Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-K**

 

**(MarkOne)**

 
| **x**                                             | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|---------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                        | ** ** | ** **                                                                                               |
| **For  the fiscal year ended June 30, 2008** |
| ** **                                        | ** ** | ** **                                                                                               |
| **or**                                            |
| ** **                                        | ** ** | ** **                                                                                               |
| **o**                                             | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**Forthe transition periodfrom              to              **

** **

**CommissionFile Number:  333-138342**

 

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**RafaellaApparel Group, Inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

**(212)403-0300**

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

 

Indicate by checkmark if the registrant is a well-knownseasoned 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) ofthe Exchange Act.   Yes o   No x.

 

Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer”,“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act. (Check one):

 

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

 

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

 

As of June 30, 2008,the registrant had 2,500,000 shares of its common stock, par value $0.01 pershare, outstanding.

 

 

 

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**RAFAELLA APPARELGROUP, INC.**

**ANNUAL REPORT**

**JUNE 30, 2008**

**TABLE OF CONTENTS**

** **
|                                                                                                                                                                                               | **PAGE**                                                                                                            |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                               |                                                                                                                |
| **PART I**                                                                                                                                                                                    | ** **                                                                                                          | ** ** |
| ** **                                                                                                                                                                                         | ** **                                                                                                          | ** ** |
| ITEM 1.                                                                                                                                                                                            | BUSINESS                                                                                                            | 1 |
| ITEM 1A.                                                                                                                                                                                           | RISK FACTORS                                                                                                        | 6 |
| ITEM 1B.                                                                                                                                                                                           | UNRESOLVED  STAFF COMMENTS                                                                                          | 13 |
| ITEM 2.                                                                                                                                                                                            | PROPERTIES                                                                                                          | 13 |
| ITEM 3.                                                                                                                                                                                            | LEGAL PROCEEDINGS                                                                                                   | 13 |
| ITEM 4.                                                                                                                                                                                            | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                | 13 |
|                                                                                                                                                                                               |                                                                                                                |   |
| **PART II**                                                                                                                                                                                   | ** **                                                                                                          | ** ** |
| ** **                                                                                                                                                                                         | ** **                                                                                                          | ** ** |
| ITEM 5.                                                                                                                                                                                            | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES | 14 |
| ITEM 6.                                                                                                                                                                                            | SELECTED  FINANCIAL DATA                                                                                            | 14 |
| ITEM 7.                                                                                                                                                                                            | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                         | 16 |
| ITEM 7A.                                                                                                                                                                                           | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                        | 26 |
| ITEM 8.                                                                                                                                                                                            | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        | 27 |
| ITEM 9.                                                                                                                                                                                            | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               | 27 |
| ITEM 9A(T).                                                                                                                                                                                        | CONTROLS &  PROCEDURES                                                                                     | 27 |
| ITEM 9B.                                                                                                                                                                                           | OTHER INFORMATION                                                                                                   | 28 |
|                                                                                                                                                                                               |                                                                                                                |   |
| **PART III**                                                                                                                                                                                  | ** **                                                                                                          | ** ** |
| ** **                                                                                                                                                                                         | ** **                                                                                                          | ** ** |
| ITEM 10.                                                                                                                                                                                           | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             | 28 |
| ITEM 11.                                                                                                                                                                                           | EXECUTIVE  COMPENSATION                                                                                             | 30 |
| ITEM 12.                                                                                                                                                                                           | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                    | 44 |
| ITEM 13.                                                                                                                                                                                           | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE                                           | 45 |
| ITEM 14.                                                                                                                                                                                           | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                             | 46 |
|                                                                                                                                                                                               |                                                                                                                |   |
| **PART IV**                                                                                                                                                                                   | ** **                                                                                                          | ** ** |
| ** **                                                                                                                                                                                         | ** **                                                                                                          | ** ** |
| ITEM 15.                                                                                                                                                                                           | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                                         | 47 |
| EXHIBIT  INDEX                                                                                                                                                                                     | 47                                                                                                                  |
| SIGNATURES                                                                                                                                                                                         | 51                                                                                                                  |
| SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH  REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH  HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT | 52                                                                                                                  |

 

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**PART I**

 

**ITEM 1.**                                                     BUSINESS

 

**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 timingof certain events could differ materially from those projected in orcontemplated by forward-looking statements due to a number of factorsincluding, without limitation, changes in industry trends, merchandise andfashion trends, the extent of foreign sourcing and manufacturing, competitionin the apparel industry, changes in general economic conditions, failure toanticipate consumer spending patterns, financial or political instability inany of the nations in which our goods are manufactured and risks relating tothe execution of management’s business strategy, any of which could causeactual results to differ materially.

 

**GENERAL**

** **

Rafaella Apparel Group, Inc. (the “Company”)acquired substantially all of the assets of Rafaella Sportswear, Inc. inan acquisition consummated on June 20, 2005.  Except as otherwise indicated, references to “we”,“us”, the Company and Rafaella Apparel Group, Inc., for periods prior tothe acquisition, refer to our predecessor.

 

**Our Company**

** **

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 the Rafaella brand andprivate label brands of our customers. We design, source and market pants, sweaters, blouses, t-shirts, jacketsand skirts for all seasons of the year. Our in-house design staff develops our lines to include basic stylingwith updated features and colors using a variety of natural and syntheticfabrics.  Using our designspecifications, we outsource the production of our clothing line tomanufacturers primarily in Asia and sell directly to department, specialty andchain stores and off-price retailers.  Wehave over 600 customers, representing over 3,800 individual retaillocations.  Our customers include some ofthe larger retailers of women’s clothing in the United States.

 

**Our Industry**

** **

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, thereis a growing trend toward consolidation in the industry, decreasing the numberof retailers and the floor space available 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.

 

**Products**

** **

Our lines consist of fashionbasics with updated features and colors. We design our products to appeal to our target market of women aged 30to 55.  Our products are divided intothree broad categories based on size: Missy, Petite and Woman.  TheMissy category comprises traditional sized clothing, whereas the Petite andWoman cater to smaller and larger framed women, respectively.  We also categorizeour clothing lines as Career or Casual. Career clothing consists of jackets, pants, skirts, shirts, blouses andsweaters designed to be worn primarily to work. Casual clothing is designed to be worn primarily as weekend wear andconsists of pants, skirts, jackets, shirts and sweaters principally made ofcotton based fabrics.  Recent fashiontrends have led to a blurring of the distinctions between these categories,with women wearing Casual separates to work and Career separates for functionsoutside 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 $50per item, t-shirts for $15 to $40 per item and jackets for $45 to $90 peritem.  We believe that our products areof an equal or higher quality than those of our competition, but retail indepartment and specialty stores at a lower price point than comparable brandedproducts of our competitors.

 

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**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 of complementary styles ofpants, sweaters, blouses, t-shirts, jackets and skirts, which are sold asindividual items, but which may be coordinated into complete outfits.  Each style in our lines comes in a variety ofcolors and/or patterns.  Fabrics includecotton and cotton blends, synthetics and synthetic blends, silk and silkblends, wool and wool blends and linen, depending upon the season and clothingstyle.  Our lines are marketedprincipally under the Rafaella brand and private label brands of our customers.

 

**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 and assistant designers, with computeraided design capabilities, in addition to a color and print specialist.  Each member of the team has responsibilityfor certain 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.  This information is used to developpreliminary expectations for the composition and basic silhouettes of the nextline.  With this guidance, the designteam develops initial sketches or prototype garments in our New York officereflecting line concepts and style ideas. From these concepts, certain styles are selected for further developmentand the design team, in conjunction with management, begins to select colorsand fabrics for the line.  Fabric samplesare ordered in each pattern and color. Using the sample fabrics, more refined prototype garments are made, eitherin our New York office or by contract manufacturers.  These refined prototypes are used for displayin the showroom during the applicable market week.  The line is further refined based on customerfeedback during the market week.

 

**Product Sourcingand Distribution**

** **

We contract for themanufacture of our products exclusively with third-party manufacturers and donot own or operate any manufacturing facilities.  During fiscal 2008, our merchandise purchases were primarilysourced from Asian manufacturing companies. In the future, we may source from other economically feasible regions ofthe world.  Outsourcing our productsallows us to maximize production flexibility, while avoiding significantcapital expenditures, work-in-process inventory build-ups and costs associatedwith managing a larger production force.

 

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

 

Since 1997, we have workedwith the same principal buying agent based in Hong Kong for the majority of ourproduct sourcing.  Historically, thisagent served as a non-exclusive buying agent for manufactured goods in Asia,principally China, Hong Kong and Vietnam. This agent also identified and qualified contract manufacturers,administered and coordinated production, and managed the quality controlprocess for production administered and coordinated by this agent as well aswhen we utilized certain other agents in Asia. Compensation to our agent is based on a percentage of the full cost ofthe finished garment before shipping costs and customs duties.  During fiscal 2008, we determined to ceaseour relationship with this Hong Kong agent, effective October 31,2008.  We have established a subsidiaryin Hong Kong to perform these activities in-house and expect a seamlesstransition from our former agent.

 

We source fabric for many ofour manufacturers.  Due to our largeannual purchases of our higher volume fabrics, we have been able to negotiatefavorable pricing with our fabric suppliers. We negotiate directly with our suppliers for the purchase of requiredfabrics, which are purchased either directly by us or by our manufacturersunder our directions.

 

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We have a comprehensivequality control program that begins overseas to ensure that raw materials andfinished goods meet our specifications for design, fit and quality.  Fabric purchases are inspected upon receiptat the manufacturers’ facilities, and prior to commencement of production.  Inspections are handled by representatives ofour buying agent as well 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 facilities located in Bayonne, New Jersey and ourthird party logistic providers’ locations. Management believes that our low return rate on defective merchandise islargely due to our rigorous quality control processes.

 

We utilize a centralizeddistribution system, under which most merchandise is received, processed anddistributed through our Bayonne, New Jersey facility.  From these facilities, merchandise is inspected,packed and shipped to our customers via common carriers.  Tofacilitate the distribution process and control warehouse costs, all of ourproducts, other than those ordered to support our replenishment and privatelabel programs, are packaged into pre-established packages, or pre-packs, priorto being shipped to our Bayonne facilities. Each pre-pack contains six garments, in a single style and color, and ina preset range of sizes.  We offer threepre-pack size ranges in Missy, two in Petite and one in Woman.  Management believes the use of pre-packshelps minimize our distribution costs and reduce shipping errors and reducesour risk of unsold inventory in an undesirable assortment of sizes that may bedifficult to sell at acceptable gross profit margins.

 

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

 

**Sales, Marketingand Advertising**

 

We maintain a direct sales force that operates out ofour New York showroom.  Our direct salesforce is compensated exclusively on a salaried basis with a discretionaryannual performance bonus.  This in-housesales force, together with management, accounted for approximately 97% of ourfiscal 2008 sales.  We also haveindependent, non-exclusive sales representatives operating in various regionsof the U.S. who are compensated exclusivelyon a commission basis.  These salesrepresentatives accounted for approximately 3% of our fiscal 2008 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 our Casual and Career lines for theapplicable retail season.  During andshortly following market weeks, many of our customers provide us withnon-binding indications as to their initial orders for that season.  Historically, a very high percentage of theseindications have translated into actual orders and sales.  As a result, we are able to gatherinformation that enables us to refine our production plans to better meet theanticipated demand on a cost-effective basis.

 

To date, we have notincurred significant media based advertising costs but instead have relied onin-store displays of our clothing lines, together with our attractive products and strong value proposition, toencourage purchases by our target end customer. We intend to increase our use of media based advertising, specificallyin-store and internet advertisements.

 

**Customers**

** **

Our principal customers are departmentand specialty stores.  The department and specialty stores channelrepresented approximately 60% of our total net sales in fiscal 2008 and theother approximately 40% of our total net sales in fiscal 2008 were to off-priceretailers and private label customers. While certain of our customers consist of separate department andspecialty store chains or off-price retailers with common ownership, thesecustomers have separate purchasing departments and are therefore viewed by usas separate customers.  Divisions ofBelk, Macy’s, and Kohl’s, our three largest customers (when viewed on a commonownership basis), accounted for 21%, 20% and 18%, respectively, of our totalnet sales in fiscal 2008.

 

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We believe we have strongrelationships with our customers.  Wehave over 600 customers, representing over 3,800 individual retail storelocations.  Our top ten customersaccounted for approximately 92% of net sales for fiscal 2008.  It has been our experience that many majorretailers are continuing to consolidate their women’s apparel suppliers bypurchasing from a select group of established brand name vendors, such as ourcompany.  We are continuing to seek newrelationships and expand our presence to new points of sale.

 

**Competition**

 

The United States retailapparel industry is 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 thatthe principal competitive factors in the industry are:

 

·                  consistent fit;

·                  productquality;

·                  styling;

·                  price;

·                  brandname 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, we believe that our continued dedication tocustomer service, productassortment and consistency, quality control and pricing enable us to competeeffectively.  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.

 

**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 nothave rights to these marks for other product categories.  We regard these trademarks and otherproprietary rights as valuable assets and from time to time we take action toprotect our trademarks against infringement.

 

**InformationSystems**

** **

We have a limitedinformation technology team and rely on third-party providers fortelecommunications, Electronic Data Interchange (“EDI”) applications and othersupport.  Our financial and operationalinformation and reporting needs are met by a software package written primarily for apparel companies andfurther customized for our needs by a third party software development andmaintenance firm.  We own substantiallyall of our computer equipment and contract with third parties to maintainbackup systems.

 

Our customers can elect touse EDI to trade and process orders with us on a simplified and expeditedbasis.  We use EDI with certain customersto provide advance-shipping notices, process orders and conduct billing operations.  In addition, certain other customers use EDIto communicate to us their weekly inventory requirements on a store-by-storebasis.  As of June 30, 2008, we had41 customers that use EDI to communicate with us.  In fiscal 2008, total sales to thesecustomers were approximately 84% of our overall total sales.

 

**Imports, ImportRestrictions and Other Government Regulations**

** **

***Imports andImport Restrictions***

 

Our transactions with ourforeign suppliers are subject to the risks of doing business abroad.  Imports into the United States are affectedby, among other things, the cost and availability of transportation of theproducts and the imposition of import duties and restrictions.  The countries that we source our productsfrom may, from time to time, also impose restrictions or take various economicactions, which could affect our ability to import products from such countriesat the current or increased levels. Imports into the United States can also be subjected to variousadditional restrictions and the assessment of punitive antidumping duties orcountervailing duties when goods are shipped to the U.S. at less than fairvalue 

 

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(dumping)or with certain countervailable subsidies from the exporting nation.  In 2007, the U.S. Government altered a morethan twenty-year policy by applying its antisubsidy laws to certain exportsfrom China.  Bills have been introducedand are pending in Congress which, if enacted, would make it easier forcountervailing duty cases 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.  We cannot predict the likelihood or frequencyof any such events occurring.

 

Various private interestshave proposed extending a soon to expire monitoring program covering textileimports from Vietnam and expanding it to cover imports from certain otherdeveloping countries.  Should theseproposals in the future be adopted and should they result in affirmativedeterminations of injury, they could result in additional restrictions orduties.

 

On November 8, 2005, the governments of theUnited States and China entered into a Memorandum of Understanding that tookeffect on January 1, 2006, and that established agreed quota levels onseveral textile categories including products imported by us.  The quota agreement, which remains in effectwith respect to goods exported from China through December 31, 2008,allows for annual import growth in all categories.  The bilateral agreement eliminates some ofthe uncertainty inherent in unilateral safeguard actions.  To the extent our suppliers are not able toacquire sufficient amounts of export quota for covered products, the cost ofacquiring such quota increases, or a particular category is fully utilizedprior to year’s end, we may be limited or prevented from acquiring productsfrom our foreign suppliers based in China or the cost of our products importedfrom China may rise, in which case our operations could be seriously disruptedand our business negatively impacted until alternative suppliers are found.

 

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

 

New and proposed reporting requirements to be made ator prior to the time of entry may also impact the speed and efficiency at whichour goods may enter into the commerce of the United States.  These include, among others, a requirement toannotate each entry when made on the basis of the “first sale” method of appraisement,the new “10 + 2” security filing, and an anticipated filing to be made withrespect to a host of products (likely to include apparel) originating fromcertain plant products.  Increased timelags for the release of imported product may also be the case with respect toongoing governmental initiatives in the areas of supply chain security andproduct safety.

 

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

 

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

 

***Other GovernmentRegulation***

 

We are subject to federal, state and local laws andregulations regarding our business. These include the Consumer Product Safety Act, the Textile Fiber ProductIdentification Act, the Flammable Fabric Act and the rules and regulationsof the Federal Trade Commission and the Consumer Product Safety Commission, orthe 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 theCPSC.  We believe that we are incompliance in all material respects with all applicable governmentalregulations.

 

**Employees**

** **

As of June 30, 2008, wehad approximately 163 employees, of whom approximately 69 were employed in NewYork and approximately 94 were employed in New Jersey.  We are not a party to any labor agreementsand none of our 

 

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employeesare represented by a union.  We considerour relationship with our employees to be good and have not experienced anyinterruption of our operations due to labor disputes with our employees.

 

**ITEM 1A.      RISKFACTORS**

** **

**Risks Related toOur Business and Industry**

** **

***Our business couldbe negatively impacted by significant changes in the financial condition, orbankruptcy, of 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 significant adversechange in a customer or its financial position or a customer’s bankruptcyfiling or liquidation could cause us to limit or discontinue business with thatcustomer, require us to assume more credit risk relating to that customer’sreceivables, or limit our ability to collect amounts related to previouspurchases by that customer, all of which could harm our business, financialcondition and results of operations by causing a significant decline inrevenues attributable to such customers, particularly if our third-party factoris unwilling to assume the credit risk on receivables from such customers orlimits the amount of credit risk it is willing to take from such customers.

 

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

 

There has been, and continues to be, consolidationactivity in the United States 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 suchitems themselves.  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 StoresCompany, formerly our biggest customer, was acquired by Macy’s in August 2005,to whom we 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 if one of these majorcustomers decreases its business with us.***

 

In fiscal 2008, our department and specialty storeschannel accounted for approximately 60% of our total net sales.  In that period, our largest customer in thisdistribution channel, when viewed on a common ownership basis, accounted forapproximately 21% of total net sales across its separate department storechains.  The other approximately 40% ofour total net sales in fiscal 2008 were to off-price retailers and privatelabel 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 merchandise purchased from us, or to change its manner of doingbusiness with us, could substantially reduce our revenues and materiallyadversely affect our profitability.

 

***Our success dependsin part on the efforts of our management team.***

 

As of June 20, 2006, Ronald Frankel (ChiefExecutive Officer of our predecessor and a former advisor to us), Robert Newman(our former Vice President - Sales) and Asher Haddad (our former Vice President- Warehouse) are no longer executive officers of our company although Mr. Frankelremains a member of our board of directors. Mr. Frankel 

 

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co-founded ourpredecessor and had been primarily responsible for our predecessor’s strategicplanning and oversight of merchandising, production and sales.  Glenn Palmer served as our Chief ExecutiveOfficer from June 20, 2005 until his resignation on April 20,2006.  Since April 25, 2006, ChristaMichalaros has served as our new Chief Executive Officer.  Nichole Vowteras has served as our ExecutiveVice President Sourcing and Production since May 1, 2006, Rosemary Mancinohas served as our President of Sales & Planning since August 1,2006 and Husein Jafferjee has served as our Chief Operating Officer since January 31,2008.

 

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

 

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

 

For fiscal 2008, 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;

 

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

 

·                  imposition ofduties, taxes and other charges on imports;

 

·                  significantdevaluation of the dollar against foreign currencies;

 

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

 

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

 

·                  disease,epidemics and health-related concerns, such as SARS or the mad cow or hoof andmouth 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

 

·                  violations byforeign 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 operations anddamage customer relationships.***

 

We use third-party manufacturers to assemble orproduce all of our products.  We aredependent on the ability of these third-party manufacturers to adequatelyfinance the assembly or production of goods ordered and maintain sufficientmanufacturing capacity.  The use ofthird-party manufacturers to assemble or produce finished goods and theresulting lack of 

 

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direct control couldsubject us to difficulty in obtaining timely delivery of products of acceptablequality.  We do not have long-termcontracts with any of our manufacturers and an unexpected interruption insupply from any of our manufacturers could disrupt our operations until asuitable alternate manufacturer can be found and supply restored.  Even if an alternate manufacturer can befound promptly, such manufacturer may not be able to provide us with productsor manufacturing services of a comparable quality, at an acceptable price or ona timely basis.  As a result, ourbusiness relationship with our customers purchasing such products, or anyproducts incorporating such products or services, may be terminated, reduced orotherwise modified by such customer. There can be no assurance that there will not be a disruption in thesupply of our products from third-party manufacturers or, in the event of adisruption, that we would be able to substitute suitable alternate third-partymanufacturers in a timely manner, or that a customer will not terminate, reduceor otherwise modify its business relationship with us as a result thereof.  The failure of any third-party manufacturerto perform, or the loss or reduction of supply from any third-partymanufacturer, or the termination, reduction or modification of such customerbusiness relationship, could have a material adverse effect on our business,results of operations and financial condition.

 

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

 

***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 seniorrevolving credit facility, pursuant to which we have been able to obtain a lineof credit and letters of credit.  If weare unable to meet the covenants in our senior revolving credit facility and,as a result, are unable to borrow under the facility, or to have letters ofcredit issued on our behalf, or we are unable to extend or renew or refinancesuch facility on terms satisfactory to us, our ability to purchase inventorywould be curtailed or eliminated, which would significantly affect ourmarketing and sales efforts, thus significantly harming our business.

 

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

 

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

 

·                  establishing andmaintaining favorable brand recognition;

 

·                  developingproducts that appeal to consumers;

 

·                  pricing productsappropriately; and

 

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

 

The United States apparel industry is highlyfragmented and includes a number of very large companies, many of which havegreater financial, technical and marketing resources, greater manufacturingcapacity and more extensive 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 competeeffectively.  Additionally, in responseto the continued consolidation of our customers, our competitors mayconsolidate as well in order to increase their ability to servicecustomers.  The competitive nature of theapparel industry may result in lower prices for our products and decreasedgross profit margins, which may materially adversely affect our sales andprofitability.

 

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

 

Prices in the United States apparel industry have beendeclining over the past several years primarily as a result of the movement ofmanufacturing operations offshore, the growth of the mass market retail channelof distribution, increased 

 

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competition,consolidation in the retail apparel industry and the general economic slowdownof recent years.  Products manufacturedoffshore generally cost less to manufacture than those made domesticallyprimarily because labor costs are lower offshore.  Many of our competitors also source theirproduct requirements from developing countries, possibly from developingcountries with lower costs than the developing countries from which we sourceour products, and those manufacturers may use these cost savings to reduceprices.  To remain competitive, we mayhave to 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 our productioncosts, or if our production costs increase and we cannot increase our 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 United States apparel industry has relatively longlead times for the design and production of products.  Consequently, we must commit in some cases toproduction in advance of orders based on forecasts of consumer demand.  If we fail to forecast consumer demandaccurately, we may underproduce or overproduce a product and encounterdifficulty in filling customer orders or in liquidating excess inventory.  Additionally, if we overproduce a productbased on an aggressive forecast of consumer demand, retailers may not be ableto sell the product in amounts and at prices they deem acceptable and mayexpect sales allowances and cancel future orders.  These outcomes could have a material adverseeffect on our sales, brand image and financial conditions seriously affectingour profitability.

 

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

 

The United States apparel industry has historicallybeen subject to cyclical variations, recessions in the general economy oruncertainties regarding future economic prospects that affect consumer spendinghabits which could negatively impact our business overall and specifically oursales, gross margins and profitability. The success of our operations depends on consumer spending.  Consumer spending is impacted by a number offactors, including actual and perceived economic conditions affectingdisposable consumer income (such as unemployment, wages and salaries), businessconditions, interest rates, availability of credit and tax rates in the generaleconomy and in the international, regional and local markets where our productsare sold.  Any significant deteriorationin general economic conditions or increases in interest rates could reduce thelevel of consumer 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 consequence tothem and with little or no notice to us. In addition, we cannot provide assurance as to the quantities or timingrequired by our customers for our products.

 

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Whether in response tochanges affecting the industry or a customer’s specific business pressures, anycancellation, delay or other modification in our customers’ orders couldsignificantly reduce our revenue, cause our operating results to fluctuate fromperiod to period and make it more difficult for us to predict our revenue.  In addition, if our forecasts are incorrect,we may have excess unsold inventory, which we may have to sell at a discount ormay not be able to sell at all.

