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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

**(Mark One)**

 

**x****                ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the fiscal year ended June 30, 2010**

** **

**or**

** **

**o****                   TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thetransition periodfrom              to           **

 

**Commission File Number:  333-138342**

 

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**Rafaella Apparel Group, Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

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

**(212) 403-0300**

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

 

Indicateby checkmark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes o   No x.

 

Indicateby checkmark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Exchange Act.  Yes o   No x.

 

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

 

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

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-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) |   |                              |

 

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

 

Asof October 13, 2010, the registrant had 2,500,000 shares of its commonstock, par value $0.01 per share, outstanding.

 

 

 

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**RAFAELLA APPAREL GROUP, INC.**

**ANNUAL REPORT**

**JUNE 30, 2010**

**TABLE OF CONTENTS**

** **
| ** **                                                                                                                                                                                              | ** **                                                                                                          | ** ** | **PAGE** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| **PART I**                                                                                                                                                                                         |                                                                                                                |       | 1        |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| ITEM 1.                                                                                                                                                                                                 | BUSINESS                                                                                                            |       | 1        |
| ITEM 1A.                                                                                                                                                                                                | RISK FACTORS                                                                                                        |       | 5        |
| ITEM 1B.                                                                                                                                                                                                | UNRESOLVED  STAFF COMMENTS                                                                                          |       | 13       |
| ITEM 2.                                                                                                                                                                                                 | PROPERTIES                                                                                                          |       | 13       |
| ITEM 3.                                                                                                                                                                                                 | LEGAL PROCEEDINGS                                                                                                   |       | 13       |
| ITEM 4.                                                                                                                                                                                                 | (Removed and Reserved)                                                                                              |       | 14       |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| **PART II**                                                                                                                                                                                        |                                                                                                                |       | 14       |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| 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                                                        |       | 32       |
| ITEM 8.                                                                                                                                                                                                 | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       | 32       |
| ITEM 9.                                                                                                                                                                                                 | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               |       | 33       |
| ITEM 9A(T).                                                                                                                                                                                             | CONTROLS &  PROCEDURES                                                                                     |       | 33       |
| ITEM  9B.                                                                                                                                                                                               | OTHER  INFORMATION                                                                                                  |       | 33       |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| **PART III**                                                                                                                                                                                       |                                                                                                                |       | 34       |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| ITEM 10.                                                                                                                                                                                                | DIRECTORS, EXECUTIVE  OFFICERS AND CORPORATE GOVERNANCE                                                             |       | 34       |
| ITEM 11.                                                                                                                                                                                                | EXECUTIVE  COMPENSATION                                                                                             |       | 36       |
| ITEM 12.                                                                                                                                                                                                | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                    |       | 46       |
| ITEM 13.                                                                                                                                                                                                | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE                                           |       | 47       |
| ITEM 14.                                                                                                                                                                                                | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                                             |       | 48       |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| **PART IV**                                                                                                                                                                                        |                                                                                                                |       | 49       |
|                                                                                                                                                                                                    |                                                                                                                |       |     |
| ITEM 15.                                                                                                                                                                                                | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                                         |       | 49       |
| EXHIBIT INDEX                                                                                                                                                                                      |                                                                                                                | 50         |
| SIGNATURES                                                                                                                                                                                              |                                                                                                                | 54         |
| 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 |                                                                                                                | 54         |

 

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**PART I**

**ITEM 1.             BUSINESS**

** **

**GENERAL**

 

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

** **

**OurCompany**

 

Weare an established wholesaler, designer, sourcer, marketer and distributer of afull line of women’s career and casual sportswear separates within the UnitedStates.  We have been in the women’sapparel business since 1982 and market our products primarily under theRafaella brand and private label brands of our customers.  We design, source and market pants, sweaters,blouses, knits, jackets and skirts for all seasons of the year.  Our in-house design staff develops our linesto include core basics, fashion related separates and replenishment items withupdated features and colors using a variety of natural and syntheticfabrics.  Using our designspecifications, we outsource the manufacturing and production of our clothingline to factories primarily in Asia and also in the Middle East.  We sell our products directly to department,specialty and chain stores and off-price retailers.  We have over 240 customers, representing over3,900 individual retail locations.  Ourcustomers include some of the largest retailers of women’s clothing in theUnited States.

** **

**OurIndustry**

 

Theretail women’s apparel industry is highly competitive, with many providers ofsimilar types of clothing as are designed and marketed by us.  In addition, there has been a consolidationin the industry, decreasing the number of retailers and the floor spaceavailable for our products.  Wholesalersof women’s apparel are subject to pricing pressures from both retailers andconsumers, stemming from the increased competition for customers and economiccycles that impacts the spending of our consumers.

 

Thewomen’s apparel industry in which we operate has historically been subject tocyclical variations, current general economic conditions, and perceived oranticipated future economic conditions. The current economic environment, characterized by a dramatic decline inconsumer discretionary spending, has materially and adversely affected theretail and wholesale apparel industry. Discretionary purchases, such as women’s apparel, have been especiallynegatively impacted in the current economic environment.

** **

**Products**

 

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

 

Ourbranded products are priced to retail at the entry level in the “better”sportswear departments of our retail customers. Our pants, skirts, blouses and sweaters typically retail for $40 to $80per item, knits for $25 to $55 per item and jackets for $60 to $120 peritem.  We believe that our products areof an equal or higher quality than those of our competition.

** **

**Seasonality**

 

Wepresent seasonal “lines” each year corresponding to the retail selling seasons,Spring, Summer, Fall and Holiday.  Eachline consists of complementary styles of pants, sweaters, blouses, knits,jackets and skirts, which are sold as individual items, but which may becoordinated into complete outfits.  Eachstyle in our lines comes in a variety of colors and/or patterns.  Fabrics include cotton and cotton blends,synthetics and synthetic blends, silk and silk blends, wool and wool blends andlinen, depending upon the season and clothing style.  Our lines are marketed principally under theRafaella brand and private label brands of our customers.

 

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**Design**

 

Ourdesign team, operating out of our headquarters in New York, is responsible forthe development of new products and our seasonal lines according to ourmerchandising calendar.  The teamincludes a creative director along with staff designers and assistant designers,with computer aided design capabilities, in addition to a color and printspecialist.  Each member of the team hasresponsibility for certain products, creating several groupings for a givenseason.

 

Thedesign staff interprets emerging trends in fashion from European travel andtrend services, and receives market feedback from our management and salesforce, in order to stay abreast of new design concepts.  This information is used to developpreliminary expectations for the composition and silhouettes of the nextline.  With this guidance, the designteam develops initial sketches and design prototype garments reflecting lineconcepts and style ideas.  From theseconcepts, certain styles are selected for further development and the designteam, in conjunction with management, begins to select colors and fabrics forthe line.  Fabric samples are ordered ineach pattern and color.  Using the samplefabrics, more refined prototype garments are made by our manufacturers.  These refined samples are used for display inthe showroom during the applicable market week. The line is further refined based on customer feedback during the marketweek.

 

**ProductSourcing and Distribution**

 

Wecontract for the manufacturing of our products exclusively with third-partymanufacturers and do not own or operate any manufacturing facilities.  During fiscal 2010, our merchandise purchaseswere primarily sourced from manufacturers in Asia and also in the MiddleEast.  In the future, we may exploresourcing opportunities in other areas of the world.  Outsourcing our products allows us tomaximize production flexibility, while avoiding significant capitalexpenditures, work-in-process inventory build-ups and costs associated withmanaging a larger production force. Approximately 97% and 3% of our goods were manufactured in Asia and theMiddle East, respectively.  Our threelargest third-party manufacturers accounted for approximately 30%, 17% and 15%of our product purchases in fiscal 2010.

