Committee alsohas the discretion to award performance bonuses, even if the Company did notachieve its financial performance targets (e.g., due to uncontrollable eventsor extenuating circumstances as determined by the Compensation Committee).

 

Our executiveofficers can earn from 0% to 200% of their target performance bonus based uponthe Company’s achievement of pre-determined Earnings Before Interest, Taxes,Deprecation, and Amortization (“EBITDA”) targets established by theCompensation Committee.

 

Based upon theperformance of the Company in 2007, our executive officers earned 100% of theirtarget performance bonuses.  Our ChiefExecutive Officer, Chief Financial Officer, Executive Vice President Sourcingand Production, President of Sales & Planning, and Chief InformationOfficer, Vice President Strategic Planning received annual performance bonusesof $700,000, $300,000, $200,000, $200,000, and $57,222, respectively.  In addition, our Chief Information Officer,Vice President Strategic Planning received a signing bonus of $50,000 uponjoining the Company in March 2007.

 

***Equity Incentives***

 

Our EquityIncentive Plan (the “Plan”) allows for various types of equity awards,including stock options and restricted stock. Awards under our Plan have beengranted 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.

 

All awardsunder our Plan must be approved by our Compensation Committee. Our CompensationCommittee determines the type, timing, and amount of equity awards granted toeach of our executive officers after considering their base salary and targetperformance bonus in relation to the Company’s compensation philosophy.

 

Awards grantedunder the Plan 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 June20, 2005 redemption value of the redeemable convertible preferred stock).

 

***Perquisites and Other Benefits***

 

Pursuant tothe Company’s 401(k) plan, the Company provides its executives the samelevel of matching contributions available to all eligible employees, which isequal to 100% of each executive officer’s first 3% of pre-tax contributions,subject to the provisions of the 401(k) plan and Internal Revenue Servicelimitations.  The Company also providesour executive officers with a medical insurance policy that reimburses ourexecutives for certain medical expenses. Additional information on executive officer perquisites and otherbenefits can be found in the footnotes to the Fiscal 2007 Summary CompensationTable in this Form 10-K.

 

***PotentialPayments upon a Termination or Change in Control***

 

The following is adescription of the specific circumstances relating to termination of employmentand change in control of the Company that will trigger payments to each namedexecutive officer and a calculation of the estimated payments to such officersas a result of the occurrence of such events had they occurred on June 30,2007, the end of the Company’s fiscal year.

**Christa Michalaros**

We have entered into anemployment agreement with Christa Michalaros 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 employment relationship created thereunder will continuefor consecutive one (1) year periods commencing on each July 1.  The agreement provides for payments to bemade to Ms. Michalaros upon certain termination events.  Ms. Michalaros will also be entitled tocertain payments under our Equity Incentive Plan in the event a “LiquidityEvent” occurs, which is defined as (1) any Person who is (i) not an Affiliateof the Company or (ii) not Cerberus or an Affiliate of Cerberus becomes thebeneficial owner, directly or indirectly, of fifty percent (50%) or more of thecombined voting power of the then outstanding voting securities of the Company;(2) the sale, transfer or other disposition of all or substantially all of thebusiness and assets of the Company, whether by sale of assets, merger orotherwise to a person other than an Affiliate of Cerberus; (3) if specified bythe Board in an Award Agreement at the time of grant, the consummation of anInitial Public Offering; or (4) the dissolution or liquidation of the Company.

Under Ms.Michalaros’ employment agreement, the following payments will be made to her orher representatives 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 to performthe essential functions of her job with or without reasonable accommodation fora period of (i) 90 consecutive days; or (ii) 180 days in any one (1) yearperiod); or (4) the she resigns for any reason:

(a) her accrued butunpaid base salary and benefits in accordance with the agreement, if any, tothe date of termination;

(b) the unpaid portion ofthe Bonus, if any, relating to the fiscal year prior to the fiscal year of herdisability, resignation or termination by the Company for Cause;

(c) certain expensesreimbursable pursuant to the agreement that have been incurred but not yetreimbursed at the date of termination; and

(d) any rights she may have under the Company’s benefit plans andCOBRA, and any rights she may have to indemnification pursuant to theagreement, the by-laws or certificate of

35

----

incorporation of the Company, or otherwise under law, and any rightsshe may have under any directors and officers liability policies maintained bythe Company or its affiliates.

Should Ms.Michalaros terminate her employment by making an election not to renew the termas provided in the agreement, she shall receive the payments set forth aboveand the bonus for the fiscal year ending at the end of the term, determined inaccordance with the terms of the agreement (subject to the minimum bonus of$350,000 for the fiscal year ending June 30, 2007; however, assuming this occurredon the last day of fiscal 2007, the amount would be $700,000), payable ninety(90) days after the end of the fiscal year; provided that the Company in itssole discretion may elect, by written notice given no later 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) below in exchange for her(i) agreement to be subject to and legally bound by the non-competition andproperty covenants set forth in the agreement and (ii) execution andnonrevocation of a valid release agreement in a form reasonably acceptable tothe Company and Ms. Michalaros.

If Ms. Michalarosis terminated by the Company without Cause, or leaves her employ for “GoodReason” as that term is defined in the agreement, or the Company elects not torenew the 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) payment for accruedunused vacation days, payable within thirty (30) days after the date oftermination;

(b) continued base salaryfor twelve (12) months after the date of termination, payable on the lastbusiness day of the month; and

(c) a prorated bonus equal to the bonus earned as of the date oftermination based on the achievement of prorated performance measures derivedfrom the annual business plan for the fiscal year of termination as measured onthe date of termination, or, in the first year of the term, the minimum bonusof $350,000, payable in a lump sum within thirty (30) days after the date oftermination.

36

----

 
| **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** | ** ** | **Termination  due to the  Executive’s  Disability** | ** ** | **Termination  upon the  Executive’s  Death** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                           |       |                                                  |       |                                                                |       |                                                    |       |                                            |       |
| Cash Severance  (base salary)       |       | —                                       | (1)        | —                                                |       | $                                                              | 700,000    |                                                  | $          | 700,000                                                             |       | —                                                  |       | —                                          |       | — |   |
| Stock Options                       |       | —                                       | (2)        | —                                                |       | —                                                         | (2)        | —                                                | (2)        | —                                                              | (3)        | —                                                  | (3)        | —                                          | (4)        |
|                                     |            |                                              |            |                                                       |            |                                                                |            |                                                       |            |                                                                     |            |                                                         |            |                                                 |            |  |  |

----

(1)   Assumes the Company would not elect to makecertain discretional payments.

(2)   Non-vested options are forfeited.  Fair market value is currently calculated asbelow the exercise price, therefore it is assumed options would not beexercised.

(3)   Non-vested options are forfeited; vestedoptions may be exercised by Ms. Michalaros’ representative until one year orexpiration.  It is assumed options wouldnot be exercised currently due to the issue discussed in (2) above.

(4)   While all non-vested options would havevested, fair market value is below the exercise price.

**Chad Spooner**

We have entered into anemployment agreement with Chad J. Spooner which commenced on June 20,2005.  Under the terms of the agreement,the initial period was from June 20, 2005 through June 20, 2006; thereafter,the agreement and the employment relationship created thereunder will continuefor consecutive one (1) year periods commencing on each July 1.  The agreement provides for payments to bemade to Mr. Spooner upon certain termination events.  Mr. Spooner will also be entitled to certainpayments under our Equity Incentive Plan in the event a “Liquidity Event”occurs, which is defined as (1) any Person who is (i) not an Affiliate of theCompany or (ii) not Cerberus or an Affiliate of Cerberus becomes the beneficialowner, directly or indirectly, of fifty percent (50%) or more of the combinedvoting power of the then outstanding voting securities of the Company; (2) thesale, transfer or other disposition of all or substantially all of the businessand assets of the Company, whether by sale of assets, merger or otherwise to aperson other than an Affiliate of Cerberus; (3) if specified by the Board in anAward Agreement at the time of grant, the consummation of an Initial PublicOffering; or (4) the dissolution or liquidation of the Company.

Under Mr.Spooner’s employment agreement, the following payments will be made to him orhis representatives if (1) he is terminated by the Company for Cause (generallydefined as conviction for the commission of a felony; dishonesty; refusal tofollow directions 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) the Companyterminates his employment due to his disability (meaning a determination by theCompany in accordance with applicable law that as a result of a physical ormental injury or illness, Mr. Spooner is unable to perform the essentialfunctions of his job with or without

37

----

reasonable accommodationfor a period of (i) 90 consecutive days; or (ii) 180 days in any one (1) yearperiod); or (4) the he resigns for any reason:

(a) his accrued butunpaid base salary and benefits in accordance with the agreement, if any, tothe date of termination;

(b) the unpaid portion ofhis bonus, if any, relating to the fiscal year prior to the fiscal year of his,disability, resignation or termination by the Company for Cause; and

(c) certain expenses reimbursable pursuant to the agreement that havebeen incurred but not yet reimbursed at the date of termination.

If we elect not torenew Mr. Spooner’s term, he will be entitled to the benefits described in theprevious paragraph along with (i) continued base salary for twelve (12) monthsafter the date of termination, payable on the last business day of the month;and (ii) reimbursement of the cost of continuation coverage of group healthcoverage pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1986for a maximum of twelve (12) months to the extent he so elects and is eligibleand subject to the terms of the plan and the law.

If we were toterminate Mr. Spooner without Cause, in addition to the payments upontermination specified in (a) through (c), above, Mr. Spooner will receive,upon execution without revocation of a valid release agreement in a formreasonably acceptable to the Company:

(a) payment for accruedunused vacation days, payable within thirty (30) days after the date oftermination;

(b) continued base salaryfor twelve (12) months after the date of termination, payable on the lastbusiness day of the month;

(c) a prorated bonusequal to the bonus earned as of the date of termination based on theachievement of prorated performance measures derived from the annual businessplan for the fiscal year of termination as measured on the date of termination,payable in a lump sum within thirty (30) days after the date of termination(which would have been an amount of $300,000 on the last day of fiscal 2007);and

(d) reimbursement of the cost of continuation coverageof group health coverage pursuant to the Consolidated Omnibus BudgetReconciliation Act of 1986 for a maximum of twelve (12) months to the extentMr. Spooner so elects and is eligible and subject to the terms of the plan andthe law.
| **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)       |       | —                                       |       | —                                                |       | $                                                     | 400,000    |                                                                | —     |                                                    | —     |                                            | —     |   |
| Stock Options                       |       | —                                       | (1)        | —                                                |       | —                                                | (1)        | —                                                              | (2)        | —                                                  | (2)        | —                                          | (3)        |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                     |            |                                                         |            |                                                 |            |  |

 

38

----

----

(1)   Non-vested options are forfeited.  Fair market value is currently calculated asbelow the exercise price, therefore it is assumed options would not beexercised.

(2)   Non-vested options are forfeited; vestedoptions may be exercised by Mr. Spooner’s representative until one year orexpiration.  It is assumed options wouldnot be exercised currently due to the issue discussed in (1) above.

(3)   While all non-vested options would havevested, fair market value is below the exercise price.

**Nichole Vowteras**

We have entered into anemployment agreement with Nichole Vowteras which commenced on May 1,2006.  Under the terms of the agreement,the term is from May 1, 2006 until her employment is terminated by any ofthe methods discussed below.  Ms. Vowteraswill 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. Vowteras’employment agreement, the following payments will be made to her or herrepresentatives if (1) she is terminated by the Company for Cause (generallydefined as conviction for the commission of a felony; dishonesty; refusal tofollow directions 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) the Companyterminates her employment due to her disability (meaning a determination by theCompany in accordance with applicable law that as a result of a physical ormental injury or illness, Ms. Vowteras is unable to perform the essentialfunctions of her job with or without reasonable accommodation for a period of(i) 90 consecutive days; or (ii) 180 days in any one (1) year period); or (4)the she resigns for any reason:

(a) her accrued butunpaid base salary, if any, to the date of termination, payable within thirty(30) days after her termination;

(b) the unpaid portion ofthe bonus, if any, relating to the fiscal year prior to the fiscal year of herdeath, disability, resignation or termination by the Company for Cause, payablein accordance with the terms of the agreement, with a minimum $50,000 bonus tobe paid in the first fiscal year of her employment;

(c) certain expensesreimbursable pursuant to the agreement that have been incurred but not yetreimbursed at the date of termination; and

(d) any rights she mayhave under the Company’s benefit plans and the Consolidated Omnibus BudgetReconciliation Act.

39

----

If Ms. Vowteras is terminated by the Company withoutCause, in addition to the benefits described in the previous paragraph, shewill receive, upon execution without revocation of a valid release agreement ina form reasonably acceptable to the Company, continued payment of her basesalary for six months following the date of termination.
| **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)        |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                     |            |                                                         |            |                                                 |            |  |

----

(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 are forfeited;vested options may be exercised by Ms. Vowteras’ representative until one yearor expiration.  It is assumed optionswould not be exercised currently due to the issue discussed in (2) above.

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

**Rosemary Mancino**

We have entered into anemployment agreement with Rosemary Mancino which commenced on August 14,2006.  Under the terms of the agreement,the term is from August 14, 2006 until her employment is terminated by any ofthe methods 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 Person who is(i) not an Affiliate of the Company or (ii) not Cerberus or an Affiliate ofCerberus becomes the beneficial owner, directly or indirectly, of fifty percent(50%) or more of the combined voting power of the then outstanding votingsecurities of the Company; (2) the sale, transfer or other disposition of allor substantially all of the business and assets of the Company, whether by saleof assets, merger or otherwise to a person other than an Affiliate of Cerberus;(3) if specified by the Board in an Award Agreement at the time of grant, theconsummation of an Initial Public Offering; or (4) the dissolution orliquidation 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 (generallydefined as conviction for the commission of a felony; dishonesty; refusal tofollow directions of 

40

----

the Board; grossnonfeasance; breach of confidentiality or restrictive covenant provisions; orcertain other instances of willful misconduct); (2) her employment terminatesdue to her death; (3) the Company terminates her employment due to herdisability (meaning a determination by the Company in accordance withapplicable law that as a result of a physical or mental injury or illness, Ms.Mancino is unable to perform the essential functions of her job with or withoutreasonable accommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) the she resigns for any reason:

(a) her accrued butunpaid base salary, if any, to the date of termination, payable within thirty(30) days after her termination;

(b) the unpaid portion ofthe bonus, if any, relating to the fiscal year prior to the fiscal year of herdeath, disability, resignation or termination by the Company for Cause, payablein accordance with the terms of the agreement;

(c) certain expensesreimbursable pursuant to the agreement that have been incurred but not yetreimbursed at the date of termination; and

(d) any rights she may have under the Company’s benefit plans and theConsolidated Omnibus 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.
| **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)        |
|                                           |            |                                                    |            |                                                                   |            |                                                                               |            |                                                                                       |            |                                                                           |            |                                                             |            |  |

----

(1)   Non-vested options are forfeited.  Fair market value is currently calculated asbelow the exercise price, therefore it is assumed options would not beexercised.

(2)   Non-vested options are forfeited; vestedoptions may be exercised by Ms. Mancino’s representative until one year orexpiration.  It is assumed options wouldnot be exercised currently due to the issue discussed in (2) above.