 

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

 

Our transactions with ourforeign suppliers are subject to the risks of doing business abroad.  Imports into the United States are affectedby, among other things, the cost and availability of transportation of theproducts and the imposition of import duties and restrictions.  The countries that we source our productsfrom may, from time to time, also impose restrictions or take various economicactions, which could affect our ability to import products from such countriesat the current or increased levels. Imports into the United States can also be subjected to various additionalrestrictions and the assessment of punitive antidumping duties orcountervailing duties when goods are shipped to the U.S. at less than fairvalue (dumping) or with certain countervailable subsidies from the exportingnation.  In 2007, the U.S. Governmentaltered a more than twenty-year policy by applying its antisubsidy laws tocertain exports from China.  Bills havebeen introduced and are pending in Congress which, if enacted, would make iteasier for countervailing duty cases 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.  We cannot predict the likelihood or frequencyof any such events occurring.

 

Various private interestshave proposed extending a soon to expire monitoring program covering textileimports from Vietnam and expanding it to cover imports from certain otherdeveloping countries.  Should theseproposals in the future be adopted and should they result in affirmative determinationsof injury, they could result in additional restrictions or duties.

 

On November 8, 2005,the governments of the United States and China entered into a Memorandum ofUnderstanding that took effect on January 1, 2006, and that establishedagreed quota levels on several textile categories including products importedby us.  The quota agreement, whichremains in effect with respect to goods exported from China through December 31,2008, allows for annual import growth in all categories.  The bilateral agreement eliminates some ofthe uncertainty inherent in unilateral safeguard actions.  To the extent our suppliers are not able toacquire sufficient amounts of export quota for covered products, the cost ofacquiring such quota increases, or a particular category is fully utilizedprior to year’s end, we may be limited or prevented from acquiring productsfrom our foreign suppliers based in China or the cost of our products importedfrom China may rise, in which case our operations could be seriously disruptedand our business negatively impacted until alternative suppliers are found.

 

In addition, variouseconomic factors, including, but not limited to, the exchange rate between theU.S. and Chinese currencies, and increased cost for raw materials, labor andtransportation, could materially impact the availability or cost at which wecould import our products.

 

New and proposed reportingrequirements to be made at or prior to the time of entry may also impact thespeed and efficiency at which our goods may enter into the commerce of the UnitedStates.  These include, among others, arequirement to annotate each entry when made on the basis of the “first sale”method of appraisement, the new “10 + 2” security filing, and an anticipatedfiling to be made with respect to a host of products (likely to includeapparel) originating from certain plant products.  Increased time lags for the release ofimported product may also be the case with respect to ongoing governmentalinitiatives in the areas of supply chain security and product safety.

 

We monitor these and 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 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 and restrictionson the transfer of funds.

 

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***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 apparel industrywe 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 strain on 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 the Sarbanes-Oxley Act, our managementis required to deliver a report that assesses the effectiveness of our internalcontrol over financial reporting, although an attestation report of ourregistered public accounting firm on the operating effectiveness of suchinternal control is temporarily not required. In order to maintain and improve the effectiveness of our disclosurecontrols and procedures and internal control over financial reporting,significant resources and management oversight will be required as we may needto devote additional time and personnel to legal, financial and accountingactivities to ensure our ongoing compliance with the public company reportingrequirements.

 

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

 

***We may be adversely affected by our limited historical booksand records and our lack of formalized internal controls.***

 

Our predecessor and its management maintained verylimited records of the corporate actions of our predecessor and itssubsidiaries, including records relating to stock transfers and actions by ourpredecessor’s Board of Directors.  Inaddition, our predecessor’s control procedures were informal and/orundocumented.  Our predecessor was notsubject to the requirements of Section 404 of the Sarbanes-Oxley Act of2002 and the rules and regulations of the Securities and Exchange Commission,or SEC, thereunder.  As a result, ourpredecessor’s management did not evaluate or assess its internal control overfinancial reporting.  Any inadequacies ininternal controls of our predecessor 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.

 

***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 financialpenalties to our customers, which could become significant if there iswidespread 

 

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non-compliance.  In addition, our customers may decline toorder additional products from us in the event we are consistently unable tocomply with the relevant standards and procedures.

 

**Risks Related toOur Indebtedness**

** **

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

 

We have a substantial amount of debt.  As of June 30, 2008, we hadapproximately $124.3 million at maturity of senior secured notes outstanding,excluding interest accrued thereon, and the ability to utilize$9.6 million of availability under our credit facility for letters ofcredit and loans, subject to compliance with our financial and other covenantsand the terms set forth therein.  Oursubstantial debt could have important consequences to holders of our seniorsecured notes.  For example, it could:

 

·      make us vulnerable to general adverse economicand industry conditions;

·      limit our ability to obtain additional financingfor future working capital, capital expenditures, product development efforts,strategic acquisitions and other general corporate requirements;

·      expose us to interest rate fluctuations becausethe interest on the debt under our revolving credit facility is at variablerates;

·      require us to dedicate a substantial portion ofour cash flow from operations to payments on our debt, thereby reducing theavailability of our cash flow for operations and other purposes;

·      limit our flexibility in planning for, orreacting to, changes in our business and the industry in which we operate; and

·      place us at a competitive disadvantage comparedto our competitors that may have proportionately less debt.

 

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

 

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

 

·      economic and competitive conditions affecting themarket for our products and the women’s apparel market generally;

·      operating difficulties, increased operating costsor pricing pressures we may experience; and

·      increased raw material costs.

 

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

 

If our cash flow and capital resources areinsufficient to fund our debt service obligations, we may be forced to reduceor delay capacity expansion and capital expenditures, sell material assets oroperations, obtain additional capital or restructure our debt.  In the event that we are required to disposeof material assets or operations or restructure our debt to meet our debtservice and other obligations, we cannot assure you as to the terms of any suchtransaction or how soon any such transaction could be completed, if at all.

 

***The terms of ourindebtedness impose significant operating and financial restrictions on us,which may prevent us from pursuing certain business opportunities and takingcertain actions.***

 

Our senior revolving credit facility and the indenturegoverning the notes impose significant operating and financial restrictions onus.  These restrictions limit orprohibit, among other things, our ability to:

 

·      declare dividends orredeem or repurchase capital stock;

 

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

 

·      incur liens;

 

·      make loans andinvestments;

 

·      guarantee or incuradditional debt;

 

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

 

·      engage in mergers,acquisitions and other business combinations;

 

·      sell assets;

 

·      make capital expenditures;

 

·      transact with affiliates;and

 

·      alter the business weconduct.

 

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

 

·      a minimum working capitalrequirement; and

 

·      a rolling six-month periodnet-income provision (as defined).

 

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 1B.**        UNRESOLVED STAFF COMMENTS

** **

None.

 

**ITEM 2.**                  PROPERTIES

** **

We maintain our headquarters in a 30,000 square footoffice facility at 1411 Broadway in New York, New York.  The headquarters houses our design studio andsales showroom, in addition to our sourcing, finance and administrativefunctions.  Our warehouse anddistribution facilities occupy approximately 182,000 square feet in Bayonne,New Jersey.  The facilities are leased atmarket rents. The New York office lease expires in January 2013.  The New Jersey leases expire in December 2010and January 2011. In addition, we lease third-party storage anddistribution facilities on a month-to-month basis and pay a fee per itemshipped by the third party on our behalf. We own no real property orfacilities.

 

**ITEM 3.**                  LEGAL PROCEEDINGS

** **

None.

 

**ITEM 4.**                  SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS

** **

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

 

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**PART II**

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

 

There is no established public market for the commonstock of the Company.  All theoutstanding common stock of the Company, consisting of 2,500,000 shares, isowned by RSW 2005, Inc.  RA CerberusAcquisition, LLC, controlled by affiliates of Cerberus Capital Management, L.P.(“Cerberus”), owns 100% of the Company’s convertible preferred stock, which isconvertible at its option into common stock equal to 67.5% of the Company’soutstanding 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 (“HSBC”) andthe indenture governing our 11 1⁄4% Senior Secured Notes due 2011.

 

The Company has adopted an equity incentive plan.  As of June 30, 2008, options to purchasea total of 1,111,111 shares of common stock of the Company were outstandingpursuant to this plan.

 

**ITEM 6.**                  SELECTED FINANCIALDATA

** **

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 year ended June 30,2004 and for the period from July 1, 2004 through June 19, 2005 and,for us, for the period from June 20, 2005 through June 30, 2005 andthe fiscal years ended June 30, 2008, 2007 and 2006.  This table should be read in conjunction withthe Company’s consolidated financial statements and related notes appearingelsewhere in this Annual Report.

 

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**RAFAELLA APPARELGROUP, 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,** | ** ** |
| ** **                                                      | ** ** | **2004**                                       | ** ** | **2005**                                                                 | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
| ** **                                                      | ** ** | **(Dollars in thousands)**           | ** ** |
| **Income Statement Data:**                                      | ** ** | ** **                                     | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  sales                                                      |       | $                                              | 205,663    |                                                                     | $          | 225,558 |   | $ | 4,215 |   | $ | 222,187 |   | $ | 191,284 |   | $ | 177,990 |   |
| Cost  of sales                                                  |       | 127,531                                        |       | 138,883                                                                  |       | 3,074 |   | 148,555 |   | 127,170 |   | 129,086 |   |
| Gross  profit                                                   |       | 78,132                                         |       | 86,675                                                                   |       | 1,141 |   | 73,632 |   | 64,114 |   | 48,904 |   |
| Selling,  general and administrative expenses (3)               |       | 16,795                                         |       | 17,509                                                                   |       | 971 |   | 29,938 |   | 30,951 |   | 67,017 |   |
| Operating  income (loss)                                        |       | 61,337                                         |       | 69,166                                                                   |       | 170 |   | 43,694 |   | 33,163 |   | (18,113 | ) |
| Other  expense (income):                                        |       |                                           |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Interest                                                        |       | 464                                            |       | 1,079                                                                    |       | 664 |   | 22,631 |   | 23,884 |   | 14,840 |   |
| Other                                                           |       | 766                                            |       | (47                                                                      | )          | — |   | — |   | — |   | — |   |
| Total  other expense (income)                                   |       | 1,230                                          |       | 1,032                                                                    |       | 664 |   | 22,631 |   | 23,884 |   | 14,840 |   |
| Income  (loss) before provision for (benefit from) income taxes |       | 60,107                                         |       | 68,134                                                                   |       | (494 | ) | 21,063 |   | 9,279 |   | (32,953 | ) |
| Provision  for (benefit from) income taxes (2)                  |       | 2,151                                          |       | 2,249                                                                    |       | (212 | ) | 8,463 |   | 2,999 |   | (8,199 | ) |
| Net  income (loss)                                              |       | 57,956                                         |       | 65,885                                                                   |       | (282 | ) | 12,600 |   | 6,280 |   | (24,754 | ) |
| **Balance Sheet Data (at end of period):**                      |       |                                           |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Cash  and cash equivalents                                      |       | $                                              | 28         |                                                                     | —     |   | $ | 52 |   | $ | 27,273 |   | $ | 11,390 |   | $ | 17,131 |   |
| Accounts  receivable                                            |       | 18,115                                         |       | —                                                                   |       | 23,180 |   | 22,510 |   | 20,785 |   | 15,286 |   |
| Inventories                                                     |       | 45,717                                         |       | —                                                                   |       | 52,120 |   | 47,054 |   | 44,375 |   | 33,249 |   |
| Total  assets                                                   |       | 64,387                                         |       | —                                                                   |       | 213,954 |   | 223,195 |   | 193,804 |   | 148,848 |   |
| Current  portion of senior secured notes                        |       | —                                         |       | —                                                                   |       | — |   | 17,265 |   | 234 |   | 865 |   |
| Senior  secured notes                                           |       | —                                         |       | —                                                                   |       | 163,439 |   | 147,157 |   | 133,144 |   | 119,748 |   |
| Total  liabilities                                              |       | 33,804                                         |       | —                                                                   |       | 200,233 |   | 196,874 |   | 160,962 |   | 141,118 |   |
| Redeemable  convertible preferred stock                         |       | —                                         |       | —                                                                   |       | 40,110 |   | 44,110 |   | 48,110 |   | 52,110 |   |
| Total  stockholders’ equity (deficit)                      |       | 30,583                                         |       | —                                                                   |       | (26,389 | ) | (17,789 | ) | (15,268 | ) | (44,380 | ) |
| **Other Financial Data:**                                       |       |                                           |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Net  cash flows provided by (used in):                          |       |                                           |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Operating  activities                                           |       | $                                              | 46,186     |                                                                     | $          | 51,201 |   | $ | 7,739 |   | $ | 36,765 |   | $ | 16,743 |   | $ | 16,872 |   |
| Investing  activities                                           |       | (38                                            | )          | (5                                                                       | )          | (175,045 | ) | (283 | ) | (214 | ) | (966 | ) |
| Financing  activities                                           |       | (46,155                                        | )          | (49,366                                                                  | )          | 167,358 |   | (9,261 | ) | (32,412 | ) | (10,165 | ) |
| Depreciation  and amortization                                  |       | 144                                            |       | 125                                                                      |       | 71 |   | 5,453 |   | 4,985 |   | 4,504 |   |
| Capital  expenditures                                           |       | 38                                             |       | 5                                                                        |       | — |   | 95 |   | 214 |   | 966 |   |

 

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(1)    On June 20, 2005,pursuant to a Securities Purchase Agreement dated April 15, 2005, asamended, Rafaella Apparel Group, Inc. issued redeemable convertiblepreferred stock to RA Cerberus Acquisition, LLC for $40.0 million.  Immediately prior to the issuance of thepreferred stock, Rafaella Sportswear, Inc. contributed substantially allof its assets to Rafaella Apparel Group, Inc. in exchange for 100% of itscommon stock and the assumption of certain liabilities related to thecontributed assets.  Immediatelyfollowing the issuance of the preferred stock, Rafaella Apparel Group, Inc.redeemed 75% of the common stock held by Rafaella Sportswear, Inc. for$175.0 million.  The June 20, 2005acquisition was accounted for as a purchase in accordance with FinancialAccounting Standards No. 141, “Business Combinations,” and Emerging IssuesTask Force 88-16, “Basis in Leveraged Buyout Transaction.”  As a 

 

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result of theacquisition and the resulting purchase accounting adjustments, the financialstatements including and after June 20, 2005 are not comparable to thepredecessor periods.

 

(2)    Our predecessorwas taxed as an S corporation.  Aprovision has been made for certain state and local income taxes applicable toS corporations.

 

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

 
| **ITEM  7.** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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:

 

·      Company Overview

 

·      Critical Accounting Policiesand Estimates

 

·      Results of Operations, and

 

·      Liquidity and CapitalResources

 

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.

 

**COMPANY OVERVIEW**

** **

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 the Rafaella brand andprivate label brands of our customers. We design, source and market pants, sweaters, blouses, t-shirts, jacketsand skirts for all seasons of the year. Our in-house design staff develops our lines to include basic stylingwith updated features and colors using a variety of natural and syntheticfabrics.  Using our designspecifications, we outsource the production of our clothing line tomanufacturers primarily in Asia, and sell directly to department, specialty andchain stores and off-price retailers.  Wehave over 600 customers, representing over 3,800 individual retaillocations.  Our customers include some ofthe larger retailers of women’s clothing in the United States.

 

**Critical Trends;Performance Drivers**

** **

***PrimaryRevenue Variables***

*** ***

Our revenues are impacted by the following factors:

 

·      customer acceptance of ourfabrics and designs;

·      the performance of ourproducts within the prevailing retail environment;

·      the accuracy of our forecastof demand for our products;

·      actions of our competitors;

·      pricing pressures due tocompetitive market conditions and buying power of retailers;

·      ability of our third-partymanufacturers to timely deliver products of acceptable quality;

·      overall levels of consumerspending for apparel;

·      national and regionaleconomic conditions; and

·      the economic impact ofuncontrollable factors, such as terrorism and war.

 

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***PrimaryExpense Variables***

 

Variations in our cost of sales are primarily due to:

 

·      fluctuations in the price,availability and quality of raw materials;

·      the length and level ofvariation in the production runs we order from third party manufacturers;

·      international economic andpolitical conditions;

·      fluctuations in duties,taxes and other charges on imports;

·      fluctuations in energyprices which impact manufacturing costs and inbound transportation costs;

·      reductions in the value ofour unsold inventories; and

·      pricing pressures due tocompetition for manufacturing sources.

 

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

 

·      changes in headcount andsalaries and related fringe benefits;

·      costs associated withproduct development;

·      changes in warehousing anddistribution expenses associated with sales volumes, outbound transportationexpenses impacted by changes in energy costs, and the need for third partystorage or shipping services;

·      increases in marketingexpenses;

·      costs associated withenhancing and maintaining an adequate system of internal controls; and

·      costs associated withregulatory compliance.

 

***Consolidationin the Industry***

*** ***

There has been, and continues to be, consolidationactivity in the United States 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 StoresCompany, formerly our largest customer, was acquired by Macy’s in August 2005,to whom we 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 pricingand trade terms, to comply with increasingly more stringent vendor operatingprocedures and policies and to alter our products or product mix to providedifferent items such as exclusive merchandise, private label products or moreupscale goods.  If we are unable toprovide more favorable terms or to develop satisfactory products, programs orsystems to comply with any new product requirements, operating procedures orpolicies, this could adversely affect our operating results in any reportingperiod.

 

***ChangingCustomer Tastes***

*** ***

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

 

***Competition***

*** ***

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

 

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·      establishing and maintainingfavorable brand recognition;

·      developing products thatappeal to consumers;

·      pricing productsappropriately; and

·      obtaining access to, andsufficient floor space in, retail stores.

 

The United States apparel industry is highlyfragmented and includes a number of very large brands and companies marketingmultiple brands, many of which have greater financial, technical and marketingresources, greater manufacturing capacity and more extensive and establishedcustomer relationships than we do.  Webelieve we have maintained prices for our branded products in department andspecialty stores at more than 20% below comparable products offered by ourbranded competitors.  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.

 

***ImportRestrictions and Regulations***

*** ***

Our transactions with ourforeign suppliers are subject to the risks of doing business abroad.  Imports into the United States are affectedby, among other things, the cost and availability of transportation of theproducts and the imposition of import duties and restrictions.  The countries that we source our productsfrom may, from time to time, also impose restrictions or take various economicactions, which could affect our ability to import products from such countriesat the current or increased levels. Imports into the United States can also be subjected to variousadditional restrictions and the assessment of punitive antidumping duties orcountervailing duties when goods are shipped to the U.S. at less than fairvalue (dumping) or with certain countervailable subsidies from the exportingnation.  In 2007, the U.S. Governmentaltered a more than twenty-year policy by applying its antisubsidy laws tocertain exports from China.  Bills havebeen introduced and are pending in Congress which, if enacted, would make iteasier for countervailing duty cases 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.  We cannot predict the likelihood or frequencyof any such events occurring.

 

Various private interestshave proposed extending a soon to expire monitoring program covering textileimports from Vietnam and expanding it to cover imports from certain otherdeveloping countries.  Should theseproposals in the future be adopted and should they result in affirmativedeterminations of injury, they could result in additional restrictions orduties.

 

On November 8, 2005,the governments of the United States and China entered into a Memorandum ofUnderstanding that took effect on January 1, 2006, and that establishedagreed quota levels on several textile categories including products importedby us.  The quota agreement, whichremains in effect with respect to goods exported from China through December 31,2008, allows for annual import growth in all categories.  The bilateral agreement eliminates some ofthe uncertainty inherent in unilateral safeguard actions.  To the extent our suppliers are not able toacquire sufficient amounts of export quota for covered products, the cost ofacquiring such quota increases, or a particular category is fully utilizedprior to year’s end, we may be limited or prevented from acquiring productsfrom our foreign suppliers based in China or the cost of our products importedfrom China may rise, in which case our operations could be seriously disruptedand our business negatively impacted until alternative suppliers are found.

 

In addition, variouseconomic factors, including, but not limited to, the exchange rate between theU.S. and Chinese currencies, and increased cost for raw materials, labor andtransportation, could materially impact the availability or cost at which wecould import our products.

 

New and proposed reportingrequirements to be made at or prior to the time of entry may also impact thespeed and efficiency at which our goods may enter into the commerce of theUnited States.  These include, amongothers, a requirement to annotate each entry when made on the basis of the “firstsale” method of appraisement, the new “10 + 2” security filing, and ananticipated filing to be made with respect to a host of products (likely toinclude apparel) originating from certain plant products.  Increased time lags for the release ofimported product may also be the case with respect to ongoing governmentalinitiatives in the areas of supply chain security and product safety.

 

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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 exporting countries,any significant fluctuations in the value of the dollar against foreigncurrencies and restrictions on the transfer of funds.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

** **

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

 

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

 

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

 

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

 

Deferred taxes are provided for the future taxconsequences attributable to differences between the financial statementcarrying amounts of assets and liabilities and their respective tax bases, asmeasured by enacted tax rates in effect in periods when the deferred tax assetsand liabilities are expected to be settled or realized.  We evaluate the probability of realizing ourdeferred tax assets on an on-going basis. This evaluation includes estimating our future taxable income for theyears in which our deferred taxes are expected to reverse, which includesconsideration of tax planning strategies. We provide a valuation allowance if we determine it is more likely thannot that we will not be able to realize our deferred tax assets.  As of June 30, 2008, we concluded that avaluation allowance of approximately $4.3 million relating to certain capitalloss carry forwards was necessary.

 

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

 

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

 

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*Inventories*. Substantially all of the inventory we purchased in fiscal year 2008 wasproduced in Asia.  Inventory costsinclude amounts paid to purchase piece goods and manufacture our products,duty, quota, inbound freight, and costs associated with our buying agent (whichtypically include a buying commission of 1-3% of the full cost of the finishedgarment before shipping costs and customs duties).  Inventories are stated at the lower of costor market, with cost being determined by the first-in, first-out (FIFO)method.  Inventories consist of rawmaterials (primarily piece goods at our contractors), merchandise in transitand finished goods in warehouses.  We takeownership of the finished goods when they are shipped and management recordsthe merchandise in transit balance based on documentation provided by ourbuying agent.  For inventory markdowns,we estimate the percentage of finished goods we will not be able to sell in thenormal course of business and the associated average loss per unit, and writedown the value of these goods to the recovery value expected to be realizedthrough off-price channels.

 

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

 

Intangible assets consist of the trademark and tradename, and customer relationships of the Predecessor, and non-compete agreementswith officers of the Predecessor, acquired on June 20, 2005.  Customer relationships are amortized usingstraight-line and accelerated methods over their estimated useful lives of 7and 15 years, respectively.  Non-competeagreements are amortized using the straight-line method over their estimateduseful lives of 2 and 10 years.  Ownedtrademarks have been determined to have indefinite lives and are not subject toamortization.

 

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 and inherently uncertain. Actual future results may differ from those estimates.  If the estimated fair value of the assets isless than their carrying amount, an impairment loss is recognized equal to suchdifference.

 

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

 

*Stock-based Compensation.*  Effective July 1, 2006, the Companyadopted Statement of Financial Accounting Standards No. 123(R) “ShareBased Payments” (“SFAS 123R”), which revises Statement of Financial AccountingStandards No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”)and requires companies to expense the fair value of employee stock options andother forms of stock based compensation. The computation of the expenses associated with stock based compensationrequires the use of a valuation model. The Company currently uses the Black Scholes option pricing model tocalculate the fair value of its stock options. The Black Scholes model requires assumptions regarding the estimatedlength of time participants will retain their vested stock options beforeexercising them and the estimated volatility of the Company’s common stock overthe expected term.  Changes in theassumptions to reflect future stock price volatility and future stock awardexercise experience could result in a change in the assumptions used to valueawards in the future and may result in a material change to the fair valuecalculation of stock based awards.  Therewas no effect from the change of applying the original provisions of SFAS 123to the Company’s results of operations and cash flows for the year ended June 30,2007, as a result of the Company’s adoption of SFAS 123R, effective July 1,2006.  Compensation expense related to 

 

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stock-based awards wasnot significant to the Company’s consolidated statement of operations for theyears ended June 30, 2008 and 2007. Refer to Note 3 of the Company’s consolidated financial statements forfurther information.