 

Weutilize individual purchase orders specifying the price, quantity and designspecifications of the merchandise to be produced; approximately 45% of our 2010merchandise purchases were secured by letters of credit.  We do not have long-term, formal arrangementswith our manufacturers, and wecontinually seek additional suppliers for our production needs to provideadditional capacity and flexibility as needed. Because we have been using many of the same manufacturers for severalyears, we believe we have established and maintained excellent relationshipswith high-quality manufacturers, fabric suppliers and agents.  These relationships facilitate our ability tocontrol the quality of our products, achieve favorable pricing for productionand ensure a reliable supply of products. However, based on our past experience of adding and removing suppliers,we believe that we are not dependent on any particular supplier and, ifnecessary, can replace in a timely manner any supplier at a similar cost andquality.

 

From1997 through the end of October 2008, we worked with the same principal buyingagent based in Hong Kong for the majority of our product sourcing.  Historically, this agent served as anon-exclusive buying agent for manufactured goods in Asia, principally China,Hong Kong and Vietnam.  This agent alsoidentified and qualified contract manufacturers, administered and coordinatedproduction, and managed the quality control process for production administeredand coordinated by this agent as well as when we utilized certain other agentsin Asia.  Compensation to our agent wasbased on a percentage of the full cost of the finished garment before shippingcosts and customs duties.  During fiscal2008, we decided to cease our relationship with this Hong Kong agent, effectiveOctober 31, 2008, and we established a subsidiary in Hong Kong to performthese activities in-house beginning in November 2008.

 

Wesource fabric for many of our manufacturers. Due to our large annual purchases of our higher volume fabrics, we havebeen able to negotiate favorable pricing with our fabric suppliers.  We negotiate directly with our suppliers forthe purchase of required fabrics, which are purchased either directly by us orby our manufacturers under our directions.

 

Wehave a comprehensive quality control program that begins overseas to ensurethat raw materials and finished goods meet our specifications for design, fitand quality.  Fabric purchases areinspected upon receipt at the manufacturers’ facilities, and prior tocommencement of production.  Inspectionsare handled by representatives of our Hong Kong office as well as ourmanufacturers’ staffs.  Quality controlinspectors also inspect finished goods before shipment to the United States, aswell as once they reach the warehouse and distribution facilities that weutilize.  Management believes that ourlow return rate on defective merchandise is largely due to our rigorous qualitycontrol processes.

 

ThroughJune 2010, we utilized a centralized distribution system, under which mostmerchandise was received, processed and distributed through our Bayonne, NewJersey facilities.  On June 17,2010, we entered into a distribution agreement with a third party to providewarehousing, distribution and logistics services with respect to effectivelyall of our goods that are distributed in the Northeast.  Pursuant to this distributionagreement, such third party, through its warehouse facilities in NewJersey, will be the 

 

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exclusiveprovider to us of all warehousing, distribution and logistics services withrespect to effectively all of our goods distributed in the Northeast.  Theagreement provides that we will utilize this service provider for a minimumvolume of units to be determined with respect to each of our fiscal yearsduring the term of the agreement, commencing with the 2011 fiscal year thatbegan on July 1, 2010.  The term of this distribution agreement isfor three years, subject to termination by the parties under certaincircumstances, including but not limited to upon a material breach (subject tonotice and cure), force majeure, or by either party for any reason upon no lessthan 180 days prior written notice.

 

Oncemerchandise is received, merchandise is inspected, packed and shipped to ourcustomers 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 distribution facilities.  Each pre-pack contains six, eight or tengarments, in a single style and color, and in a preset range of sizes.  We offer pre-pack size ranges in Missy, Petiteand Woman.  Management believes the useof pre-packs helps minimize our distribution costs and reduce shipping errorsand reduces our risk of unsold inventory in an undesirable assortment of sizesthat may be difficult to sell at acceptable gross profit margins.

 

Manyof our customers have developed their own extensive individual policies andprocedures regarding virtually all aspects of shipping and product packagingand presentation, including, among others, standards for hangers, shipping boxes, labels, shipping procedures,barcoding and hangtags.  Before we shiporders to our customers, we confirm that the products and procedures beingfollowed comply with the relevant standards in order to mitigate the financialpenalties imposed by the customer for non-compliance with their policies andprocedures.  We use a system, which wasdeveloped to ensure compliance, which includes automation of certaincomponents, such as the submission of advance shipping notices to our customersscheduled for several hours in advance of each customer’s deadline for suchnotices.  In addition, we monitor eachcustomer’s policies and procedures guidelines, review customer manuals on aregular basis, and modify our systems accordingly.

 

**Sales,Marketing and Advertising**

 

Wemaintain a direct sales force that operates out of our New York showroom.  Our direct sales force is compensatedexclusively on a salaried basis; discretionary annual performance bonuses canbe earned based upon the Company’s achievement of pre-determined financialperformance targets.  This in-house salesforce, together with management, accounted for approximately 99% of our fiscal2010 sales.  Independent, non-exclusivesales representatives who are compensated exclusively on a commission basis accounted for approximately 1% of ourfiscal 2010 sales.

 

Weintroduce our products to existing and prospective customers during marketweeks, which occur four to six months ahead of the corresponding retail sellingseasons.  During market weeks, customersvisit our showroom to view our Casual and Career line of separates 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.

 

Todate, we have not incurred significant media based advertising costs.  We raise awareness of the Rafaella brandthrough a focused, cost effective on-line approach utilizing social networking,blogging and e-mail blasts.  We maximizemedia coverage in major publications such as Oprah, In Style, WWD andLucky magazine and through regional satellite media tours.

 

**Customers**

 

Ourprincipal customers are department and specialty stores.  The department and specialty stores channelrepresented approximately 69% of our total net sales in fiscal 2010 and theother approximately 31% of our total net sales in fiscal 2010 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 of Macy’s,Belk, Kohl’s, and Bon-Ton, our four largest customers (when viewed on a commonownership basis), accounted for 31%, 20%, 12% and 11%, respectively, of ourtotal net sales in fiscal 2010.

 

Webelieve we have strong relationships with our customers.  We have over 240 customers, representing over3,900 individual retail store locations. Our top ten customers (when viewed on common ownership basis) accountedfor approximately 95% of net sales for fiscal 2010.  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.

 

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**Backlog**

 

Asof September 27, 2010 and September 25, 2009, we had unfilledcustomer orders of approximately $43.4 million and $36.2 million ofmerchandise, respectively.  The amount ofunfilled customer orders at a particular time is affected by a number offactors, including product mix, the timing of receipt and processing ofcustomer orders and the product manufacturing and shipping schedule, which isdependent to a certain extent on customer demand.  Accordingly, a comparison of unfilled ordersfrom period to period is not necessarily meaningful and may not be indicativeof eventual actual shipments.

 

**WorkingCapital**

 

Historically,our sales and operating results fluctuate by quarter, with the greatest salestypically occurring in our first and third quarters of the fiscal year.  It is in these quarters that our Fall andSpring product lines, which traditionally have had the highest volume of netsales, are shipped to customers. As a result, we experience significantvariability in our quarterly results and working capital requirements.Moreover, delays in shipping can cause revenues to be recognized in a laterquarter, resulting in further variability in such quarterly results.