(3)   While all non-vested options would havevested, fair market value is below the exercise price.

41

----

**Jason Epstein**

We have entered into anemployment agreement with Jason Epstein which commenced on March 19, 2007.  Under the terms of the agreement, the term isfrom March 19, 2007 until his employment is terminated by any of the methods discussedbelow.  Mr. Epstein will also be entitledto certain payments under our Equity Incentive Plan in the event a “LiquidityEvent” occurs, which is defined as (1) any Person who is (i) not an Affiliateof the Company or (ii) not Cerberus or an Affiliate of Cerberus becomes thebeneficial owner, directly or indirectly, of fifty percent (50%) or more of thecombined voting power of the then outstanding voting securities of the Company;(2) the sale, transfer or other disposition of all or substantially all of thebusiness and assets of the Company, whether by sale of assets, merger orotherwise to a person other than an Affiliate of Cerberus; (3) if specified bythe Board in an Award Agreement at the time of grant, the consummation of anInitial Public Offering; or (4) the dissolution or liquidation of the Company.

Under Mr.Epstein’s employment agreement, the following payments will be made to him orhis representatives if (1) he is terminated by the Company for Cause (generallydefined as conviction for the commission of a felony; dishonesty; refusal tofollow directions 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) the Companyterminates his employment due to his disability (meaning a determination by theCompany in accordance with applicable law that as a result of a physical ormental injury or illness, Mr. Epstein is unable to perform the essential functionsof his job with or without reasonable accommodation for a period of (i) 90consecutive days; or (ii) 180 days in any one (1) year period); or (4) heresigns for any reason:

(a) his accrued butunpaid base salary, if any, to the date of termination, payable within thirty(30) days after her termination;

(b) the unpaid portion ofthe bonus, if any, relating to the fiscal year prior to the fiscal year of hisdeath, disability, resignation or termination by the Company for Cause, payablein accordance with the terms of the agreement;

(c) certain expensesreimbursable pursuant to the agreement that have been incurred but not yetreimbursed at the date of termination; and

(d) any rights he may have under the Company’s benefit plans and theConsolidated Omnibus Budget Reconciliation Act.

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

42

----

 
| **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)        |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                     |            |                                                         |            |                                                 |            |  |

----

(1)   Non-vested options are forfeited.  Fair market value is currently calculated asbelow the exercise price, therefore it is assumed options would not beexercised.

(2)   Non-vested options are forfeited; vestedoptions may be exercised by Mr. Epstein’s representative until one year orexpiration.  It is assumed options wouldnot be exercised currently due to the issue discussed in (2) above.

(3)   While all non-vested options would havevested, fair market value is below the exercise price.

**Compensation CommitteeInterlocks and Insider Participation**

Our CompensationCommittee (the "Compensation Committee") presently consists of  Christa Michalaros, Kurt Larsen and RonaldFrankel.  Christa Michalaros is our ChiefExecutive Officer.  Neither of Mssgrs.Larsen nor Frankel are under our employ. None of our executive officers serves as a member of the board ofdirectors or compensation committee of any other entity that has one or more executiveofficers serving as a member of our board of directors of our CompensationCommittee.

43

----

 

**Summary Compensation Table**

**For the Year Ended June 30, 2007**

 
| Name and Principal Position     | ** ** | **Year** | ** ** | **Salary ($)** | ** ** | **Bonus ($)** | ** ** | **Stock  Awards  ($)** | ** ** | **Option  Awards  ($) (1)** | ** ** | **Non-Equity  Incentive  Plan  Compen-  sation ($)** | ** ** | **Change in  Pension  Value and  Nonqualified  Deferred  Compen-  sation  Earnings ($)** | ** ** | **All  Other  Compen-  sation ($)** | ** ** | **Total  ($)** | ** ** |
|--------------------------------------|------------|----------|------------|---------------------|------------|---------------|------------|------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------|------------|
| Christa Michalaros                   |       | 2007     |       | 700,000             |       | 700,000       |       | 0                      |       | 27,141                           |       | 0                                                         |       | 0                                                                                                       |       | 83,370                                   | (3)        | 1,510,511      |       |
| *Chief Executive Officer*            |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
|                                 |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| Chad Spooner                         |       | 2007     |       | 400,000             |       | 300,000       |       | 0                      |       | 0                                |       | 0                                                         |       | 0                                                                                                       |       | 27,039                                   | (2)        | 727,039        |       |
| *Chief  Financial Officer*           |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
|                                 |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| Nichole Vowteras                     |       | 2007     |       | 400,000             |       | 200,000       |       | 0                      |       | 0                                |       | 0                                                         |       | 0                                                                                                       |       | 14,538                                   |       | 614,538        |       |
| *Executive Vice President*           |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| *Sourcing and Production*            |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
|                                 |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| Rosemary Mancino                     |       | 2007     |       | 353,846             |       | 200,000       |       | 0                      |       | 0                                |       | 0                                                         |       | 0                                                                                                       |       | 24,875                                   | (2)        | 578,721        |       |
| *President  Sales & Planning*    |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
|                                 |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| Jason Epstein                        |       | 2007     |       | 115,385             |       | 107,222       |       | 0                      |       | 0                                |       | 0                                                         |       | 0                                                                                                       |       | 6,997                                    |       | 229,604        |       |
| *Chief Information Officer,*         |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| *Vice President Strategic  Planning* |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
|                                 |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |
| Stuart Elias                         |       | 2007     |       | 150,000             |       | 37,500        |       | 0                      |       | 0                                |       | 0                                                         |       | 0                                                                                                       |       | 13,786                                   |       | 201,286        |       |
| *Secretary  and Treasurer*           |       |     |       |                |       |          |       |                   |       |                             |       |                                                      |       |                                                                                                    |       |                                     |       |           |       |

----

(1) There were nostock option award forfeitures during the year ended June 30, 2007. Refer toNote 2 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. Spooner and Ms. Mancino were $20,439 and $18,875, respectively.

(3) Amountshown for Ms. Michalaros includes the cost of car service ($76,770).

** **

**Grants of Plan-Based Awards**

**For the Year Ended June 30, 2007**

 
| ** **       | ** ** | **Grant**      | ** ** | **Compensation  Committee  Grant** | ** ** | **Estimated  Future  Payouts Under  Non-Equity  Incentive  Plan  Awards** | ** ** | **Estimated  Future  Payouts** Under  Equity  Incentive  Plan  Awards | ** ** | **All  Other Stock  Awards:  Number  of  Shares  of  Stock or ** | ** ** | **All  Other Option  Awards:  Number  of  Securities  Underlying** | ** ** | **Exercise or  Base Price  of  Option  Awards** | ** ** | **Grant Date  Fair  Value  of Stock  and  Option** | ** ** |
|------------------|------------|----------------|------------|------------------------------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Name **   | ** ** | **Date ** | ** ** | **Date**                           | ** ** | **Threshold ($)**                                                         | ** ** | **Target ($)**                                                        | ** ** | **Maximum ($)**                                                            | ** ** | **Threshold (#)**                                                  | ** ** | **Target (#)**                                       | ** ** | **Maximum (#)**                                         | ** ** | **Units (#)** | ** ** | **Options (#)** | ** ** | **($/Sh)** | ** ** | **Awards** | ** ** |
| Rosemary Mancino |       | 8/14/2006      |       | 9/22/2006                          |       | 0                                                                              |       | 0                                                                          |       | 0                                                                               |       | 0                                                                       |       | 111,111                                                   |       | 0                                                            |       | 0 |   | 0 |   |                   5.33 |   | 214,866 |   |
| Jason Epstein    |       | 5/22/2007      |       | 5/22/2007                          |       | 0                                                                              |       | 0                                                                          |       | 0                                                                               |       | 0                                                                       |       | 83,334                                                    |       | 0                                                            |       | 0 |   | 0 |   |                   5.33 |   | 139,202 |   |

 

**Outstanding Equity Awards at FiscalYear-End**

**As of June 30, 2007**

 
| ** **          | ** ** | **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 |       | 111,111                                                                                  |       | 333,333                                                                              | (1)        | 0 |   | 5.33 |   | 9//22/2016 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Chad Spooner        |       | 125,000                                                                                  |       | 125,000                                                                              | (1)        | 0 |   | 5.33 |   | 6/20/2015 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Nichole Vowteras    |       | 27,778                                                                                   |       | 83,333                                                                               | (1)        | 0 |   | 5.33 |   | 9/22/2016 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Rosemary Mancino    |       | 27,778                                                                                   |       | 83,333                                                                               | (1)        | 0 |   | 5.33 |   | 9/22/2016 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Jason Epstein       |       | 0                                                                                        |       | 83,334                                                                               | (1)        | 0 |   | 5.33 |   | 5/22/2017 |   | 0 |   | 0 |   | 0 |   | 0 |   |

----

 

(1) The stock optionawards vest annually in increments of 25% for Ms. Michalaros, Mr. Spooner, Ms.Vowteras, Ms. Mancino, and Mr. Epstein beginning on the first anniversary of April25, 2006, June 20, 2005, June 21, 2006, June 21, 2006, and May 22, 2007,respectively.

44

----

 

**COMPENSATION COMMITTEE REPORT**

 

The Compensation Committee has reviewed and discussedthe Compensation Discussion and Analysis included in this annual report on Form10-K with management and, based on such review and discussions, theCompensation Committee recommended to the Board that the CompensationDiscussion and Analysis be included in this annual report.

The CompensationCommittee's Report shall not be deemed incorporated by reference by any generalstatement incorporating by reference this proxy statement 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 |
|   |   | Kurt Larsen, Director                                     |
|   |   | Ronald Frankel, Director                                  |

 

**Compensation of Directors**

We may, but are not obligated to, pay members of ourBoard of Directors, who are not our employees and are not affiliated withCerberus, directors fees equal to $50,000 per annum plus stock options equal to 1¤10 of 1% of our fully diluted common stock.

Members of our Board of Directors who are either ouremployees or affiliated with Cerberus receive no separate compensation forserving on the Board of Directors.  Allmembers of our Board of Directors are reimbursed for actual expenses incurredin connection with attendance at meetings of the Board of Directors and ofcommittees of the Board of Directors.

45

----

## **ITEM 12.               SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

The following table sets forthinformation with respect to the beneficial ownership of our issued andoutstanding common stock andconvertible preferred stock, excluding any grants made under our EquityIncentive 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 ownership is determined in accordance with the rules of theSEC.  To our knowledge, except as setforth in the Stockholders’ Agreement, each holder of our equity interestslisted below has sole voting and investment power as to such equity interestunless otherwise noted.
| ** **                                                                                 | ** ** | **Convertible Preferred  Stock** | ** ** | **Common Stock**         | ** ** | **Common Stock Equivalents** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------|------------|----------------------------------------|------------|
| **Name and Address of Beneficial Owner(1)**                       | ** ** | **Number of  Shares**            | ** ** | **Percentage  of Class** | ** ** | **Number of  Shares**             | ** ** | **Percentage  of Class** | ** ** | **Number of  Shares** | ** ** | **Percentage  of Class** | ** ** |
| Stephen Feinberg(2)(3)                                                                     |       | 7,500,000                             |       | 100                           | %          | —                                 |       | — |   | 7,500,000 |   | 75.0 | % |
| RSW 2005, Inc.                                                                             |       | —                                |       | —                        |       | 2,500,000                              |       | 100 | % | 2,500,000 |   | 25.0 | % |
| Christa Michalaros(4)                                                                      |       | —                                |       | —                        |       | 111,111                                |       | 4 | % | — |   | — |   |
| Chad Spooner(5)                                                                            |       | —                                |       | —                        |       | 125,000                                |       | 5 | % | — |   | — |   |
| Rosemary Mancino(6)                                                                        |       | —                                |       | —                        |       | 27,778                                 |       | 1 | % | — |   | — |   |
| Nichole Vowteras (7)                                                                       |       | —                                |       | —                        |       | 27,778                                 |       | 1 | % | — |   | — |   |
| Jason Epstein(8)                                                                           |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| George Kollitides(3)                                                                       |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| Kurt Larsen(3)                                                                             |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| John Kourakos                                                                              |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| Ronald Frankel(9)                                                                          |       | —                                |       | —                        |       | 2,125,000                              |       | 76.0 | % | — |   | — |   |
| Robert Newman(9)                                                                           |       | —                                |       | —                        |       | 125,000                                |       | 5.0 | % | — |   | — |   |
| Asher Haddad (9)                                                                           |       | —                                |       | —                        |       | 250,000                                |       | 9.0 | % | — |   | — |   |
| All members of our Board of Directors and executive officers as a  group (10 persons) |       |                                  |       |                          |       | 2,791,667                              |       | 100 | % | 2,500,000 |   | 25.0 | % |

----

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

(2)             AcquisitionCo., controlled by Cerberus, owns 100% of our convertible preferred stock,which preferred stock is convertible at its option into common stock equal to75% of our common stock, or approximately 67.5% of our outstanding fully-dilutedcommon stock. Stephen Feinberg exercises sole voting and investment authorityover all securities of our company owned by Acquisition Co. Thus, pursuant toRule 13d-3 under the Exchange Act, Stephen Feinberg is deemed tobeneficially own 100% of our convertible preferred stock and, upon conversion,would beneficially own approximately 67.5% of our common stock (after theexercise of all outstanding options granted pursuant to our Equity IncentivePlan).

(3)             Theaddress for Stephen Feinberg, George Kollitides and Kurt Larsen is c/o CerberusCapital Management, L.P., 299 Park Avenue, New York, New York 10171.

46

----

(4)             Includes vestedoptions for 111,111 shares of common stock but does not include non-vested optionsfor 333,333 shares of common stock, all of which were granted pursuant to Ms.Michalaros' employment agreement with us.

(5)             Includesvested options for 125,000 shares of common stock but does not includenon-vested options for 125,000 shares of common stock, all of which weregranted pursuant to Mr. Spooner's employment agreement with us.

(6)             Includes vestedoptions for 27,778 shares of common stock but does not include non-vestedoptions for 83,333 shares of common stock, all of which were granted pursuantto Ms. Mancino's employment agreement with us.

(7)             Includesvested options for 27,778 shares of common stock but does not includenon-vested options for 83,333 shares of common stock, all of which were grantedpursuant to Ms. Vowteras' employment agreement with us.

(8)             Doesnot include options for 83,334 shares of common stock, which were granted pursuantto Mr. Epstein’s employment agreement with us.

(9)             Allof the interests in us are held indirectly through RSW 2005, Inc.

47

----

## **ITEM 13.****                                              CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

**ControllingStockholder**

In connection with the June 20, 2005 acquisition,Acquisition Co., an affiliate of Cerberus, contributed $40.0 million ofequity capital to us, acquiring convertible preferred stock convertible intoapproximately 67.5% of our common stock on a fully-diluted basis.  See “Security Ownership of Certain BeneficialOwners and Management.”