 

**RESULTS OF OPERATIONS**

 

The following table summarizes the historicaloperations as a percentage of net sales for the years ended June 30, 2008,2007 and 2006.

 
| ** **                                                      | ** ** | **Year Ended  June 30, 2008**          | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                      | ** ** | **(in thousands, except percentages)** | ** ** |
| Net  sales                                                      |       | $                                                     | 177,990    |                                         | 100.0      | %                                            | $          | 191,284 |   | 100.0 | % | $ | 222,187 |   | 100.0 | % |
| Cost  of sales                                                  |       | 129,086                                               |       | 72.5                                         |       | 127,170                                      |       | 66.5 |   | 148,555 |   | 66.9 |   |
| Gross  profit                                                   |       | 48,904                                                |       | 27.5                                         |       | 64,114                                       |       | 33.5 |   | 73,632 |   | 33.1 |   |
| Selling,  general and administrative expenses                   |       | 67,017                                                |       | 37.7                                         |       | 30,951                                       |       | 16.2 |   | 29,938 |   | 13.5 |   |
| Operating  income (loss)                                        |       | (18,113                                               | )          | (10.2                                        | )          | 33,163                                       |       | 17.3 |   | 43,694 |   | 19.7 |   |
| Interest  expense and other financing, net                      |       | 14,840                                                |       | 8.3                                          |       | 23,884                                       |       | 12.5 |   | 22,631 |   | 10.2 |   |
| Income  (loss) before provision for (benefit from) income taxes |       | (32,953                                               | )          | (18.5                                        | )          | 9,279                                        |       | 4.9 |   | 21,063 |   | 9.5 |   |
| Provision  for (benefit from) income taxes                      |       | (8,199                                                | )          | (4.6                                         | )          | 2,999                                        |       | 1.6 |   | 8,463 |   | 3.8 |   |
| Net  income (loss)                                              |       | $                                                     | (24,754    | )                                            | (13.9      | )%                                           | $          | 6,280 |   | 3.3 | % | $ | 12,600 |   | 5.7 | % |

 

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

 

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

 

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

 

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

 

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

 

***Interest******expense******and other financing, net.***  Interest expense for the year ended June 30, 2008 was $14.8million.  As compared to interest expenseof $23.9 million for the year ended June 30, 2007, interest decreased by$9.0 million or 37.9%.  The decrease wasprimarily attributed to the reduction in our senior secured notes outstandingperiod over period.  In November 

 

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2007 and November 2006, we repurchased$221,000 and $17,429,000, respectively, of senior secured notes in connectionwith our excess cash flow offers.  In June 2007,we repurchased $16,062,000 of senior secured notes in connection with ourrestricted payment offer.  Finally, wepurchased $6,000,000 and $8,027,000 of our senior secured notes on the open marketin January 2008 and June 2008, respectively.  As a result of these senior secured notetransactions, interest expense (cash interest and non-cash interest associatedwith original issue discount and deferred financing costs) decreased $3.6 millionperiod over period.  During fiscal 2007,in connection with the June 2007 and November 2006 senior securednote repurchases, we wrote-off approximately $3.1 million of unamortizedoriginal issue discount and deferred financing costs to interest expense; the November 2007write-off of unamortized original issue discount and deferred financing costswas not significant.  Finally, a pre-taxgain of approximately $3.1 million, resulting from the difference between thecarrying book value of the senior secured notes and the amount paid, net ofdeferred financing costs that were written-off, was recorded in connection withour open market purchases in fiscal 2008; each of the other senior secured noterepurchases were at 101% of their principal amount at maturity.  The aggregate decrease of $9.8 milliondiscussed above, was partially offset by a reduction in interest income of $0.8million period over period.  Refer to the“Liquidity and Capital Resources” section below for further discussionsurrounding our senior secured notes.

 

***Benefit from income taxes***.  We recorded a benefit from income taxes of$8.2 million for the year ended June 30, 2008, which represents aneffective income tax rate benefit of approximately 24.9%.  We recorded a net benefit, after valuation allowance,from income taxes primarily as a result of the $34.5 million impairment chargeassociated with the decline in the fair value of the Rafaella trademark andtrade name intangible asset, as described above.  The difference between the statutory federalincome tax rate (34%) and our effective income tax rate (24.9%) is primarilyattributable to the valuation allowance of $4.3 million that we established forthe deferred tax asset that resulted from the Rafaella trademark and trade nameintangible asset impairment.  Theunderlying tax basis of the trademark and trade name is capital in nature.  The asset would generate a capital loss forincome tax purposes, which can only be used to offset capital gain income.  We determined that the deferred tax asset isnot more likely than not to be realized as there are no actual or projectedcapital gains available to offset any future capital losses that might begenerated from the Rafaella trademark and trade name deferred tax asset.

 

For the year ended June 30, 2007, we recorded aprovision for income taxes of $3.0 million, which represents an effectiveincome tax rate of approximately 32.3%. The difference between the statutory federal income tax rate (34%) andour effective income tax rate (32.3%) is attributable to state and local incometaxes, net of federal benefit.

 

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

 

***Yearended June 30, 2007 compared to year ended June 30, 2006***

 

***Net sales***.  Net sales for the year ended June 30, 2007 was$191.3 million.  As compared to net salesof $222.2 million for the year ended June 30, 2006, net sales decreased byapproximately $30.9 million or 13.9%. The decrease in net sales was principally due to an increase in customerallowances given ($3.2 million), a decrease in volume (approximately 10%), anda slight decrease in average revenue per unit (approximately 1%).  The decrease in customer sales was primarilyattributed to reductions in net sales of approximately $38.7 million related tofour customers offset by increases in customer net sales of $5.5 millionrelated to three customers.

 

***Gross profit***.  Gross profit for the year ended June 30,2007 was $64.1 million.  As a percentageof net sales, gross profit over this period was 33.5%.  As compared to the gross profit of $73.6million for the year ended June 30, 2006 (33.1% of net sales), grossprofit decreased by $9.5 million or 12.9%. The decrease in gross profit was primarily the result of the impact fromreduced gross sales ($28.7 million) and increased customer discounts,returns and allowances ($2.2 million), in addition to a $0.9million charge related to inventory recorded at fair value in connection withthe acquisition and sold during the period ended June 30, 2007 comparedwith a $9.4 million charge recorded during the period ended June 30, 2006.

 

***Selling, generaland administrative expenses***. Selling, general and administrative expenses for the year ended June 30,2007 was $31.0 million.  As compared toselling, general and administrative expenses of $29.9 million for the yearended June 30, 2006, there was an increase of $1.0 million or 3.4%.  Increases in professional fees ($1.8 million)and salaries ($0.4 million) were partially offset by decreases in employmentfees ($0.5 million), amortization of intangible assets ($0.4 

 

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million), and insurance ($0.2 million).  As a percentage of net sales, selling,general and administrative expenses was 16.2% for the year ended June 30,2007 and 13.5% for the year ended June 30, 2006.

 

***Operating income***.  Operating income for the yearended June 30, 2007 was $33.2 million. As compared to operating income of $43.7 million for the year ended June 30,2006, operating income decreased by $10.5 million or 24.1%.  The decrease was due to the decreased grossprofit and increases in selling, general and administrative expenses, asdescribed above.

 

***Interest******expense and other financing, net.***  Interest expense for the year ended June 30, 2007 was $23.9million.  As compared to interest of$22.6 million for the year ended June 30, 2006, interest increased by $1.3million.  The increase in interestexpense resulted from $3.2 million attributed to the write-off of unamortizedoriginal issue discount and deferred financing costs and purchase considerationpaid in connection with our November 2006 and June 2007 seniorsecured notes repurchases, partially offset by increased interest income of$0.8 million, and a reduction in interest expense incurred of $1.3 million dueto our repurchase of senior secured notes and reduced borrowings under our lineof credit compared with the prior year.

 

***Provision forincome taxes***.  Werecorded a provision for income taxes of $3.0 million for the year ended June 30,2007, which represents an effective income tax rate of approximately32.3%.  For the year ended June 30,2006, we recorded a provision for income taxes of $8.5 million, which represents an effectiveincome tax rate of approximately 40.2%. The decrease in our effective rate in 2007 is principally due to a changein estimate regarding the allocation of taxable income in certain jurisdictionsin 2006.

 

***Net income***.  Net income for the year ended June 30,2007 was $6.3 million.  Net income as apercentage of net sales for the year 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 or50.2%.  This decrease in net income was aresult of the decrease in operating income, the increase in interest expenseand the decrease in the provision for income taxes, as described above.

 

**LIQUIDITY ANDCAPITAL RESOURCES**

** **

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

 

Effective June 20, 2005, we entered into arevolving credit facility with HSBC.  Thecredit facility provides us with a revolving line of credit, which can be usedfor loans and letters of credit of up to $62.5 million, with a sublimit forloans of $45.0 million.  Under the creditfacility, the aggregate credit available to us is equal to specifiedpercentages of eligible receivables and inventory, plus letters of creditissued for finished goods, subject to adjustment by the banks.  Borrowings under the credit facility bearvariable interest at our option at either (i) the prime rate minusone-half of one percent (0.50%) per annum or (ii) the London interbankoffered rate plus two and one-quarter percent (2.25%) per annum (each rate asdefined in the credit facility).  Thecredit facility requires a monthly commitment fee of 0.25% on the unused portionof the available credit under the credit facility.  At June 30, 2008, there were no loansunder the revolving credit facility and $16.9 million of letters of creditoutstanding under the credit facility. We had credit availability of approximately $9.6 million.

 

On June 20, 2005, we issued to investors $172.0million aggregate principal amount at maturity of 11.25% senior secured notesdue 2011.  These notes were issued at 95%of the face value and netted the Company a total of $163.4 million.

 

The credit facility is collateralized by substantiallyall of the Company’s assets and expires on June 20, 2010.  The senior secured notes are collateralizedby a second priority lien on substantially all of the Company’s assets.  The revolving credit agreement and theindenture to the notes contain various covenants that, among other things,place limitations on dividends and repurchases of capital stock, investments,asset sales, incurrence of additional indebtedness and have cross-defaultprovisions.  Further, the revolvingcredit agreement also contains covenants that require the Company to report netincome on a rolling six month period for the periods ended September 30, December 31,March 31 and June 30 and maintain a minimum level of working capital,which escalates during the term of the agreement.

 

During the quarter ended March 31, 2008, weamended our credit facility, whereby for the rolling six month period ended March 31,2008, the Company was permitted to incur a net loss of up to $2,000,000.  The Company was in compliance with itsrevised financial covenants as of March 31, 2008; however, our forecastsindicated that there was the likelihood that the Company would not be incompliance with its future net income financial covenant and, accordingly, wesought to further 

 

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amend the covenant.  Subsequent to March 31, 2008, theCompany amended the credit facility net income financial covenant.  For purposes of determining compliance withthe net income financial covenant, effective with the quarter ending June 30,2008, the definition of net income was amended to exclude noncash expensesassociated with (i) amortization of customer relationships and non-competeagreements, (ii) the accretion of the senior secured notes original issuediscount, (iii) amortization of deferred financing costs, and (iv) impairmentcharges, if any, resulting from a decline in the value of the Company’sintangible assets; the aggregate maximum amount of the noncash exclusions, inany one quarter, may not exceed $2,500,000 commencing with the fiscal quartersending on or after September 30, 2008.

 

As of June 30, 2008, the Company was incompliance with the financial covenants included in the credit facility.  Our forecasts indicate that the Company willbe in compliance with its future financial covenants under the creditfacility.  However, due to the inherentuncertainties in making estimates and assumptions, there can be no assurancethat the Company will satisfy either of its financial covenants in futureperiods.  A violation of the financialcovenants constitutes an event of default under the credit facility.  An event of default could result in all debtbecoming due and payable, and HSBC having the right to terminate the creditfacility and its obligation to make advances under it.

 

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

 

We currently estimate that the annual excess cash flowpayment with respect to the fiscal year ended June 30, 2008, payable in November 2008,will be approximately $939,000, and have classified the current portion ofsenior secured notes as current within the consolidated balance sheet as of June 30,2008.

 

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

 

The Company purchased, at a discount, $6,000,000 and$8,027,000 of outstanding senior secured notes on the open market in January 2008and June 2008, respectively.  Apre-tax gain of approximately $3.1 million, resulting from the differencebetween the carrying book value of the senior secured notes and the amountpaid, net of deferred financing costs that were written-off at the time ofpurchase, was recorded to interest expense during the year ended June 30,2008.

 

In August 2008, the Company purchased, at adiscount, $28.5 million of outstanding senior secured notes on the openmarket.  A pre-tax gain of approximately$17.6 million, resulting from the difference between the carrying book value ofthe senior secured notes and the amount paid, net of deferred financing coststhat were written-off at the time of purchase, will be recorded in the quarterending September 30, 2008.

 

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

 

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

 

We believe that cash flow from operations andavailable borrowings under our senior revolving credit facility will provideadequate resources to meet our capital requirements and operational needs forthe foreseeable future.

 

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The following table summarizes our net cash providedby or used in our operating, investing and financing activities for the yearsended June 30, 2008, 2007 and 2006:

 
| ** **                                                | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                | ** ** | **(in thousands)**                      | ** ** |
| Net  cash provided by (used in):                          |       |                                         |       |                                         |       |                                         |       |
| Operating  activities                                     |       | $                                            | 16,872     |                                         | $          | 16,743                                       |       | $ | 36,765 |   |
| Investing  activities                                     |       | (966                                         | )          | (214                                         | )          | (283                                         | )          |
| Financing  activities                                     |       | (10,165                                      | )          | (32,412                                      | )          | (9,261                                       | )          |
| **Net increase (decrease) in cash and cash  equivalents** | ** ** | **$**                                        | **5,741**  | ** **                                   | **$**      | **(15,883**                                  | **)**      | **$** | **27,221** | ** ** |

 

***OperatingActivities***

 

Cash flows provided by operating activities for theyears ended June 30, 2008, 2007 and 2006 were $16.9 million, $16.7 millionand $36.8 million, respectively.  Thechange in cash flows provided by operating activities between 2008 and 2007 wasnot significant.  However, cash flowsprovided by operating activities was negatively impacted period over period asa result of the decrease in our operating income (excluding non-cashitems).  The decrease was primarilyoffset by reductions in payments associated with interest, income taxes andinventory purchases.  The decrease in cashflows provided by operating activities from 2006 to 2007 is the result of lowernet income, changes in deferred income taxes, and decreases in cash flows fromworking capital related to accounts payable and inventories.  For each of the years ended June 30,2008, 2007 and 2006, significant non-cash items included amortization ofdeferred finance charges, accretion of original issue discount, depreciationand amortization, and the provision for deferred income taxes.  A non-cash impairment charge of $34.5 millionwas recorded during 2008 related to the decline in the fair value of theRafaella trademark and trade name intangible asset.  In addition, during 2008, a non-cash gain of$3.7 million was recorded in connection with the senior secured notespurchases.

 

***InvestingActivities***

*** ***

Net cash used in investing activities for the yearsended June 30, 2008, 2007 and 2006 were $1.0 million, $0.2 million and$0.3 million, respectively.  In 2008, thecash usage was a result of computer and software ($0.5 million), machinery andequipment ($0.3 million), and leasehold improvement ($0.2 million) capitalexpenditures.  Net cash used in investingactivities for 2007 and 2006 was not significant.

 

***FinancingActivities***

*** ***

Net cash used in financing activities for the yearsended June 30, 2008, 2007 and 2006 were $10.2 million, $32.4 million and$9.3 million, respectively.  In 2008 and2007, the use of cash was primarily for the June 2007, November 2007,and November 2006 senior secured note repurchases and our January 2008and June 2008 senior secured note open market purchase discussedabove.  In 2006, we repaid borrowingsoutstanding under our credit facility totaling $9.3 million.

 

**Off-Balance SheetArrangements**

** **

As of June 30, 2008, we had outstanding lettersof credit totaling $14.1 million in connection with purchase orders formerchandise from third-party manufacturers and standby letters of credittotaling $2.8 million issued by HSBC, which serve as security for obligationsunder certain operating leases and a customs bond.

 

We enter into employment and consulting agreementswith certain of our employees from time to time.  These contracts typically provide forseverance and other benefits. Individually, none of the contracts are expected to be material,although in the aggregate, our obligations under these contracts could besignificant.  Additionally, we havecertain operating leases, which are disclosed in the consolidated financialstatements.  The Company has no otheroff-balance sheet arrangements.

 

**Due From Factor**

 

We factor certain of our receivables to GMACCommercial Finance LLC, a commercial factor. The receivables are sold to GMAC on a non-recourse basis, subject toadjustment for sales discounts, sales returns, markdown allowances,miscellaneous charges and disputes.  Upona sale, GMAC assumes the credit and collection risk.  We do not borrow from our 

 

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factor and the amount duefrom the factor is pledged to our revolving credit facility lenders as securityfor amounts outstanding under our revolving credit facility.

 

**Contractual CashObligations**

 

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)                  |       | $                                        | 124,261    |   | $ | 29,396 |   | $ | 94,865 |   |   |   |   |   |
| Interest  on senior secured notes (1)      |       | 32,573                                   |       | 11,228 |   | 21,345 |   |   |   |   |   |
| FIN  48 liabilities and interest           |       | 7,294                                    |       |   |   | 7,294 |   |   |   |   |   |
| Operating  lease obligations               |       | 8,380                                    |       | 2,132 |   | 4,035 |   | $ | 2,213 |   |   |   |
| Purchase  obligations                      |       | 28,214                                   |       | 28,214 |   |   |   |   |   |   |   |
| Total  contractual cash obligations        |       | $                                        | 200,722    |   | $ | 70,970 |   | $ | 127,539 |   | $ | 2,213 |   | $ | 0 |   |
|                                            |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)    Thepayment schedule for the senior secured notes and cash interest on our seniorsecured notes reflects the expected reduction 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 and the reduction resultingfrom the August 2008 open market purchase. Amounts presented are based on the senior secured notes principal amountoutstanding. Actual cash paid in connection with the August 2008 seniorsecured note open market purchase approximated $9.1 million.

 

This table does not reflect up to $45 million ofdirect borrowing availability under our senior revolving credit facility.  The senior revolving credit facility matureson June 20, 2010.

 

**Effects of Inflation**

 

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

 

**Recent AccountingPronouncements**

 

**On September 15, 2006, theFASB issued FASB Statement No. 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 effective for fiscal yearsbeginning after November 15, 2007. In February 2008, the FASB issued Staff Positions No. FAS157-1 and No. FAS 157-2 which delayed the effective date of SFAS 157 forone year for certain non financial assets and liabilities and removed certainleasing transactions from its scope.  TheCompany is currently analyzing SFAS 157 and its impact on the Company’s financialcondition and results of operations.**

** **

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

 

**ITEM 7A.**      QUANTITATIVE AND 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 to market risks, includingchanges in interest rates and a reduction in the value of the dollar.

 

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Market risks related to our operations resultprimarily from changes in interest rates. Our interest rate exposure relates primarily to our variable interestline of credit.  Borrowings under thecredit facility bear variable interest at the Company’s option at either (i) theprime rate minus one-half of one percent (0.50%) per annum or (ii) theLondon interbank offered rate plus two and one-quarter percent (2.25%) perannum (each rate as defined in the credit facility).  There were no loan borrowings or repaymentsunder the revolving credit facility during the year ended June 30, 2008.

 

When purchasing apparel from foreign manufacturers, weuse letters of credit that require the payment in U.S.  currency upon receipt of bills of lading forthe products and other documentation. Prices are fixed in U.S. dollars at the time the purchase orders and/orletters of credit are issued, which mitigates the risk of a reduction in thevalue of the dollar.  However, purchaseprices for the Company’s products may be impacted by fluctuations in theexchange rate between the U.S. dollar and the local currencies of the foreignmanufacturers, which may have the effect of increasing the Company’s cost ofgoods in the future.  Due to the numberof currencies involved and the fact that not all foreign currencies react inthe same manner against the U.S. dollar, the Company cannot quantify in anymeaningful way the potential effect of such fluctuations on future income.  The Company does not engage in hedgingactivities with respect to such exchange rate risk.

 

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

 

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

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

 

None.

 

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

** **

**Management’s Evaluation ofDisclosure Controls and Procedures**

 

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

 

As of the period ended June 30,2008 (the “Evaluation Date”), an evaluation of the effectiveness of the Company’sdisclosure controls and procedures was conducted under the supervision of, andreviewed by, our Chief Executive Officer and Chief Financial Officer.  Based on that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective at the Evaluation Date.

 

**Management’s Assessment ofInternal Control Over Financial Reporting**

 

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f) and 15d-15(f).  Our internal control over financial reportingincludes those policies and procedures that (i) pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the Company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof our assets that could have a material effect on the financial statements.

 

Internal control over financial reporting is designedto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements prepared for externalpurposes in accordance with generally accepted accounting principles.  Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

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Under the supervision and with the participation ofour Chief Executive Officer and Chief Financial Officer, management conductedan evaluation of the effectiveness of our internal control over financialreporting as of June 30, 2008 based on the framework in *Internal Control — Integrated Framework*issued by theCommittee of Sponsoring Organizations of the Treadway Commission and inaccordance with the interpretive guidance issued by the SEC in Release No. 34-55929.  Based on that evaluation, managementconcluded that our internal control over financial reporting was effective asof June 30, 2008.

 

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

 

**Changes in Internal Control OverFinancial Reporting**

 

There have been no changes in our internal controlover financial reporting that have occurred during our fiscal quarter ended June 30,2008 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**ITEM 9B.**        OTHER INFORMATION

 

**None.**

 

**PART III**

** **

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

** **

The following table sets forth certain informationregarding the members of our board of directors and executive officers.  All directors are elected annually and holdoffice until their successors are elected and qualified, or until their earlierremoval or resignation.

 
| **Name**              | ** ** | **Age** | ** ** | **Position**                                                  |
|-----------------------|------------|---------|------------|---------------------------------------------------------------|
| Christa Michalaros    |       | 47      |       | Chief Executive Officer and Director                          |
| Chad Spooner          |       | 36      |       | Chief Financial Officer                                       |
| Rosemary Mancino      |       | 51      |       | President of Sales & Planning                        |
| Husein Jafferjee      |       | 55      |       | Chief Operating Officer                                       |
| Nichole Vowteras      |       | 51      |       | Executive Vice President Sourcing and Production              |
| Jason Epstein         |       | 34      |       | Chief Information Officer, Vice President Strategic  Planning |
| John Kourakos         |       | 59      |       | Director, Chairman of the Board                               |
| George Kollitides     |       | 38      |       | Director                                                      |
| Trish Mattler-Gateley |       | 38      |       | Director                                                      |
| Ronald Frankel        |       | 71      |       | Director                                                      |
| Robert Newman         |       | 64      |       | Director                                                      |

 

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

 

**Chad Spooner** hasbeen our Chief Financial Officer since June 20, 2005 and prior to that,was part of the Cerberus operations team since 2004.  Prior to joining Cerberus, Mr. Spoonerwas employed by GE, from 1993 to 2004. During his tenure at GE, Mr. Spooner held various positions inmanufacturing and finance.  Mr. Spoonerheld assignments in sourcing, engineering and manufacturing in GE’s ManufacturingManagement Program.  Subsequent to that, Mr. Spoonerspent several years on GE’s Corporate Audit Staff, where he audited numerous GEindustrial and financial services businesses. He then went on to serve as a Finance Manager for GE Healthcare Europein Paris, France.  Mr. Spooner wasthen promoted to GE’s 

 

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Corporate FinancialPlanning and Analysis Group, where he covered the financial performance ofnumerous GE businesses.  Following thatrole, Mr. Spooner became the CFO for GE Energy’s Contractual Servicebusiness, a global multi-billion dollar turbine maintenance business.

 

**Rosemary Mancino** became ourPresident of Sales & Planning on August 1, 2006.  Ms. Mancino joined Rafaella with nearly30 years of retail/apparel experience. Prior to joining the Rafaella, Ms. Mancino was employed as SeniorVice President Sales, Retail Planning and In Store Services for five years byTommy Hilfiger USA.  Prior to that shewas employed by Liz Claiborne for ten years, where her last position wasserving as Vice President/General Manager of Sales for the Liz Claiborne casualdivision.  All of the aforementionedcompanies are principally in the business of women’s apparel.