 

Workingcapital requirements vary throughout the year. Working capital typically increases during the first and third quartersof the fiscal year as inventory builds to support peak shipping/selling periodsand, accordingly, typically decreases during the second and fourth quarters ofthe fiscal year as inventory is delivered/sold. Cash provided by operating activities is typically higher in the secondand fourth quarters of the fiscal year due to the reduced working capitalrequirements during that period.  Toenable the Company to have adequate liquidity to conduct its operations, in June 2005the Company established a secured revolving credit facility agreement (the “**Credit Facility**”) with HSBC Bank USA, National Association (“**HSBC**”), which has been amended from time to time, and mostrecently on May 21, 2010, when the Company amended and restated thesecured credit facility with HSBC, as agent and as a lender, and CerberusCapital Management, L.P. as a lender and the term lender (the “**Amended and Restated Financing Agreement**”).

 

**Competition**

 

TheUnited States retail apparel industry is highly competitive andfragmented.  Our competitors includenumerous apparel designers, manufacturers, importers, licensors and our owncustomers’ private label programs, many of which are larger and have greaterfinancial and marketing resources than are available to us.  We believe that the principal competitivefactors in the industry are:

 

·                  consistent fit;

·                  productquality;

·                  styling;

·                  price;

·                  brand name andbrand identity; and

·                  reliability ofdeliveries.

 

Westrive to focus on these points and respond quickly to customer demand with ourrange of products and our ability to operate within the industry’s productionand delivery constraints.  Based oncustomer feedback, we believe that our continued dedication to customerservice, product assortment and consistency, quality control and pricing enableus to compete effectively.  We believe thatour established brand and relationships with retailers have resulted in a loyalfollowing of customers and consumers.

 

**Trademarks**

 

The“Rafaella” and “V Verrazano” (stylized) brand names, which are our materialtrademarks, are registered in the United States and in certain foreignjurisdictions for use in the women’s sportswear market.  We do not have rights to these marks forother product categories.  We regardthese trademarks and other proprietary rights as valuable assets and from timeto time we take action to protect our trademarks against infringement.

 

**InformationSystems**

 

Wehave limited information technology resources and rely on third-party providersfor telecommunications, Electronic Data Interchange (**“EDI”**)applications and other support.  Ourfinancial and operational information and reporting needs are met by a softwarepackage written primarily for apparel companies and further customized for ourneeds by a third party software development 

 

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andmaintenance firm.  We own substantiallyall of our computer equipment and contract with third parties to maintainbackup systems.

 

Ourcustomers can elect to use EDI to trade and process orders with us on asimplified and expedited basis.  We useEDI with certain customers to provide advance-shipping notices, process ordersand conduct billing operations.  Inaddition, certain other customers use EDI to communicate to us their weeklyinventory requirements on a store-by-store basis.  As of June 30, 2010, we had 14 customersthat use EDI to communicate with us.  Infiscal 2010, total sales to these customers were approximately 93% of ouroverall total sales.

 

**Imports, ImportRestrictions and Other Government Regulations**

 

***Imports and Import Restrictions***

 

Ourtransactions with our foreign suppliers are subject to the risks of doingbusiness abroad.  Imports into the UnitedStates are affected by, among other things, the cost and availability oftransportation, 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 certaincountervailing subsidies from the exporting nation.  In 2007, the U.S. Government altered a morethan twenty-year policy by applying its antisubsidy laws to certainexports from China.  In addition, billshave been introduced in Congress which would hold China and other countriesaccountable for currency manipulation through the assessment of penalduties.  The effect of these changescould be an increase to the cost of goods imported by us from China.  The pendency of the above-described actionscould 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.

 

***Other Government Regulation***

 

Weare subject to federal, state and local laws and regulations regarding ourbusiness.  These include the ConsumerProduct Safety Improvement Act, the Textile Fiber Product Identification Act,the Flammable Fabric Act and the rules and regulations of the FederalTrade Commission and the Consumer Product Safety Commission, or the CPSC, aswell as similar laws and regulations under state requirements.  We believe that we are in compliance in allmaterial respects with all applicable governmental regulations relating to ourimported products.

 

**Employees**

 

Asof June 30, 2010, we had approximately 154 employees, of whomapproximately 48 were employed in New York, approximately 75 were employed inNew Jersey, and approximately 31 were employed in Hong Kong.  We reduced our New Jersey workforce byapproximately 70 employees subsequent to June 30, 2010 as a result of usentering into a distribution agreement with a third party to provide certain warehousing,distribution and logistics services.  Weare not a party to any labor agreements and none of our employees are represented by a union. We consider our relationship with our employees to be satisfactory andhave not experienced any interruption of our operations due to labor disputes with our employees.

 

**ITEM 1A.               RISKFACTORS**

 

**RisksRelated to Our Indebtedness**

 

***Our senior secured notes mature on June 15, 2011 and managementcurrently does not believe that we will have sufficient cash on hand, based oncurrent cash flow projections, to repay the senior secured notes in June 2011at principal or face value.***

 

Oursenior secured notes issued pursuant to our outstanding indenture mature on June 15,2011. Management currently does not believe that we will have sufficient cashon hand, based on current cash flow projections, to repay the senior securednotes in June 2011 at principal or face value. We are currently exploringvarious alternatives with respect to refinancing, extending or otherwise restructuringthe senior secured notes, although at the present time we do not have anyarrangement or agreement to do so and there can be no assurances that we willbe able to refinance, extend or restructure the senior secured notes on termsand conditions acceptable to the Company, or at all, or on a timely basis.  As a consequence of the fact that there is noassurance that the Company will be able to refinance, extend or restructure thesenior secured notes on terms and conditions acceptable to the Company on atimely basis, there is substantial doubt that the Company can continue as agoing concern.  Further, credit orfinancial market disruptions such 

 

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asthose that have recently been experienced in the United States and abroad mayhave a material adverse effect on our ability to refinance, extend orrestructure our senior secured notes on a timely basis and on terms acceptableto us, if at all.  See Risk Factordirectly below “*We may not be able to continue as a goingconcern*.”

 

***We may not be able to continue as a going concern.***

 

Absenta successful refinancing, extension or restructuring of our senior securednotes on terms and conditions satisfactory to us and on a timely basis, whichis not solely within our control, we do not expect our forecasted cash andcredit availability to be sufficient to meet our repayment obligation withrespect to the senior secured notes as they come due over the next twelvemonths. As a result, there is substantial doubt we can continue as a goingconcern. Our consolidated financial statements have been prepared on the basisof a going concern, which contemplates continuity of operations, therealization of assets and the satisfaction of liabilities in the normal courseof business. If we were unable to continue as a going concern, we will need toliquidate our assets and we might receive significantly less than the values atwhich they are carried on our consolidated financial statements. See Note 2(Basis of Presentation) to our consolidated financial statements includedherein.  The accompanying consolidatedfinancial statements do not include any adjustments related to the recoverabilityand classification of recorded assets or the amounts and classification ofliabilities that might result from the uncertainty associated with our abilityto meet our obligations as they come due.

 

***The Credit Facility expires on June 10, 2011 and we may be unableto refinance on terms acceptable to us, if at all.***

 

OurCredit Facility expires on June 10, 2011, and unless we are able torefinance, extend or restructure our senior secured notes, we will not be ableto refinance our Credit Facility, which expires five (5) days prior to thematurity of the indenture.  We rely uponaccess to the credit markets as a source of liquidity for the portion of ourworking capital requirements not provided by cash from operations. Accordingly,even if we are able to refinance, extend or restructure our indenture, marketdisruptions such as those that have recently been experienced in the UnitedStates and abroad may increase our cost of borrowing or adversely affect ourability to access sources of liquidity upon which we rely to finance ouroperations and satisfy our obligations as they become due. These disruptionsinclude turmoil in the financial services industry, unprecedented volatility inthe markets where our outstanding indebtedness trades, and general economicdownturns. If we are unable to access credit at competitive rates, or if ourshort-term or long-term borrowing costs dramatically increase, our ability tofinance our operations, meet our short-term obligations and implement ouroperating strategy could be adversely affected. All of the foregoing could havea material adverse effect on our ability to refinance all or any portion of theCredit Facility, and we may be unable to refinance the Credit Facility on termsacceptable to us, if at all.