*Stockholders’ Agreement*

In connection with an April 15, 2005 Securities PurchaseAgreement, as amended, we entered into a Stockholders’ Agreement withAcquisition Co. and our predecessor. This Stockholders Agreement provides that we will have a Board ofDirectors that will consist of seven directors, four of whom are designated byAcquisition Co., two of whom are designated by RSW 2005, Inc., which iscontrolled by Ronald Frankel, and one of whom is designated jointly byAcquisition Co. and RSW 2005, Inc. Our Board of Directors currently consists ofsix directors, four of whom were designated by Acquisition Co. and two of whomwere designated by our predecessor.  Weanticipate appointing an independent director in the future.  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.

**Consulting Agreement**

Rafaella entered into a Consulting Agreement andGeneral Release effective April 25, 2006 with Glenn S. Palmer (the “ConsultingAgreement and General Release”), our former Chief Executive Officer.  Under the Consulting Agreement and GeneralRelease, Mr. Palmer received a bonus in respect of fiscal year 2006 in theamount of $250,000 and, payment for accrued but unused vacation days,reimbursement for the cost of group medical and dental continuation coverageand reimbursement for legal fees.  Underthe Consulting Agreement and General Release, Mr. Palmer provided consultingservices to the Company for the period commencing on April 25, 2006 and endingon April 25, 2007 for an aggregate consulting fee of $600,000, payable inapproximately equal weekly installments. In addition, Mr. Palmer received an option to purchase 111,111 shares ofRafaella’s common stock, par value $0.01 per share, at an exercise price of$5.33 per share, under Rafaella’s Equity Incentive Plan.  Mr. Palmer is subject to the confidentialityprovisions and eighteen-month post-employment non-competition andnon-solicitation covenants in his employment agreement.

**RelatedParty Transactions Policy and Procedure**

Our finance department isprimarily responsible for developing and implementing processes and controls toobtain information from our directors, executive officers and significantstockholders regarding related party transactions and then determining, basedon the facts and circumstances, whether we or a related-party has a direct orindirect material interest in our transactions. Our audit committee does not have a written policy regarding theapproval of related party transactions but will apply its review procedures topotential related-person transactions as a part of its standard operatingprocedures. In the course of management’s and the audit committee’s review, thefollowing matters will be considered:

·                 the nature of the related party’s interest in thetransaction;

·                 the material terms of the transaction, including,the amount involved and type of transaction;

·                 the importance of the transaction to the relatedparty and to us;

·                 whether the transaction would impair the judgmentof a director or executive officer to act in our best interest and the bestinterest of our stockholders; and

·                 any other matters management or the auditcommittee deems appropriate.

Since July 1, 2006, the beginningof the Company’s most recent fiscal year, we have not been a party to, and wehave no plans to be a party to, any transaction or series of similartransactions in which the amount involved exceeded or will exceed $120,000 andin which any current director, executive officer, holder of more than 5% of ourcapital stock, or any member of the immediate family of any of the foregoing,had or will have a direct or indirect material interest.

**DirectorIndependence**

The board of directors has notmade a determination as to whether each director is “independent” because allof the members of our board have either been appointed by Cerberus or RSW 2005,Inc. The Company has no securities listed for trading on a national securitiesexchange or in an automated inter-dealer quotation system of a nationalsecurities association, which has requirements that a majority of its board ofdirectors be independent. The Company does not believe any of its directorswould be considered independent under the New York Stock Exchange’s definitionof independence.

48

----

## **Item 14.****                                              Principal Accountant Fees and Services**

The following table presents fees for servicesrendered by PricewaterhouseCoopers LLP relating to the years ended June 30, 2007and 2006.
| ** **             | ** ** | **Period Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006(4)** | ** ** |
|------------------------|------------|------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **             | ** ** | **(in thousands)**                             | ** ** |
| Audit fees(1)          |       | $                                              | 365        |                                            | $          | 265 |   |
| Audit-related  fees(2) |       | 152                                            |       | 34                                              |       |
| Tax fees(3)            |       | 90                                             |       | 201                                             |       |
| All other fees         |       | 2                                              |       | —                                          |       |
| Total                  |       | $                                              | 609        |                                            | $          | 500 |   |

----

(1)             Fees for audit ofannual financial statements.

(2)             Fees for professionalservices for consultations related to financial accounting and reportingstandards, due diligence related to acquisitions, and the Company’sRegistration Statements on Form S-4.

(3)             Fees related toprofessional services for tax compliance, tax advice and tax planning.

(4)    Fees forservices rendered relating to the year ended June 30, 2006 have beenupdated to include amounts previously not disclosed.

Under the Audit Committee’s Charter, the committee hasthe sole authority for appointing, compensating, retaining and overseeing thework of the Company’s independent auditors. In addition, the committee has thesole 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 adoptedpolices and procedures for pre-approving certain services performed by theindependent auditors. The committee has pre-approved the use of the independentauditors for specific types of services that fall within categories ofnon-audit services, including various tax services. Management of the Companyreviews the nature of the professional services to be rendered by theindependent auditors with the committee during each committee meeting.

# **PART IV**

## **Item 15.****                                             ****Exhibits and Financial StatementSchedules**

**Exhibits and FinancialStatement Schedules**
| ExhibitNo.       | ** ** | **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 111¤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 |
|             |       |                                                                                                                                                                                                                           |
|   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                         |

 

49

----

 
| 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                                                            |
|         |   |                                                                                                                                                                                               |
| 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                                                                      |
|         |   |                                                                                                                                                                                               |
| 12.1**  |   | Statement Re: computation of ratios                                                                                                                                                                |
|         |   |                                                                                                                                                                                               |
| 21.1*        |   | List of subsidiaries of Rafaella Apparel Group, Inc.                                                                                                                                          |
|         |   |                                                                                                                                                                                               |
| 23.3***      |   | Consent of Schulte Roth & Zabel LLP (incorporated  by reference in Exhibit 5.1)                                                                                                      |
|         |   |                                                                                                                                                                                               |
| 24.1*        |   | Power of Attorney (included on signature page of  initial filing)                                                                                                                                  |
|         |   |                                                                                                                                                                                               |
| 31.1***      |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                      |
|         |   |                                                                                                                                                                                               |
| 31.2***      |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                      |
|         |   |                                                                                                                                                                                               |
| 32.1***      |   | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002                                                         |

 

50

----

 

----

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

**                          Previouslyfiled as an exhibit to Amendment No. 2 to the Registration Statement onForm S-4 originally filed with the SEC on February 5, 2007.

***                   Filed herewith

****            Previously filed as anexhibit to the quarterly report on Form 10-Q for the period endedMarch 31, 2007.

51

----

**Rafaella Apparel Group, Inc. andSubsidiaryConsolidated Financial Statements**

**Table of Contents**

 
|                                                                                                                                                                                                                                          | ** ** | **Page** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Audited Financial Statements                                                                                                                                                                                                             |       |     |
| Report of Independent Registered Public Accounting  Firm                                                                                                                                                                                 |       | F-2      |
| Report of Independent Registered Public Accounting  Firm                                                                                                                                                                                 |       | F-3      |
| Consolidated  Balance Sheets at June 30, 2007 and 2006                                                                                                                                                                              |       | F-4      |
| Consolidated Statements of Operations for the years  ended June 30, 2007 and 2006, the period from July 1, 2004 to  June 19, 2005, and the period from June 20, 2005 to June 30,  2005                          |       | F-5      |
| Consolidated Statements of Stockholders’ Equity  (Deficit) for the years ended June 30, 2007 and 2006, the period from  July 1, 2004 to June 19, 2005, and the period from June 20,  2005 to June 30, 2005 |       | F-6      |
| Consolidated Statements of Cash Flows for the years  ended June 30, 2007 and 2006, the period from July 1, 2004 to  June 19, 2005, and the period from June 20, 2005 to June 30,  2005                          |       | F-7      |
| Notes to Consolidated Financial Statements                                                                                                                                                                                               |       | F-8      |

 

F-1

----

**Report of Independent RegisteredPublic Accounting Firm**

To the Board ofDirectors and Stockholders of Rafaella Apparel Group, Inc:

In ouropinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, stockholders’ equity (deficit) and cashflows present fairly, in all material respects, the financial position ofRafaella Apparel Group, Inc. and its subsidiary (the “Successor Company”)at June 30, 2007 and 2006, and the results of their operations and theircash flows for the fiscal years then ended and for the period fromJune 20, 2005 to June 30, 2005 in conformity with accountingprinciples generally accepted in the United States of America. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

Asexplained in Note 1 to the consolidated financial statements, theSuccessor Company acquired controlling ownership of the predecessor in apurchase transaction as of June 20, 2005.

/s/PricewaterhouseCoopers LLPNew York, New YorkSeptember 24, 2007

 

F-2

----

 

**Report of Independent RegisteredPublic Accounting Firm**

To the Board ofDirectors and Stockholders of Rafaella Apparel Group, Inc:

In ouropinion, the accompanying consolidated statements of operations, stockholders’equity (deficit) and cash flows present fairly, in all material respects, theresults of operations and cash flows of Rafaella Sportswear, Inc. and itssubsidiary (the “Predecessor Company”) for the period from July 1, 2004 toJune 19, 2005 in conformity with accounting principles generally acceptedin the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit. We conducted ouraudit of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

Asexplained in Note 1 to the consolidated financial statements, theSuccessor Company acquired controlling ownership of the Predecessor Company ina purchase transaction as of June 20, 2005.

/s/PricewaterhouseCoopers LLPNew York, New YorkOctober 28, 2005, except for Note 17,for which the date is October 27, 2006

F-3

----

 

**Rafaella Apparel Group, Inc. andSubsidiaryConsolidated Balance Sheets(In thousands, except number of shares)**

 
| ** **                                                                                                                                                                              | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                              | ** ** | ***(Successor)***       | ** ** |
| **Assets**                                                                                                                                                                              |       |                    |       |                    |       |
| Current assets:                                                                                                                                                                         |       |                    |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                              |       | $                       | 11,390     |                    | $          | 27,273 |   |
| Receivables, net                                                                                                                                                                        |       | 20,785                  |       | 22,510                  |       |
| Inventories                                                                                                                                                                             |       | 44,375                  |       | 47,054                  |       |
| Deferred income  taxes                                                                                                                                                                  |       | 3,510                   |       | 4,040                   |       |
| Other current  assets                                                                                                                                                                   |       | 2,186                   |       | 2,140                   |       |
| Total current  assets                                                                                                                                                                   |       | 82,246                  |       | 103,017                 |       |
| Equipment and leasehold  improvements, net                                                                                                                                              |       | 284                     |       | 115                     |       |
| Intangible assets, net                                                                                                                                                                  |       | 104,154                 |       | 109,094                 |       |
| Deferred financing  costs, net                                                                                                                                                          |       | 7,079                   |       | 10,928                  |       |
| Other assets                                                                                                                                                                            |       | 41                      |       | 41                      |       |
| Total assets                                                                                                                                                                            |       | $                       | 193,804    |                    | $          | 223,195 |   |
|                                                                                                                                                                                    |       |                    |       |                    |       |
| **Liabilities and Stockholders’ Equity  (Deficit)**                                                                                                                                |       |                    |       |                    |       |
| Current liabilities:                                                                                                                                                                    |       |                    |       |                    |       |
| Accounts payable                                                                                                                                                                        |       | $                       | 13,886     |                    | $          | 16,922 |   |
| Accrued expenses  and other current liabilities                                                                                                                                         |       | 3,628                   |       | 2,757                   |       |
| Current portion  of senior secured notes                                                                                                                                                |       | 234                     |       | 17,265                  |       |
| Total current  liabilities                                                                                                                                                              |       | 17,748                  |       | 36,944                  |       |
| Senior secured notes                                                                                                                                                                    |       | 133,144                 |       | 147,157                 |       |
| Deferred income taxes                                                                                                                                                                   |       | 9,750                   |       | 12,644                  |       |
| Deferred rent                                                                                                                                                                           |       | 320                     |       | 129                     |       |
| Total  liabilities                                                                                                                                                                      |       | 160,962                 |       | 196,874                 |       |
| Commitments and  contingencies                                                                                                                                                          |       |                    |       |                    |       |
| Redeemable convertible  preferred stock—$.01 par value; redemption value $5.33 per share plus 10% per  annum; 7,500,000 shares authorized; 7,500,000 shares issued and outstanding |       | 48,110                  |       | 44,110                  |       |
| Stockholders’ equity (deficit):                                                                                                                                                    |       |                    |       |                    |       |
| Common  stock—$.01 par value; 11,111,111 shares authorized; 2,500,000 shares issued  and outstanding                                                                               |       | 25                      |       | 25                      |       |
| Additional paid  in capital                                                                                                                                                             |       | 241                     |       |                    |       |
| Deemed dividend,  in excess of predecessor basis                                                                                                                                        |       | (26,022                 | )          | (26,022                 | )          |
| Retained  earnings                                                                                                                                                                      |       | 10,488                  |       | 8,208                   |       |
| Total  stockholders’ equity (deficit)                                                                                                                                              |       | (15,268                 | )          | (17,789                 | )          |
| Total liabilities and  stockholders’ equity (deficit)                                                                                                                              |       | $                       | 193,804    |                    | $          | 223,195 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

F-4

----

 

**RafaellaApparel Group, Inc. and Subsidiary**

**Consolidated Statements of Operations**

**(In thousands)**

 
| ** **                                                      | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** | **For the Period  from June 20,  2005 through  June 30, 2005** | ** ** | ** ** | ** ** | **For the Period  from July 1,  2004 through  June 19, 2005** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **(Successor)**                              | ** ** | ** **                                   | ** ** | **(Predecessor)**                                                                                 | ** ** |
| Net sales                                                       |       | $                                            | 191,284    |                                         | $          | 222,187                                                                                           |       | $          | 4,215      |                                                                                             |       |   | $ | 225,558 |   |
| Cost of sales                                                   |       | 127,170                                      |       | 148,555                                      |       | 3,074                                                                                             |       |       |       | 138,883                                                                                          |       |
| Gross profit                                                    |       | 64,114                                       |       | 73,632                                       |       | 1,141                                                                                             |       |       |       | 86,675                                                                                           |       |
| Selling, general and  administrative expenses                   |       | 30,951                                       |       | 29,938                                       |       | 971                                                                                               |       |       |       | 17,509                                                                                           |       |
| Operating income                                                |       | 33,163                                       |       | 43,694                                       |       | 170                                                                                               |       |       |       | 69,166                                                                                           |       |
| Other expenses:                                                 |       |                                         |       |                                         |       |                                                                                              |       |       |       |                                                                                             |       |
| Interest expense,  net                                          |       | 23,884                                       |       | 22,631                                       |       | 664                                                                                               |       |       |       | 1,079                                                                                            |       |
| Other income                                                    |       |                                         |       |                                         |       |                                                                                              |       |       |       | (47                                                                                              | )          |
|                                                            |       | 23,884                                       |       | 22,631                                       |       | 664                                                                                               |       |       |       | 1,032                                                                                            |       |
| Income (loss)  before provision for (benefit from) income taxes |       | 9,279                                        |       | 21,063                                       |       | (494                                                                                              | )          |       |       | 68,134                                                                                           |       |
| Provision for (benefit  from) income taxes                      |       | 2,999                                        |       | 8,463                                        |       | (212                                                                                              | )          |       |       | 2,249                                                                                            |       |
| Net income  (loss)                                              |       | 6,280                                        |       | 12,600                                       |       | (282                                                                                              | )          |       |       | 65,885                                                                                           |       |
| Dividends accrued on  redeemable convertible preferred stock    |       | 4,000                                        |       | 4,000                                        |       | 110                                                                                               |       |       |       |                                                                                             |       |
| Net income (loss)  available to common stockholders             |       | $                                            | 2,280      |                                         | $          | 8,600                                                                                             |       | $          | (392       | )                                                                                                |       |   | $ | 65,885 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