 

**Husein Jafferjee** became ourChief Operating Officer in January 2008. Prior to joining Rafaella, Mr. Jafferjee held roles at Elie Tahari,Ltd. as Executive Vice President and Chief Operating Officer (2003-2008) andChief Financial Officer (2000-2003). Previously, Mr. Jafferjee was Chief Financial Officer of UrbanChildren’s Stores, Inc., Chief Financial Officer of Henri Bendel Inc. andChief Financial Officer of Mexx, USA, Inc. He has also held variousfinancial management positions at Bankers Trust Co., Cosmair, Inc. andTouche Ross & Co.  Mr. Jafferjeeholds a B.S. in Physics from the University of Manchester (UK) and is a fellowof the Institute of Chartered Accounts in England and Wales.

 

**Nichole Vowteras** became ourExecutive Vice President Sourcing and Production on May 1, 2006.  Prior to her joining Rafaella as VicePresident - Sourcing and Production, Ms. Vowteras was employed as VicePresident of Manufacturing for Garfield Marks for 21¤2years, as Senior Vice President of Production for Guess, Inc.  for one year and with Reebok for eight years,where her last position was serving as Vice President of WorldwideSourcing.  All of the aforementionedcompanies are principally in the business of women’s apparel and footwear.

 

**Jason Epstein** became our Chief Information Officer, VicePresident Strategic Planning on March 19, 2007.  Mr. Epstein joined Rafaella with morethan 14 years of experience in technology, management, operations and businessdevelopment.  Prior to joining Rafaella, Mr. Epsteinwas 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.

 

**John Kourakos** is Chairman of theBoard of Directors and was elected as a director in 2007.  Mr. Kourakos has over twenty-five yearsof experience in the apparel industry. Most recently 2002 to 2004, he was Group President of Warnaco’sSportswear group which included the Calvin Klein Jeans, Calvin Klein Underwearand Chaps by Ralph Lauren divisions. Prior to that, 1996 to 2001, he was President of the Men’s Sportswearand Tommy Jeans divisions at Tommy Hilfiger. Before joining Tommy Hilfiger, he was President of Warnaco’s CalvinKlein Men’s and Women’s Underwear/Calvin Klein Men’s Accessories division from1994 to 1996.  Mr. Kourakos alsoserved in a number of other key management positions including President ofCalvin Klein Menswear at Calvin Klein, Inc., where he managed the men’slines of Calvin Klein jeans, underwear and sportswear, and as Vice President ofSales for the Ralph Lauren Womenswear line and Executive Vice President ofMerchandising for the Calvin Klein line at Bidermann Industries.

 

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

 

**Trish Mattler-Gateley** is one of our directors and waselected as a director in 2008.  Ms. Mattler-Gateley is currentlya Finance Executive at Cerberus.  Shejoined Cerberus in 2006.  Prior tojoining Cerberus, she spent five years with Resources Global Professionals assistingpublic high profile power, oil & gas and telecom companies throughtheir corporate compliance, restatement and Sarbanes Oxley efforts.  Prior to that, she held CFO positions in thehigh-tech industry at Productopia, Inc. and Brigade Corporation.  Ms. Mattler-Gateley is a CPA in Californiaand holds a BS degree in Accounting from Saint Mary’s College.

 

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

 

**Robert Newman** is amember of our Board of Directors and was elected as a director in 2005 and hehad been employed by our predecessor as Vice President-Sales since 1992.  Mr. Newman has held sales positions inthe apparel 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.

 

**Code ofBusiness Conduct**

 

The Company has adopted a Code of Business Conduct,which applies to all employees and officers of the Company and provides that,in the conduct of all corporate activities, integrity and ethical conduct isexpected.  In addition, the Code ofBusiness Conduct addresses and provides guidance on a number ofbusiness-specific issues, including but not limited to conflicts of interest.  You may obtain a copy of the Company’s Codeof Ethics, free of charge, by submitting a request in writing to the attentionof Chad Spooner, Rafaella Apparel Group, Inc., 1411 Broadway, New York,New York 10018.

 

**AuditCommittee Financial Expert**

 

Our Board of Directors has separately designated anaudit committee and the functions of a traditional audit committee are carriedout by three of the members of the Board, Messrs. Kourakos, Kollitides andMattler-Gateley, of whom Mr. Kourakos is independent.  Our Board has determined that each member ofthe Board is financially literate but no determination has been made as to theability of any director to qualify as a “financial expert” within the meaningof the regulations adopted by the Securities and Exchange Commission.  However, based on their backgrounds and theirunderstanding of the Company’s business, the Board of Directors believes thatthe members of the Audit Committee will be able to provide effective oversightfor the Company’s financial reporting process and its relationship with itsindependent accountants.

 

**ITEM 11.**               EXECUTIVE COMPENSATION

 

**COMPENSATION DISCUSSION AND ANALYSIS**

 

***Overview***

 

This Compensation Discussion and Analysis, orCD&A, is intended to provide information regarding the Company’s executivecompensation program and practices.  ThisCD&A covers a variety of topics, including: the Company’s compensation philosophy regarding executive compensation,the role of our Compensation Committee in setting the compensation of ourexecutive officers, and executive compensation decisions for fiscal 2008.

 

***CompensationPhilosophy***

 

The Company is committed to achieving long-term,sustainable growth and increasing stockholder value.  The Company’s compensation program for ourexecutive officers is designed to support these objectives and encourage strongfinancial performance on an annual basis by awarding annual performancebonuses, and on a long-term basis by linking a portion of our executiveofficers’ total compensation to Company performance in the form of equityincentive compensation.  The Company’scompensation philosophy is to set our executive officers’ compensation, whichprincipally includes base salary, annual performance bonus, and long-termequity incentives, at levels that will attract, motivate, and retain superiorexecutive talent in a highly competitive environment.

 

The Company’s compensation philosophy is to set ourexecutive officers’ compensation, including base salary, annual performancebonus, and long-term equity incentives, at levels that will attract, motivate,and retain superior executive talent in a highly competitive environment.

 

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***Roleof the Compensation Committee***

 

Our Compensation Committee sets the compensation ofour executive officers, including the mix of base salary, annual performancebonus, and long-term equity incentives. Our Compensation Committee also sets the financial performance targetsfor our executive officers’ annual performance bonuses.  Our Compensation Committee consists of Ms. Michalarosand Messrs. Kourakos, Kollitides and Frankel, of whom Mr. Kourakos isindependent.

 

To maintain the effectiveness of our executive officercompensation program, and keep it consistent with our compensation philosophy,our Compensation Committee takes into account the Company’s growth andprofitability, individual executive officer performance, the nature and scopeof each executive officer’s responsibilities, and each officer’s effectivenessin supporting the Company’s long-term goals. Our Compensation Committee also considers the recommendations of ourChief Executive Officer regarding the base salary and annual performance bonusof our executive officers, other than her own.

 

***TotalCompensation***

 

In setting a total compensation target for eachexecutive officer, we consider objective and subjective factors, such asindividual and Company performance, prior equity awards, potential futureearnings from equity awards, retention, and motivation.

 

In 2008, as set forth in more detail in the SummaryCompensation Table, the total compensation of our Chief Executive Officer was$786,434; the total compensation of our Chief Financial Officer was $426,897;the total compensation of our Chief Operating Officer was $689,130; the totalcompensation of our President of Sales & Planning was $426,897; thetotal compensation of our Chief Information Officer, Vice President StrategicPlanning was $423,528; and the total compensation of our Executive VicePresident Sourcing and Production was $414,482.

 

***BaseSalary***

 

In setting our executive officers’ base salaries wetake into consideration subjective factors, such as the relativeresponsibilities of each executive officer and the cross-functional leadershiproles and business contributions.

 

As discussed further below under the headingEmployment Agreements, our executive officers have employment agreements withthe Company.  These employment agreementswere entered into by each of our executive officers upon joining the Companybetween June 2005 and February 2008, and provide the executiveofficers with threshold base salary levels. Each year, our Compensation Committee evaluates whether it isappropriate to approve salaries in excess of the contractual minimums.  In 2008, we provided our Chief ExecutiveOfficer, Chief Financial Officer, Chief Operating Officer, President of Sales &Planning, Chief Information Officer, Vice President Strategic Planning, andExecutive Vice President Sourcing and Production, with base salaries of$700,000, $400,000, $230,769, $400,000, $400,000, and $400,000, respectively.

 

In addition to the base salary above, our ChiefOperating Officer received a signing bonus of $300,000 upon joining the Companyin February 2008, and a guaranteed bonus of $150,000 for the year ended June 30,2008.

 

***AnnualPerformance Bonus***

 

Our practice is to make cash performance bonuses asignificant component of our executive officers’ total compensation.  We believe this design aligns the interestsof our executive officers with the interests of our stockholders.

 

Our Compensation Committee approves a target bonus foreach executive officer that is based on a percentage of their basesalaries.  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 canearn their target bonuses based upon the Company’s achievement ofpre-determined financial performance targets. Our Compensation Committee has the discretion not to award performancebonuses, 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 executive officers can earn from 0% to 200% oftheir target performance bonus based upon the Company’s achievement ofpre-determined Earnings Before Interest, Taxes, Deprecation, and Amortization (“EBITDA”)targets 

 

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established by theCompensation Committee.  Based upon theperformance of the Company in 2008, none of our executive officers qualifiedfor performance bonuses.

 

***EquityIncentives***

 

Our Equity Incentive Plan (the “Plan”) allows forvarious types of equity awards, including stock options and restrictedstock.  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.  No equity awards were made during fiscal2008.

 

All awards under our Plan must be approved by ourCompensation 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 granted under the Plan have been limited totime-based stock options.  All of theawards vest in annual increments of 25% over the first four years of the grant,expire no later than ten years after the grant date, and have an exercise priceof $5.33 per share (the June 20, 2005 redemption value of the redeemableconvertible preferred stock).  No optionswere exercised during fiscal 2008.

 

***Perquisitesand Other Benefits***

 

Pursuant to the Company’s 401(k) plan, theCompany provides its executives the same level of matching contributionsavailable to all eligible employees, which is equal to 100% of each executiveofficer’s first 3% of pre-tax contributions, subject to the provisions of the401(k) plan and Internal Revenue Service limitations.  The Company also provides our executiveofficers with a medical insurance policy that reimburses our executives forcertain medical expenses.  Additionalinformation on executive officer perquisites and other benefits can be found inthe footnotes to the Fiscal 2008 Summary Compensation Table in this Form 10-K.

 

***Employment Agreements***

 

Employment agreements for senior management are usedby the Company to establish key elements of the agreement between the Companyand the executive, including the minimum periods of employment and thefundamental elements of compensation, as well as the details of the individualarrangement that differ from the Company’s standard plans and programs.  The employment agreements with executiveofficers are discussed in detail below, in the section entitled “Agreements andPotential Payouts upon Termination or Change in Control.” Also, detailed inthat section are the potential payouts for each of the officers under thevariety of potential termination scenarios covered by the agreements.

 

**COMPENSATION OF EXECUTIVEOFFICERS**

 

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

 

The following is a description of the currentemployment arrangements between us and the named executive officers, includingthe specific circumstances relating to termination of employment and change incontrol of the Company that will trigger payments to each named executiveofficer and a calculation of the estimated payments to such officers as aresult of the occurrence of such events had they occurred on June 30,2008, the end of the Company’s last fiscal year.

 

**Christa Michalaros**

 

We have entered into an employment agreement withChrista Michalaros, our Chief Executive Officer, which commenced on April 25,2006.  Under the terms of the agreement,the initial period was from April 25, 2006 through June 30, 2007;thereafter, the agreement and the employment relationship created thereunderwill continue for 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 anAffiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberusbecomes the beneficial owner, directly or indirectly, of fifty percent (50%) ormore of the combined voting power of the then outstanding voting securities ofthe Company; (2) the sale, transfer or other disposition of all orsubstantially all of the business and assets of the Company, whether by sale ofassets, merger or otherwise to a person

 

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other than an Affiliateof Cerberus; (3) if specified by the Board in an Award Agreement at thetime of grant, the consummation of an Initial Public Offering; or (4) thedissolution or liquidation of the Company.

 

Under Ms. Michalaros’ employment agreement, thefollowing payments will be made to her or her representatives if (1) sheis terminated by the Company for Cause (generally defined as conviction for thecommission of a felony; dishonesty; refusal to follow directions of the Board;gross nonfeasance; breach of confidentiality or restrictive covenantprovisions; or certain other instances of willful misconduct); (2) heremployment terminates due to her death; (3) the Company terminates heremployment due to her disability (meaning a determination by the Company inaccordance with applicable law that as a result of a physical or mental injuryor illness, Ms. Michalaros is unable to perform the essential functions ofher 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) theshe resigns for any reason:

 

(a)           her accrued but unpaidbase salary and benefits in accordance with the agreement, if any, to the dateof 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 haveunder the Company’s benefit plans and COBRA, and any rights she may have toindemnification pursuant to the agreement, the by-laws or certificate ofincorporation of the Company, or otherwise under law, and any rights she mayhave under any directors and officers liability policies maintained by theCompany or its affiliates.

 

Should Ms. Michalaros terminate her employment bymaking an election not to renew the term as provided in the agreement, sheshall receive the payments set forth above and the bonus for the fiscal yearending at the end of the term, determined in accordance with the terms of theagreement (assuming this occurred on the last day of fiscal 2008, the amountwould have been $0), payable ninety (90) days after the end of the fiscal year;provided that the Company in its sole discretion may elect, by written noticegiven no later than fifteen (15) days prior to the end of the term, to pay tothe Executive the incremental severance payments set forth in sections (a) and(b) of the next paragraph in exchange for her (i) agreement to besubject to and legally bound by the non-competition and property covenants setforth in the agreement and (ii) execution and nonrevocation of a validrelease agreement in a form reasonably acceptable to the Company and Ms. Michalaros.

 

If Ms. Michalaros is terminated by the Companywithout Cause, or leaves her employ for “Good Reason” as that term is definedin the agreement, or the Company elects not to renew the term, in addition tothe payments upon termination specified in the previous paragraph, Ms. Michalaroswill receive, upon execution without revocation of a valid release agreement ina form reasonably 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; and

 

(c)           a prorated bonus equalto the bonus earned as of the date of termination based on the achievement ofprorated performance measures derived from the annual business plan for thefiscal year of termination as measured on the date of termination, payable in alump sum within thirty (30) days after the date of termination.

 

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

 

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(1)   Assumesthe Company would not elect to make certain discretionary payments.

 

(2)   Non-vestedoptions are forfeited.  Fair market valueis currently calculated as below the exercise price, therefore it is assumedoptions would not be exercised.

 

(3)   Non-vestedoptions are forfeited; vested options may be exercised by Ms. Michalaros’representative until one year or expiration. It is assumed options would not be exercised currently due to the issuediscussed in (2) above.

 

(4)   Whileall non-vested options would have vested, fair market value is below theexercise price.

 

(5)   Thecash severance summary assumes the executive did not receive a bonus.

 

**Chad Spooner**

 

We have entered into an employment agreement with ChadJ. Spooner, our Chief Financial Officer, 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 thereunderwill continue for 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 tocertain payments under our Equity Incentive Plan in the event a “LiquidityEvent” occurs, which is defined as (1) any Person who is (i) not anAffiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberusbecomes the beneficial owner, directly or indirectly, of fifty percent (50%) ormore of the combined voting power of the then outstanding voting securities ofthe Company; (2) the sale, transfer or other disposition of all orsubstantially all of the business and assets of the Company, whether by sale ofassets, merger or otherwise to a person other than an Affiliate of Cerberus; (3) ifspecified 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 Mr. Spooner’s employment agreement, thefollowing payments will be made to him or his representatives if (1) he isterminated by the Company for Cause (generally defined as conviction for thecommission of a felony; dishonesty; refusal to follow directions of the Board;gross nonfeasance; breach of confidentiality or restrictive covenantprovisions; or certain other instances of willful misconduct); (2) hisemployment terminates due to his death; (3) the Company terminates hisemployment due to his disability (meaning a determination by the Company inaccordance with applicable law that as a result of a physical or mental injuryor illness, Mr. Spooner is unable to perform the essential functions ofhis 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) thehe resigns for any reason:

 

(a)           his accrued but unpaidbase salary and benefits in accordance with the agreement, if any, to the dateof termination;

 

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

 

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

 

If we elect not to renew Mr. Spooner’s term, hewill be entitled to the benefits described in the previous paragraph, uponexecution without revocation of a valid release agreement in a form reasonablyacceptable to the Company, along with (i) continued base salary for twelve(12) months after the date of termination, payable on the last business day ofthe month; and (ii) reimbursement of the cost of continuation coverage ofgroup health coverage pursuant to the Consolidated Omnibus

 

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Budget Reconciliation Actof 1986 for a maximum of twelve (12) months to the extent he so elects and iseligible and subject to the terms of the plan and the law.

 

If we were to terminate Mr. Spooner withoutCause, in addition to the payments upon termination specified in (a) through (c),above, Mr. Spooner will receive, upon execution without revocation of avalid release agreement in a form reasonably 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 bonus equalto the bonus earned as of the date of termination based on the achievement ofprorated performance measures derived from the annual business plan for thefiscal year of termination as measured on the date of termination, payable in alump sum within thirty (30) days after the date of termination (which wouldhave been an amount of $0 on the last day of fiscal 2008); and

 

(d)           reimbursement of thecost of continuation coverage of group health coverage pursuant to theConsolidated Omnibus Budget Reconciliation Act of 1986 for a maximum of twelve(12) months to the extent Mr. Spooner so elects and is eligible andsubject to the terms of the plan and the law.

 
| **Component of  Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Company  without  Cause** | ** ** | **Termination  by the  Company  by Notice of Intent not to Renew** | ** ** | **Termination  upon the  Executive’s  Death or Disability** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                  |       |                                                                    |       |                                                                  |       |                                            |       |
| Cash Severance (4)                  |       | —                                       |       | —                                                |       | $                                                     | 400,000    |                                                                    | $          | 400,000                                                               |       | —                                          |       | — |   |
| Stock Options                       |       | —                                       | (1)        | —                                                |       | —                                                | (1)        | —                                                                  | (2)        | —                                                                | (2)        | —                                          | (3)        |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                         |            |                                                                       |            |                                                 |            |  |  |

 

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(1)   Non-vestedoptions are forfeited.  Fair market valueis currently calculated as below the exercise price, therefore it is assumedoptions would not be exercised.

 

(2)   Non-vestedoptions are forfeited; vested options may be exercised by Mr. Spooner’srepresentative until one year or expiration. It is assumed options would not be exercised currently due to the issuediscussed in (1) above.

 

(3)   Whileall non-vested options would have vested, fair market value is below theexercise price.

 

(4)   Thecash severance summary assumes the executive did not receive a bonus.

 

**Husein Jafferjee**

 

We have entered into an employment agreement withHusein Jafferjee, our Chief Operating Officer, which commenced on January 31,2008.  Under the terms of the agreement,the initial period is from January 31, 2008 through January 31, 2010;thereafter, the agreement and the employment relationship created thereunderwill continue for consecutive twelve (12) month periods commencing on each January 31.  The agreement provides for payments to bemade to Mr. Jafferjee upon certain termination events, as long as heexecutes a general release in favor of the Company, its affiliates andCerberus, provided that the release shall not release any rights to terminationpayments, the transaction bonus or to indemnification.

 

Under Mr. Jafferjee’s employment agreement, thefollowing payments will be made to him or his representatives if (1) hisemployment is terminated by the Company for Cause (generally defined as arrestor formal charge with any felony; dishonesty; refusal to follow directions ofthe Board; gross negligence; or other instances of willful misconduct); (2) hisemployment terminates due to his death or disability (meaning a physical or mentalincapacity that (i) prevents Mr. Jafferjee from performing theessential functions of his job for a period of one hundred eighty (180) or moredays in any twelve (12) month period or (ii) can be expected, in theopinion of a licensed physician selected by the Board and reasonably acceptableto Mr. Jafferjee, to result in Mr. Jafferjee’s death or to last for acontinuous period of 180 or more days in any twelve (12) month period); (3) Mr. Jafferjeeterminates his employment by giving the Company notice of his intent not torenew or (4) Mr. Jafferjee terminates his employment without “GoodReason” as that term is defined in the agreement:

 

(a)           his Base Salary at therate in effect at the time of termination until the effective date oftermination;

 

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(b)           payment for any accruedbut unused vacation days;

 

(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 haveunder the Company’s benefit plans or by law, to the extent they do not conflictwith his employment agreement.

 

the foregoing (a) through (d) referred to herein as the “AccruedBenefits”.  In addition, if Mr. Jafferjee’semployment is terminated by the Company without Cause, or leaves his employ forGood Reason before October 31, 2008, Mr. Jafferjee will have to repaythe $300,000 signing bonus.

 

If the Company terminates Mr. Jafferjee’semployment by giving him notice of its intent not to renew for another term,then Mr. Jafferjee will receive:

 

(a)           the Accrued Benefits;

 

(b)           payment of his basesalary for the remainder of the term (until January 31, 2010) or twelve(12) months, payable in four installments; and

 

(c)           a pro-rated annualbonus.

 

If Mr. Jafferjee is terminated by the Companywithout Cause, or leaves his employ for Good Reason, he will receive thepayments specified in the previous paragraph and:

 

(a)           payment of his COBRApremiums until the earlier of 12 months after the date of termination or when Mr. Jafferjeefirst becomes eligible for equivalent insurance coverage; and

 

(b)           if Mr. Jafferjee’semployment is terminated on or before December 31, 2008, any unpaid 2008annual bonus as of the termination date.

 

If Mr. Jafferjee’s employment isterminated by the Company without Cause or by Mr. Jafferjee with GoodReason within two (2) years following a change of control, then Mr. Jafferjeewill receive the payments specified in the previous paragraph, except thatinstead of four (4) separate payments, Mr. Jafferjee will receivetwelve (12) months of his base salary payable in a lump sum.

 
| **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  by the  Executive  by Notice of  Intent not to  Renew or  Without  Good Reason** | ** ** | **Termination  upon the  Executive’s  Death or  Disability** | ** ** | **Termination  by the  Company by  Notice of  Intent not to  Renew** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                           |       |                                                  |       |                                                                                                 |       |                                                                   |       |                                                                 |       |
| Cash Severance                      |       |                                         | (1)        | —                                                |       | $                                                              | 950,000    |                                                  | $          | 950,000                                                                                              |       | —                                                                 |       | —                                                               |       | $ | 950,000 |   |
|                                     |            |                                              |            |                                                       |            |                                                                |            |                                                       |            |                                                                                                      |            |                                                                        |            |                                                                      |            |  |  |  |

 

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(1)   Assumes the Company would notelect to make certain discretionary payments and does not include repayment ofhis $300,000 signing bonus.

 

Also, under Mr. Jafferjee’s employment agreement,he is entitled to receive a transaction bonus in an amount equal to 2.5% of theAppreciated Value in connection with a Sale Transaction and 2.5% of the NetDividends paid other than in connection with a Sale Transaction.

 

A “Sale Transaction” is defined as:

 

(1) a “Change in Control” (generally defined as (i) atransaction(s) resulting in the sale of all or substantially all of theassets of the Company to a person or entity who is not a stockholder of theCompany or an affiliate of such a stockholder (such person or entity being a “ThirdParty”); or (ii) a transaction(s) resulting in the sale by anystockholders of the Company, or any of their affiliates, or a merger or otherbusiness combination, involving the Company, resulting in more than fiftypercent (50%) of the voting stock of the Company being held by a ThirdParty);  and

 

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(2) other than in connection with a Change inControl, (A) all transactions by the common stockholders of the Company orany affiliates of such common stockholders resulting in the sale of commonsecurities of the Company to one or more Third Parties and (B) the sale bythe Company of its common securities pursuant to an initial public offering.

 

“Appreciated Value” is defined as:

 

(1) the net value of all cash, securities andother consideration in any form paid by a Third Party to the Company and/or thecommon stockholders in connection with Sale Transactions (including theaggregate amount of any Dividends in connection with or in contemplation of aSale Transaction) and taking into account the Net Dividends calculated inconnection with any Dividends paid after the Effective Date to the CommonStockholders or any affiliates of such common stockholders; minus

 

(ii) in the case of a Sale Transaction in whichthe Company receives consideration from the Third Party, the sum of (x) theamount of any debt or preferred stock (based upon its aggregate liquidationpreference plus any accrued and unpaid dividends or other preferred return)assumed, acquired, redeemed or repaid (directly or indirectly) in connectionwith the Sale Transaction, or which remains on the Company’s financialstatements at the time of the Sale Transaction and (y) $53,333,333 (the “FloorAmount”); or

 

(iii) in the case of a Sale Transaction in whichthe common stockholders receive consideration from the Third Party, the sum of (x) theamount of any preferred stock of the class or series issued and outstanding onthe Effective Date (based upon its aggregate liquidation preference plus anyaccrued and unpaid dividends or other preferred return) that is issued andoutstanding as of the time of such Sale Transaction and (y) the FloorAmount minus (A) the number of shares of such preferred stockissued and outstanding as of the time of such Sale Transaction multiplied by (B) theoriginal issue price thereof.