 

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

 

Wehave a substantial amount of debt.  As ofJune 30, 2010, we had approximately $71.9 million (based upon accretedvalue at maturity) of senior secured notes outstanding under the indenture,excluding interest accrued thereon and $10.2 million of letters of creditoutstanding under our Credit Facility, and the ability to utilize $3.6 millionof availability (inclusive of $6.5 million of cash collateral deposited by theCompany as of period end) under the Credit Facility for letters of credit,subject to compliance with our financial and other covenants and the terms setforth therein.  Our substantial debtcould have material adverse consequences. For example, it could:

 

·                  make usvulnerable to general adverse economic and industry conditions;

·                  limit ourability to refinance, extend or restructure the senior secured notes, increasethe cost of a refinancing, extending or restructuring of the indenture;

·                  limit ourability to refinance or extend the Credit Facility beyond the current maturitydate, increase the cost of a refinancing or extension of the Credit Facility orlimit our ability to obtain additional financing for future working capital,capital expenditures, product development, strategic acquisitions and othergeneral corporate requirements;

·                  expose us tointerest rate fluctuations because the interest on the debt under the CreditFacility is at variable rates;

·                  require us todedicate a substantial portion of our cash flow from operations to payments onour debt, thereby reducing the availability of our cash flow for operations andother purposes;

·                  limit ourflexibility in planning for, or reacting to, changes in our business and theindustry in which we operate; and

·                  place us at acompetitive disadvantage compared to our competitors that may haveproportionately less debt.

 

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

 

Toservice our debt, we require a significant amount of cash.  Our ability to generate cash, make requiredpayments or to refinance our obligations depends on our successful financialand operating performance.  We cannotprovide assurance that our operating and financial performance, cash flow andcapital resources will be sufficient for us to service our debt in the future.  Our 

 

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financialand operating performance, cash flow and capital resources performance dependupon prevailing economic conditions, and certain financial, business and otherfactors, many of which are beyond our control. These factors include, among others:

 

·                  economic andcompetitive conditions affecting the market for our products and the women’sapparel market generally;

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

·                  increasedproduction labor and raw material costs.

 

Ifour cash flow and capital resources are insufficient to fund our debt serviceobligations, we may be forced to reduce or delay capacity expansion and capitalexpenditures, sell material assets or operations, obtain additional capital orrestructure our debt.  In the event thatwe are required to dispose of material assets or operations or restructure ourdebt to meet our debt service and other obligations, there can be no assurancesas to the terms of any such transaction or how soon any such transaction couldbe completed, if at all.

 

***Certain terms of ourCredit Facility will require us to tie up significant cash resources.***

 

Commencing onDecember 16, 2010, the terms of our Credit Facility require us to providecash collateralization of 105% with respect to all outstanding letters ofcredit.  We typically have approximately$4 million of standby letters of credit outstanding at any time, and from timeto time, based upon the most recent historical fiscal year, we may have up toan additional $8 million of letters of credit outstanding.  Accordingly, once this cash collateralizationfeature goes into effect, at any point in time we may have up to approximately$13 million of cash collateralizing letters of credit.  This substantial cash collateralizationrequirement may significantly reduce our liquidity, which in turn may imposesignificant operating restrictions on the Company and may limit, or evenprohibit, the Company from operating as it otherwise might in the absence ofsuch cash collateralization requirements.

 

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

 

TheCredit Facility and the indenture governing the notes impose significantoperating and financial restrictions on us. These restrictions limit or prohibit, among other things, our abilityto:

 

·                  declaredividends or redeem or repurchase capital stock;

·                  prepay, redeemor repurchase debt (including the senior secured notes);

·                  incur liens;

·                  make loans andinvestments;

·                  guarantee orincur additional debt;

·                  amend orotherwise alter terms of debt (including the senior secured notes);

·                  engage inmergers, acquisitions and other business combinations;

·                  sell assets;

·                  make capitalexpenditures;

·                  transact withaffiliates; and

·                  alter thebusiness we conduct.

 

Inaddition, the Credit Facility also includes the following financial covenants:

 

·                  a minimumworking capital requirement;

·                  a minimumrolling quarterly period net-income (as defined) requirement; and

·                  a cashcollateral requirement.

 

Certainof these financial covenants become more restrictive over time.

 

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

 

**RisksRelated to Our Business and Industry**

 

***Slowdowns in general economic activity have detrimentally impacted ourcustomers and have had an adverse effect on our sales and profitability.***

 

Ourbusiness is sensitive to the business cycle of the national economy.Deterioration in general economic conditions adversely affect demand for ourproducts, and cause sales of our products to decrease. Many of our customers,particularly department and specialty stores, have cancelled or scaled backpurchases of products such as ours as a result of the dramatic decline inconsumer discretionary spending and strategic initiatives by our customers toreduce (carry less) on-hand inventory in stores.  This reduced customer demand has adverselyaffected our results of operations and may continue to do so. ** **Further deteriorationin economic conditions, along with decreasing levels of spending by ourcustomers, will continue to adversely affect our revenues and profits 

 

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throughreduced purchases of our products. In such circumstances, we may reduce priceson certain items, which would further adversely affect our profitability.

 

Inaddition, there could be a number of other effects from the ongoing economicdownturn. The inability of key suppliers to access liquidity, or the insolvencyof key suppliers, could lead to delivery delays or failures. Financialdifficulties of our customers could adversely impact our results of operations.Finally, other counterparty failures, including banks and counterparties toother contractual arrangements, could negatively impact our business.

 

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

 

Anumber of apparel retailers have experienced financial difficulties over thepast several years.  A significantadverse change in financial condition or results of operations or a customer’sbankruptcy filing or liquidation could cause us to limit or discontinuebusiness with that customer, or limit our ability to collect amounts related toprevious purchases by that customer, all of which could harm our financialcondition, results of operations or our cash flow from operations, particularlygiven the concentration of our customers and if our third-party factor isunwilling to assume the credit risk on receivables from such customers orlimits the amount of credit risk it is willing to take from such customers.Consistent with industry practices, we sell products to select customers onopen account after completing an appropriate credit review of the customer.

 

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

 

Infiscal 2010, our department and specialty stores channel accounted forapproximately 69% of our total net sales. The other approximately 31% of our total net sales in fiscal 2010 wereto off-price retailers and private label customers.

 

Whilecertain of our customers consist of separate department and specialty storechains or off-price retailers with common ownership, these customers haveseparate purchasing departments and are therefore viewed by us as separatecustomers.  Divisions of Macy’s, Belk,Kohl’s, and Bon-Ton, our four largest customers (when viewed on a commonownership basis), accounted for 31%, 20%, 12% and 11%, respectively, of ourtotal net sales in fiscal 2010.

 

Adecision by any of our major customers, whether motivated by competitive conditions,financial difficulties (ours or theirs), change of ownership, change ofmanagement or otherwise, to decrease significantly the amount of merchandisepurchased from us, to increase the use of their own private label brands forwhich we are not the manufacturer or sourcer, or to change its manner of doingbusiness with us, could substantially reduce our revenues and materiallyadversely affect our operations and our ability to generate profits.