F-5

----

 

**RafaellaApparel Group, Inc. and Subsidiary**

**Consolidated Statements ofStockholders’ Equity (Deficit)**

**(In thousands, except number ofshares)**

 
| ** **                                                              | ** ** | **Common Stock** | ** ** | **Additional  Paid in** | ** ** | **Deemed  Dividend, in  excess of  predecessor** | ** ** | **Retained  Earnings  (Accumulated** | ** ** | ** **   | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------|------------|--------------|------------|
| ** **                                                              | ** ** | **Shares**            | ** ** | **Amount**                   | ** ** | **Capital**                                                | ** ** | **basis**                            | ** ** | **Deficit)** | ** ** | **Total** | ** ** |
| *(Predecessor)*                                                         | * *   | * *              | * *   | * *                     | * *   | * *                                                   | * *   | * *                             | * *   | * *     | * *   | * * | * * |
| Balance at June 30, 2004                                                |       | 33.3                  |       | $                            | 50         |                                                       | $          |                                 |       | $            |       |   | $ | 30,533 |   | $ | 30,583 |   |
| Net income for the period from July 1, 2004 through June 19, 2005       |       |                  |       |                         |       |                                                       |       |                                 |       | 65,885       |       | 65,885 |   |
| Stockholder distributions                                               |       |                  |       |                         |       |                                                       |       |                                 |       | (73,834      | )          | (73,834 | ) |
| Balance at June 19, 2005                                                |       | 33.3                  |       | $                            | 50         |                                                       | $          |                                 |       | $            |       |   | $ | 22,584 |   | $ | 22,634 |   |
| * *                                                                | * *   | * *              | * *   | * *                     | * *   | * *                                                   | * *   | * *                             | * *   | * *     | * *   | * * | * * |
| *(Successor)*                                                           | * *   | * *              | * *   | * *                     | * *   | * *                                                   | * *   | * *                             | * *   | * *     | * *   | * * | * * |
| Issuance of common stock at carryover basis of Continuing  Stockholders |       | 2,500,000             |       | $                            | 25         |                                                       | $          |                                 |       | $            | 7,728      |   | $ |   |   | $ | 7,753 |   |
| Deemed dividend to Continuing Stockholders                              |       |                  |       |                         |       |                                                       |       | (33,750                              | )          |         |       | (33,750 | ) |
| Net loss for the period from June 20, 2005 through June 30, 2005        |       |                  |       |                         |       |                                                       |       |                                 |       | (282         | )          | (282 | ) |
| Accretion of preferred stock to redemption value                        |       |                  |       |                         |       |                                                       |       |                                 |       | (110         | )          | (110 | ) |
| Balance at June 30, 2005                                                |       | 2,500,000             |       | 25                           |       |                                                       |       | (26,022                              | )          | (392         | )          | (26,389 | ) |
| Net income                                                              |       |                  |       |                         |       |                                                       |       |                                 |       | 12,600       |       | 12,600 |   |
| Accretion of preferred stock to redemption value                        |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| 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 | ) |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

F-6

----

 

**RafaellaApparel Group, Inc. and Subsidiary**

**Consolidated Statements of Cash Flows**

**(In thousands)**
| ** **                                                                                | ** ** | **Year Ended**

**June 30,  2007** | ** ** | **Year Ended  June 30, 2006** | ** **        | **For the  Period from  June 20, 2005  through  June 30, 2005** | ** ** | ** ** | **For the  Period from  July 1, 2004  through  June 19, 2005** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------|-------------------|-----------------------------------------------------------------------------------------------|------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **(Successor)**                                        | ** ** | ** **                                   | **(Predecessor)** | ** **                                                                                    |
| Cash flows provided  by operating activities:                                             |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Net income (loss)                                                                         |       | $                                                      | 6,280      |                                         | $                 | 12,600                                                                                        |       | $          | (282                                                                                         | )          |   | $ | 65,885 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Amortization of deferred finance charges                                                  |       | 3,849                                                  |       | 2,087                                        |              |                                                                                          |       |       |                                                                                         |       |
| Accretion of original issue discount                                                      |       | 772                                                    |       | 983                                          |              | 39                                                                                            |       |       |                                                                                         |       |
| Depreciation and amortization                                                             |       | 4,985                                                  |       | 5,453                                        |              | 71                                                                                            |       |       | 125                                                                                          |       |
| Stock-based compensation expense                                                          |       | 241                                                    |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Deferred income taxes                                                                     |       | (2,364                                                 | )          | 8,026                                        |              | (212                                                                                          | )          |       |                                                                                         |       |
| Deferred rent                                                                             |       | 191                                                    |       | 129                                          |              |                                                                                          |       |       | 306                                                                                          |       |
| Changes in operating assets and liabilities:                                              |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Accounts receivable                                                                       |       | 1,725                                                  |       | 670                                          |              | 11,555                                                                                        |       |       | (15,648                                                                                      | )          |
| Inventories                                                                               |       | 2,679                                                  |       | 5,066                                        |              | (2,241                                                                                        | )          |       | 7,036                                                                                        |       |
| Other current assets                                                                      |       | (46                                                    | )          | (1,930                                       | )                 | 857                                                                                           |       |       | (818                                                                                         | )          |
| Accounts payable                                                                          |       | (2,440                                                 | )          | 2,404                                        |              | (3,155                                                                                        | )          |       | (5,259                                                                                       | )          |
| Accrued expenses and other current liabilities                                            |       | 871                                                    |       | 1,277                                        |              | 1,107                                                                                         |       |       | (426                                                                                         | )          |
| Net cash provided by operating activities                                                 |       | 16,743                                                 |       | 36,765                                       |              | 7,739                                                                                         |       |       | 51,201                                                                                       |       |
| Cash flows used  in investing activities:                                                 |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Purchase of business, net of cash acquired                                                |       |                                                   |       | (188                                         | )                 | (175,045                                                                                      | )          |       |                                                                                         |       |
| Purchase of equipment and leasehold improvements                                          |       | (214                                                   | )          | (95                                          | )                 |                                                                                          |       |       | (5                                                                                           | )          |
| Net cash used in investing activities                                                     |       | (214                                                   | )          | (283                                         | )                 | (175,045                                                                                      | )          |       | (5                                                                                           | )          |
| Cash flows (used  in) provided by financing activities:                                   |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Net borrowings (repayments) on short-term  borrowings                                     |       |                                                   |       | (9,261                                       | )                 | (22,983                                                                                       | )          |       | 24,468                                                                                       |       |
| Issuance of senior secured notes                                                          |       |                                                   |       |                                         |              | 163,400                                                                                       |       |       |                                                                                         |       |
| Deferred financing costs                                                                  |       |                                                   |       |                                         |              | (13,059                                                                                       | )          |       |                                                                                         |       |
| Issuance of redeemable convertible preferred stock                                        |       |                                                   |       |                                         |              | 40,000                                                                                        |       |       |                                                                                         |       |
| Repurchase of senior secured notes                                                        |       | (31,816                                                | )          |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Decrease in book overdraft                                                                |       | (596                                                   | )          |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Stockholder distributions                                                                 |       |                                                   |       |                                         |              |                                                                                          |       |       | (73,834                                                                                      | )          |
| Net cash (used in) provided by financing activities                                       |       | (32,412                                                | )          | (9,261                                       | )                 | 167,358                                                                                       |       |       | (49,366                                                                                      | )          |
| Net (decrease)  increase in cash and cash equivalents                                     |       | (15,883                                                | )          | 27,221                                       |              | 52                                                                                            |       |       | 1,830                                                                                        |       |
| Cash and cash  equivalents, beginning of period                                           |       | 27,273                                                 |       | 52                                           |              |                                                                                          |       |       | 28                                                                                           |       |
| Cash and cash  equivalents, end of period                                                 |       | $                                                      | 11,390     |                                         | $                 | 27,273                                                                                        |       | $          | 52                                                                                           |       |   | $ | 1,858 |   |
| Supplemental  disclosures of cash flow information:                                       |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Cash paid during the period for:                                                          |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Interest                                                                                  |       | $                                                      | 20,104     |                                         | $                 | 19,293                                                                                        |       | $          | 44                                                                                           |       |   | $ | 567 |   |
| Income taxes                                                                              |       | 7,326                                                  |       | 2,511                                        |              |                                                                                          |       |       | 2,688                                                                                        |       |
| Supplemental  disclosures of non-cash investing and financing activities:                 |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Acquisition (Note 1)                                                                      |       |                                                   |       |                                         |              |                                                                                          |       |       |                                                                                         |       |
| Fair value of assets acquired, including cash of  $1,858                                  |       |                                                   |       | $                                            | 188               |                                                                                          | $          | 250,421    |                                                                                         |       |   |   |
| Liabilities assumed                                                                       |       |                                                   |       |                                         |              | (65,765                                                                                       | )          |       |                                                                                         |       |
| Continuing stockholders interest (carryover basis)                                        |       |                                                   |       |                                         |              | (7,753                                                                                        | )          |       |                                                                                         |       |
| Cash paid                                                                                 |       |                                                   |       | $                                            | 188               |                                                                                          | $          | 176,903    |                                                                                         |       |   |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

F-7

----

**Rafaella Apparel Group, Inc.Notes to Consolidated Financial Statements**

**1.  Description of Business and Acquisition**

RafaellaApparel Group, Inc. (“Rafaella Apparel Group” or the “Successor”) is aDelaware corporation formed to effect the acquisition of RafaellaSportswear, Inc. (the “Predecessor”) by RA Cerberus Acquisition, LLC. OnJune 20, 2005, pursuant to a Securities Purchase Agreement datedApril 15, 2005, as amended, Rafaella Apparel Group issued redeemableconvertible preferred stock (the “Preferred Stock”) to RA Cerberus Acquisition,LLC for $40,000,000. Immediately prior to the issuance of the Preferred Stock,the Predecessor contributed substantially all of its assets to Rafaella ApparelGroup in exchange for 100% of its common stock (10,000,000 shares) and theassumption of certain liabilities related to the contributed assets.Immediately following the issuance of the Preferred Stock, Rafaella ApparelGroup issued $172,000,000 Senior Secured Notes at 95% of face value, resultingin proceeds of $163,400,000 (see Note 8). In addition, Rafaella ApparelGroup entered into a $62,500,000 revolving credit facility of which $17,654,982was borrowed at closing.

Theproceeds from the Preferred Stock, Senior Secured Notes and revolving creditborrowings were used to redeem 7,500,000 shares of common stock for$175,000,000, pay buyers transaction costs of $1,810,407, retire short termborrowings of $32,287,356 and pay debt issuance costs of $11,957,219, of whichcosts, $763,637 was paid to RA Cerberus Acquisition, LLC.

ThePreferred Stock entitles its holder to vote with the common stockholders as asingle voting class and the Preferred Stock is convertible, at the option ofthe holder, into 7,500,000 shares of common stock, representing a 75% ownershipinterest of Rafaella Apparel Group. The stockholders of the Predecessor (“ContinuingStockholders”) retained a 25% interest in the Successor through the Predecessor’sownership of the common stock.

Theabove transaction was accounted for as a purchase of the Predecessor’s businessin accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,“Business Combinations,” and the Emerging Issues Task Force IssueNo. 88-16, “Basis in Leveraged Buyout Transactions” (“EITF 88-16”). Inaccordance with EITF 88-16, the portion of the Continuing Stockholders’ basisin the Predecessor represented by their 25% residual interest in the Successor(carryover basis) has been assigned to the assets and liabilities acquired. Theremainder of the investment in the assets and liabilities acquired (the 75%acquired by RA Cerberus Acquisition, LLC) was recorded at fair value. As aresult, the assets and liabilities were assigned new values, which are partcarryover basis and part fair value basis. The Continuing Stockholders’residual interest in the Successor applied to the incremental debt resultingfrom the acquisition is accounted for as a deemed dividend and recognized as areduction of stockholders’ equity (deficit).

Thefollowing table summarizes the consideration related to the acquisition:

|                                                                  | ** ** | **(in thousands)** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|
| Cash costs, including  accrued transaction fees of $93           |       | $                       | 177,091    |   |
| Common stock held by  Continuing Stockholders at carryover basis |       | 7,753                   |       |
| Deemed dividend to  Continuing Stockholders                      |       | (33,750                 | )          |
| Total purchase price                                             |       | $                       | 151,094    |   |

 

Thetotal purchase price of $151,094,000, including an additional purchase priceadjustment of $188,000 determined in 2006, was allocated to the assets acquiredand liabilities assumed based on their estimated fair values as of theacquisition date, after taking into consideration the carry over basisdiscussed above. These allocations were initially determined using managementestimates and 

 

F-8

----

consideration of apreliminary valuation report with respect to the intangible assets acquired.Management’s consideration of a final valuation report resulted in an increasein the allocation of the purchase price to the fair value of customerrelationships ($34,805,000) and non-compete agreements ($3,067,000) and adecrease in deferred taxes ($945,000) and the purchase price assigned to thefair value of the trademark and trade name ($36,927,000).

Thefollowing table summarizes the estimated values of the assets acquired andliabilities assumed on June 20, 2005 (in thousands):

| Cash                                  |   | $       | 1,858   |   |
|---------------------------------------|--------|---------|---------|--------|
| Receivables                           |   | 34,735  |    |
| Inventories                           |   | 49,879  |    |
| Other current assets                  |   | 1,068   |    |
| Equipment and leasehold  improvements |   | 100     |    |
| Other assets                          |   | 41      |    |
| Trademark and trade  name             |   | 67,901  |    |
| Customer relationships                |   | 43,525  |    |
| Non-compete  agreements               |   | 3,067   |    |
| Deferred taxes, net                   |   | (789    | )       |
| Assumed liabilities                   |   | (50,291 | )       |
|                                  |   | $       | 151,094 |   |

 

Thefair value assigned to inventories exceeded its historical cost by $11,198,000,of which $945,000, $9,392,000 and $861,000 relating to inventory sold wascharged to cost of sales for the years ended June 30, 2007 and 2006, and forthe period from June 20, 2005 to June 30, 2005, respectively.

 

F-9

----

RafaellaApparel Group, together with the Predecessor for all periods presented prior toJune 20, 2005, is hereinafter referred to as the “Company.” As a result ofthe acquisition, the financial statements including and after June 20,2005 are not comparable to those prior to that date.

TheCompany is a designer, manufacturer (using independent contractors) andmarketer of a full line of women’s career and casual sportswear separates underthe Rafaella brand. The Company’s products are sold to department and specialtystores and off-price retailers located throughout the United States of America.

**2.  Significant Accounting Policies**

**Basisof consolidation**

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiary, Verrazano, Inc., which wasincorporated on January 23, 2004, and commenced operations shortlythereafter. All significant intercompany accounts and transactions have beeneliminated in consolidation.