 

“Net Dividends” is defined as:

 

(i) the aggregate value of all cash, securitiesand other consideration paid by the Company to the Common Stockholders or anyaffiliates of such Common Stockholders (other than in connection with a SaleTransaction) in the form of dividends, other distributions or as a repurchaseof any common securities of the Company (collectively, “Dividends”) and takinginto account the “Appreciated Value” calculated in connection with prior SaleTransactions; minus

 

(ii) the sum of (x) the amount of anypreferred stock of the class or series issued and outstanding (based upon itsaggregate liquidation preference plus any accrued and unpaid dividends or otherpreferred return) that is issued and outstanding as of the time of suchDividend and (y) the Floor Amount minus (A) the number ofshares of such preferred stock issued and outstanding as of the time of suchDividend multiplied by (B) the original issue price thereof.

 

Calculations of Appreciated Value or Net Dividendsshall be made in connection with any Sale Transaction or Dividend payment.

 

In the event a Change in Control is consummated priorto full vesting of the Sale/Dividend Payment and provided that Mr. Jafferjee’semployment has not terminated as of the date of such Change in Control, Mr. Jafferjeeshall be one hundred percent (100%) vested in the entire Sale/Dividend Payment,which shall be payable in a lump sum within thirty (30) days of such Change inControl.

 

As of July 31, 2008, Mr. Jafferjee’s Sale/Dividendpayment was 8% vested.  Provided that Mr. Jafferjeeremains an employee of the Company or its subsidiaries on each Vesting Date asdescribed below, the Vesting Schedule is as indicated below:

 

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| **Vesting  Date: On the following anniversaries of the  effective date:** | ** ** | **The following percent of the Sale/Dividend Payment shall vest:** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| 9  month                                                                  |       | 4                                                                  | %          |
| 12  month                                                                 |       | 5                                                                  | %          |
| 15  month                                                                 |       | 6                                                                  | %          |
| 18  month                                                                 |       | 6                                                                  | %          |
| 21  month                                                                 |       | 7                                                                  | %          |
| 24  month                                                                 |       | 7                                                                  | %          |
| 27  month                                                                 |       | 8                                                                  | %          |
| 30  month                                                                 |       | 9                                                                  | %          |
| 33  month                                                                 |       | 10                                                                 | %          |
| 36  month                                                                 |       | 10                                                                 | %          |
| 39  month                                                                 |       | 10                                                                 | %          |
| 42  month                                                                 |       | 10                                                                 | %          |

 

IfMr. Jafferjee’s employment with the Company and its subsidiariesterminates for any reason prior to the consummation of a Change in Control, anythen-unvested portion of his Sale/Dividend Payment shall immediately becancelled, and Mr. Jafferjee (and his estate, designated beneficiary orother legal representative, as applicable) shall forfeit any rights orinterests in and with respect to any such unvested portion of his Sale/DividendPayment.

 

Inthe event any Sale Transaction is consummated, or any Net Dividend is paid, onor prior to the eighteen (18) month anniversary of the termination of Mr. Jafferjee’semployment with the Company and its subsidiaries, Mr. Jafferjee shall beentitled to the portion of his Sale/Dividend Payment that had vested on orprior to the effective date of termination; provided, however,that if Mr. Jafferjee is seventy percent (70%) or more vested, the periodshall be extended to twenty-four (24) months. Such amount shall be payable to Mr. Jafferjee in a lump sum withinsixty (60) days of the date of such Sale Transaction or Net Dividend payment.

 

Inthe event any Sale Transaction is consummated, or any Net Dividend is paid,after such eighteen (18) month or twenty-four (24) month anniversary, asapplicable, any rights or interests in his entire Sale/Dividend Payment shallbe cancelled and Mr. Jafferjee (and Mr. Jafferjee’s estate,designated beneficiary or other legal representative, as applicable) shallforfeit any rights or interests in and with respect to the entire Sale/DividendPayment.

 

**Nichole Vowteras**

 

We have entered into an employment agreement withNichole Vowteras, our Executive Vice President Sourcing and Production, whichcommenced on May 1, 2006.  Under theterms of the agreement, the term is from May 1, 2006 until her employmentis terminated by any of the methods discussed below.  Ms. Vowteras 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 anAffiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberusbecomes the beneficial owner, directly or indirectly, of fifty percent (50%) ormore of the combined voting power of the then outstanding voting securities ofthe Company; (2) the sale, transfer or other disposition of all orsubstantially all of the business and assets of the Company, whether by sale ofassets, merger or otherwise to a person other than an Affiliate of Cerberus; (3) ifspecified 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. Vowteras’ employment agreement, thefollowing payments will be made to her or her representatives if (1) sheis terminated by the Company for Cause (generally defined as the commission ofa felony; dishonesty; refusal to follow directions of the Board; grossnonfeasance; breach of confidentiality or restrictive covenant provisions; orcertain other instances of willful misconduct); (2) her employmentterminates due to her death; (3) the Company terminates her employment dueto her disability (meaning a determination by the Company in accordance withapplicable law that as a result of a physical or mental injury or illness, Ms. Vowterasis 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 anyreason:

 

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

 

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(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 haveunder the Company’s benefit plans and the Consolidated Omnibus BudgetReconciliation Act.

 

If Ms. Vowteras is terminated by the Companywithout Cause, in addition to the benefits described in the previous paragraph,she will receive, upon execution without revocation of a valid releaseagreement in a form reasonably acceptable to the Company, continued payment ofher base salary 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 optionsmay be exercised by Ms. Vowteras’ 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 have vested,fair market value is below the exercise price.

 

**Rosemary Mancino**

 

We have entered into an employment agreement withRosemary Mancino, our President of Sales & Planning, which commencedon August 14, 2006.  Under the termsof the agreement, the term is from August 14, 2006 until her employment isterminated by any of the methods discussed below.  Ms. Mancino 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 anAffiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberusbecomes the beneficial owner, directly or indirectly, of fifty percent (50%) ormore of the combined voting power of the then outstanding voting securities ofthe Company; (2) the sale, transfer or other disposition of all orsubstantially all of the business and assets of the Company, whether by sale ofassets, merger or otherwise to a person other than an Affiliate of Cerberus; (3) ifspecified 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’s employment agreement, thefollowing payments will be made to her or her representatives if (1) sheis terminated by the Company for Cause (generally defined as the commission ofa felony; dishonesty; refusal to follow directions of the Board; grossnonfeasance; breach of confidentiality or restrictive covenant provisions; orcertain other instances of willful misconduct); (2) her employmentterminates due to her death; (3) the Company terminates her employment dueto her disability (meaning a determination by the Company in accordance withapplicable law that as a result of a physical or mental injury or illness, Ms. Mancinois 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 anyreason:

 

(a)           her accrued but unpaidbase 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

 

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(d)           any rights she may haveunder the Company’s benefit plans and the Consolidated Omnibus Budget ReconciliationAct.

 

If Ms. Mancino is terminated by the Companywithout Cause, in addition to the benefits described in the previous paragraph,she will receive, upon execution without revocation of a valid releaseagreement in a form reasonably acceptable to the Company, continued payment ofher base salary 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-vestedoptions are forfeited.  Fair market valueis currently calculated as below the exercise price, therefore it is assumedoptions would not be exercised.

 

(2)   Non-vestedoptions are forfeited; vested options may be exercised by Ms. Mancino’srepresentative until one year or expiration. It is assumed options would not be exercised currently due to the issuediscussed in (2) above.

 

(3)   Whileall non-vested options would have vested, fair market value is below theexercise price.

 

**Jason Epstein**

 

We have entered into an employment agreement withJason Epstein, our Chief Information Officer, Vice President StrategicPlanning, 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 themethods discussed below.  Mr. Epsteinwill 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 Mr. Epstein’s employment agreement, thefollowing payments will be made to him or his representatives if (1) he isterminated by the Company for Cause (generally defined as the commission of afelony; dishonesty; refusal to follow directions of the Board; grossnonfeasance; breach of confidentiality or restrictive covenant provisions; orcertain other instances of willful misconduct); (2) his employmentterminates due to his death; (3) the Company terminates his employment dueto his disability (meaning a determination by the Company in accordance withapplicable law that as a result of a physical or mental injury or illness, Mr. Epsteinis unable to perform the essential functions of his job with or withoutreasonable accommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) he resigns for any reason:

 

(a)           his accrued but unpaidbase 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 haveunder the Company’s benefit plans and the Consolidated Omnibus BudgetReconciliation Act.

 

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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.

 
| **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 areforfeited; vested options may be exercised by Mr. Epstein’s representativeuntil one year or expiration.  It isassumed options would not be exercised currently due to the issue discussed in (2) above.

 

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

 

**Compensation Committee Interlocks and InsiderParticipation**

 

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

 

**SummaryCompensation Table**

 

**For theYear Ended June 30, 2008**

 
| **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                             |       | 2008     |       | 700,000             |       | 0                  |       | 0                      |       | 23,263                      |       | 0                                                       |       | 0                                                                                                       |       | 63,171                                   | (3)        | 786,434        |       |
| *Chief Executive Officer*                      |       | 2007     |       | 700,000             |       | 700,000            |       | 0                      |       | 27,141                      |       | 0                                                       |       | 0                                                                                                       |       | 83,370                                   |       | 1,510,511      |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
| Chad Spooner                                   |       | 2008     |       | 400,000             |       | 0                  |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 26,897                                   | (2)        | 426,897        |       |
| *Chief Financial Officer*                      |       | 2007     |       | 400,000             |       | 300,000            |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 27,039                                   |       | 727,039        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
| Nichole Vowteras                               |       | 2008     |       | 400,000             |       | 0                  |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 14,482                                   | (2)        | 414,482        |       |
| *Executive Vice President*                     |       | 2007     |       | 400,000             |       | 200,000            |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 14,538                                   |       | 614,538        |       |
| *Sourcing and Production*                      |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
| Rosemary Mancino                               |       | 2008     |       | 400,000             |       | 0                  |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 26,897                                   | (2)        | 426,897        |       |
| *President Sales & Planning*          |       | 2007     |       | 353,846             |       | 200,000            |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 24,875                                   |       | 578,721        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
| Husein Jafferjee                               |       | 2008     |       | 230,769             |       | 450,000            | (4)        |                   |       |                        |       |                                                    |       |                                                                                                    |       | 8,361                                    | (2)        | 689,130        |       |
| *Chief Operating Officer*                      |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
|                                           |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |
| Jason Epstein                                  |       | 2008     |       | 400,000             |       | 0                  |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 23,528                                   |       | 423,528        |       |
| *Chief Information Officer,*                   |       | 2007     |       | 115,385             |       | 107,222            |       | 0                      |       | 0                           |       | 0                                                       |       | 0                                                                                                       |       | 6,997                                    |       | 229,604        |       |
| *Vice President Strategic Planning*            |       |     |       |                |       |               |       |                   |       |                        |       |                                                    |       |                                                                                                    |       |                                     |       |           |       |

 

----

(1) Therewere no stock option award forfeitures during the year ended June 30,2008. Refer to Note 3 of the Company’s consolidated financial statements andthe Company’s Critical Accounting Policies and Estimates discussion includedwithin Management’s Discussion and Analysis of Financial Condition and Resultsof Operations included elsewhere herein for further information on the assumptionsused to fair value the stock option awards.

 

(2) Medicalbenefits paid for Mr. Spooner, Ms. Vowteras, Ms. Mancino, Mr. Jafferjeeand Mr. Epstein were $20,297, $7,882, $20,297, $8,361 and $20,297,respectively.

 

(3) Amountshown for Ms. Michalaros includes the cost of car service ($56,571).

 

(4) Amountshown for Mr. Jafferjee includes a $300,000 signing bonus.

 

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

 

**As of June 30, 2008**

 
| ** **          | ** ** | **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 |       | 222,222                                                                            |       | 222,222                                                                              | (1)        | 0 |   | 5.33 |   | 9//22/2016 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Chad Spooner        |       | 187,500                                                                            |       | 62,500                                                                               | (1)        | 0 |   | 5.33 |   | 6/20/2015 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Nichole Vowteras    |       | 55,556                                                                             |       | 55,555                                                                               | (1)        | 0 |   | 5.33 |   | 9/22/2016 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Rosemary Mancino    |       | 55,556                                                                             |       | 55,555                                                                               | (1)        | 0 |   | 5.33 |   | 9/22/2016 |   | 0 |   | 0 |   | 0 |   | 0 |   |
| Jason Epstein       |       | 20,833                                                                             |       | 62,501                                                                               | (1)        | 0 |   | 5.33 |   | 5/22/2017 |   | 0 |   | 0 |   | 0 |   | 0 |   |

 

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

 

**COMPENSATION COMMITTEE REPORT**

 

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

 

The Compensation Committee’sReport shall not be deemed incorporated by reference by any general statementincorporating by reference this proxy statement into any filing under theSecurities Act of 1933 or under the Securities Exchange Act of 1934, except tothe extent that the Company specifically incorporates this CompensationCommittee’s Report by reference, and shall not otherwise be deemed filed undersuch Acts.

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

 

**Compensationof Directors**

 

We may, but are notobligated to, pay members of our Board of Directors, who are not our employeesand are not affiliated with Cerberus, directors fees equal to $50,000 per annumplus stock options equal to 1/10 of 1% of our fully diluted common stock.  Other than Mr. Kourakos, none of our nonemployee directors received any fee payments or equity grants.

 

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

 

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

 

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Mr. Kourakos’ feewas $150,000 on an annualized basis from October 1, 2007 until June 30,2008 and $200,000 per year commencing on July 1, 2008.  For fiscal year 2008, Mr. Kourakos waspaid aggregate fees of $125,000 and was reimbursed $11,614 in the aggregate inconnection with health insurance, travel, auto expenses and legal fees.

 

Mr. Kourakos isentitled, subject to vesting, to receive a transaction bonus in an amount equalto 1.0% of the Appreciated Value in connection with Sale Transactions and 1.0%of the Net Dividends paid other than in connection with a Sale Transaction(each as previously defined under “Transaction Bonus”).

 

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

 

In the event a Change inControl is consummated prior to full vesting of his Sale/Dividend Payment andprovided that Mr. Kourakos’ service has not terminated as of the date ofsuch Change in Control, Mr. Kourakos shall be one hundred percent (100%)vested in the entire Sale/Dividend Payment, which shall be payable in a lumpsum within thirty (30) days of such Change in Control.

 

As of August 31,2008, Mr. Kourakos’ Sale/Dividend payment was 12% vested.  Provided that Mr. Kourakos continues hisservice to the Company or its subsidiaries on each Vesting Date as describedbelow, the Vesting Schedule is as indicated below:

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

 

If Mr. Kourakos’position as chairman of the board terminates for any reason prior to theconsummation of a Change in Control, any then-unvested portion of hisSale/Dividend Payment shall immediately be cancelled, and Mr. Kourakos(and his estate, designated beneficiary or other legal representative, asapplicable) shall forfeit any rights or interests in and with respect to anysuch unvested portion of his Sale/Dividend Payment.

 

In the event anySale Transaction is consummated, or any Net Dividend is paid, on or prior tothe first (1st) anniversary of Mr. Kourakos’ termination as chairman ofthe board, Mr. Kourakos shall be entitled to the portion of hisSale/Dividend Payment that had vested on or prior to the effective date oftermination.  Such amount shall bepayable to Mr. Kourakos in a lump sum within sixty (60) days of the dateof such Sale Transaction or Net Dividend payment.

 

In the event anySale Transaction is consummated, or any Net Dividend is paid, after such first(1st) anniversary, any rights or interests in the entire Sale/Dividend Paymentshall be cancelled and Mr. Kourakos (and Mr. Kourakos’ estate,designated beneficiary or other legal representative, as applicable) shallforfeit any rights or interests in and with respect to his entire Sale/DividendPayment.

 

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Director Compensation

 
| **Name**      | ** ** | **Fees Earned** | ** ** | **All Other Compensation(1)** | ** ** |
|---------------|------------|----------------------|------------|-----------------------------------------|------------|
|          |       |                 |       |                                    |       |
| John Kourakos |       | $                    | 125,000    |                                    | $          | 11,614 |   |
|               |            |                      |            |                                         |            |  |  |

 

----

(1) Includesreimbursements in connection with health insurance, travel, auto expenses andlegal fees.

 

**ITEM 12.**               SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS

** **

The following table setsforth information with respect to the beneficial ownership of our issued andoutstanding common stock and convertible preferred stock, excluding any grantsmade under our Equity Incentive Plan, none of which have vested or will vest inthe next sixty days, by:

 

·      each person who is known byus to beneficially own 5% or more of our issued and outstanding common stockand convertible preferred stock;

 

·      each member of our Board ofDirectors;

 

·      each of our executiveofficers named under “Management—Compensation of Executive Officers;” and

 

·      all members of our Board ofDirectors and our named executive officers as a group.

 

Beneficial ownership isdetermined in accordance with the rules of the SEC.  To our knowledge, except as set forth in theStockholders’ Agreement, each holder of our equity interests listed below hassole voting and investment power as to such equity interest unless otherwisenoted.

 
| ** **                                                                                 | ** ** | **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.(9)                                                                     |       | —                                |       | —                        |       | 2,500,000                              |       | 100 | % | 2,500,000 |   | 25.0 | % |
| Christa Michalaros(4)                                                                      |       | —                                |       | —                        |       | 222,222                                |       | 8 | % | 222,222 |   | 2 | % |
| Chad Spooner(5)                                                                            |       | —                                |       | —                        |       | 187,500                                |       | 7 | % | 187,500 |   | 2 | % |
| Rosemary Mancino(6)                                                                        |       | —                                |       | —                        |       | 55,556                                 |       | 2 | % | 55,556 |   | — |   |
| Nichole Vowteras (7)                                                                       |       | —                                |       | —                        |       | 55,556                                 |       | 2 | % | 55,556 |   | — |   |
| Jason Epstein(8)                                                                           |       | —                                |       | —                        |       | 20,833                                 |       | — |   | 20,833 |   | — |   |
| George Kollitides(3)                                                                       |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| John Kourakos                                                                              |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| Husein Jafferjee                                                                           |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| Trish Mattler-Gateley(3)                                                                   |       | —                                |       | —                        |       | —                                 |       | — |   | — |   | — |   |
| Ronald Frankel(9)                                                                          |       | —                                |       | —                        |       | 2,125,000                              |       | 85.0 | % | — |   | — |   |
| Robert Newman(9)                                                                           |       | —                                |       | —                        |       | 125,000                                |       | 5.0 | % | — |   | — |   |
| Asher Haddad (9)                                                                           |       | —                                |       | —                        |       | 250,000                                |       | 10.0 | % | — |   | — |   |
| All members of our Board of Directors and executive  officers as a group (11 persons) |       |                                  |       |                          |       | 3,041,667                              |       | 100 | % | 3,041,667 |   | 29 | % |

 

----

(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 outstandingfully-diluted common stock.  StephenFeinberg exercises sole voting and investment authority over all securities ofour company owned by Acquisition Co. Thus, pursuant to Rule 13d-3 underthe Exchange Act, Stephen Feinberg is deemed to beneficially own 100% of ourconvertible preferred stock and, upon conversion, would 

 

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beneficially own approximately 67.5% of our commonstock (after the exercise of all outstanding options granted pursuant to ourEquity Incentive Plan).

 

(3)    Theaddress for Stephen Feinberg, George Kollitides and Trish Mattler-Gateley isc/o Cerberus Capital Management, L.P., 299 Park Avenue, New York, New York10171.

 

(4)    Includesvested options for 222,222 shares of common stock but does not includenon-vested options for 222,222 shares of common stock, all of which weregranted pursuant to Ms. Michalaros’ employment agreement with us.

 

(5)    Includesvested options for 187,500 shares of common stock but does not includenon-vested options for 62,500 shares of common stock, all of which were grantedpursuant to Mr. Spooner’s employment agreement with us.

 

(6)    Includesvested options for 55,556 shares of common stock but does not includenon-vested options for 55,555 shares of common stock, all of which were grantedpursuant to Ms. Mancino’s employment agreement with us.

 

(7)    Includesvested options for 55,556 shares of common stock but does not includenon-vested options for 55,555 shares of common stock, all of which were grantedpursuant to Ms. Vowteras’ employment agreement with us.

 

(8)    Includesvested options for 20,833 shares of common stock but does not includenon-vested options for 62,501 shares of common stock, all of which were grantedpursuant to Mr. Epstein’s employment agreement with us.

 

(9)    Allof our common stock beneficially owned by Messrs. Frankel, Newman andHaddad are held by them indirectly through RSW 2005, Inc.

 

**Equity Compensation Plan Information(1)**

 
| **Plan category**                                           | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrents and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrents and rights** | ** ** | **Number of securities remaining   available for future issuance   under equity compensation plans   (excluding securities reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                            | ** ** | **(b)**                                                                            | ** ** | **(c)**                                                                                                                                               | ** ** |
|                                                        |       |                                                                                               |       |                                                                               |       |                                                                                                                                                  |       |
| Equity compensation  plans approved by security holders     |       | —                                                                                             |       | —                                                                             |       | —                                                                                                                                                |       |
| Equity compensation  plans not approved by security holders |       | 1,111,111                                                                                          |       | $                                                                                  | 5.33       |                                                                                                                                                  | 0          |   |
| Total                                                       |       | 1,111,111                                                                                          |       | $                                                                                  | 5.33       |                                                                                                                                                  | 0          |   |

 

----

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

 

**ITEM 13.**         CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

** **

**Controlling Stockholder**

** **

In connection with the June 20,2005 acquisition, Acquisition Co., an affiliate of Cerberus, contributed$40.0 million of equity capital to us, acquiring convertible preferredstock convertible into approximately 67.5% of our common stock on afully-diluted basis.  See “SecurityOwnership of Certain Beneficial Owners and Management.”

 

*Stockholders’ Agreement*

 

In connection with an April 15,2005 Securities Purchase Agreement, as amended, we entered into a Stockholders’Agreement with Acquisition Co. and our predecessor.  This Stockholders Agreement provides that we willhave a Board of Directors that will consist of seven directors, four of whomare designated by Acquisition Co., two of whom are designated by RSW 2005, Inc.,which is controlled by Ronald Frankel, and one of whom is designated jointly byAcquisition Co. and RSW 2005, Inc. Our Board of Directors currentlyconsists of six directors, four of whom were designated by Acquisition Co. andtwo of whom were designated by our predecessor. The Stockholders’ Agreement also contains certain restrictions ontransfers by stockholders of their capital stock and tag-along rights,drag-along rights and a right of first refusal with respect to certainpermitted transfers.

 

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**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’sand the audit committee’s review, the following matters will be considered:

 

·      the nature of the relatedparty’s interest in the transaction;

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

·      the importance of thetransaction to the related party and to us;

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

·      any other matters managementor the audit committee deems appropriate.

 

Since July 1, 2007,the beginning of the Company’s most recent fiscal year, we have not been aparty to, and we have no plans to be a party to, any transaction or series ofsimilar transactions in which the amount involved exceeded or will exceed $120,000and in which any current director, executive officer, holder of more than 5% ofour capital stock, or any member of the immediate family of any of theforegoing, had or will have a direct or indirect material interest.

 

**DirectorIndependence**

 

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

 

**ITEM 14.**               PRINCIPAL ACCOUNTANT FEES AND SERVICES

** **

The following tablepresents fees for services rendered by PricewaterhouseCoopers LLP relating tothe years ended June 30, 2008 and 2007.

 
| ** **            | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** |
|-----------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in thousands)**                      | ** ** |
| Audit fees(1)         |       | $                                            | 401        |                                         | $          | 365 |   |
| Audit-related fees(2) |       | 88                                           |       | 152                                          |       |
| Tax fees(3)           |       | 132                                          |       | 90                                           |       |
| All other fees(4)     |       | 2                                            |       | 2                                            |       |
| Total                 |       | $                                            | 623        |                                         | $          | 609 |   |

 

----

(1)    Feesfor audit of annual financial statements and review of quarterly financialstatements.