 

***Competition in the apparel industry could reduce our sales and ourprofitability.***

 

Asan apparel company, we face competition on many fronts, including thefollowing:

 

·                  establishingand maintaining favorable brand recognition;

·                  developingproducts that appeal to consumers;

·                  pricingproducts appropriately; and

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

 

TheUnited States apparel industry is highly fragmented and includes a number ofvery large companies, many of which have greater financial, technical andmarketing resources, greater sourcing and manufacturing capacity and moreextensive and established customer relationships than we do.  The competitive responses encountered fromthese larger, more established apparel companies may be more aggressive andcomprehensive than we anticipate and we may not be able to compete effectively ina variety of ways, including but not limited to with respect to quality,production capacity and price. Additionally, we may compete with some of our customers which engage intheir own sourcing and manufacturing of certain products.  Further, in response to the continuedconsolidation of our customers, our competitors may consolidate as well inorder to increase their ability to service customers.  The competitive nature of the apparelindustry may result in lower prices for our products and decreased gross profitmargins, which may materially adversely affect our sales and financialcondition.

 

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

 

Therehas been, and continues to be, consolidation activity in the U.S. retail women’sapparel industry.  With the growing trendtowards consolidation, we are increasingly dependent upon key retailers whosebargaining strength and share of our business is growing.  It is possible that these larger retailersmay, instead of continuing to purchase women’s sportswear separates from us, decideto manufacture or source such items themselves; or instead of using the Companyas their manufacturer or sourcer for their own private label brands, turn to acompetitor or directly manufacture or source such items.

 

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Thereis also the possibility that customers may consolidate with one or more oftheir other vendors and begin sourcing items from such vendors.  Consolidation may also result in storeclosures which could adversely impact our sales.

 

Inaddition, as a result of consolidation, we may face greater pressure from theselarger customers to provide more favorable price and trade terms, to complywith increasingly more stringent vendor operating procedures and policies andto alter our products or product mix to provide different items such asexclusive merchandise, private label products or more upscale goods.  If we are unable to provide more favorableterms or to develop satisfactory products, programs or systems to comply withany new product requirements, operating procedures or policies, this couldadversely affect our operating results.

 

***The apparel industry is subject to pricing pressures that may cause usto lower the prices we charge for our products.***

 

Pricesin the United States apparel industry have been declining over the past severalyears primarily as a result of the movement of manufacturing operationsoffshore, the growth of the mass market retail channel of distribution,increased competition, consolidation in the retail apparel industry and thegeneral economic slowdown of recent years. Products manufactured offshore generally cost less to manufacture thanthose made domestically primarily 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 ourproduction costs, or if our production costs increase and we cannot increaseour prices.

 

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

 

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

 

***Our business will suffer if we fail to continually anticipate customertastes.***

 

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

 

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

 

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

 

Weneed significant working capital to purchase inventory and are often requiredto post letters of credit when placing an order with one of our third-partymanufacturers or fabric suppliers.  Weexpect to meet our working capital needs primarily through our operating cashflow but we may also utilize the Credit Facility, pursuant to which we havebeen able to obtain letters of credit and commencing on December 16, 2010, revolvingdirect debt advances up to $5,000,000. If we are unable to meet the covenants in the Credit Facility and, as aresult, are unable to have letters of credit issued on our behalf, or we areunable to extend or renew or refinance such facility on terms satisfactory tous, our ability to purchase inventory would be curtailed or eliminated, whichwould significantly affect our marketing and sales efforts, thus significantlyharming our business.

 

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

 

TheUnited States apparel industry has historically been subject to cyclicalvariations, recessions in the general economy or uncertainties regarding futureeconomic prospects that affect consumer spending habits which could negativelyimpact our business overall and specifically our sales, gross margins andprofitability.  The success of ouroperations depends on consumer spending. Consumer spending is impacted by a number of factors, including actualand perceived economic conditions affecting disposable consumer income (such asunemployment, wages and salaries), business conditions, interest rates,availability of credit and tax rates in the general economy and in theinternational, regional and local markets where our products are sold.  Any significant deterioration in generaleconomic conditions, actual or perceived, or increases in interest rates couldreduce the level of consumer spending and inhibit consumers’ use ofcredit.  In addition, war, terroristactivity or the threat of either may adversely affect consumer spending, andthereby have a material adverse effect on our financial condition and resultsof operations.

 

***Fluctuations in the price,availability and quality of fabrics or other raw materials, as well as theprice of labor, could cause production delays and increase costs.***

 

Fluctuations in the price,availability and quality of fabrics or other raw materials, such as cotton, aswell as the price of labor, used in our manufactured apparel could have amaterial adverse effect on our cost of sales or our ability to meet customerdemands.  The prices for fabrics dependlargely 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 transportation costs.  In addition to fluctuations of labor costs,foreign labor strikes or boycotts could cause production delays, reduceinventory available to us to meet customer demands, and increase costs. We maynot be able to pass all or any portion of the higher raw materials prices andrelated transportation costs on to our customers.

 

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

 

Wesell our products pursuant to individual purchase orders instead of long-termpurchase commitments.  We typically donot enter into long-term contracts with customers.  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. Whether in response to changesaffecting 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.

 

***Many of our customers require our compliance with their vendoroperating policies and procedures.***

 

Manyof our customers have developed extensive policies and procedures regardingvirtually all aspects of shipping and product packaging and presentation,including standards for hangers, shipping boxes, labels, shipping procedures,barcoding and hangtags, among others. These policies and procedures are often extensively documented, verydetailed and unique to each customer, requiring us to develop and maintain a systemto ensure compliance with each customer’s individual manual of policies andprocedures.  Although we have implementeda system that we believe is sufficient to ensure compliance with our customer’sshipping and packaging requirements, we cannot provide assurance that thissystem or any future system will adequately address customer requirements.  If we do not comply with these policies andprocedures we may be required to pay financial penalties to our customers,which could become significant if there is widespread 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.

 

***The extent of our foreign sourcing and manufacturing may adverselyaffect our business.***

 

Forfiscal 2010, all of our products were manufactured outside the United States,including a significant portion from China, Vietnam and Indonesia.  As a result of the magnitude of our foreignsourcing and manufacturing, our business may be subject to risks, including thefollowing:

 

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

 

·                  imposition ofduties, taxes and other charges on imports;

 

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·                  significantdevaluation of the dollar against foreign currencies;

 

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

 

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

 

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

 

·                  violations byforeign contractors of labor and wage standards and resulting adversepublicity.

 

Ifthese risks limit or prevent us from acquiring products from foreign suppliersor significantly increase the cost of our products, our operations could beseriously disrupted until alternative suppliers are found, which couldnegatively impact our business.

 

***Our reliance on third-party manufacturers could cause delays, adverselyaffect operations and damage customer relationships.***

 

Weuse third-party manufacturers to assemble or produce all of our products.  We are dependent on the ability of thesethird-party manufacturers to adequately finance the assembly or production ofgoods ordered and maintain sufficient manufacturing capacity.  The use of third-party manufacturers to assembleor produce finished goods and the resulting lack of 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.

 

Inaddition, any negative publicity that third-party manufacturers may receive asa result of the use of labor practices by such manufacturers that areinconsistent with labor practices utilized in the United States, or which areregarded as deficient relative to labor practices utilized elsewhere in theworld, may lead our customers to terminate, reduce or otherwise modify theirbusiness relationships with us.  Any suchpublicity, or resulting change in any of our customer business relationships,could also have a material adverse effect on our business, results ofoperations and financial condition.