**Useof estimates**

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Estimates by their nature are based on judgments andavailable information. Therefore, actual results could differ materially fromthose estimates under different assumptions and conditions. The most significantassumptions and estimates involved in preparing the financial statementsinclude, among other things, income taxes, allowances for sales returns,discounts and customer markdowns, lower of cost or market estimates related toinventory and the estimated useful lives of intangible assets.

**Cashand 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 interest expense, net, that was earned on the Company’s cashand cash equivalents amounted to $1,079,000 and $315,000 for the years endedJune 30, 2007 and 2006,  respectively.Interest income was not significant for the periods from July 1, 2004through June 19, 2005 and June 20, 2005 through June 30, 2005.

 

F-10

----

**Receivables**

TheCompany assigns and sells certain of its accounts receivable pursuant to anagreement with a large commercial financial institution (the “factor”) wherebythe factor pays the Company after the factor receives payment from the Company’scustomer. The factor will assume credit risk on all assigned accounts receivablefor which it has provided written credit approval. If the receivable becomesgreater than 60 days past due, the full amount of the receivable ispayable by the factor, except for accounts receivable due from department andchain stores, which are due on the earlier of receipt of payment from thecustomer or 20 days after the customer becomes bankrupt or insolvent. Anallowance for sales discounts, returns, allowable customer markdowns, co-opadvertising and operational chargebacks is included as a reduction to net salesand receivables. Certain of these provisions result from seasonal negotiationswith customers, as well as historic deduction trends and the evaluation ofcurrent market conditions. The Company also grants credit directly to certain customersin the normal course of business without participation by the factor. Anallowance for doubtful accounts is determined through an analysis of the agingof accounts receivable at the date of the financial statements, assessments ofcollectibility based on an evaluation of historic and anticipated trends, thefinancial condition of the Company’s customers, and an evaluation of the impactof economic conditions. The Company’s historical estimates of these costs havenot differed materially from actual results.

**Inventories**

Inventoriesare stated at the lower of cost or market, with cost being determined under theFIFO (First-in, First-out) method. Cost includes amounts paid to the productmanufacturer, plus duty, quota, freight and buying commissions.

**Long-livedassets**

Equipmentand leasehold improvements are stated at cost less accumulated depreciation andamortization. The Company capitalizes improvements to the extent they increasethe economic life of the asset. Furniture, fixtures, and equipment aredepreciated using the straight-line method over their estimated useful lives of3 to 7 years. Leasehold improvements are amortized over the shorter of theremaining lease term or the estimated useful lives of the assets. Depreciationand amortization expense is included in selling, general and administrativeexpenses. Expenditures for maintenance and repairs are expensed in the periodincurred.

Intangibleassets consist of the trademark and trade name, and customer relationships ofthe Predecessor, and non-compete agreements with officers of the Predecessor,acquired on June 20, 2005. Customer relationships are amortized using anaccelerated method over their estimated useful lives of 15 years.Non-compete agreements are amortized using the straight-line method over theirestimated useful lives of 2 and 10 years. Owned trademarks have beendetermined to have indefinite lives and are not subject to amortization.

TheCompany’s policy is to evaluate depreciable and amortizable assets forimpairment whenever events or changes in circumstances indicate that thecarrying amount of such assets may not be recoverable from the undiscountedcash flows expected from the use of the asset. 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.

Thetrademark and trade name, which have been determined to be indefinite livedassets, are tested for impairment at least annually or when changes incircumstances indicate that their carrying amount may not 

 

F-11

----

be recoverable, bycomparing the carrying amount of the assets to their fair values based on anincome approach using the relief-from-royalty method. This method assumes that,in lieu of ownership, a firm would be willing to pay a royalty in order toexploit the related benefits of these assets. This approach is dependent upon anumber of factors, including estimates of future growth and trends, royaltyrates for intellectual property, discount rates and other variables. TheCompany bases its fair value estimates on assumptions it believes arereasonable, but which are unpredictable and inherently uncertain. Actual futureresults may differ from those estimates. If the estimated fair value of theassets is less than their carrying amount, an impairment loss is recognizedequal to such difference.

**Deferredfinancing costs**

Costsassociated with obtaining long-term financing are deferred and amortized, underthe effective interest method, over the terms of the related debt. Amortizationof these costs is included in interest expense.

**Revenuerecognition**

Salesare recognized when merchandise is shipped and title and risk of loss aretransferred to customers. Revenue is recorded net of estimated discounts,returns and allowances. Discounts are based on trade terms. Returns andallowances require pre-approval from management. On a seasonal basis, theCompany negotiates price allowances with its customers as sales incentives orfor the cost of certain promotions. These allowances are estimated based onhistoric trends, seasonal results, an evaluation of current economic conditionsand retailer performance.

**Costof sales**

Costof sales includes expenses to acquire and produce goods for sale, includingproduct costs, freight-in, import costs, third party inspection activity,buying agent commissions, and provisions for shrinkage, excess and obsoleteinventory. Warehousing activities, including receiving, storing, picking,packing and general warehousing charges, are included in selling, general andadministrative expenses.

**Advertising**

TheCompany records advertising expense as incurred. Cooperative advertisingexpenses without specific performance guidelines are reflected as a reductionof net sales and for the years ended June 30, 2007 and 2006, and for theperiods from July 1, 2004 through June 19, 2005 and June 20,2005 through June 30, 2005 were approximately $1,478,000, $1,393,000,$831,000 and $35,000, respectively. The Company had no advertising other thancooperative advertising during the periods presented.

**Shippingand handling costs**

TheCompany includes shipping and handling costs associated with inbound freight incost of sales. Shipping and handling costs associated with outbound freight areincluded in selling, general and administrative expenses and for the yearsended June 30, 2007 and 2006, and for the periods from July 1, 2004through June 19, 2005 and June 20, 2005 through June 30, 2005 amountedto approximately $470,000, $573,000, $751,000 and $15,000, respectively.

 

F-12

----

**Stock-basedcompensation**

TheRafaella Apparel Group, Inc. Equity Incentive Plan (the “Plan”) provides forthe issuance of stock option and restricted stock-based compensation awards tosenior 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 terms of individual awards may vary, employeestock options granted to-date vest in annual increments of 25% over the firstfour years of the grant, expire no later than ten years after the grant date,and have an exercise price of $5.33 per share.

Underthe Plan, unvested awards become immediately vested upon the occurrence of aLiquidity Event. A Liquidity Event, as defined in the Plan, is (i) achange in control, (ii) the sale, transfer or other disposition of all orsubstantially all of the business and assets, (iii) the consummation of aninitial public offering, or (iv) the dissolution or liquidation of theCompany. Common stock acquired through the exercise of stock option grants orvesting of restricted stock issued under the Plan may not be sold, disposed ofor otherwise transferred by a participant of the Plan prior to a LiquidityEvent without the consent of Cerberus Capital Management, L.P. (“Cerberus”),shareholder of the Company.

Underthe Plan, prior to a Liquidity Event, the Company has the right, but not theobligation, to purchase from a participant and to cause the participant to sellto the Company, common stock acquired through the exercise of stock optiongrants or vesting of restricted stock issued following the participant’s(i) death, (ii) termination of employment with the Company as aresult of disability, (iii) termination of employment by the Companywithout cause, (iv) termination of employment by the Company for cause, or(v) termination of employment with the Company for any other reason. The purchaseprice for shares under clauses (i), (ii), or (iii) above is the greater of(a) the purchase price paid for such shares by the participant and(b) the fair market value of such shares. The purchase price for sharesunder clauses (iv) and (v) above is the lesser of (a) the purchase price,if any, paid for such shares by the participant, or if no price was paid, onedollar ($1.00) and (b) 50% of the fair market value of such shares. If at anytime after an initial public offering, a participant’s employment or relationshipis terminated for cause, the Company has the right, but not the obligation, topurchase from the participant and to cause the participant to sell to theCompany, all common stock acquired through the exercise

F-13

----

of stock optiongrants or vesting of restricted stock issued for the same purchase price asthat of clauses (iv) and (v) above. In the event that the Company does notexercise its repurchase rights above, Cerberus may also elect to repurchase theshares under the same terms and conditions.

EffectiveJuly 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payments” (“SFAS123R”), which revises SFAS No. 123, “Accounting for Stock-Based Compensation”(“SFAS 123”). SFAS 123R is supplemented by the SEC Staff’s views regardingthe interaction between SFAS 123R and certain SEC rules and regulationsincluding the valuation of share-based payment arrangements. The Company hasfollowed the prospective method of transition; accordingly, prior periods havenot been retroactively adjusted. Prior to adopting SFAS 123R, the Company appliedthe recognition and measurement principles of SFAS 123 using the minimum valuemethod. Accordingly, the Company will continue to amortize compensation costsunder the minimum value method for stock options accounted for prior to theeffective date of SFAS 123R. There was no effect from the change of applyingthe original provisions of SFAS 123 to the Company’s results of operations andcash flows for the year ended June 30, 2007, as a result of the Company’s adoptionof SFAS 123R, effective July 1, 2006.

UnderSFAS 123R, the Company is required to select a valuation technique oroption-pricing model that meets the criteria as stated in the standard. TheCompany has continued to use the Black-Scholes model, the option-pricing modelused under SFAS 123 and permissible under SFAS 123R, which requires the inputof subjective assumptions. These assumptions include estimating the length oftime participants will retain their vested stock options before exercising themand the estimated volatility of the Company’s common stock price over theexpected term. Under SFAS 123, the Company accounted for employee stock optionawards using the minimum value method, which excludes volatility in determiningthe fair value of a stock option under the Black-Scholes option-pricing model.However, for stock option awards granted to a consultant, pursuant to anagreement entered into in April 2006, the Company used volatility assumptionsbased on the average volatilities of other public entities determined to besimilar to the Company. The Company, in determining those entities, consideredcharacteristics such as industry, stage of life cycle, size, and financialleverage. As a result of the Company’ adoption of SFAS 123R, the Company is nolonger permitted to use the minimum value method. Effective July 1, 2006, theCompany utilizes the Black-Scholes option-pricing model with volatilityassumptions developed similarly to those used to value the stock optionsgranted to the consultant. Changes in the subjective assumptions can materiallyaffect the estimate of fair value of stock-based compensation and,consequently, the related amount recognized in the consolidated statement ofoperations.

AtJune 30, 2006, 916,666 stock options were outstanding pursuant to formal stockoption grants or committed pursuant to contractual obligations of the Company.During October 2006, the Company formally granted 777,777 stock options, whichincluded 666,666 stock options the Company was committed to issue pursuant tocontractual obligations at June 30, 2006 and an additional 111,111 stockoptions pursuant to an employment agreement for which service commenced inAugust 2006. Other than the August 2006 stock option award and a grant of83,334 stock options in May 2007, there were no other stock option grants,exercises or forfeitures during the year ended June 30, 2007. Accordingly, atJune 30, 2007, options to purchase a total of 1,111,111 shares of common stockof the Company at $5.33 per share were outstanding. At June 30, 2007, 402,778options were vested and exercisable. Of the outstanding and unvested options, 250,000vest within the next year and 458,333 vest over a three year period. The stockoptions have a weighted average exercise price of $5.33 per share and aweighted average remaining contractual life of 9.0 years. 

Eachof the individuals who were formally granted stock option awards during October2006 entered into contractual agreements with the Company, which included stockoption grants under the provisions of the Company’s Plan. As a mutualunderstanding of the terms of the awards existed and there was no performancecriteria necessary to receive the grants other than to enter into suchcontractual agreements with the Company, grant dates were determined based uponthe effective date of each of the respective agreements. Accordingly, exceptfor the August 2006 and May 2007 stock option awards, the Company has accountedfor each of the stock option awards granted during the year ended June 30, 2006in accordance with SFAS 123. The August 2006 and May 2007 stock option awardswere accounted for as grants during the year ended June 30, 2007 under SFAS123R. As of June 30, 2007, common stock that could be acquired through theexercise of 555,556 stock options are

F-14

----

subject to thecall right provisions described above. Subsequent to a Liquidity Event, thecall right provisions lapse, except for employees terminated for cause. As aresult of the call right provisions, the stock option awards do notsubstantively vest prior to the occurrence of a Liquidity Event. Accordingly,stock-based compensation expense will not be recognized unit it is probablethat a Liquidity Event will occur. As of June 30, 2007, it was not probablethat a Liquidity Event will occur. Unrecognized compensation costs related tothese options approximated $379,000 at June 30, 2007.

TheCompany recorded compensation expense related to 555,555 stock options, notsubject to the call right provisions described above, of approximately $241,000during the year ended June 30, 2007. As of June 30, 2007, there was anadditional $66,000 of unrecognized compensation cost related to these options,which will be recognized ratably as compensation expense over a weightedaverage vesting period of 2.8 years.

Thefollowing assumptions were used to estimate the fair value of the stock optionsgranted under the Black-Scholes option-pricing model under SFAS 123 and SFAS123R:

|                                                  | ** ** | **SFAS 123**             | ** ** | **SFAS 123R**            |
|--------------------------------------------------|------------|--------------------------|------------|--------------------------|
| Dividend yield                                   |       | 0%                       |       | 0%                       |
| Expected  volatility                             |       | 0.0% (employee),         |       | Range of 40% to 50%      |
|                                             |       | 50%  (non-employee)      |       |                     |
| Risk-free  interest rate                         |       | Range of 3.86%  to 4.82% |       | Range of 4.76%  to 4.92% |
| Expected life                                    |       | 5 Years                  |       | 4 - 5 Years              |
| Weighted average  fair value  of options granted |       | $0.36                    |       | $1.82                    |

**Incometaxes**

Deferredtaxes are provided for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of assets and liabilities andtheir respective tax bases, as measured by enacted tax rates in effect inperiods when the deferred tax assets and liabilities are expected to be settledor realized. A valuation allowance is provided on deferred tax assets when itis more likely than not that such deferred tax asset will not be realized.

ThePredecessor, with the consent of its stockholders, elected to be taxed as an Scorporation under the Internal Revenue Code, as well as for state purposes,which provides that, in lieu of corporate income taxes, the stockholders aretaxed on their proportionate share of the Predecessor’s taxable income.Therefore, for all periods prior to June 20, 2005, no provision orliability for federal income taxes is reflected in these financial statements;however, a provision has been made for certain state and local income taxes.Rafaella Apparel Group is a C corporation responsible for federal, state andlocal income taxes. Accordingly, a provision for federal, state and localincome taxes is reflected in the results of operations for the period fromJune 20, 2005 through June 30, 2005 and for the years endedJune 30, 2007 and 2006.

**Recentaccounting pronouncements**

InJune 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertaintyin income taxes recognized in an enterprise’s financial statements inaccordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48prescribes a recognition threshold and measurement attribute for financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. The Company is currently analyzing FIN 48 and its impact onthe Company’s financial condition and results of operations.

F-15

----

OnSeptember 13, 2006, the SEC staff issued Staff Accounting Bulletin No. 108,“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 wasissued in order to eliminate the diversity of practice surrounding how publiccompanies quantify financial statement misstatements. The adoption of SAB 108 didnot have an impact on the Company’s financial position or results of operations.