 

(2)    Feesfor professional services for consultations in fiscal 2008 related to theCompany’s implementation of FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes — an interpretation of FASB Statement No. 109”and Section 404 of the Sarbanes-Oxley Act of 2002.  The fees for fiscal 2007 related to theCompany’s Registration Statement on Form S-4.

 

(3)    Feesrelated to professional services for tax compliance, tax advice and tax planning.  These services include tax return preparationservices, technical tax advice on U.S. and international tax matters andassistance with tax audit defense matters.

 

(4)    Feesfor permissible work provided by PricewaterhouseCoopers LLP that do not meetany of the above-category descriptions. The fees relate to the use of Comperio, PricewaterhouseCoopers LLP’saccounting research software.

 

Under the Audit Committee’sCharter, the committee has the sole authority for appointing, compensating,retaining and overseeing the work of the Company’s independent auditors.  In addition, the committee has the soleauthority to 

 

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approve allengagement fees and terms and all permissible non-audit services to be providedby the independent auditors. Subsequent to the Company’s Registration Statementon Form S-4 filed February 9, 2007, the committee has approved eachsuch audit and non-audit service to be provided by the Company’s independentauditors.  The committee has also adoptedpolices and procedures for pre-approving certain services performed by theindependent auditors.  The committee haspre-approved the use of the independent auditors for specific types of servicesthat fall within categories of non-audit services, including various taxservices.  The percentage of fees paidfor audit-related, tax and all other fees that were approved by the AuditCommittee was 100% in fiscal 2008. Management of the Company reviews the nature of the professionalservices to be rendered by the independent auditors with the committee duringeach committee meeting.

 

**PART IV**

** **

**ITEM 15.**               EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

** **

**(a) Documentsfiled as part of this report:**

 

(1)                                 FinancialStatements

 
|                                                                                                                        | **Page** |
|------------------------------------------------------------------------------------------------------------------------|----------|
| Report of Independent Registered Public Accounting  Firm                                                               | F-2      |
| Consolidated  Balance Sheets at June 30, 2008 and 2007                                                            | F-3      |
| Consolidated  Statements of Operations for the years ended June 30, 2008, 2007 and  2006                          | F-4      |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the years ended  June 30, 2008, 2007 and 2006 | F-5      |
| Consolidated  Statements of Cash Flows for the years ended June 30, 2008, 2007 and  2006                          | F-6      |
| Notes to  Consolidated Financial Statements                                                                            | F-7      |

** **

(2)                                 FinancialStatement Schedules

 

None.

 

(3)                                 Listof Exhibits

 

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

 

**(b) Exhibits**

 

See the Exhibit Indexbelow.

 

**(c) SeparateFinancial Statements and Schedules**

 

None.

 

**EXHIBITINDEX**

** **

**Form 10-K for Fiscal Year Ended June 30,2008**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                     |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                |
| 2.1*             |       | Securities Purchase Agreement,  dated April 15, 2005, among RA Cerberus Acquisition, LLC, Rafaella  Sportswear, Inc., Verrazano, Inc., Ronald Frankel and Rafaella  Corporation |
|             |       |                                                                                                                                                                                                |
| 2.2*             |       | Amendment No. 1 to  the Securities Purchase Agreement, dated May 27, 2005                                                                                                                 |
|             |       |                                                                                                                                                                                                |
| 2.3*             |       | Contribution Agreement,  dated June 20, 2005, among Rafaella Sportswear, Inc. and Rafaella  Apparel Group, Inc.                                                                      |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                            |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                       |
| 3.1*             |       | Amended and Restated  Certificate of Incorporation of Rafaella Apparel Group, Inc.                                                                                                                                    |
|             |       |                                                                                                                                                                                                                       |
| 3.2*             |       | Bylaws of Rafaella  Corporation                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                       |
| 3.3*             |       | Certificate of  Incorporation of Verrazano, Inc.                                                                                                                                                                      |
|             |       |                                                                                                                                                                                                                       |
| 3.4*             |       | Bylaws of  Verrazano, Inc.                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                       |
| 4.1*             |       | Stockholder’s  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  RA Cerberus Acquisition, LLC, Rafaella Sportswear, Inc. and  the principals set forth therein            |
|             |       |                                                                                                                                                                                                                       |
| 4.2*             |       | Indenture for the 11 1/4% Senior Secured Notes  due 2011, dated June 20, 2005, among Rafaella Apparel  Group, Inc., the guarantors named therein and The Bank of New York, as  trustee and collateral agent |
|             |       |                                                                                                                                                                                                                       |
| 4.3*             |       | First Supplemental  Indenture, dated July 12, 2006, among Rafaella Apparel Group, Inc.,  the guarantors named therein and the Bank of New York, as trustee and  collateral agent                                 |
|             |       |                                                                                                                                                                                                                       |
| 4.4*             |       | Form of 111¤4%  Senior Secured Notes due 2011 (included in Exhibit 4.2)                                                                                                                                |
|             |       |                                                                                                                                                                                                                       |
| 4.5*             |       | Form of Guarantee  (included in Exhibit 4.2)                                                                                                                                                                     |
|             |       |                                                                                                                                                                                                                       |
| 4.6*             |       | Registration Rights  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  Jeffries & Company, Inc. and the guarantors named therein                                                |
|             |       |                                                                                                                                                                                                                       |
| 4.7*             |       | Intercreditor  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  Verrazano, Inc., HSBC Bank USA, National Association, The Bank of New  York, as trustee and collateral agent            |
|             |       |                                                                                                                                                                                                                       |
| 4.8*             |       | Second Lien Security  Agreement, dated June 20, 2005, in favor of The Bank of New York, among  Rafaella Apparel Group, Inc., the additional grantors listed therein and  The Bank of New York                    |
|             |       |                                                                                                                                                                                                                       |
| 10.1*            |       | Note Purchase  Agreement, dated June 13, 2005, among the Company, Jeffries &  Company, Inc. and the guarantors named therein                                                                            |
|             |       |                                                                                                                                                                                                                       |
| 10.2*            |       | Escrow Agreement, dated  June 20, 2005, among Rafaella Apparel Group, Inc., RA Cerberus  Acquisition, LLC, Ronald Frankel, and JPMorgan Chase Bank, N.A., as  escrow agent                        |
|             |       |                                                                                                                                                                                                                       |
| 10.3*            |       | Redemption Agreement,  dated June 20, 2005, among Rafaella Apparel Group, Inc., Rafaella  Sportswear, Inc. and RA Cerberus Acquisition, LLC                                                       |
|             |       |                                                                                                                                                                                                                       |
| 10.4*            |       | Financing Agreement,  dated June 20, 2005, among Rafaella Apparel Group, Inc.,  Verrazano, Inc., HSBC Bank USA, National Association and Israel Discount  Bank of New York                                  |
|             |       |                                                                                                                                                                                                                       |
| 10.5*            |       | Continuing Indemnity  Agreement, dated June 20, 2005, between Rafaella Apparel  Group, Inc. and HSBC Bank USA, National Association                                                                              |
|             |       |                                                                                                                                                                                                                       |
| 10.6*            |       | Pledge Agreement, dated  June 20, 2005, among Rafaella Apparel Group, Inc. and HSBC Bank  USA, National Association, as Agent                                                                                    |
|             |       |                                                                                                                                                                                                                       |
| 10.7*            |       | Continuing Letter of  Credit Agreement, dated June 20, 2005, among Rafaella Apparel  Group, Inc. and HSBC Bank USA, National Association                                                                         |
|             |       |                                                                                                                                                                                                                       |
| 10.8*            |       | Deposit Account Control  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  The Bank of New York and HSBC Bank USA, National Association                                                       |
|             |       |                                                                                                                                                                                                                       |
| 10.9*            |       | Trademark Collateral  Security Agreement, dated June 20, 2005, among Rafaella Apparel  Group, Inc. and HSBC Bank USA, National Association                                                                       |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 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, previously filed as Exhibit 10.19 to  Rafaella’s Quarterly Report on Form 10-Q for the quarterly period ending  March 31, 2007, filed May 15, 2007, and herein incorporated by  reference.                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.20            |       | Employment Agreement, dated  as of January 8, 2008, between Rafaella Apparel Group, Inc. and  Husein Jafferjee, previously filed as Exhibit 10.20 to Rafaella’s  Current Report on Form 8-K, filed January 14, 2008, and herein  incorporated by reference.                                                                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.21            |       | Consent and Amendment  No. 3 to Financing Agreement, dated March 4, 2008, among Rafaella  Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA, National  Association and Israel Discount Bank of New York, previously filed as  Exhibit 10.21 to Rafaella’s Quarterly Report on Form 10-Q for the  quarterly period ending March 31, 2008, filed May 15, 2008, and  herein incorporated by reference. |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.22            |       | Amendment No. 4 to  Financing Agreement, dated March 28, 2008, among Rafaella Apparel  Group, Inc., Verrazano, Inc., HSBC Bank USA, National Association  and Israel Discount Bank of New York, previously filed as Exhibit 10.22  to Rafaella’s Quarterly Report on Form 10-Q for the quarterly period  ending March 31, 2008, filed May 15, 2008, and herein incorporated  by reference.            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.23            |       | Amendment No. 5 to  Financing Agreement, dated May 14, 2008, among Rafaella Apparel  Group, Inc., Verrazano, Inc., HSBC Bank USA, National Association  and Israel Discount Bank of New York, previously filed as Exhibit 10.23  to Rafaella’s Quarterly Report on Form 10-Q for the quarterly period  ending March 31, 2008, filed May 15, 2008, and herein incorporated  by reference.              |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.24            |       | Amendment to Employment  Agreement, dated as of August 28, 2008, between Rafaella Apparel  Group, Inc. and Husein Jafferjee, previously filed as Exhibit 10.24  to Rafaella’s Current Report on Form 8-K, filed September 3, 2008,  and herein incorporated by reference.                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.25            |       | Agreement for Chairman  of Board of Directors, dated as of October 1, 2007, between Rafaella  Apparel Group, Inc. and John Kourakos, previously filed as  Exhibit 10.25 to Rafaella’s Current Report on Form 8-K, filed  September 3, 2008, and herein incorporated by reference.                                                                                                                                    |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                        |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                   |
| 10.26**          |       | Amendment No. 1 to  Financing Agreement, dated March 31, 2006, among Rafaella Apparel  Group, Inc., Verrazano, Inc., HSBC Bank USA, National Association  and Israel Discount Bank of New York.    |
|             |       |                                                                                                                                                                                                                   |
| 10.27**          |       | Amendment No. 2 to  Financing Agreement, dated December 31, 2006, among Rafaella Apparel  Group, Inc., Verrazano, Inc., HSBC Bank USA, National Association  and Israel Discount Bank of New York. |
|             |       |                                                                                                                                                                                                                   |
| 21.1**           |       | List of subsidiaries of  Rafaella Apparel Group, Inc.                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                   |
| 31.1**           |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                                                                         |
|             |       |                                                                                                                                                                                                                   |
| 31.2**           |       | Certification of 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                                                                             |

 

----

*           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.

 

**         Filedherewith. 

 

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**SIGNATURES**

** **

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

 
| September 29, 2008 | RAFAELLA APPAREL  GROUP, INC. |
|-------------------------|-------------------------------|
|                    |                          |
|                    |                          |
|                    | By:                           | /s/ Christa Michalaros |
|                    |                          | Christa Michalaros |
|                    |                          | Chief Executive Officer  and Director |
|                    |                          | (Principal Executive  Officer) |
|                    |                          |

 

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

 

 
| **Signature**                 | ** ** | **Title**                             | ** ** | **Date**                | ** ** |
|-------------------------------|------------|---------------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** |                                  |       |                    |       |
| **/s/ Christa Michalaros**    | ** ** | Chief Executive Officer  and Director |       | September 29, 2008 |       |
| ** **                    | ** ** | (Principal Executive  Officer)        |       |                    |       |
| **Christa Michalaros**        | ** ** | ** **                            | ** ** | ** **              | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | ** **              | ** ** |
| **/s/ Chad J. Spooner**       | ** ** | Chief Financial Officer  (Principal   |       | September 29, 2008 |       |
| ** **                    | ** ** | Financial and Accounting  Officer)    |       |                    |       |
| **Chad J. Spooner**           | ** ** | ** **                            | ** ** | ** **              | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | ** **              | ** ** |
| **/s/ John Kourakos**         | ** ** | Director, Chairman of  the Board      |       | September 29, 2008 |       |
| ** **                    | ** ** |                                  |       |                    |       |
| **John Kourakos**             | ** ** | ** **                            | ** ** | ** **              | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | ** **              | ** ** |
| **/s/George Kollitides**      | ** ** | Director                              |       | September 29, 2008 |       |
| ** **                    | ** ** |                                  |       |                    |       |
| **George Kollitides**         | ** ** | ** **                            | ** ** | ** **              | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | ** **              | ** ** |
| **/s/ Trish Mattler-Gateley** | ** ** | Director                              |       | September 29, 2008 |       |
| ** **                    | ** ** |                                  |       |                    |       |
| **Trish Mattler-Gateley**     | ** ** | ** **                            | ** ** | ** **              | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | ** **              | ** ** |
| **/s/ Ronald Frankel**        | ** ** | Director                              |       | September 29, 2008 |       |
| ** **                    | ** ** |                                  |       |                    |       |
| **Ronald Frankel**            | ** ** | ** **                            | ** ** | ** **              | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | ** **              | ** ** |
| **/s/ Robert Newman**         | ** ** | Director                              |       | September 29, 2008 |       |
| ** **                    | ** ** |                                  |       |                    |       |
| **Robert Newman**             | ** ** | ** **                            | ** ** | ** **              | ** ** |

 

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**SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTSFILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTSWHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT**

 

No annual report or proxymaterial has been or will be distributed to the shareholders.

 

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

 

**Tableof Contents**

 
|                                                                                                                        | ** ** | **Page** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Audited Financial Statements                                                                                           |       |     |
|                                                                                                                   |       |     |
| Report of Independent Registered Public Accounting Firm                                                                |       | F-2      |
| Consolidated  Balance Sheets at June 30, 2008 and 2007                                                            |       | F-3      |
| Consolidated  Statements of Operations for the years ended June 30, 2008, 2007 and  2006                          |       | F-4      |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the years ended  June 30, 2008, 2007 and 2006 |       | F-5      |
| Consolidated  Statements of Cash Flows for the years ended June 30, 2008, 2007 and  2006                          |       | F-6      |
| Notes  to Consolidated Financial Statements                                                                            |       | F-7      |

 

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Table of Contents

 

**Report of Independent RegisteredPublic Accounting Firm**

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

 

In our opinion, theaccompanying consolidated balance sheets and the related consolidatedstatements of income, shareholders’ equity and cash flows present fairly, inall material respects, the financial position of Rafaella Apparel Group, Inc.and its subsidiaries (the "Company") at June 30, 2008 and June 30,2007, and the results of their operations and their cash flows for each of thethree years in the period ended June 30, 2008 in conformity with accountingprinciples generally accepted in the United States of America.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.  Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 2 tothe consolidated financial statements, the Company changed the manner in whichit accounts for uncertain tax positions in 2008. The Company adopted theprovisions of FASB Interpretation No. 48, "Accounting for Uncertainty inIncome Taxes - an Interpretation of FASB Statement No. 109" on July 1,2007. As a result of this adoption, the Company recognized an increase in liabilitiesfor uncertain tax positions of $6.3 million with a corresponding increase inthe deferred tax asset of $5.9 million representing the gross unrecognized taxbenefits.  Upon adoption, $0.6 million ofinterest, net of $0.2 million tax benefit, was recorded to retained earnings.

 

PricewaterhouseCoopersLLP

New York, NY

 

September 19, 2008

 

F-2

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Table of Contents

 

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

 
| ** **                                                                                                                                                                               | ** ** | **June 30,  2008** | ** ** | **June 30,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Assets**                                                                                                                                                                               |       |                    |       |                    |       |
| Current assets:                                                                                                                                                                          |       |                    |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                               |       | $                       | 17,131     |                    | $          | 11,390 |   |
| Receivables, net                                                                                                                                                                         |       | 15,286                  |       | 20,785                  |       |
| Inventories                                                                                                                                                                              |       | 33,249                  |       | 44,375                  |       |
| Deferred income  taxes                                                                                                                                                                   |       | 3,578                   |       | 3,510                   |       |
| Other current  assets                                                                                                                                                                    |       | 1,023                   |       | 2,186                   |       |
| Total current  assets                                                                                                                                                                    |       | 70,267                  |       | 82,246                  |       |
| Equipment and  leasehold improvements, net                                                                                                                                               |       | 1,082                   |       | 284                     |       |
| Intangible  assets, net                                                                                                                                                                  |       | 65,314                  |       | 104,154                 |       |
| Deferred  financing costs, net                                                                                                                                                           |       | 4,807                   |       | 7,079                   |       |
| Other assets                                                                                                                                                                             |       | 47                      |       | 41                      |       |
| Deferred income  taxes                                                                                                                                                                   |       | 7,331                   |       |                    |       |
| Total assets                                                                                                                                                                             |       | $                       | 148,848    |                    | $          | 193,804 |   |
|                                                                                                                                                                                     |       |                    |       |                    |       |
| **Liabilities  and Stockholders’ Equity (Deficit)**                                                                                                                                 |       |                    |       |                    |       |
| Current  liabilities:                                                                                                                                                                    |       |                    |       |                    |       |
| Accounts payable                                                                                                                                                                         |       | $                       | 10,549     |                    | $          | 13,886 |   |
| Accrued expenses  and other current liabilities                                                                                                                                          |       | 2,278                   |       | 3,628                   |       |
| Current portion  of senior secured notes                                                                                                                                                 |       | 865                     |       | 234                     |       |
| Total current  liabilities                                                                                                                                                               |       | 13,692                  |       | 17,748                  |       |
| Senior secured  notes                                                                                                                                                                    |       | 119,748                 |       | 133,144                 |       |
| Income taxes                                                                                                                                                                             |       | 7,294                   |       | 9,750                   |       |
| Deferred rent                                                                                                                                                                            |       | 384                     |       | 320                     |       |
| Total liabilities                                                                                                                                                                        |       | 141,118                 |       | 160,962                 |       |
| Commitments and  contingencies                                                                                                                                                           |       |                    |       |                    |       |
| Redeemable  convertible preferred stock—$.01 par value; redemption value $5.33 per share  plus 10% per annum; 7,500,000 shares authorized; 7,500,000 shares issued and  outstanding |       | 52,110                  |       | 48,110                  |       |
| Stockholders’  equity (deficit):                                                                                                                                                    |       |                    |       |                    |       |
| Common  stock—$.01 par value; 11,111,111 shares authorized; 2,500,000 shares issued  and outstanding                                                                                |       | 25                      |       | 25                      |       |
| Additional paid  in capital                                                                                                                                                              |       | 264                     |       | 241                     |       |
| Deemed dividend,  in excess of predecessor basis                                                                                                                                         |       | (26,022                 | )          | (26,022                 | )          |
| Retained  earnings (deficit)                                                                                                                                                             |       | (18,647                 | )          | 10,488                  |       |
| Total  stockholders’ equity (deficit)                                                                                                                                               |       | (44,380                 | )          | (15,268                 | )          |
| Total  liabilities and stockholders’ equity (deficit)                                                                                                                               |       | $                       | 148,848    |                    | $          | 193,804 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

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Table of Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**Consolidated Statements of Operations**

**(Inthousands)**

 
| ** **                                                      | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                            |       |                                         |       |                                         |       |                                         |       |
| Net sales                                                       |       | $                                            | 177,990    |                                         | $          | 191,284                                      |       | $ | 222,187 |   |
| Cost of sales                                                   |       | 129,086                                      |       | 127,170                                      |       | 148,555                                      |       |
| Gross profit                                                    |       | 48,904                                       |       | 64,114                                       |       | 73,632                                       |       |
| Selling, general  and administrative expenses                   |       | 67,017                                       |       | 30,951                                       |       | 29,938                                       |       |
| Operating income  (loss)                                        |       | (18,113                                      | )          | 33,163                                       |       | 43,694                                       |       |
| Interest expense  and other financing, net                      |       | 14,840                                       |       | 23,884                                       |       | 22,631                                       |       |
| Income (loss)  before provision for (benefit from) income taxes |       | (32,953                                      | )          | 9,279                                        |       | 21,063                                       |       |
| Provision for  (benefit from) income taxes                      |       | (8,199                                       | )          | 2,999                                        |       | 8,463                                        |       |
| Net income  (loss)                                              |       | (24,754                                      | )          | 6,280                                        |       | 12,600                                       |       |
| Dividends  accrued on redeemable convertible preferred stock    |       | 4,000                                        |       | 4,000                                        |       | 4,000                                        |       |
| Net income  (loss) available to common stockholders             |       | $                                            | (28,754    | )                                            | $          | 2,280                                        |       | $ | 8,600 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

F-4

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Table of Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

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

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

 
| ** **                                        | ** ** | **Common Stock** | ** ** | **Additional  Paid in** | ** ** | **Deemed  Dividend, in  excess of  predecessor** | ** ** | **Retained  Earnings  (Accumulated** | ** ** | ** **   | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------|------------|--------------|------------|
| ** **                                        | ** ** | **Shares**            | ** ** | **Amount**                   | ** ** | **Capital**                                                | ** ** | **basis**                            | ** ** | **Deficit)** | ** ** | **Total** | ** ** |
| Balance at  June 30, 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 | ) |
| Net loss                                          |       |                  |       |                         |       |                                                       |       |                                 |       | (24,754      | )          | (24,754 | ) |
| Accretion of  preferred stock to redemption value |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| Stock-based  compensation expense                 |       |                  |       |                         |       | 23                                                         |       |                                 |       |         |       | 23 |   |
| Adoption of FIN  48                               |       |                  |       |                         |       |                                                       |       |                                 |       | (381         | )          | (381 | ) |
| Balance at  June 30, 2008                    |       | 2,500,000             |       | $                            | 25         |                                                       | $          | 264                                  |       | $            | (26,022    | ) | $ | (18,647 | ) | $ | (44,380 | ) |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

F-5

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**RafaellaApparel Group, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(Inthousands)**

 
| ** **                                                                                | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                                                      |       |                                         |       |                                         |       |                                         |       |
| Cash flows provided  by operating activities:                                             |       |                                         |       |                                         |       |                                         |       |
| Net income  (loss)                                                                        |       | $                                            | (24,754    | )                                            | $          | 6,280                                        |       | $ | 12,600 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                         |       |                                         |       |                                         |       |
| Amortization of  deferred finance charges                                                 |       | 2,302                                        |       | 3,849                                        |       | 2,087                                        |       |
| Accretion of  original issue discount                                                     |       | 1,040                                        |       | 772                                          |       | 983                                          |       |
| Depreciation and  amortization                                                            |       | 4,504                                        |       | 4,985                                        |       | 5,453                                        |       |
| Stock-based  compensation expense                                                         |       | 23                                           |       | 241                                          |       |                                         |       |
| Income taxes                                                                              |       | (10,236                                      | )          | (2,364                                       | )          | 8,026                                        |       |
| Deferred rent                                                                             |       | 64                                           |       | 191                                          |       | 129                                          |       |
| Gain on senior  secured notes purchases                                                   |       | (3,670                                       | )          |                                         |       |                                         |       |
| Intangible asset  impairment                                                              |       | 34,504                                       |       |                                         |       |                                         |       |
| Changes in  operating assets and liabilities:                                             |       |                                         |       |                                         |       |                                         |       |
| Accounts  receivable                                                                      |       | 5,499                                        |       | 1,725                                        |       | 670                                          |       |
| Inventories                                                                               |       | 11,126                                       |       | 2,679                                        |       | 5,066                                        |       |
| Other current  assets                                                                     |       | 1,163                                        |       | (46                                          | )          | (1,930                                       | )          |
| Accounts payable                                                                          |       | (3,336                                       | )          | (2,440                                       | )          | 2,404                                        |       |
| Accrued expenses  and other current liabilities                                           |       | (1,351                                       | )          | 871                                          |       | 1,277                                        |       |
| Other assets                                                                              |       | (6                                           | )          |                                         |       |                                         |       |
| Net cash  provided by operating activities                                                |       | 16,872                                       |       | 16,743                                       |       | 36,765                                       |       |
| Cash flows used  in investing activities:                                                 |       |                                         |       |                                         |       |                                         |       |
| Purchase of  business, net of cash acquired                                               |       |                                         |       |                                         |       | (188                                         | )          |
| Purchase of  equipment and leasehold improvements                                         |       | (966                                         | )          | (214                                         | )          | (95                                          | )          |
| Net cash used in  investing activities                                                    |       | (966                                         | )          | (214                                         | )          | (283                                         | )          |
| Cash flows (used  in) provided by financing activities:                                   |       |                                         |       |                                         |       |                                         |       |
| Net borrowings  (repayments) on short-term borrowings                                     |       |                                         |       |                                         |       | (9,261                                       | )          |
| Repurchase of  senior secured notes                                                       |       | (10,135                                      | )          | (31,816                                      | )          |                                         |       |
| Deferred  financing costs                                                                 |       | (30                                          | )          |                                         |       |                                         |       |
| Decrease in book  overdraft                                                               |       |                                         |       | (596                                         | )          |                                         |       |
| Net cash (used in)  provided by financing activities                                      |       | (10,165                                      | )          | (32,412                                      | )          | (9,261                                       | )          |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 5,741                                        |       | (15,883                                      | )          | 27,221                                       |       |
| Cash and cash  equivalents, beginning of period                                           |       | 11,390                                       |       | 27,273                                       |       | 52                                           |       |
| Cash and cash  equivalents, end of period                                                 |       | $                                            | 17,131     |                                         | $          | 11,390                                       |       | $ | 27,273 |   |
| Supplemental  disclosures of cash flow information:                                       |       |                                         |       |                                         |       |                                         |       |
| Cash paid during  the period for:                                                         |       |                                         |       |                                         |       |                                         |       |
| Interest                                                                                  |       | $                                            | 15,538     |                                         | $          | 20,104                                       |       | $ | 19,293 |   |
| Income taxes                                                                              |       | 548                                          |       | 7,326                                        |       | 2,511                                        |       |
| Supplemental  disclosures of non-cash financing activities:                               |       |                                         |       |                                         |       |                                         |       |
| Accretion of  preferred stock to redemption value                                         |       | $                                            | 4,000      |                                         | $          | 4,000                                        |       | $ | 4,000 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

F-6

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

 

**1.  Description of Business and Acquisition**

 

Rafaella Apparel Group, Inc., together with itssubsidiaries (the “Company”), is a designer, sourcer and marketer of a fullline of women’s career and casual sportswear separates sold primarily under theRafaella brand and private label brands of our customers.  The Company’s products are sold to departmentand specialty stores and off-price retailers located throughout the UnitedStates of America.