 

***Our international operations and the operations of many of ourmanufacturers are subject to additional risks that are beyond our control andthat could harm our business.***

 

Dueto our operations and our manufacturing relationships abroad, we are subject tonumerous domestic and foreign laws and regulations affecting our business, suchas those related to labor, employment, worker health and safety, antitrust andcompetition, environmental protection, consumer protection, import/export, andanti-corruption, including but not limited to the Foreign Corrupt Practices Actwhich generally prohibits giving anything of value intended to influence theawarding of government contracts or for performance of certain othergovernmental acts. Although we have put into place policies and proceduresaimed at ensuring legal and regulatory compliance, our employees,subcontractors and agents could take actions that violate these requirements.Violations of these regulations could subject us to criminal or civilenforcement actions, any of which could have a material adverse effect on ourbusiness.

 

***We cannot predict how import restrictions will impact our business.***

 

Ourtransactions with our foreign suppliers are subject to the risks of doingbusiness abroad.  Imports into the UnitedStates are affected by, among other things, the cost and availability oftransportation of the products and the imposition of import duties andrestrictions.  The countries that wesource our products from may, from time to time, also impose restrictions ortake various economic actions, which could affect our ability to importproducts from such countries at the current or increased levels.  Imports into the 

 

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UnitedStates can also be subjected to various additional restrictions and theassessment of punitive antidumping duties or countervailing duties when goodsare shipped to the U.S. at less than fair value (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.  In addition,bills have been introduced in Congress which would hold China and othercountries accountable for currency manipulation through the assessment of penalduties.  The effect of these changescould be an increase to the cost of goods imported by us from China.  The pendency of the above-described actionscan have a disruptive effect on imports from the exporting country while theaction is pending as a result of the potentially resulting uncertainty.  We cannot predict the likelihood or frequencyof any such events occurring.

 

Variousinterests have proposed extending an expired monitoring program coveringtextile imports from Vietnam and expanding it to cover imports from China.Should these proposals in the future be adopted and should they result inaffirmative determinations of injury, they could result in additionalrestrictions or duties.

 

U.S.import quotas on apparel imported from China expired on December 31, 2008.  On September 11, 2009, acting under theauthority of the China product safeguard provision (section 421 of the TradeAct of 1974, as amended), the U.S. President proclaimed that certain passengervehicle and light truck tires from China are being imported into the UnitedStates in such increased quantities or under such conditions as to cause orthreaten to cause market disruption to the domestic producers of like ordirectly competitive products.  Thedetermination further provided for the imposition of additional import dutieson such products, for a period of three years, as a remedy.  It is possible that other U.S. domesticinterests may petition for similar relief in the form of additional importduties or other measures such as quotas. We cannot predict whether such action would be sought or approved.

 

Inaddition, various economic factors, including, but not limited to, the exchangerate between the U.S. and Chinese currencies, and increased cost for rawmaterials, labor and transportation, could materially impact the availabilityor cost at which we could import our products.

 

Newand proposed reporting requirements to be made at or prior to the time of entrymay also impact the speed and efficiency at which our goods may enter into theU.S. market.  These include, amongothers, the new “10 + 2” security filing. Increased time lags for the release of imported product may also be thecase with respect to ongoing governmental initiatives in the areas of supplychain security and product safety.

 

Wemonitor these and other trade related developments and continually seek tominimize our potential exposure to related risks through, among other measures,shifts of production among countries and manufacturers.

 

Inaddition to the factors outlined above, our import operations may be adverselyaffected by political or economic instability resulting in the disruption oftrade from exporting countries, any significant fluctuations in the value ofthe dollar against foreign currencies and restrictions on the transfer offunds.

 

***We may be unable to protect our trademarks and other intellectualproperty rights or expand our use of our trademark outside of the women’ssportswear market.***

 

Webelieve that our trademarks are important to our success and our competitiveposition due to their name recognition with our customers.  There can be no assurance that the actions wehave taken to establish and protect our trademarks will be adequate to preventuse of our marks or similar marks by others, or imitation of our products byothers or to prevent others from seeking to block sales of our products as aviolation of the trademarks and other proprietary rights of others.  Also, others may assert rights in, orownership of, our trademarks and other proprietary rights, and we may be unableto successfully resolve such disputes to our satisfaction.  Our rights in the Rafaella mark are limitedto use for the women’s sportswear segment of the apparel business.  Other parties are using similar marks inother segments of the apparel business. If we expand outside the women’s sportswear segment of the apparelindustry we may need to market our products under a different trademark.

 

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

 

Competitionfor qualified personnel in the United States apparel industry is intense and wecompete for these individuals with other companies having greater financial andother resources.  Our continued successwill depend, in significant part, upon the continued services of our existingsenior management team and on our continued ability to attract, retain andmotivate qualified management, administrative and sales personnel to supportour existing operations and our continued growth.  The loss of the services of our executiveofficers could adversely affect our future operating results, which depend to asubstantial degree on their experience and knowledge of our business and theircustomer and vendor relationships.  Wemay not be able to replace any of our executive officers with sufficientlyexperienced and qualified personnel.  Thetemporary or permanent loss of the services of any member of our 

 

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seniormanagement team, or our inability to attract and retain other qualifiedpersonnel could have a material adverse effect on our business, results ofoperations and financial condition.

 

***Disruption in our distribution center could adversely affect ourresults of operations.***

 

We maintain one centraldistribution center that we have outsourced to a third party provider with whomwe have a distribution agreement, but over which we otherwise have nocontrol.  A serious disruption to ourdistribution center or to the flow of goods in or out of our center due to suchthird party’s failure or inability to provide the services for which we havecontracted, or due to fire, earthquake, act of terrorism or any other cause,could materially impair our ability to distribute our products to customers ina timely manner or at a reasonable cost. In addition, in the event of a fire, earthquake, or act of terrorism, wecould also suffer damages to a significant portion of our inventory. We couldincur significantly higher costs and longer lead times associated withdistributing our products to our customers during the time that it takes for usto reopen or replace our distribution center, or to find another third partyprovider, as the case may be. As a result, any such disruption could have amaterial adverse effect on our business, results of operations and financialcondition.

 

***The requirements of complying with the Exchange Act and theSarbanes-Oxley Act may strain our resources 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 increase our costs and may place a strain on ourresources.  The Sarbanes-Oxley Actrequires that we maintain and certify that we have effective disclosurecontrols and procedures and internal control over financial reporting.  Pursuant to Section 404 of theSarbanes-Oxley Act, our management is required to deliver a report thatassesses the effectiveness of our internal control over financial reporting,although an attestation report of our registered public accounting firm on theoperating effectiveness of such internal control is not required.  In order to maintain and improve theeffectiveness of our disclosure controls and procedures and internal controlover financial reporting, significant resources and management oversight willbe required as we may need to devote additional time and personnel to legal,financial and accounting activities to ensure our ongoing compliance with thepublic company reporting requirements.

 

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

 
| **ITEM 1B.** | **UNRESOLVED STAFF COMMENTS** |
|--------------|-------------------------------|

 

None.