OnSeptember 15, 2006, the FASB issued FASB Statement No. 157, “Fair ValueMeasurements” (“SFAS 157”). SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. SFAS 157 iseffective for fiscal years beginning after November 15, 2007. The Company iscurrently analyzing SFAS 157 and its impact on the Company’s financialcondition and results of operations.

F-16

----

 

**3.  Receivables**

Receivablesconsist of (in thousands):

|                                                             | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                  | ** ** | **(Successor)**             | ** ** |
| Due from factor                                             |       | $                           | 14,562     |                        | $          | 16,891 |   |
| Trade receivables                                           |       | 13,141                      |       | 13,226                      |       |
|                                                        |       | 27,703                      |       | 30,117                      |       |
| Less: Allowances for  sales returns, discounts, and credits |       | 6,918                       |       | 7,607                       |       |
|                                                        |       | $                           | 20,785     |                        | $          | 22,510 |   |

 

Forthe years ended June 30, 2007 and 2006, the provision for sales, returns,discounts and credits charged to earnings was $35,141,000 and $32,985,000,respectively, and decreased by authorized deductions taken by customers of $35,830,000and $25,378,000, respectively. For the period from July 1, 2004 throughJune 19, 2005, the provision for sales returns, discounts and credits chargedto earnings was $27,514,000 and decreased by authorized deductions taken bycustomers of $25,800,000. Such allowances were not significant for the periodfrom June 20, 2005 through June 30, 2005.

**4.  Inventories**

Inventoriesare summarized as follows (in thousands):

|                                    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **(Successor)**             | ** ** |
| Piece goods (held by  contractors) |       | $                           | 9,139      |                        | $          | 4,877 |   |
| Finished goods:                    |       |                        |       |                        |       |
| In warehouse                       |       | 27,936                      |       | 21,918                      |       |
| In transit                         |       | 7,300                       |       | 20,259                      |       |
|                               |       | $                           | 44,375     |                        | $          | 47,054 |   |

 

**5.  Equipment and Leasehold Improvements**

Equipmentand leasehold improvements consist of the following (in thousands):

|                                                  | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **(Successor)**             | ** ** |
| Furniture, fixtures and  equipment               |       | $                           | 327        |                        | $          | 195 |   |
| Leasehold improvements                           |       | 82                          |       |                        |       |
|                                             |       | 409                         |       | 195                         |       |
| Less: Accumulated  depreciation and amortization |       | (125                        | )          | (80                         | )          |
|                                             |       | $                           | 284        |                        | $          | 115 |   |

 

F-17

----

Depreciation and amortization expense of equipment andleasehold improvements for the years ended June 30, 2007 and 2006, and theperiods from July 1, 2004 through June 19, 2005 and June 20,2005 through June 30, 2005 were approximately $45,000, $77,000, $125,000and $3,000, respectively.

**6.  Intangible Assets**

Intangibleassets resulting from the acquisition, consist of the following as ofJune 30, 2007 and 2006, as adjusted in 2006 based on consideration of afinal valuation report, as described in Note 1 (in thousands):

|                                 | ** ** | **Estimated  Lives** | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Customer relationships          |       | 15 years             |       | $        | 43,525     |     | $          | 43,525 |   |
| Less: Accumulated  amortization |       |                 |       | (9,326   | )          | (4,889   | )          |
|                            |       |                 |       | 34,199   |       | 38,636   |       |
|                            |       |                 |       |     |       |     |       |
| Non-compete  agreements         |       | 2, 10 years          |       | 3,067    |       | 3,067    |       |
| Less: Accumulated  amortization |       |                 |       | (1,013   | )          | (510     | )          |
|                            |       |                 |       | 2,054    |       | 2,557    |       |
|                            |       |                 |       |     |       |     |       |
|                            |       |                 |       |     |       |     |       |
| Trademark and trade  name       |       | Indefinite life      |       | 67,901   |       | 67,901   |       |
| Total intangible assets         |       |                 |       | $        | 104,154    |     | $          | 109,094 |   |

 

TheCompany’s indefinite-lived intangible assets consist of the Rafaellatrademark and trade name, as the Company believes these assets will contributeto cash flows indefinitely. These assets have been in existence since theCompany’s inception 25 years ago, and there is no foreseeable limit on theperiod of time over which they are expected to contribute to cash flows. Theamortization expense related to intangible assets for the years endedJune 30, 2007 and 2006, and the period from June 20, 2005 throughJune 30, 2005 was approximately $4,940,000, and $5,376,000 and $23,000,respectively.

Estimated amortization expense for the next five yearsis as follows:

|      | ** ** | **(in thousands)** | ** ** |
|------|------------|-------------------------|------------|
| 2008 |       | $                       | 4,335      |   |
| 2009 |       | 4,209                   |       |
| 2010 |       | 3,934                   |       |
| 2011 |       | 3,661                   |       |
| 2012 |       | 3,401                   |       |
|      |            |                         |            |  |

 

**7.  Short-term Borrowings**

EffectiveJune 20, 2005, the Company entered into a revolving credit facility withHSBC Bank USA, National Association (“HSBC”). The credit facility provides theCompany with a revolving line of credit, which can be used for loans andletters of credit of up to $62,500,000, with a sublimit for loans of$45,000,000. Under the credit facility, the aggregate credit available to theCompany is equal to specified percentages of eligible receivables and inventory,plus letters of credit issued for finished goods, subject to adjustment byHSBC. Borrowings under the credit facility bear variable interest at theCompany’s option at either (i) the prime rate minus one-half of onepercent (0.50%) per annum or (ii) the London interbank offered rate plustwo and one-quarter percent (2.25%) per annum (each rate as defined in thecredit facility). The credit facility provides for a monthly commitment fee of0.25% on the unused portion of the available credit under the credit facility.At June 30, 2007, there were no loans and $18.1 million of letters ofcredit outstanding under the credit facility. The Company had creditavailability of approximately $19.8 million.

F-18

----

Pursuantto the credit agreement, the Company remits funds from the collection ofreceivables to pay down borrowings outstanding under the revolving creditfacility. Under the Company’s factoring agreement, the Company directs itscustomers to remit payments on accounts receivable to GMAC, its factor. At therequest of HSBC, the Company has directed GMAC to remit the funds from thecollection of receivables directly to an HSBC account to reduce borrowingsoutstanding under the revolving credit facility. The factoring agreement can beterminated by the Company or the factor at anytime, with sixty days notice, atwhich point all proceeds from receivables shall be deposited, as directed byHSBC, for the payment of outstanding borrowings. Payments from customers inconnection with these arrangements are reflected in operating cash flows ascollections of receivables. Funds remitted under this arrangement to reduceshort-term borrowings are reflected in cash flows used in financing activitiesin the statement of cash flows.

Therewere no loan borrowings or repayments under the revolving credit facilityduring the year ended June 30, 2007. Total loan borrowings and repaymentsunder the revolving credit facility amounted to $64,891,000 and $74,152,000,respectively, in 2006, $173,660,000 and $149,192,000, respectively, in theperiod from July 1, 2004 through June 19, 2005, and $20,464,000 and$43,447,000, respectively, for the period from June 20, 2005 throughJune 30, 2005.

Thecredit facility is collateralized by substantially all the assets of theCompany and expires on June 20, 2010. The credit agreement containsvarious covenants that, among others, require the Company to maintain a minimumlevel of working capital that escalates each year over the term of the facility($40,000,000 as of June 30, 2007), report net income in quarterly periodssubsequent to June 30, 2005 and places limitations on dividends andrepurchases of capital stock, investments, asset sales and incurrence ofadditional indebtedness. The Company amended the net income covenant during theyear ended June 30, 2007 to require net income on a rolling six-monthperiod for the periods ended September 30, December 31,March 31, and June 30. A default on the senior secured notes willtrigger a default under the revolving credit facility. As of June 30,2007, the Company was in compliance with the financial covenants included inthe credit facility.

Priorto June 20, 2005, the Predecessor had a $62,500,000 working capital lineof credit with two banks that was used for loans and letters of credit.Interest was charged at 1% below the prime rate or 1.75% above LIBOR, at theCompany’s option. The line of credit was collateralized by substantially all ofthe Company’s assets. The line of credit was terminated in connection with theacquisition described in Note 1.

**8.  Senior Secured Notes**

Inconnection with the acquisition described in Note 1, the Company receivedaggregate proceeds of $163,400,000 from the issuance of 11.25% senior securednotes, face value $172,000,000. The notes were issued at 95% of face value,resulting in an original issue discount of $8,600,000 that is being amortizedunder the effective interest method over the term of the notes. Senior securednotes principal amount outstanding at June 30, 2007 and 2006 is$138,509,000 and $172,000,000, respectively. At June 30, 2007 and 2006,the unamortized original issue discount is $5,131,000 and $7,577,000,respectively. The notes bear cash interest at 11.25%. After giving effect tothe original issue discount and costs associated with the transaction, thenotes have an effective interest rate of approximately 13.7%. The notes matureon June 15, 2011 and cash interest is payable semiannually on June 15and December 15 of each year, commencing December 15, 2005. The notesare collateralized by a second priority lien on substantially all of the assetsof the Company. The notes are subordinated to amounts outstanding under therevolving credit facility.

F-19

----

Within 100 days after the end of each fiscal year,beginning with the fiscal year ended on June 30, 2006, we must make anoffer to repurchase all or a portion of the senior secured notes at 101% oftheir principal amount at maturity plus accrued and unpaid interest to the dateof purchase, with 50% of excess cash flow, as defined, from the previous fiscalyear. In connection with the fiscal year ended June 30, 2006, werepurchased $17,429,000 of the senior secured notes at 101% of their principalamount at maturity, plus accrued and unpaid interest, for approximately$18.4 million on November 8, 2006. The Company wrote-off$1.7 million of unamortized original issue discount and deferred financingcosts to interest expense in connection with the November 8, 2006 excesscash flow repurchase.

We repurchased$16,062,000 of the senior secured notes at 101% of their principal amount atmaturity, plus accrued and unpaid interest, for approximately$16.3 million on June 29, 2007. The Company wrote-off $1.4 millionof unamortized original issue discount and deferred financing costs to interestexpense in connection with the June 29, 2007 senior secured noterepurchase.

We currentlyestimate that the annual excess cash flow payment with respect to the fiscalyear ended June 30, 2007, payable on or before November 6, 2007, willbe approximately $234,000, and have classified this amount in the currentportion of senior secured notes in the consolidated balance sheet as ofJune 30, 2007.

**9.  Redeemable Convertible Preferred Stock**

OnJune 20, 2005, the Company issued 7,500,000 shares of redeemableconvertible preferred stock (the “Preferred Stock”) for $40,000,000. Theholders of the Preferred Stock vote with the common stockholders as a singlevoting class, have certain veto rights and the right to designate the majorityof the members of the board of directors. The holders of the Preferred Stockare not entitled to dividends, unless a dividend is declared with respect tothe common stockholders.

ThePreferred Stock is redeemable at the option of the holder upon the earlier of(i) a change in control of the Company, as defined in the certificate ofincorporation, (ii) June 20, 2010, if no principal amounts of thesenior secured notes are outstanding, and (iii) December 20, 2011, ifprincipal amounts of the senior secured notes are outstanding. The PreferredStock is redeemable at its original purchase price, plus a return of 10% perannum, which is being accreted through a charge to retained earnings. Since theredemption of the Preferred Stock is outside the control of the Company, it isclassified outside of stockholders’ equity (deficit) on the consolidatedbalance sheets. For the years ended June 30, 2007 and 2006, and for theperiod from June 20, 2005 through June 30, 2005, the Company accreted$4,000,000, $4,000,000, and $110,000, respectively, towards the PreferredStock.

ThePreferred Stock is convertible into common stock on a one for one basis. Suchconversion ratio is subject to adjustment in the event of additional issuancesof common stock at prices less than the original conversion price.

 

F-20

----

**10.  Income Taxes**

Theprovision for (benefit from) income taxes consists of the following (inthousand):
| ** **      | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** | **Period from  June 20,  2005 through  June 19, 2005** | ** ** | ** ** | ** ** | **Period from  July 1,  2004 through  June 19, 2005** | ** ** |
|-----------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------|------------|
| ** **      | ** ** | **(Successor)**                              | ** ** | ** **                                   | ** ** | **(Predecessor)**                                                               | ** ** |
| Current:        |       |                                         |       |                                         |       |                                                                            |       |       |       |                                                                           |       |
| Federal         |       | $                                            | 5,106      |                                         | $          | 181                                                                             |       | $          |       |                                                                           |       |   | $ |   |   |
| State and local |       | 257                                          |       | 255                                          |       |                                                                            |       |       |       | 2,249                                                                          |       |
|            |       | 5,363                                        |       | 436                                          |       |                                                                            |       |       |       | 2,249                                                                          |       |
| Deferred:       |       |                                         |       |                                         |       |                                                                            |       |       |       |                                                                           |       |
| Federal         |       | (1,939                                       | )          | 7,113                                        |       | (151                                                                            | )          |       |       |                                                                           |       |
| State and local |       | (425                                         | )          | 914                                          |       | (61                                                                             | )          |       |       |                                                                           |       |
|            |       | (2,364                                       | )          | 8,027                                        |       | (212                                                                            | )          |       |       |                                                                           |       |
|            |       | $                                            | 2,999      |                                         | $          | 8,463                                                                           |       | $          | (212       | )                                                                              |       |   | $ | 2,249 |   |

 

Theeffective income tax rate differs from the statutory income tax rate asfollows:
| ** **                                                                      | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** | **For the  Period from  June 20, 2005  through  June 19, 2005** | ** ** | ** ** | ** ** | **For the  Period from  July 1, 2004  through  June 19, 2005** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **(Successor)**                              | ** ** | ** **                                   | ** ** | **(Predecessor)**                                                                             | ** ** |
| Statutory federal  income tax rate                                              |       | 34.0                                         | %          | 35.0                                         | %          | 35.0                                                                                          | %          |       |       | 35.0                                                                                         | %          |
| State and local income taxes,  net of federal benefit for Successor             |       | (1.7                                         | )          | 5.2                                          |       | 8.0                                                                                           |       |       |       | 3.3                                                                                          |       |
| Federal income taxes  not applicable due to S Corporation status of Predecessor |       |                                         |       |                                         |       |                                                                                          |       |       |       | (35.0                                                                                        | )          |
| Effective tax rate                                                              |       | 32.3                                         | %          | 40.2                                         | %          | 43.0                                                                                          | %          |       |       | 3.3                                                                                          | %          |

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amount used for income tax purposes. As discussed in Note 1, theCompany recorded an additional $945,000 during the year ended June 30,2006 in deferred tax assets, as a result of the final purchase priceallocation.