 

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

 

The June 20, 2005 transaction was accounted foras a purchase of the Predecessor’s business in accordance with Statement ofFinancial Accounting Standards No. 141, “Business Combinations,” and theEmerging Issues Task Force Issue No. 88-16, “Basis in Leveraged BuyoutTransactions”.  As the stockholders ofthe Predecessor (“Continuing Stockholders”) retained a 25% interest in theCompany through the Predecessor’s ownership of the common stock, the assets andliabilities of the Company were assigned new values, which are part carryoverbasis (25%) and part fair value basis (75%). The Continuing Stockholders’ residual interest in the Company applied tothe incremental debt resulting from the acquisition was accounted for as adeemed dividend and recognized as a reduction of stockholders’ equity(deficit).

 

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

 

**2.  Significant Accounting Policies**

 

**Basis ofconsolidation**

 

The accompanying consolidated financial statementsinclude the accounts of the Company and its wholly-owned subsidiaries.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

**Use ofestimates**

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Estimates by their nature are based on judgments and availableinformation.  Therefore, actual resultscould differ materially from those estimates under different assumptions andconditions.  The most significantassumptions and estimates involved in preparing the financial statementsinclude, among other things, income taxes, customer allowances for discounts,returns, markdowns, co-op advertising and operational chargebacks, lower ofcost or market estimates related to inventory, and the estimated useful livesand fair values of intangible assets.

 

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**Cash and cash equivalents**

 

Cash and cash equivalents include overnight deposits with banks, whichare unrestricted as to withdrawal or use, and have an original maturity ofthree months or less.  Interest income,included within interest expense, net, and other financing, that was earned onthe Company’s cash and cash equivalents amounted to $310,000, $1,079,000, and$315,000 for the years ended June 30, 2008, 2007 and 2006, respectively.

 

**Receivables**

 

The Company assigns and sells certain of its accounts receivablepursuant to an agreement with a large commercial financial institution (the “factor”)whereby the factor pays the Company after the factor receives payment from theCompany’s customer.  The factor willassume credit risk on all assigned accounts receivable for which it hasprovided written credit approval.  If thereceivable becomes greater than 60 days past due, the full amount of thereceivable is payable by the factor, except for accounts receivable due fromdepartment and chain stores, which are due on the earlier of receipt of paymentfrom the customer or 20 days after the customer becomes bankrupt orinsolvent.  An allowance for salesdiscounts, returns, markdowns, co-op advertising and operational chargebacks isincluded as a reduction to net sales and receivables.  Certain of these provisions result fromseasonal negotiations with customers, as well as historic deduction trends andthe evaluation of current market conditions. The Company also grants credit directly to certain customers in thenormal course of business without participation by the factor.  An allowance for doubtful accounts isdetermined through an analysis of the aging of accounts receivable at the dateof the financial statements, assessments of collectibility based on anevaluation of historic and anticipated trends, the financial condition of theCompany’s customers, and an evaluation of the impact of economicconditions.  The Company’s historicalestimates of these costs have not differed materially from actual results.

 

**Inventories**

 

Inventories are stated at the lower of cost or market, with cost beingdetermined under the FIFO (First-in, First-out) method.  Cost includes amounts paid to purchase piecegoods and manufacture the Company’s products, plus duty, quota, inbound freightand buying commissions.

 

**Long-lived assets**

 

Equipment and leasehold improvements are stated at cost lessaccumulated depreciation and amortization. The Company capitalizes improvements to the extent they increase theeconomic life of the asset.  Furniture,fixtures, and equipment are depreciated using the straight-line method overtheir estimated useful lives of 3 to 10 years.  Leasehold improvements are amortized over theshorter of the remaining lease term or the estimated useful lives of theassets.  Depreciation and amortizationexpense is included in selling, general and administrative expenses.  Expenditures for maintenance and repairs areexpensed in the period incurred.

 

Intangible assets consist of the trademark and trade name, customerrelationships of the Predecessor, and non-compete agreements with officers ofthe Predecessor, acquired on June 20, 2005.  Customer relationships are amortized usingstraight-line and accelerated methods over their estimated useful lives of 7and 15 years, respectively. Non-compete agreements are amortized using the straight-line method overtheir estimated useful lives of 2 and 10 years.  Owned trademarks have been determined to haveindefinite lives and are not subject to amortization.

 

The Company’s policy is to evaluate depreciable and amortizable assetsfor impairment 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 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 been determined to beindefinite lived assets, are tested for impairment at least annually or whenchanges in circumstances indicate that their carrying amount may not berecoverable, by comparing the carrying amount of the assets to their fairvalues based on an income approach using the relief-from-royalty method.  This method assumes that, in lieu ofownership, a firm would be willing to pay a royalty in order to exploit therelated benefits of these assets.  Thisapproach is dependent upon a number of factors, including estimates of futuregrowth and trends, royalty rates for intellectual property, discount rates andother variables.  The Company bases itsfair value estimates on assumptions it believes are reasonable, but which areunpredictable and inherently uncertain. Actual future results may differ from those 

 

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estimates.  Ifthe estimated fair value of the assets is less than their carrying amount, animpairment loss is recognized equal to such difference.

 

**Deferred financing costs**

 

Costs associated with obtaining long-term financing are deferred andamortized, under the effective interest method, over the terms of the relateddebt.  Amortization of these costs isincluded in interest expense.

 

**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 andallowances.  Discounts are based on tradeterms.  Returns and allowances requirepre-approval from management.  On aseasonal basis, the Company negotiates price allowances with its customers assales incentives or for the cost of certain promotions.  These allowances are estimated based onhistoric trends, seasonal results, an evaluation of current economicconditions, and retailer performance.

 

**Cost of sales**

 

Cost of sales includes expenses to acquire and produce goods for sale,including product costs, freight, import costs, third party inspectionactivity, and provisions for shrinkage, excess and obsolete inventory.  Warehousing activities, including receiving,storing, picking, packing and general warehousing costs, are included inselling, general and administrative expenses.

 

**Advertising**

 

The Company records advertising expense as incurred.  Cooperative advertising expenses withoutspecific performance guidelines are reflected as a reduction of net sales andfor the years ended June 30, 2008, 2007 and 2006 were approximately$2,302,000, $1,478,000, and $1,393,000, respectively.  Non cooperative advertising expensesapproximated $225,000 for the year ended June 30, 2008.  Non cooperative advertising for the yearsended June 30, 2007 and 2006 was not significant.

 

**Shipping and handling costs**

 

The Company includes shipping and handling costs associated withinbound freight in cost of sales. Shipping and handling costs associated with outbound freight areincluded in selling, general and administrative expenses and for the yearsended June 30, 2008, 2007 and 2006 amounted to approximately $332,000,$470,000, and $573,000, respectively.

 

**Income taxes**

 

Deferred taxes are provided for the future tax consequencesattributable to differences between the financial statement carrying amounts ofassets and liabilities and their respective tax bases, as measured by enactedtax rates in effect in periods when the deferred tax assets and liabilities areexpected to be settled or realized.  Avaluation allowance is provided on deferred tax assets when it is more likelythan not that such deferred tax asset will not be realized.

 

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

 

**Recent accounting pronouncements**

 

On September 15, 2006, the FASB issued FASB Statement No. 157,“Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles, and expands disclosuresabout fair value measurements.  SFAS 157is effective for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued StaffPositions No. FAS 157-1 and No. FAS 157-2 which delayed the effective

 

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date of SFAS 157 for one year for certain nonfinancial assets and liabilities and removed certain leasing transactions fromits scope.  The Company is currentlyanalyzing SFAS 157 and its impact on the Company’s financial condition andresults of operations.

 

In April 2008, the FASB issued FASB Staff Position No. (“FSP”)FAS 142-3, “Determination of the Useful Life of Intangible Assets.”  This FSP amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under FASB Statement No. 142,“Goodwill and Other Intangible Assets” (“SFAS No. 142”).  The intent of this FSP is to improve theconsistency between the useful life of a recognized intangible asset under SFASNo. 142 and the period of expected cash flows used to measure the fairvalue of the asset under SFAS No. 141(R), “Business Combinations” andother U.S. generally accepted accounting principles.  This FSP is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those fiscal years. The Company is currently evaluating the impact of this FSP, if any, onits results of operations and financial position.

 

**3. Stock-based compensation**

 

The Rafaella Apparel Group, Inc. Equity Incentive Plan (the “Plan”)provides for the issuance of stock option and restricted stock-basedcompensation awards to senior management, other key employees, and consultantsto the Company.  The Company has reserved1,111,111 shares of common stock for issuance pursuant to the terms of thePlan.  While the terms of individualawards may vary, employee stock options granted to-date vest in annualincrements of 25% over the first four years of the grant, expire no later thanten years after the grant date, and have an exercise price of $5.33 per share.

 

Under the Plan, unvested awards become immediately vested upon theoccurrence of a Liquidity Event.  ALiquidity Event, as defined in the Plan, is (i) a change in control, (ii) thesale, transfer or other disposition of all or substantially all of the businessand assets, (iii) the consummation of an initial public offering, or (iv) thedissolution or liquidation of the Company. Common stock acquired through the exercise of stock option grants or vestingof restricted stock issued under the Plan may not be sold, disposed of orotherwise transferred by a participant of the Plan prior to a Liquidity Eventwithout the consent of Cerberus Capital Management, L.P. (“Cerberus”),shareholder of the Company.

 

Under the Plan, prior to a Liquidity Event, the Company has the right,but not the obligation, to purchase from a participant and to cause theparticipant to sell to the Company, common stock acquired through the exerciseof stock option grants or vesting of restricted stock issued following theparticipant’s (i) death, (ii) termination of employment with theCompany as a result of disability, (iii) termination of employment by theCompany without cause, (iv) termination of employment by the Company forcause, or (v) termination of employment with the Company for any otherreason.  The purchase price for sharesunder clauses (i), (ii), or (iii) above is the greater of (a) thepurchase price paid for such shares by the participant and (b) the fairmarket value of such shares.  Thepurchase price for shares under clauses (iv) and (v) above is thelesser of (a) the purchase price, if any, paid for such shares by theparticipant, or if no price was paid, one dollar ($1.00) and (b) 50% ofthe fair market value of such shares.  Ifat any time after an initial public offering, a participant’s employment orrelationship is terminated for cause, the Company has the right, but not theobligation, to purchase from the participant and to cause the participant tosell to the Company, all common stock acquired through the exercise of stockoption grants or vesting of restricted stock issued for the same purchase priceas that 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.

 

Effective July 1, 2006, the Company adopted SFAS No. 123R, “Share-BasedPayments” (“SFAS 123R”), which revises SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”). SFAS 123R is supplemented by the SEC Staff’s views regarding theinteraction between SFAS 123R and certain SEC rules and regulationsincluding the valuation of share-based payment arrangements.  The Company has followed the prospectivemethod of transition; accordingly, prior periods have not been retroactivelyadjusted.  Prior to adopting SFAS 123R,the Company applied the recognition and measurement principles of SFAS 123using the minimum value method. 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 wasno effect from the change of applying the original provisions of SFAS 123 tothe Company’s results of operations and cash flows for the year ended June 30,2007, as a result of the Company’s adoption of SFAS 123R, effective July 1,2006.

 

Under SFAS 123R, the Company is required to select a valuationtechnique or option-pricing model that meets the criteria as stated in thestandard.  The Company has continued touse the Black-Scholes model, the option-pricing model used 

 

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under SFAS 123 and permissible under SFAS 123R, whichrequires the input of subjective assumptions. These assumptions include estimating the length of time participantswill retain their vested stock options before exercising them and the estimatedvolatility of the Company’s common stock price over the expected term.  Under SFAS 123, the Company accounted foremployee stock option awards using the minimum value method, which excludesvolatility in determining the fair value of a stock option under theBlack-Scholes option-pricing model. However, for stock option awards granted to a consultant, pursuant to anagreement entered into in April 2006, the Company used volatilityassumptions based on the average volatilities of other public entitiesdetermined to be similar to the Company. The Company, in determining those entities, considered characteristicssuch as industry, stage of life cycle, size, and financial leverage.  As a result of the Company’ adoption of SFAS123R, the Company is no longer permitted to use the minimum value method.  Effective July 1, 2006, the Companyutilizes the Black-Scholes option-pricing model with volatility assumptionsdeveloped similarly to those used to value the stock options granted to theconsultant.  Changes in the subjectiveassumptions can materially affect the estimate of fair value of stock-basedcompensation and, consequently, the related amount recognized in theconsolidated statement of operations.

 

At June 30, 2006, 916,666 stock options were outstanding pursuantto formal stock option grants or committed pursuant to contractual obligationsof the Company.  During October 2006,the Company formally granted 777,777 stock options, which included 666,666stock options the Company was committed to issue pursuant to contractualobligations at June 30, 2006 and an additional 111,111 stock optionspursuant to an employment agreement for which service commenced in August 2006.  Other than the August 2006 stock optionaward and a grant of 83,334 stock options in May 2007, there were no otherstock option grants, exercises or forfeitures during the years ended June 30,2008 and 2007.  Accordingly, at June 30,2008, options to purchase a total of 1,111,111 shares of common stock of theCompany at $5.33 per share were outstanding. At June 30, 2008, 652,778 options were vested and exercisable.  Of the outstanding and unvested options,250,000 vest within the next year and 208,333 vest within the next threeyears.  The stock options have a weightedaverage exercise price of $5.33 per share and a weighted average remainingcontractual life of 8.0 years.

 

Each of the individuals who were formally granted stock option awardsduring October 2006 entered into contractual agreements with the Company,which included stock option grants under the provisions of the Company’sPlan.  As a mutual understanding of theterms of the awards existed and there was no performance criteria necessary toreceive the grants other than to enter into such contractual agreements withthe Company, grant dates were determined based upon the effective date of eachof the respective agreements. Accordingly, except for the August 2006 and May 2007 stockoption awards, the Company has accounted for each of the stock option awardsgranted during the year ended June 30, 2006 in accordance with SFAS123.  The August 2006 and May 2007stock option awards were accounted for as grants during the year ended June 30,2007 under SFAS 123R.  As of June 30,2008, common stock that could be acquired through the exercise of 555,556 stockoptions are subject to the call right provisions described above.  Subsequent to a Liquidity Event, the callright provisions lapse, except for employees terminated for cause.  As a result of the call right provisions, thestock option awards do not substantively vest prior to the occurrence of aLiquidity Event.  Accordingly,stock-based compensation expense will not be recognized until it is probablethat a Liquidity Event will occur.  As ofJune 30, 2008, it was not probable that a Liquidity Event will occur.  Unrecognized compensation costs related tothese options approximated $379,000 at June 30, 2008.

 

The Company recorded compensation expense related to 555,555 stockoptions, not subject to the call right provisions described above, ofapproximately $23,000 and $241,000 during the years ended June 30, 2008and 2007, respectively.  As of June 30,2008, there was an additional $43,000 of unrecognized compensation cost relatedto these options, which will be recognized ratably as compensation expense overa weighted average vesting period of 1.8 years.

 

The following assumptions were used to estimate the fair value of thestock options granted under the Black-Scholes option-pricing model under SFAS123 and SFAS 123R:

 
| ** **                                      | ** ** | **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                    |

 

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The Company is obligated to pay certain cash payments equal to three andfive-tenths percent (3.5%) of the Appreciated Value of the Company inconnection with Sale Transactions and three and five-tenths percent (3.5%) ofthe Net Dividends paid other than in connection with a Sale Transaction (eachterm as defined) in connection with two separate agreements entered into amongthe Company and an employee and a member of the Company’s board of directorsduring the year ended June 30, 2008. As the cash payments are contingent in nature, compensation expense willnot be recognized until it is probable that such payments will occur.  As of June 30, 2008, it was not probablethat a Sale Transaction or a Net Dividend payment will occur.

 

**4. Receivables**

 

Receivables consist of (in thousands):

 
| ** **                                                  | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
|                                                        |       |                   |       |                   |       |
| Due from factor                                             |       | $                      | 12,732     |                   | $          | 14,562 |   |
| Trade  receivables                                          |       | 10,000                 |       | 13,141                 |       |
|                                                        |       | 22,732                 |       | 27,703                 |       |
| Less: Allowances  for sales returns, discounts, and credits |       | (7,446                 | )          | (6,918                 | )          |
|                                                        |       | $                      | 15,286     |                   | $          | 20,785 |   |

 

For the years ended June 30, 2008, 2007 and 2006, the provisionfor sales returns, discounts and credits charged to earnings was $34,364,000,$35,141,000 and $32,985,000, respectively, and decreased by authorizeddeductions taken by customers of $33,836,000, $35,830,000 and $25,378,000,respectively.

 

**5. Inventories**

 

Inventories are summarized as follows (in thousands):

 
| ** **                         | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|------------------------------------|------------|------------------------|------------|------------------------|------------|
|                               |       |                   |       |                   |       |
| Piece goods  (held by contractors) |       | $                      | 1,544      |                   | $          | 9,139 |   |
| Finished goods:                    |       |                   |       |                   |       |
| In warehouse                       |       | 20,170                 |       | 27,936                 |       |
| In transit                         |       | 11,535                 |       | 7,300                  |       |
|                               |       | $                      | 33,249     |                   | $          | 44,375 |   |

 

**6. Equipment and Leasehold Improvements**

 

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

 
| ** **                                       | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                             |       |                        |       |                        |       |
| Furniture,  fixtures and equipment               |       | $                           | 1,136      |                        | $          | 327 |   |
| Leasehold  improvements                          |       | 239                         |       | 82                          |       |
|                                             |       | 1,375                       |       | 409                         |       |
| Less:  Accumulated depreciation and amortization |       | (293                        | )          | (125                        | )          |
|                                             |       | $                           | 1,082      |                        | $          | 284 |   |

 

Depreciation and amortization expense of equipment and leaseholdimprovements for the years ended June 30, 2008, 2007 and 2006 were approximately$168,000, $45,000 and $77,000, respectively.

 

**7. Intangible Assets**

 

Intangible assets resulting from the June 20, 2005 acquisition,consist of the following as of June 30, 2008 and 2007 (in thousands):

 

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| ** **                      | ** ** | **Estimated  Lives** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Customer  relationships         |       | 7, 15 years          |       | $        | 43,525     |     | $          | 43,525 |   |
| Less:  Accumulated amortization |       |                 |       | (13,406  | )          | (9,326   | )          |
|                            |       |                 |       | 30,119   |       | 34,199   |       |
|                            |       |                 |       |     |       |     |       |
| Non-compete  agreements         |       | 2, 10 years          |       | 3,067    |       | 3,067    |       |
| Less:  Accumulated amortization |       |                 |       | (1,269   | )          | (1,013   | )          |
|                            |       |                 |       | 1,798    |       | 2,054    |       |
|                            |       |                 |       |     |       |     |       |
| Trademark and  trade name       |       | Indefinite life      |       | 33,397   |       | 67,901   |       |
| Total intangible  assets        |       |                 |       | $        | 65,314     |     | $          | 104,154 |   |

 

The Company’s indefinite-lived intangible assets consist of theRafaella trademark and trade name, as the Company believes these assets willcontribute to cash flows indefinitely. These assets have been in existence since the Company’s inception 25years ago, and there is no foreseeable limit on the period of time over whichthey are expected to contribute to cash flows. In accordance with SFAS No. 142, the Company’s trademark and tradename are reviewed at least annually for impairment.  The Company performed its annual impairmenttest of the trademark and trade name during the fourth quarter of the fiscalyear ended June 30, 2008 and determined that the trademark and trade namewas impaired necessitating a charge of $34.5 million.  The impairment was due to decreased sales andcash flows attributable to the Rafaella brand as a result of reduced forecastsfor future years given the current state of the US apparel retail environment.  The impairment charge of $34.5 million is reflectedwithin selling, general and administrative expenses for the year ended June 30,2008.  There were no impairments orimpairment indicators present and no impairment loss was recorded during thefiscal years ended June 30, 2007 and 2006. The amortization expense related to intangible assets for the yearsended June 30, 2008, 2007 and 2006 was approximately $4,336,000,$4,940,000, and $5,376,000, respectively.

 

Estimated amortization expense for the next five yearsis as follows:

 
| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2009       |       | $                       | 4,209      |   |
| 2010       |       | 3,934                   |       |
| 2011       |       | 3,661                   |       |
| 2012       |       | 3,401                   |       |
| 2013       |       | 2,874                   |       |
|            |            |                         |            |  |

 

**8. Short-term Borrowings**

 

Effective June 20, 2005, the Company entered into a revolvingcredit facility with HSBC Bank USA, National Association (“HSBC”).  The credit facility provides the Company witha revolving line of credit, which can be used for loans and letters of creditof up to $62,500,000, with a sublimit for loans of $45,000,000.  Under the credit facility, the aggregatecredit available to the Company is equal to specified percentages of eligiblereceivables and inventory, plus letters of credit issued for finished goods,subject to adjustment by HSBC. 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 facilityprovides for a monthly commitment fee of 0.25% on the unused portion of theavailable credit under the credit facility. At June 30, 2008, there were no loans and $16.9 million of lettersof credit outstanding under the credit facility.  The Company had credit availability ofapproximately $9.6 million.

 

Pursuant to the credit agreement, the Company remits funds from thecollection of receivables to pay down borrowings outstanding under therevolving credit facility.  Under theCompany’s factoring agreement, the Company directs its customers to remitpayments on accounts receivable to GMAC, its factor.  At the request of HSBC, the Company hasdirected GMAC to remit the funds from the collection of receivables directly toan HSBC account to reduce borrowings outstanding under the revolving creditfacility.  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 in connection withthese arrangements are reflected in 

 

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operating cash flows as collections of receivables.  Funds remitted under this arrangement toreduce short-term borrowings are reflected as cash flows used in financingactivities in the statement of cash flows.

 

Loan borrowings and repayments under the revolving credit facility were$12.8 million and $12.8 million, respectively, during the year ended June 30,2008.  There were no loan borrowings orrepayments under the revolving credit facility during the year ended June 30,2007.  Total loan borrowings andrepayments under the revolving credit facility amounted to $64,891,000 and$74,152,000, respectively, during the year ended June 30, 2006.