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

 

Wemaintain our headquarters in a 30,000 square foot office facility at 1411Broadway in New York, New York.  Theheadquarters houses our design studio and sales showroom, in addition to oursourcing, finance and administrative functions. We sublease a portion of our headquarters to a third party.  The New York office lease and relatedsublease expire in January 2013. Our warehouse and distribution facilities occupy approximately 182,000square feet in Bayonne, New Jersey. We have surrendered a portion of theBayonne facilities as of September 30, 2010 (approximately 114,000 square feet)pursuant to which the Company terminated its obligations under its leasewithout penalty.  We also sublease theremainder of our Bayonne facilities (approximately 68,000 square feet) to athird party.  The New Jersey lease andrelated sublease expire in January 2011. Our product sourcing and production facilities occupy approximately6,000 square feet in Kowloon Bay, Kowloon (Hong Kong).  The Hong Kong lease expires inNovember 2011.  The facilities areleased at market rents.  In addition, welease third-party storage and distribution facilities on a month-to-month basisand pay a fee per item shipped by the third party on our behalf.  We own no real property or facilities.

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

 

DuringApril 2009, Kobra International, Ltd. d/b/a Nicole Miller (**“Nicole Miller”**) commenced arbitration proceedings againstthe Company alleging that the Company’s decision to suspend performance aslicensee under the parties’ License Agreement (the **“License”**)constituted an anticipatory breach and/or repudiation of the License.  Nicole Miller originally sought $1.5 millionin purported damages.  On April 29,2009, the Company filed papers denying Nicole Miller’s claims in theirentirety, asserting that the suspension of performance was permitted by theLicense and asserting a counterclaim of $1.0 million alleging that NicoleMiller’s subsequent termination of the License was improper. On January 29,2010, Nicole Miller asserted an additional $2.5 million in purporteddamages.  On or about May 25, 2010, thearbitrator issued a Final Award (the **“Award”**). TheAward directed the Company to pay Nicole Miller approximately $0.6 millioncorresponding to compensation for guaranteed minimum royalties of $0.4 millionand 

 

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attorney’sfees and certain expenses of $0.2 million; $0.4 million and $0.2 million ofexpense was recorded by the Company during the years ended June 30, 2010 and2009, respectively in connection with the Award.  The Company paid the Award in full in May2010. The Award is in full settlement of all claims submitted in connectionwith the arbitration proceedings.

 

Additionally,the Company, from time to time, is party to various legal proceedings.  While management, including external counsel,currently believes that the ultimate outcome of these proceedings, individuallyand in the aggregate, will not have a material adverse impact on its financialposition or results of operations, litigation is subject to inherentuncertainties.

 
| **ITEM  4.** | **(Removed and Reserved)** |
|--------------|----------------------------|

 

**PART II**

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

 

Thereis no established public market for the common stock of the Company.  All the outstanding common stock of theCompany, consisting of 2,500,000 shares, is owned by RSW 2005, Inc.  RA Cerberus Acquisition, LLC, controlled byaffiliates of Cerberus Capital Management, L.P. (**“Cerberus”**),owns 100% of the Company’s convertible preferred stock, which is convertible atits option into common stock equal to 68.2% of the Company’s outstandingfully-diluted common stock.

 

Nodividends have been declared on our common stock during the two most recentfiscal years or since June 30, 2010. We do not intend to pay dividends on our common stock in the foreseeablefuture.  Payment of dividends is withinthe discretion of the Company’s board of directors and depends on variousfactors, including our net income, financial condition, cash requirements andother factors deemed relevant by our board of directors.  The amounts available to pay dividends arelimited by the terms of the Financing Agreement, dated June 20, 2005, betweenthe Company and HSBC Bank USA, National Association (**“HSBC”**)and the indenture governing our 11 1⁄4% Senior Secured Notes due 2011.  We must also obtain the affirmative vote orwritten consent of the holders of a majority of the then outstanding shares of Series A Preferred Stock in order(i) to make (or permit anysubsidiary to make) any declaration, payment or setting aside for payment ofany dividend or other distribution of any sort in respect of any of our capitalstock other than the Series A Preferred Stock or (ii) to repurchase,redeem or acquire any outstanding stock of the Corporation other than theSeries A Preferred Stock.

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

 

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

 

Thesummary selected historical financial data presented below is for the fiscalyears ended June 30, 2010, 2009, 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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**RAFAELLAAPPAREL GROUP, INC.**

 
| ** **                                                           | ** ** | **Fiscal Year  Ended June 30,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                                       | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** |
| ** **                                                           | ** ** | **(Dollars in thousands)**           | ** ** |
| **Income Statement Data:**                                           | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                            |       | $                                              | 222,187    |   | $ | 191,284 |   | $ | 177,990 |   | $ | 147,965 |   | $ | 113,955 |   |
| Cost of sales                                                        |       | 148,555                                        |       | 127,170 |   | 129,086 |   | 113,037 |   | 78,979 |   |
| Gross profit                                                         |       | 73,632                                         |       | 64,114 |   | 48,904 |   | 34,928 |   | 34,976 |   |
| Selling, general and administrative expenses  (1)               |       | 29,938                                         |       | 30,951 |   | 67,017 |   | 56,039 |   | 28,313 |   |
| Operating income (loss)                                              |       | 43,694                                         |       | 33,163 |   | (18,113 | ) | (21,111 | ) | 6,663 |   |
| Other expense (income):                                              |       |                                           |       |   |   |   |   |   |   |   |   |
| Interest Expense, net                                                |       | 22,631                                         |       | 23,884 |   | 17,964 |   | 13,232 |   | 10,527 |   |
| Gain on senior secured note purchases                                |       | —                                         |       | — |   | (3,124 | ) | (25,632 | ) | (8,036 | ) |
|                                                                 |       |                                           |       |   |   |   |   |   |   |   |   |
| Total other expense (income)                                         |       | 22,631                                         |       | 23,884 |   | 14,840 |   | (12,400 | ) | 2,491 |   |
| Income (loss) before provision for (benefit  from) income taxes |       | 21,063                                         |       | 9,279 |   | (32,953 | ) | (8,711 | ) | 4,172 |   |
| Provision for (benefit from) income taxes                       |       | 8,463                                          |       | 2,999 |   | (8,199 | ) | 6,726 |   | 3,269 |   |
| Net income (loss)                                                    |       | 12,600                                         |       | 6,280 |   | (24,754 | ) | (15,437 | ) | 903 |   |
| **Balance Sheet Data (at end of  period):**                          |       |                                           |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                            |       | $                                              | 27,273     |   | $ | 11,390 |   | $ | 17,131 |   | $ | 17,698 |   | $ | 20,610 |   |
| Accounts receivable                                                  |       | 22,510                                         |       | 20,785 |   | 15,286 |   | 11,550 |   | 10,854 |   |
| Inventories                                                          |       | 47,054                                         |       | 44,375 |   | 33,249 |   | 12,334 |   | 13,595 |   |
| Total assets                                                         |       | 223,195                                        |       | 193,804 |   | 148,848 |   | 87,479 |   | 83,741 |   |
| Current portion of senior secured notes                              |       | 17,265                                         |       | 234 |   | 865 |   | — |   | 71,084 |   |
| Senior secured notes                                                 |       | 147,157                                        |       | 133,144 |   | 119,748 |   | 82,992 |   | — |   |
| Total liabilities                                                    |       | 196,874                                        |       | 160,962 |   | 141,118 |   | 95,162 |   | 90,502 |   |
| Redeemable convertible preferred stock                          |       | 44,110                                         |       | 48,110 |   | 52,110 |   | 56,110 |   | 60,110 |   |
| Total stockholders’ equity (deficit)                            |       | (17,789                                        | )          | (15,268 | ) | (44,380 | ) | (63,793 | ) | (66,871 | ) |
| **Other Financial Data:**                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Net cash flows provided by (used in):                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Operating activities                                                 |       | $                                              | 36,765     |   | $ | 16,743 |   | $ | 16,872 |   | $ | 13,252 |   | $ | 7,703 |   |
| Investing activities                                                 |       | (283                                           | )          | (214 | ) | (966 | ) | (1,083 | ) | (273 | ) |
| Financing activities                                                 |       | (9,261                                         | )          | (32,412 | ) | (10,165 | ) | (11,602 | ) | (4,518 | ) |
| Depreciation and amortization                                        |       | 5,453                                          |       | 4,985 |   | 4,504 |   | 4,671 |   | 4,745 |   |
| Capital expenditures                                                 |       | 95                                             |       | 214 |   | 966 |   | 1,083 |   | 273 |   |

 

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(1)          The Company recordedimpairment charges of $25.8 million and $34.5 million during the years endedJune 30, 2009 and 2008, respectively, related to the decline in the fairvalue of the Rafaella trademark and trade name intangible asset.  The impairment charges are reflected withinselling, general and administrative expenses.