F-21

----

** **

Thecomponents of deferred taxes as of June 30, 2007 and 2006, relatingprimarily to temporary differences arising as a result of the acquisition, areas follows (in thousands):

 
| ** **                                | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **(Successor)**         | ** ** |
| Deferred tax  assets:                     |       |                    |       |                    |       |
| Accounts receivable                       |       | $                       |       |                    | $          | 8 |   |
| Inventories                               |       | 2,561                   |       | 2,941                   |       |
| Accrued expenses and other liabilities    |       | 1,093                   |       | 558                     |       |
| Depreciation                              |       |                    |       | 16                      |       |
| Deferred financing costs and other assets |       | 427                     |       | 229                     |       |
| Net operating loss carryforward           |       |                    |       | 352                     |       |
| Alternative minimum tax credits           |       |                    |       | 181                     |       |
| Stock-based compensation                  |       | 93                      |       |                    |       |
| Total deferred tax assets                 |       | 4,174                   |       | 4,285                   |       |
| Deferred tax  liabilities:                |       |                    |       |                    |       |
| Intangible assets                         |       | (10,372                 | )          | (12,889                 | )          |
| Accounts receivable                       |       | (21                     | )          |                    |       |
| Depreciation                              |       | (21                     | )          |                    |       |
| Total deferred tax liabilities            |       | (10,414                 | )          | (12,889                 | )          |
| Net deferred  taxes                       |       | $                       | (6,240     | )                       | $          | (8,604 | ) |

 

TheCompany had a federal net operating loss carryforward of approximately $101,000as of June 30, 2006, which expires in 2025. Additionally, the Company hadapproximately $6,233,000 of state net operating loss carryforwards, whichexpire between 2012 and 2025. During the years ended June 30, 2007 and2006, the Company used $101,000 and $9,037,000 of federal net operating losscarryforwards, respectively. State net operating loss carryforwards of $6,233,000were used during the year ended June 30, 2007. As of June 30, 2007,there were no operating loss carryforwards.

F-22

----

** **

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

TheCompany maintains its cash accounts in one commercial bank located in New York.The cash balances are insured by the Federal Deposit Insurance Corporation(FDIC) up to $100,000 per bank.

Receivablesarise in the normal course of business. Management minimizes its credit riskwith respect to trade receivables sold to its factor. For trade receivables notfactored, management monitors the creditworthiness of such customers andreviews the outstanding receivables at period end, as well as uncollectedaccount experience and establishes an allowance for doubtful accounts as deemednecessary. Such allowances were not significant for the periods presented.

Forthe 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. For the year ended June 30, 2006, sales to three customersapproximated $69.2 million, $38.5 million, and $29.9 million ofthe Company’s consolidated net sales. For the period from July 1, 2004through June 19, 2005, sales to three customers approximated $67.9 million,$26.4 million, and $26.0 million of the Company’s consolidated netsales. For the period from June 20, 2005 through June 30, 2005, salesto three customers approximated $1.7 million, $0.9 million, and $0.5 millionof the Company’s consolidated net sales. Accounts receivable, net ofallowances, from four customers approximated $3.6 million,$2.9 million, $2.8 million, and $2.3 million at June 30,2007. Accounts receivable, net of allowances, from three customers approximated$5.3 million, $4.4 million, and $3.3 million at June 30,2006.

**12.  Commitments and Contingencies**

TheCompany, from time to time, is party to 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 our financial position or results of operations,litigation is subject to inherent uncertainties.

TheCompany is obligated to pay minimum rental payments under non-cancellableoperating leases for showroom, office, and warehouse space expiring at variousdates through January 2013. The lease agreements provide for fixed rentescalations over their terms. The Company recognizes such minimum rentalcommitments as rent expense on a straight-line basis. The Company is alsoresponsible for additional rent based on increases in certain costs of theleased premises. Minimum rental commitments, in the aggregate and for each ofthe next five years, are as follows:

 

| Years ending June 30, | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------------|------------|
| 2008                                 |       | $          | 1,770      |                    |
| 2009                                 |       | 1,549      |       |
| 2010                                 |       | 1,338      |       |
| 2011                                 |       | 1,365      |       |
| 2012                                 |       | 1,392      |       |
| Thereafter                           |       | 821        |       |
|                                 |       | $          | 8,235      |                    |

 

Rentexpense for the years ended June 30, 2007 and 2006, and for the periodsfrom July 1, 2004 through June 19, 2005 and June 20, 2005through June 30, 2005 was approximately $1,915,000, $1,895,000, $1,688,000and $52,000, respectively.

TheCompany was contingently liable for open letters of credit of approximately $18.1 millionand $29.6 million as of June 30, 2007 and 2006, respectively.

F-23

----

** **

**13.  Retirement Plan**

TheCompany has a defined contribution retirement plan which covers all employeesand provides for eligible employees to make elective contributions of up to 15%of their salary. Company matching contributions to the plan for the years endedJune 30, 2007 and 2006, and the periods from July 1, 2004 throughJune 19, 2005 and June 20, 2005 through June 30, 2005 wereapproximately $181,000, $166,000, $131,000 and $3,000, respectively.

**14.  Fair Value of Financial Instruments**

Thefair value of cash and cash equivalents, receivables and accounts payableapproximate their carrying value due to their short-term maturities. AtJune 30, 2007, the fair value of the senior secured notes, determinedbased upon quoted market prices, was approximately $139,894,000. AtJune 30, 2006, the fair value of the senior secured notes, wasapproximately $195,000,000. This was determined using a present value methodbased upon interest rates that the Company believes it could obtain forfinancing with similar terms.

**15.  Accrued Expenses and Other CurrentLiabilities**

Accruedexpenses and other current liabilities consist of (in thousands):

|                                    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **(Successor)**             | ** ** |
| Accrued interest  expense          |       | $                           | 693        |                        | $          | 806 |   |
| Accrued  compensation and benefits |       | 2,676                       |       | 1,880                       |       |
| Other accrued  liabilities         |       | 259                         |       | 71                          |       |
|                               |       | $                           | 3,628      |                        | $          | 2,757 |   |

 

**16.  Quarterly Financial Data (unaudited) (inthousands)**
| ** **        | ** ** | **Quarter ended**       | ** ** |
|-------------------|------------|------------------------------|------------|
| ** **        | ** ** | **September 30,  2006** | ** ** | **December 31,  2006(2)** | ** ** | **March 31,  2007** | ** ** | **June 30,  2007(2)** | ** ** |
| ** **        | ** ** | **(Successor)**              | ** ** |
| Net sales         |       | $                            | 56,819     |   | $ | 42,779 |   | $ | 45,633 |   | $ | 46,053 |   |
| Gross profit      |       | 22,435                       |       | 12,321 |   | 15,817 |   | 13,541 |   |
| Net income (loss) |       | 5,551                        |       | (1,180 | ) | 1,641 |   | 268 |   |
|                   |            |                              |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **   | ** ** | **Quarter ended**       | ** ** |
|--------------|------------|------------------------------|------------|
| ** **   | ** ** | **September 30,  2005** | ** ** | **December 31,  2005** | ** ** | **March 31,  2006(1)** | ** ** | **June 30,  2006** | ** ** |
| ** **   | ** ** | **(Successor)**              | ** ** |
| Net sales    |       | $                            | 63,741     |   | $ | 51,696 |   | $ | 65,109 |   | $ | 41,641 |   |
| Gross profit |       | 19,240                       |       | 14,948 |   | 25,932 |   | 13,512 |   |
| Net income   |       | 4,207                        |       | 1,709 |   | 6,141 |   | 543 |   |
|              |            |                              |            |  |  |  |  |  |  |  |  |  |  |

----

(1)             Netincome includes a reduction of $1,822 for additional amortization related tointangible assets, net of income taxes, as a result of the final purchase priceallocation described in Note 1.

(2)             TheCompany wrote-off $845 and $1,014 of unamortized original issue discount anddeferred financing costs, net of income taxes, in connection with the seniorsecured note repurchases (described in Note 8) during the quarterlyperiods ended June 30, 2007 and December 31, 2006, respectively.

F-24

----

 

**17.  Consolidating Financial Statements**

InJune 2005, the Company issued 11.25% Senior Secured Notes that are fully, unconditionally,jointly and severally guaranteed on a senior secured basis byVerrazano, Inc. (“Verrazano”), a wholly-owned subsidiary of theCompany. Verrazano was formed in 2004 and commenced operations in 2005. Thefollowing condensed consolidating financial information as of June 30, 2007and 2006, and for the years ended June 30, 2007 and 2006, and for the periodsfrom July 1, 2004 (period of commencement of operations of Verrazano)through June 19, 2005 and June 20, 2005 through June 30, 2005 isprovided in lieu of separate financial statements for the Company andVerrazano.

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Statement of Operations**

**Yearended June 30, 2007**

**(In thousands)**
| ** **                                    | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------|------------|-----------|
| ** **                                    | ** ** | **(Successor)**                  |
| 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, 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  subsidiary             |       | (1,936                           | )          |          |       | $                | 1,936      |      |   |
| Net income                                    |       | $                                | 6,280      |          | $          | 1,936            |       | $         | (1,936 | ) | $ | 6,280 |

 

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Statement of Operations**

**Yearended June 30, 2006**

**(In thousands)**
| ** **                                    | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------|------------|-----------|------------|
| ** **                                    | ** ** | **(Successor)**                  | ** ** |
| Net sales                                     |       | $                                | 192,594    |          | $          | 29,593           |       |      |       | $ | 222,187 |   |
| Cost of sales                                 |       | 128,318                          |       | 20,237        |       |             |       | 148,555   |       |
| Gross profit                                  |       | 64,276                           |       | 9,356         |       |             |       | 73,632    |       |
| Selling, general and  administrative expenses |       | 27,319                           |       | 2,619         |       |             |       | 29,938    |       |
| Operating income                              |       | 36,957                           |       | 6,737         |       |             |       | 43,694    |       |
| Interest expense, net                         |       | 22,631                           |       |          |       |             |       | 22,631    |       |
| Income before provision  for income taxes     |       | 14,326                           |       | 6,737         |       |             |       | 21,063    |       |
| Provision for income  taxes                   |       | 6,033                            |       | 2,430         |       |             |       | 8,463     |       |
| Equity in earnings of  subsidiary             |       | (4,307                           | )          |          |       | $                | 4,307      |      |       |   |
| Net income                                    |       | $                                | 12,600     |          | $          | 4,307            |       | $         | (4,307     | ) | $ | 12,600 |   |

 

F-25

----

 

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Statements of Operations**

**Forthe period from July 1, 2004 through June 19, 2005**

**andthe period from June 20, 2005 through June 30, 2005**

**(In thousands)**
| ** **                                                      | ** ** | **For the period from July 1, 2004  through June 19, 2005** | ** ** | ** **    | ** ** | **For the period from June 20, 2005  through June 30, 2005** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|---------------|------------|-----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **Rafaella  Sportswear**                                                                                 | ** ** | **Verrazano** | ** ** | **Eliminations**                                                                                          | ** ** | **Total** | ** ** | ** ** | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **(Predecessor)**                                                                                        | ** ** | ** **    | ** ** | **(Successor)**                                                                                           | ** ** |
| Net sales                                                       |       | $                                                                                                        | 207,433    |          | $          | 18,125                                                                                                    |       |   |   | $ | 225,558 |   |   |   | $ | 3,229 |   | $ | 986 |   |   |   | $ | 4,215 |   |
| Cost of sales                                                   |       | 128,100                                                                                                  |       | 10,783        |       |                                                                                                      |       | 138,883 |   |   |   | 2,520 |   | 554 |   |   |   | 3,074 |   |
| Gross profit                                                    |       | 79,333                                                                                                   |       | 7,342         |       |                                                                                                      |       | 86,675 |   |   |   | 709 |   | 432 |   |   |   | 1,141 |   |
| Selling, general and  administrative expenses                   |       | 16,482                                                                                                   |       | 1,027         |       |                                                                                                      |       | 17,509 |   |   |   | 915 |   | 56 |   |   |   | 971 |   |
| Operating  income (loss)                                        |       | 62,851                                                                                                   |       | 6,315         |       |                                                                                                      |       | 69,166 |   |   |   | (206 | ) | 376 |   |   |   | 170 |   |
| Interest expense, net                                           |       | 1,078                                                                                                    |       | 1             |       |                                                                                                      |       | 1,079 |   |   |   | 664 |   |   |   |   |   | 664 |   |
| Other income                                                    |       | (47                                                                                                      | )          |          |       |                                                                                                      |       | (47 | ) |   |   |   |   |   |   |   |   |   |   |
| Income (loss) before  provision for (benefit from) income taxes |       | 61,820                                                                                                   |       | 6,314         |       |                                                                                                      |       | 68,134 |   |   |   | (870 | ) | 376 |   |   |   | (494 | ) |
| Provision for (benefit  from) income taxes                      |       | 2,015                                                                                                    |       | 234           |       |                                                                                                      |       | 2,249 |   |   |   | (363 | ) | 151 |   |   |   | (212 | ) |
| Equity in earnings of  subsidiary                               |       | (6,080                                                                                                   | )          |          |       | $                                                                                                         | 6,080      |   |   |   |   |   | (225 | ) |   |   | $ | 225 |   |   |   |
| Net income (loss)                                               |       | $                                                                                                        | 65,885     |          | $          | 6,080                                                                                                     |       | $ | (6,080 | ) | $ | 65,885 |   |   |   | $ | (282 | ) | $ | 225 |   | $ | (225 | ) | $ | (282 | ) |

 

F-26

----

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Statement of Cash Flows**

**Yearended June 30, 2007**

**(In thousands)**
| ** **                                                                         | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|------------------|------------|-----------|------------|
| ** **                                                                         | ** ** | **(Successor)**              | ** ** |
| 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  subsidiary                                                  |       | (1,936                       | )          |          |       | 1,936            |       |      |       |
| Stock-based compensation  expense                                                  |       | 241                          |       |          |       |             |       | 241       |       |
| Deferred 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-27