 

The credit facility is collateralized by substantially all of theassets of the Company and expires on June 20, 2010.  The credit agreement contains various covenantsthat, among others, require the Company to maintain a minimum level of workingcapital, report net income on a rolling six month period for the periods ended September 30,December 31, March 31 and June 30 and places limitations ondividends and repurchases of capital stock, investments, asset sales andincurrence of additional indebtedness.  Adefault on the senior secured notes will trigger a default under thisarrangement.

 

During the quarter ended March 31, 2008, the Company amended itscredit facility, whereby for the rolling six month period ended March 31,2008, the Company was permitted to incur a net loss of up to $2,000,000.  The Company was in compliance with itsrevised financial covenants as of March 31, 2008; however, the Company’sforecasts indicated that there was the likelihood that the Company would not bein compliance with its future net income financial covenant and, accordingly,the Company sought to further amend the covenant.  Subsequent to March 31, 2008, theCompany amended the credit facility net income financial covenant.  For purposes of determining compliance withthe net income financial covenant, effective with the quarter ending June 30,2008, the definition of net income was amended to exclude noncash expensesassociated with (i) amortization of customer relationships and non-competeagreements, (ii) the accretion of the senior secured notes original issuediscount, (iii) amortization of deferred financing costs, and (iv) impairmentcharges, if any, resulting from a decline in the value of the Company’sintangible assets; the aggregate maximum amount of the noncash exclusions, inany one quarter, may not exceed $2,500,000 commencing with the fiscal quartersending on or after September 30, 2008.

 

As of June 30, 2008, the Company was in compliance with thefinancial covenants included in the credit facility.  The Company’s forecasts indicate that theCompany will be in compliance with its future financial covenants under thecredit facility.  However, due to theinherent uncertainties in making estimates and assumptions, there can be noassurance that the Company will satisfy either of its financial covenants infuture periods.  A violation of thefinancial covenants constitutes an event of default under the creditfacility.  An event of default couldresult in all debt becoming due and payable, and HSBC having the right toterminate the credit facility and its obligation to make advances under it.

 

**9. Senior Secured Notes**

 

On June 20, 2005, the Company received aggregate proceeds of$163,400,000 from the issuance of 11.25% senior secured notes, face value$172,000,000.  The notes were issued at95% of face value, resulting in an original issue discount of $8,600,000 thatis being amortized under the effective interest method over the term of thenotes.  Senior secured notes principalamount outstanding at June 30, 2008 and 2007 is $124,261,000 and$138,509,000, respectively.  At June 30,2008 and 2007, the unamortized original issue discount is $3,648,000 and$5,131,000, respectively.  The notes bearcash interest at 11.25%.  After givingeffect to the original issue discount and costs associated with the issuance,the notes have an effective interest rate of approximately 13.7%.  The notes mature on June 15, 2011 andcash interest is payable semiannually on June 15 and December 15 ofeach year, commencing December 15, 2005. The notes are collateralized by a second priority lien on substantiallyall of the assets of the Company.  Thenotes are subordinated to amounts outstanding under the revolving creditfacility.

 

Within 100 days after the end of each fiscal year, beginning with thefiscal year ended on June 30, 2006, the Company must make an offer torepurchase all or a portion of the notes at 101% of their principal amount atmaturity plus accrued and unpaid interest to the date of purchase, with 50% ofexcess cash flow, as defined, from the previous fiscal year.  Senior secured note aggregate principalamounts of $221,000 and $17,429,000 were repurchased during November 2007 and2006, respectively, in connection with excess cash flow offers made by theCompany.  The November 2007 and 2006repurchases of the notes, which were at 101% of their principal amount atmaturity plus accrued and unpaid interest to the date of purchase, approximated$234,000 and $18.4 million, respectively. The Company wrote-off $1.7 million of unamortized original issuediscount and deferred financing costs to interest expense in connection withthe November 2006 repurchase. Unamortized original issue discount and deferred financing costsassociated with the November 2007 repurchase were not significant.

 

F-14

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Tableof Contents

 

The Company currently estimates that the annual excesscash flow payment with respect to the fiscal year ended June 30, 2008,payable in November 2008, will be approximately $939,000, and hasclassified the current portion of senior secured notes as current within theconsolidated balance sheet as of June 30, 2008.

 

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

 

The Company purchased, at a discount, $6,000,000 and$8,027,000 of outstanding senior secured notes on the open market in January 2008and June 2008, respectively.  A pre-taxgain of approximately $3.1 million, resulting from the difference between thecarrying book value of the senior secured notes and the amount paid, net ofdeferred financing costs that were written-off at the time of purchase, wasrecorded to interest expense during the year ended June 30, 2008.

 

In August 2008, the Company purchased, at adiscount, $28.5 million of outstanding senior secured notes on the openmarket.  A pre-tax gain of approximately$17.6 million, resulting from the difference between the carrying book value ofthe senior secured notes and the amount paid, net of deferred financing coststhat were written-off at the time of purchase, will be recorded in the quarterending September 30, 2008.

 

The senior secured notes indenture contains certaincovenants, including limitations on dividends and repurchases of capital stock,investments, asset sales and additional indebtedness.  In addition, a default on the revolvingcredit facility will trigger a default with respect to the senior securednotes.

 

**10.  Redeemable Convertible Preferred Stock**

 

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

 

The Preferred Stock is redeemable at the option of theholder upon the earlier of (i) a change in control of the Company, asdefined in the certificate of incorporation, (ii) June 20, 2010, ifno principal amounts of the senior secured notes are outstanding, and (iii) December 20,2011, if principal amounts of the senior secured notes are outstanding.  The Preferred Stock is redeemable at itsoriginal purchase price, plus a return of 10% per annum, which is beingaccreted through a charge to retained earnings. Since the redemption of the Preferred Stock is outside the control ofthe Company, the Preferred Stock is classified outside of stockholders’ equity(deficit) on the consolidated balance sheets. For each of the years ended June 30, 2008, 2007 and 2006, theCompany accreted $4,000,000 towards the Preferred Stock.

 

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

 

**11.  Income Taxes**

 

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

 
| ** **       | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** |
|------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **       | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** |
| Current:         |       |                                         |       |                                         |       |                                         |       |
| Federal          |       | $                                            | 1,714      |                                         | $          | 5,106                                        |       | $ | 181 |   |
| State  and local |       | 322                                          |       | 257                                          |       | 255                                          |       |
|             |       | 2,036                                        |       | 5,363                                        |       | 436                                          |       |
| Deferred:        |       |                                         |       |                                         |       |                                         |       |
| Federal          |       | (9,462                                       | )          | (1,939                                       | )          | 7,113                                        |       |
| State  and local |       | (773                                         | )          | (425                                         | )          | 914                                          |       |
|             |       | (10,235                                      | )          | (2,364                                       | )          | 8,027                                        |       |
|             |       | $                                            | (8,199     | )                                            | $          | 2,999                                        |       | $ | 8,463 |   |

 

F-15

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Tableof Contents

 

The effective income taxrate differs from the statutory income tax rate as follows:

 
| ** **                                            | ** ** | **Year Ended  June 30, 2008** | ** ** | **Year Ended  June 30, 2007** | ** ** | **Year Ended  June 30, 2006** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                            | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** |
| Statutory  federal income tax rate                    |       | (34.0                                        | )%         | 34.0                                         | %          | 35.0                                         | %          |
| State  and local income taxes, net of federal benefit |       | (3.5                                         | )          | (1.7                                         | )          | 5.2                                          |       |
| Valuation  allowance                                  |       | 11.2                                         |       |                                         |       |                                         |       |
| FIN  48 interest and liabilities                      |       | 1.4                                          |       |                                         |       |                                         |       |
| Effective  tax rate                                   |       | (24.9                                        | )%         | 32.3                                         | %          | 40.2                                         | %          |

 

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

 

The components of deferred taxes as of June 30,2008 and 2007, relating primarily to temporary differences arising as a resultof the acquisition, are as follows (in thousands):

 
| ** **                                  | ** ** | **June 30,  2008** | ** ** | **June 30,  2007** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| Deferred  tax assets:                       |       |                    |       |                    |       |
| Accounts  receivable                        |       | $                       | 192        |                    | $          |   |   |
| Inventories                                 |       | 3,052                   |       | 2,561                   |       |
| Accrued  expenses and other liabilities     |       | 484                     |       | 1,093                   |       |
| Interest                                    |       | 493                     |       |                    |       |
| Deferred  financing costs and other assets  |       | 426                     |       | 427                     |       |
| Intangible  assets                          |       | 10,460                  |       |                    |       |
| Stock-based  compensation                   |       | 105                     |       | 93                      |       |
| Other                                       |       | 70                      |       |                    |       |
| Total  deferred tax assets                  |       | 15,282                  |       | 4,174                   |       |
| Valuation  allowance on deferred tax assets |       | (4,300                  | )          |                    |       |
| Deferred  tax liabilities:                  |       |                    |       |                    |       |
| Intangible  assets                          |       |                    |       | (10,372                 | )          |
| Accounts  receivable                        |       |                    |       | (21                     | )          |
| Depreciation                                |       | (73                     | )          | (21                     | )          |
| Total  deferred tax liabilities             |       | (73                     | )          | (10,414                 | )          |
| Net  deferred taxes                         |       | $                       | 10,909     |                    | $          | (6,240 | ) |
|                                             |            |                         |            |                         |            |  |  |  |

 

During the year ended June 30,2008, the Company established a valuation allowance of $4.3 million for thedeferred tax asset that resulted from the Rafaella trademark and trade nameintangible asset impairment (note 7). The underlying tax basis of the trademark and trade name is capital innature.  The asset would generate acapital loss for income tax purposes, which can only be used to offset capitalgain income.  The Company determined thatthe deferred tax asset is not more likely than not to be realized as there areno actual or projected capital gains available to offset any future capitallosses that might be generated from the Rafaella trademark and trade namedeferred tax asset.  During the yearsended June 30, 2007 and 2006, the Company used $101,000 and $9,037,000 offederal net operating loss carryforwards, respectively.  State net operating loss carryforwards of$6,233,000 were used during the year ended June 30, 2007.  As of June 30, 2008 and 2007, there wereno operating loss carryforwards.

 

The Company recognizesinterest expense related to unrecognized tax benefits in income taxexpense.  As of June 30, 2008,accrued interest approximated $1.2 million. For the year ended June 30, 2008, interest expense related tounrecognized tax benefits recorded in income tax expense approximated $0.3million.

 

A reconciliation of thebeginning and ending amount of unrecognized tax benefits for the year ended June 30,2008 is as follows:

 

F-16

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Tableof Contents

 
| **FIN 48 Tabular Reconciliation**       | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| Gross  unrecognized tax benefits at July 1, 2007  |       | $                       | 5,893      |   |
| Gross  increases/decreases - prior period positions    |       | 198                     |       |
| Gross  unrecognized tax benefits at June 30, 2008 |       | $                       | 6,091      |   |

 

As of June 30, 2008,the Company had approximately $0.2 million of unrecognized tax benefits that,if recognized, would affect the effective tax rate.

 

The Company remainssubject to federal, state and local income tax examinations by tax authoritiesfor tax years ending subsequent to June 20, 2005, the acquisition date.  The Internal Revenue Service is currentlyauditing the Company’s 2006 federal income tax return.  In addition, the 2006 and 2005 tax years fora state and local tax jurisdiction is currently being audited.  To date, no significant adjustments have beenproposed as a result of these audits.  Atthis time, it is not reasonably possible to estimate the impact of theresolution of these audits on the Company’s financial statements.  The Company does not believe it is reasonablypossible the unrecognized tax benefits will significantly increase or decreasewithin the next twelve months.

 

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

** **

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

 

Receivables arise in the normal course ofbusiness.  Management minimizes itscredit risk with respect to trade receivables sold to its factor.  For trade receivables not factored, managementmonitors the creditworthiness of such customers and reviews the outstandingreceivables at period end, as well as uncollected account experience andestablishes an allowance for doubtful accounts as deemed necessary.  Bad debt expense approximated $0.6 millionfor the year ended June 30, 2008. Bad debt expense was not significant for any of the other periodspresented.

 

For the year ended June 30, 2008, sales to threecustomers approximated $37.3 million, $35.9 million, and $32.4 million of the Company’sconsolidated net sales.  For the yearended June 30, 2007, sales to three customers approximated$41.2 million, $40.8 million, and $21.8 million of the Company’sconsolidated net sales.  For the yearended June 30, 2006, sales to three customers approximated$69.2 million, $38.5 million, and $29.9 million of the Company’sconsolidated net sales.  Accountsreceivable, net of allowances, from four customers approximated $3.0 million,$2.8 million, $2.5 million, and $1.7 million at June 30, 2008.  Accounts receivable, net of allowances, fromfour customers approximated $3.6 million, $2.9 million,$2.8 million, and $2.3 million at June 30, 2007.

 

**13.  Commitments and Contingencies**

** **

The Company, from time to time, is party to variouslegal proceedings.  While management,including external counsel, currently believes that the ultimate outcome ofthese proceedings, individually and in the aggregate, will not have a materialadverse impact on our financial position or results of operations, litigationis subject to inherent uncertainties.

 

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

 
| **Years ending June 30,** | ** ** | **(in thousands)** | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| 2009                                     |       | $                       | 2,132      |   |
| 2010                                     |       | 2,226                   |       |
| 2011                                     |       | 1,809                   |       |
| 2012                                     |       | 1,392                   |       |
| 2013                                     |       | 821                     |       |
| Thereafter                               |       | —                  |       |
|                                     |       | $                       | 8,380      |   |

 

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Tableof Contents

 

Rent expense for the years ended June 30, 2008,2007 and 2006 was approximately $2,188,000, $1,915,000, and $1,895,000, respectively.

 

The Company was contingently liable for open lettersof credit of approximately $16.9 million and $18.1 million as of June 30,2008 and 2007, respectively.

 

**14.  Retirement Plan**

 

The Company has a defined contribution retirement planwhich covers all employees and provides for eligible employees to make electivecontributions of up to 15% of their salary. Company matching contributions to the plan for the years ended June 30,2008, 2007 and 2006, were approximately $198,000, $181,000, and $166,000,respectively.

 

**15.  Fair Value of Financial Instruments**

** **

The fair value of cash and cash equivalents,receivables and accounts payable approximate their carrying value due to theirshort-term maturities.  At June 30,2008 and 2007, the fair value of the senior secured notes, determined basedupon quoted market prices, was approximately $73,159,000 and $139,894,000,respectively.

 

**16.  Accrued Expenses and Other CurrentLiabilities**

** **

Accrued expenses andother current liabilities consist of (in thousands):

 
| ** **                         | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Accrued  interest expense          |       | $                           | 621        |                        | $          | 693 |   |
| Accrued  compensation and benefits |       | 1,152                       |       | 2,676                       |       |
| Other  accrued liabilities         |       | 505                         |       | 259                         |       |
|                               |       | $                           | 2,278      |                        | $          | 3,628 |   |

 

**17.  Quarterly Financial Data (unaudited) (inthousands)**

 
| ** **         | ** ** | **Quarter ended**        | ** ** |
|--------------------|------------|-------------------------------|------------|
| ** **         | ** ** | **June 30,  2008(1)(3)** | ** ** | **March 31,  2008(1)** | ** ** | **December 31,  2007** | ** ** | **September 30,  2007** | ** ** |
| ** **         | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  sales         |       | $                             | 41,621     |   | $ | 46,394 |   | $ | 42,563 |   | $ | 47,412 |   |
| Gross  profit      |       | 10,652                        |       | 12,960 |   | 9,266 |   | 16,026 |   |
| Net  income (loss) |       | (26,212                       | )          | 995 |   | (1,899 | ) | 2,362 |   |
|               |       |                          |       |   |   |   |   |   |   |
| ** **         | ** ** | **Quarter ended**        | ** ** |
| ** **         | ** ** | **June 30,  2007(2)**    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006(2)** | ** ** | **September 30,  2006** | ** ** |
| ** **         | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  sales         |       | $                             | 46,053     |   | $ | 45,633 |   | $ | 42,779 |   | $ | 56,819 |   |
| Gross  profit      |       | 13,541                        |       | 15,817 |   | 12,321 |   | 22,435 |   |
| Net  income (loss) |       | 268                           |       | 1,641 |   | (1,180 | ) | 5,551 |   |

 

----

(1)    TheCompany recorded gains of approximately $1.7 million and $0.4 million, net oftax, in connection with the January 2008 and June 2008 senior securednote purchases (described in Note 9) during the quarterly periods ended June 30,2008 and March 31, 2008, respectively.

 

(2)    TheCompany wrote-off $0.8 million and $1.0 million of unamortized original issuediscount and deferred financing costs, net of income taxes, in connection withthe senior secured note repurchases (described in Note 9) during thequarterly periods ended June 30, 2007 and December 31, 2006,respectively.

 

(3)    TheCompany recorded an impairment charge of $34.5 million during the quarter endedJune 30, 2008 related to the decline in the fair value of the Rafaellatrademark and trade name intangible asset. The impairment charge is reflected within selling, general andadministrative expenses.

 

F-18

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Tableof Contents

 

**18.  Consolidating Financial Statements**

 

In June 2005, the Company issued 11.25% SeniorSecured Notes that are fully, unconditionally, jointly and severally guaranteedon a senior secured basis by Verrazano, Inc. (“Verrazano”), a wholly-ownedsubsidiary of the Company.  Verrazano wasformed in 2004 and commenced operations in 2005.  The following condensed consolidatingfinancial information as of June 30, 2008 and 2007, and for the yearsended June 30, 2008, 2007 and 2006 is provided in lieu of separatefinancial statements for the Company and Verrazano.

 

F-19

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Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Balance Sheet**

**Asof June 30, 2008**

**(Inthousands)**

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

 

F-20

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Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Balance Sheet**

**Asof June 30, 2007**

**(Inthousands)**

 
| ** **                                                 | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                 | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| **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 subsidiaries                                |       | 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    |       |
| 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-21

----

Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Operations**

**Yearended June 30, 2008**

**(Inthousands)**

 
| ** **                                                      | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net sales                                                       |       | $                                | 145,561    |          | $          | 32,429                                               |       |       |       | $ | 177,990 |   |
| Cost of sales                                                   |       | 105,034                          |       | 23,977        |       | $                                                    | 75         |       | 129,086    |   |
| Gross profit                                                    |       | 40,527                           |       | 8,452         |       | (75                                                  | )          | 48,904     |       |
| Selling, general  and administrative expenses                   |       | 63,563                           |       | 3,433         |       | 21                                                   |       | 67,017     |       |
| Operating income  (loss)                                        |       | (23,036                          | )          | 5,019         |       | (96                                                  | )          | (18,113    | )          |
| Interest expense  and other financing, net                      |       | 14,840                           |       |          |       |                                                 |       | 14,840     |       |
| Income (loss)  before provision for (benefit from) income taxes |       | (37,876                          | )          | 5,019         |       | (96                                                  | )          | (32,953    | )          |
| Provision for  (benefit from) income taxes                      |       | (10,013                          | )          | 1,814         |       |                                                 |       | (8,199     | )          |
| Equity in  earnings of subsidiaries                             |       | 3,109                            |       |          |       | (3,109                                               | )          |       |       |
| Net income  (loss)                                              |       | $                                | (24,754    | )             | $          | 3,205                                                |       | $          | (3,205     | ) | $ | (24,754 | ) |

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Operations**

**Yearended June 30, 2007**

**(Inthousands)**

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

 

F-22

----

Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Operations**

**Yearended June 30, 2006**

**(Inthousands)**

 
| ** **                                    | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                    | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| 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  and other financing, 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 subsidiaries           |       | (4,307                           | )          |          |       | $                                                    | 4,307      |       |       |   |
| Net income                                    |       | $                                | 12,600     |          | $          | 4,307                                                |       | $          | (4,307     | ) | $ | 12,600 |   |

 

F-23

----

Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Cash Flows**

**Yearended June 30, 2008**

**(Inthousands)**

 
| ** **                                                                                           | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Non-  guarantor  Subsidiary  and  Eliminations** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                                                                                           | ** ** | ** **                   | ** ** | ** **    | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Cash flows  provided by (used in) operating activities:                                              |       |                         |       |          |       |                                               |       |       |       |
| Net income  (loss)                                                                                   |       | $                            | (24,754    | )             | $          | 3,205                                              |       | $          | (3,205     | ) | $ | (24,754 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                         |       |          |       |                                               |       |       |       |
| Amortization of  deferred finance charges                                                            |       | 2,302                        |       |          |       |                                               |       | 2,302      |       |
| Accretion of  original issue discount                                                                |       | 1,040                        |       |          |       |                                               |       | 1,040      |       |
| Depreciation and  amortization                                                                       |       | 4,173                        |       | 331           |       |                                               |       | 4,504      |       |
| Equity in  earnings of subsidiaries                                                                  |       | (3,109                       | )          |          |       | 3,109                                              |       |       |       |
| Stock-based  compensation expense                                                                    |       | 23                           |       |          |       |                                               |       | 23         |       |
| Income taxes                                                                                         |       | (10,121                      | )          | (115          | )          |                                               |       | (10,236    | )          |
| Deferred rent                                                                                        |       | 64                           |       |          |       |                                               |       | 64         |       |
| Gain on senior  secured notes purchases                                                              |       | (3,670                       | )          |          |       |                                               |       | (3,670     | )          |
| Intangible asset  impairment                                                                         |       | 34,504                       |       |          |       |                                               |       | 34,504     |       |
| Changes in  operating assets and liabilities:                                                        |       |                         |       |          |       |                                               |       |       |       |
| Accounts  receivable                                                                                 |       | 3,497                        |       | 2,002         |       |                                               |       | 5,499      |       |
| Inventories                                                                                          |       | 7,545                        |       | 3,581         |       |                                               |       | 11,126     |       |
| Other current  assets                                                                                |       | 1,045                        |       | (5,557        | )          | 5,675                                              |       | 1,163      |       |
| Accounts payable                                                                                     |       | 178                          |       | (3,515        | )          | 1                                                  |       | (3,336     | )          |
| Accrued expenses  and other current liabilities                                                      |       | 4,182                        |       | 45            |       | (5,578                                             | )          | (1,351     | )          |
| Other assets                                                                                         |       | (6                           | )          |          |       |                                               |       | (6         | )          |
| Net cash  provided by (used in) operating activities                                                 |       | 16,893                       |       | (23           | )          | 2                                                  |       | 16,872     |       |
| Cash flows used  in investing activities:                                                            |       |                         |       |          |       |                                               |       |       |       |
| Purchase of  equipment and leasehold improvements                                                    |       | (964                         | )          |          |       | (2                                                 | )          | (966       | )          |
| Net cash used in  investing activities                                                               |       | (964                         | )          |          |       | (2                                                 | )          | (966       | )          |
| Cash flows (used  in) provided by financing activities:                                              |       |                         |       |          |       |                                               |       |       |       |
| Increase in book  overdraft                                                                          |       |                         |       | 23            |       | (23                                                | )          |       |       |
| Repurchase of  senior secured notes                                                                  |       | (10,135                      | )          |          |       |                                               |       | (10,135    | )          |
| Deferred  financing costs                                                                            |       | (30                          | )          |          |       |                                               |       | (30        | )          |
| Net cash (used  in) provided by financing activities                                                 |       | (10,165                      | )          | 23            |       | (23                                                | )          | (10,165    | )          |
| Net increase in  cash and cash equivalents                                                           |       | 5,764                        |       |          |       | (23                                                | )          | 5,741      |       |
| Cash and cash  equivalents, beginning of period                                                      |       | 11,390                       |       |          |       |                                               |       | 11,390     |       |
| Cash and cash  equivalents, end of period                                                            |       | $                            | 17,154     |          | $          |                                               | $          | (23        | )          | $ | 17,131 |   |
|                                                                                                      |            |                              |            |               |            |                                                    |            |            |            |  |  |  |  |

 

F-24

----

Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Cash Flows**

**Yearended June 30, 2007**

**(Inthousands)**

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

 

F-25

----

Tableof Contents

 

**RafaellaApparel Group, Inc. and Subsidiaries**

**CondensedConsolidating Statement of Cash Flows**

**Yearended June 30, 2006**

**(Inthousands)**

 
| ** **                                                                                   | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Non-  guarantor  Subsidiary  and  Eliminations** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                                                                                   | ** ** | ** **                   | ** ** | ** **    | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| 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 subsidiaries                                                          |       | (4,307                       | )          |          |       | 4,307                                              |       |       |       |
| 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-26

----