----

** **

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Statement of Cash Flows**

**Yearended June 30, 2006**

**(In thousands)**
| ** **                                                                                   | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|------------------|------------|-----------|------------|
| ** **                                                                                   | ** ** | **(Successor)**              | ** ** |
| Cash flows provided by  (used in) operating activities:                                      |       |                         |       |          |       |             |       |      |       |
| Net income                                                                                   |       | $                            | 12,600     |          | $          | 4,307            |       | $         | (4,307     | ) | $ | 12,600 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                         |       |          |       |             |       |      |       |
| Amortization of  deferred finance charges                                                    |       | 2,087                        |       |          |       |             |       | 2,087     |       |
| Accretion of original  issue discount                                                        |       | 983                          |       |          |       |             |       | 983       |       |
| Depreciation and  amortization                                                               |       | 5,106                        |       | 347           |       |             |       | 5,453     |       |
| Equity in earnings of  subsidiary                                                            |       | (4,307                       | )          |          |       | 4,307            |       |      |       |
| Deferred income taxes                                                                        |       | 7,864                        |       | 162           |       |             |       | 8,026     |       |
| Deferred rent                                                                                |       | 129                          |       |          |       |             |       | 129       |       |
| Changes in operating  assets and liabilities:                                                |       |                         |       |          |       |             |       |      |       |
| Accounts  receivable                                                                         |       | 1,400                        |       | (730          | )          |             |       | 670       |       |
| Inventories                                                                                  |       | 4,854                        |       | 212           |       |             |       | 5,066     |       |
| Other current  assets                                                                        |       | (3,304                       | )          | (4,867        | )          | 6,241            |       | (1,930    | )          |
| Accounts payable                                                                             |       | 3,183                        |       | (779          | )          |             |       | 2,404     |       |
| Accrued expenses  and other current liabilities                                              |       | 6,179                        |       | 1,339         |       | (6,241           | )          | 1,277     |       |
| Net cash  provided by (used in) operating activities                                         |       | 36,774                       |       | (9            | )          |             |       | 36,765    |       |
| Cash flows used in investing  activities:                                                    |       |                         |       |          |       |             |       |      |       |
| Purchase of business,  net of cash acquired                                                  |       | (188                         | )          |          |       |             |       | (188      | )          |
| Purchase of equipment  and leasehold improvements                                            |       | (95                          | )          |          |       |             |       | (95       | )          |
| Net cash used in  investing activities                                                       |       | (283                         | )          |          |       |             |       | (283      | )          |
| Cash flows used in  financing activities:                                                    |       |                         |       |          |       |             |       |      |       |
| Net repayments on short-term  borrowings                                                     |       | (9,261                       | )          |          |       |             |       | (9,261    | )          |
| Net cash used in  financing activities                                                       |       | (9,261                       | )          |          |       |             |       | (9,261    | )          |
| Net increase (decrease)  in cash and cash equivalents                                        |       | 27,230                       |       | (9            | )          |             |       | 27,221    |       |
| Cash and cash  equivalents, beginning of period                                              |       | 43                           |       | 9             |       |             |       | 52        |       |
| Cash and cash equivalents, end of period                                                     |       | $                            | 27,273     |          | $          |             |       | $         |       |   | $ | 27,273 |   |

 

F-28

----

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Statements of Cash Flows**

**Forthe period from July 1, 2004 through June 19, 2005 and the period from June 20,2005 through June 30, 2005**

**(In thousands)**
| ** **                                                                                          | ** ** | **For the period from July 1, 2004  to June 19, 2005** | ** ** | ** **    | ** ** | **For the period from June 20, 2005  to June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|---------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **Rafaella  Sportswear**                                                                            | ** ** | **Verrazano** | ** ** | **Eliminations**                                                                                     | ** ** | **Total** | ** ** | ** ** | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                                          | ** ** | **(Predecessor)**                                                                                   | ** ** | ** **    | ** ** | **(Sucessor)**                                                                                       | ** ** |
| Cash flows provided by  (used in) operating activities:                                             |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                                                                                   | 65,885     |          | $          | 6,080                                                                                                |       | $ | (6,080 | ) | $ | 65,885 |   |   |   | $ | (282 | ) | $ | 225 |   | $ | (225 | ) | $ | (282 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Accretion of original  issue discount                                                               |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | 39 |   |   |   |   |   | 39 |   |
| Depreciation and  amortization                                                                      |       | 125                                                                                                 |       |          |       |                                                                                                 |       | 125 |   |   |   | 71 |   |   |   |   |   | 71 |   |
| Equity in earnings of  subsidiary                                                                   |       | (6,080                                                                                              | )          |          |       | 6,080                                                                                                |       |   |   |   |   | (225 | ) |   |   | 225 |   |   |   |
| Deferred income taxes                                                                               |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | (212 | ) |   |   |   |   | (212 | ) |
| Deferred rent                                                                                       |       | 306                                                                                                 |       |          |       |                                                                                                 |       | 306 |   |   |   |   |   |   |   |   |   |   |   |
| Changes in operating  assets and liabilities:                                                       |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts  receivable                                                                                |       | (15,466                                                                                             | )          | (182          | )          |                                                                                                 |       | (15,648 | ) |   |   | 12,686 |   | (1,131 | ) |   |   | 11,555 |   |
| Inventories                                                                                         |       | 13,874                                                                                              |       | (6,838        | )          |                                                                                                 |       | 7,036 |   |   |   | 4,330 |   | (6,571 | ) |   |   | (2,241 | ) |
| Other  current assets                                                                               |       | 1,718                                                                                               |       | (1            | )          | (2,535                                                                                               | )          | (818 | ) |   |   | 856 |   | (1,537 | ) | 1,538 |   | 857 |   |
| Accounts  payable                                                                                   |       | (10,280                                                                                             | )          | 5,021         |       |                                                                                                 |       | (5,259 | ) |   |   | (5,861 | ) | 2,706 |   |   |   | (3,155 | ) |
| Accrued  expenses and other current liabilities                                                     |       | (538                                                                                                | )          | (2,423        | )          | 2,535                                                                                                |       | (426 | ) |   |   | 2,520 |   | 125 |   | (1,538 | ) | 1,107 |   |
| Net  cash provided by (used in) operating activities                                                |       | 49,544                                                                                              |       | 1,657         |       |                                                                                                 |       | 51,201 |   |   |   | 13,922 |   | (6,183 | ) |   |   | 7,739 |   |
| Cash flows used in  investing activities:                                                           |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of business,  net of cash acquired                                                         |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | (175,045 | ) |   |   |   |   | (175,045 | ) |
| Purchase of equipment  and leaseehold improvements                                                  |       | (5                                                                                                  | )          |          |       |                                                                                                 |       | (5 | ) |   |   |   |   |   |   |   |   |   |   |
| Investment in subsidiary                                                                            |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | (6,192 | ) |   |   | 6,192 |   |   |   |
| Net  cash used in investing activities                                                              |       | (5                                                                                                  | )          |          |       |                                                                                                 |       | (5 | ) |   |   | (181,237 | ) |   |   | 6,192 |   | (175,045 | ) |
| Cash flows (used in)  provided by financing activities:                                             |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net borrowings  (repayments) on short-term borrowings                                               |       | 24,468                                                                                              |       |          |       |                                                                                                 |       | 24,468 |   |   |   | (22,983 | ) |   |   |   |   | (22,983 | ) |
| Issuance of senior  secured notes                                                                   |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | 163,400 |   |   |   |   |   | 163,400 |   |
| Deferred financing costs                                                                            |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | (13,059 | ) |   |   |   |   | (13,059 | ) |
| Issuance of redeemable  convertible preferred stock                                                 |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   | 40,000 |   |   |   |   |   | 40,000 |   |
| Stockholder  distributions                                                                          |       | (73,834                                                                                             | )          |          |       |                                                                                                 |       | (73,834 | ) |   |   |   |   |   |   |   |   |   |   |
| Additional paid in  capital                                                                         |       |                                                                                                |       |          |       |                                                                                                 |       |   |   |   |   |   |   | 6,192 |   | (6,192 | ) |   |   |
| Net  cash (used in) provided by financing activities                                                |       | (49,366                                                                                             | )          |          |       |                                                                                                 |       | (49,366 | ) |   |   | 167,358 |   | 6,192 |   | (6,192 | ) | 167,358 |   |
| Net increase in cash and  cash equivalents                                                          |       | 173                                                                                                 |       | 1,657         |       |                                                                                                 |       | 1,830 |   |   |   | 43 |   | 9 |   |   |   | 52 |   |
| Cash and cash  equivalents, beginning of period                                                     |       | 26                                                                                                  |       | 2             |       |                                                                                                 |       | 28 |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents, end of period                                                            |       | $                                                                                                   | 199        |          | $          | 1,659                                                                                                |       | $ |   |   | $ | 1,858 |   |   |   | $ | 43 |   | $ | 9 |   | $ |   |   | $ | 52 |   |

 

 

F-29

----

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Balance Sheet**

**Asof June 30, 2007**

**(In thousands)**
| ** **                                                | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazaon** | ** ** | **Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------|------------|------------|------------|
| ** **                                                | ** ** | **(Successor)**                  | ** ** |
| **Assets**                                                | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **       | ** ** | ** ** | ** ** |
| Current assets:                                           |       |                             |       |          |       |             |       |       |       |
| Cash and equivalents                                      |       | $                                | 11,390     |          | $          |             |       | $          |       |   | $ | 11,390 |   |
| Receivables, net                                          |       | 17,182                           |       | 3,603         |       |             |       | 20,785     |       |
| Inventories                                               |       | 39,012                           |       | 5,363         |       |             |       | 44,375     |       |
| Deferred income taxes                                     |       | 3,265                            |       | 245           |       |             |       | 3,510      |       |
| Other current assets                                      |       | 2,131                            |       | 9,054         |       | (8,999           | )          | 2,186      |       |
| Total current assets                                      |       | 72,980                           |       | 18,265        |       | (8,999           | )          | 82,246     |       |
| Equipment and leasehold  improvements, net                |       | 284                              |       |          |       |             |       | 284        |       |
| Intangible assets, net                                    |       | 102,519                          |       | 1,635         |       |             |       | 104,154    |       |
| Deferred financing  costs, net                            |       | 7,079                            |       |          |       |             |       | 7,079      |       |
| Investment in  subsidiary                                 |       | 15,209                           |       |          |       | (15,209          | )          |       |       |
| Other assets                                              |       | 41                               |       |          |       |             |       | 41         |       |
| Total assets                                              |       | $                                | 198,112    |          | $          | 19,900           |       | $          | (24,208    | ) | $ | 193,804 |   |
|                                                      |       |                             |       |          |       |             |       |       |       |
| **Liabilities and Stockholders’  Equity (Deficit)**  | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **       | ** ** | ** ** | ** ** |
| Current liabilities:                                      |       |                             |       |          |       |             |       |       |       |
| Accounts payable                                          |       | $                                | 9,301      |          | $          | 4,585            |       | $          |       |   | $ | 13,886 |   |
| Accrued expenses and  other liabilities                   |       | 12,567                           |       | 60            |       | (8,999           | )          | 3,628      |       |
| Current portion of  senior secured notes                  |       | 234                              |       |          |       |             |       | 234        |       |
| Total current  liabilities                                |       | 22,102                           |       | 4,645         |       | (8,999           | )          | 17,748     |       |
| Senior secured notes                                      |       | 133,144                          |       |          |       |             |       | 133,144    |       |
| Deferred income taxes                                     |       | 9,704                            |       | 46            |       |             |       | 9,750      |       |
| Deferred rent                                             |       | 320                              |       |          |       |             |       | 320        |       |
| Total liabilities                                         |       | 165,270                          |       | 4,691         |       | (8,999           | )          | 160,962    |       |
| Commitments and  contingencies                            |       |                             |       |          |       |             |       |       |       |
| Redeemable convertible  stock                             |       | 48,110                           |       |          |       |             |       | 48,110     |       |
| Stockholders’ equity  (deficit):                     |       |                             |       |          |       |             |       |       |       |
| Common stock                                              |       | 25                               |       |          |       |             |       | 25         |       |
| Additional paid in  capital                               |       | 241                              |       | 8,741         |       | (8,741           | )          | 241        |       |
| Deemed dividend, in  excess of predecessor basis          |       | (26,022                          | )          |          |       |             |       | (26,022    | )          |
| Retained earnings                                         |       | 10,488                           |       | 6,468         |       | (6,468           | )          | 10,488     |       |
| Total stockholders’  equity (deficit)                |       | (15,268                          | )          | 15,209        |       | (15,209          | )          | (15,268    | )          |
| Total liabilities and stockholders’ equity (deficit) |       | $                                | 198,112    |          | $          | 19,900           |       | $          | (24,208    | ) | $ | 193,804 |   |

 

F-30

----

**RafaellaApparel Group, Inc. and Subsidiary**

**CondensedConsolidating Balance Sheet**

**Asof June 30, 2006**

**(In thousands)**
| ** **                                                | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------|------------|-----------|------------|
| ** **                                                | ** ** | **(Successor)**                  | ** ** |
| **Assets**                                                |       |                             |       |          |       |             |       |      |       |
| Current assets:                                           |       |                             |       |          |       |             |       |      |       |
| Cash and equivalents                                      |       | $                                | 27,273     |          | $          |             |       | $         |       |   | $ | 27,273 |   |
| Receivables, net                                          |       | 20,649                           |       | 1,861         |       |             |       | 22,510    |       |
| Inventories                                               |       | 40,664                           |       | 6,390         |       |             |       | 47,054    |       |
| Deferred income taxes                                     |       | 3,832                            |       | 208           |       |             |       | 4,040     |       |
| Other current assets                                      |       | 3,513                            |       | 6,406         |       | (7,779           | )          | 2,140     |       |
| Total current assets                                      |       | 95,931                           |       | 14,865        |       | (7,779           | )          | 103,017   |       |
| Equipment and leasehold  improvements, net                |       | 115                              |       |          |       |             |       | 115       |       |
| Intangible assets, net                                    |       | 107,074                          |       | 2,020         |       |             |       | 109,094   |       |
| Deferred financing  costs, net                            |       | 10,928                           |       |          |       |             |       | 10,928    |       |
| Investment in  subsidiary                                 |       | 13,461                           |       |          |       | (13,461          | )          |      |       |
| Other assets                                              |       | 41                               |       |          |       |             |       | 41        |       |
| Total assets                                              |       | $                                | 227,550    |          | $          | 16,885           |       | $         | (21,240    | ) | $ | 223,195 |   |
|                                                      |       |                             |       |          |       |             |       |      |       |
| **Liabilities and Stockholders’  Equity (Deficit)**  |       |                             |       |          |       |             |       |      |       |
| Current liabilities:                                      |       |                             |       |          |       |             |       |      |       |
| Accounts payable                                          |       | $                                | 14,987     |          | $          | 1,935            |       | $         |       |   | $ | 16,922 |   |
| Accrued expenses and  other liabilities                   |       | 9,047                            |       | 1,489         |       | (7,779           | )          | 2,757     |       |
| Current portion of  senior secured notes                  |       | 17,265                           |       |          |       |             |       | 17,265    |       |
| Total current  liabilities                                |       | 41,299                           |       | 3,424         |       | (7,779           | )          | 36,944    |       |
| Senior secured notes                                      |       | 147,157                          |       |          |       |             |       | 147,157   |       |
| Deferred income taxes                                     |       | 12,644                           |       |          |       |             |       | 12,644    |       |
| Deferred rent                                             |       | 129                              |       |          |       |             |       | 129       |       |
| Total liabilities                                         |       | 201,229                          |       | 3,424         |       | (7,779           | )          | 196,874   |       |
| Commitments and  contingencies                            |       |                             |       |          |       |             |       |      |       |
| Redeemable convertible  stock                             |       | 44,110                           |       |          |       |             |       | 44,110    |       |
| Stockholders’ equity  (deficit):                     |       |                             |       |          |       |             |       |      |       |
| Common stock                                              |       | 25                               |       |          |       |             |       | 25        |       |
| Additional paid in capital                                |       |                             |       | 8,929         |       | (8,929           | )          |      |       |
| Deemed dividend, in  excess of predecessor basis          |       | (26,022                          | )          |          |       |             |       | (26,022   | )          |
| Retained earnings                                         |       | 8,208                            |       | 4,532         |       | (4,532           | )          | 8,208     |       |
| Total stockholders’  equity (deficit)                |       | (17,789                          | )          | 13,461        |       | (13,461          | )          | (17,789   | )          |
| Total liabilities and stockholders’ equity (deficit) |       | $                                | 227,550    |          | $          | 16,885           |       | $         | (21,240    | ) | $ | 223,195 |   |

 

F-31

----