 

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

 

Thefollowing is a discussion of our results of operations and financialcondition.  This discussion should beread in conjunction with our audited consolidated financial statements andnotes included elsewhere in this Annual Report.

 

**NOTEREGARDING FORWARD-LOOKING STATEMENTS**

 

*This Annual Report contains statements that are forward-looking and assuch are not historical facts. Rather, these statements constitute projections,forecasts or forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. You should not place undue relianceon these statements. Forward-looking statements include information concerningthe Company’s liquidity and possible or assumed future results of operations,including descriptions of the Company’s business strategies. These statementsoften include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,”“estimate,” “seek,” “will,” “may” or similar expressions. These statements arebased on certain assumptions that the Company has made in light of itsexperience in the industry as well as its perceptions of the historical trends,current conditions, expected future developments and other factors the Companybelieves are appropriate under these circumstances.*

 

*All such forward-looking statements speak only as of the date of thisAnnual Report. The Company expressly disclaims any obligation or undertaking torelease publicly any updates or revisions to any forward-looking statementscontained herein to reflect any change in the Company’s expectations withregard thereto or any change in events, conditions or circumstances on whichany such statement is based.*

 

*As you read this Annual Report, you should understand thatthese statements are no****guaranteesof performance or results. They involve risks, uncertainties and****assumptions.You should understand the risks and uncertainties discussed in****“Item 1A —Risk Factors” and elsewhere in this Annual Report, could affect****theCompany’s actual financial results and could cause actual results to differ****materiallyfrom those expressed in the forward-looking statements. Some important****factorsinclude, but are not limited to:*

 

·                  our ability tocontinue as a going concern;

 

·                  our ability torefinance, extend or restructure the senior secured notes;

 

·                  our ability torefinance the Credit Facility;

 

·                  our liquidityand the availability and cost of additional or continued sources of financing;

 

·                  our ability to generatesufficient cash flow to service our existing debt service obligations;

 

·                  our ability tosatisfy financial and other covenants of the Credit Facility and senior securednotes indenture;

 

·                  the continuedweakening national economy in general and the consumer retail markets inparticular;

 

·                  the financialcondition of our customers and continued consolidation among our customers inthe retail industry;

 

·                  our ability toretain major customers at current or historical levels;

 

·                  competition andpricing pressures in apparel industry;

 

·                  our continuedability to anticipate customer and consumer tastes;

 

·                  ability toaccurately forecast customer demand;

 

·                  fluctuations inthe price, availability and quality of fabrics;

 

·                  our ability tocomply with the vendor operating policies and procedures of our customers;

 

·                  our dependenceupon third party manufacturing in foreign countries and the resultingfluctuations in cost of manufacturing apparel clothing;

 

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·                  changes inexport regulations of foreign companies and changes in U.S. importrules and regulations;

 

·                  protection ofour brand and trademarks; and

 

·                  our ability toretain our senior management and attract and retain qualified and experiencedemployees.

 

**COMPANYOVERVIEW**

 

**OurCompany**

 

Weare an established wholesaler, designer, sourcer, marketer and distributer of afull 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, knits, jacketsand skirts for all seasons of the year. Our in-house design staff develops our lines to include core basics,fashion related separates and replenishment items with updated features andcolors using a variety of natural and synthetic fabrics.  Using our design specifications, we outsourcethe manufacturing and production of our clothing line to factories primarily inAsia and also the Middle East.  We sellour products directly to department, specialty and chain stores and off-priceretailers.  During fiscal 2010, we haveover 240 customers, representing over 3,900 individual retail locations.  Our customers include some of the largestretailers of women’s clothing in the United States.

 

Certainfactors not solely within our control, including the nearing maturity dates ofthe Credit Facility and our senior secured notes and our uncertainty withrespect to the refinancing thereof, raise substantial doubt about ourability to continue as a going concern.  We can give no assurance asto our ability to raise sufficient capital or revenues to meet our obligationsor our ability to continue as a going concern.

 

**OurIndustry**

 

Theretail women’s apparel industry is highly competitive, with many providers ofsimilar types of clothing as are designed and marketed by us.  In addition, there has been a consolidationin the industry, decreasing the number of retailers and the floor spaceavailable for our products.  Wholesalersof women’s apparel are subject to pricing pressures from both retailers andconsumers, stemming from the increased competition for customers and economiccycles that impacts the spending of our consumers.

 

Thewomen’s apparel industry in which we operate has historically been subject tocyclical variations, current general economic conditions, and perceived or anticipatedfuture economic conditions.  The currenteconomic environment, characterized by a dramatic decline in consumerdiscretionary spending, has materially and adversely affected the retail andwholesale apparel industry. Discretionary purchases, such as women’s apparel, have been especiallynegatively impacted in the current economic environment.

 

**CriticalTrends; Performance Drivers**

 

***Primary Revenue Variables***

 

Ourrevenues are impacted by the following factors:

 

·                  national andregional economic conditions;

·                  overall levelsof consumer spending for apparel;

·                  demand byretailers for our brand and products;

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

·                  the accuracy ofour forecast of demand for our products;

·                  the performanceof our products within the prevailing retail environment;

·                  actions of ourcompetitors;

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

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

 

***Primary Expense Variables***

 

Variationsin our cost of sales are primarily due to:

 

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

 

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

·                  fluctuations induties, taxes and other charges on imports;

·                  pricingpressures due to competition for manufacturing sources;

·                  reductions inthe value of our unsold inventories;

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

·                  internationaleconomic and political conditions.

 

Variationsin selling, general and administrative expenses are primarily due to:

 

·                  changes inheadcount and salaries and related fringe benefits;

·                  costsassociated with product development;

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

·                  costsassociated with professional services;

·                  changes in PR andmarketing expenses;

·                  changes infactoring costs and provisions for customer bad debts;

·                  costsassociated with enhancing and maintaining an adequate system of internalcontrols; and

·                  costsassociated with regulatory compliance.

 

***Consolidation in the Industry***

 

Therehas been, and continues to be, consolidation activity in the United Statesretail women’s apparel industry.  Withthe growing trend towards consolidation, we are increasingly dependent upon keyretailers whose bargaining strength and share of our business is growing.  It is possible that these larger retailersmay, instead of continuing to purchase women’s sportswear separates from us,decide to manufacture or source such items themselves.  There is also the possibility that customersmay consolidate with one or more of their other vendors and begin sourcingitems from such vendors.  Consolidationmay also result in store closures which could adversely impact our sales.

 

Inaddition, as a result of consolidation, we may face greater pressure from theselarger customers to provide more favorable pricing and trade terms, to complywith increasingly more stringent vendor operating procedures and policies andto alter our products or product mix to provide different items such asexclusive merchandise, private label products or more upscale goods.  If we are unable to provide more favorableterms or to develop satisfactory products, programs or systems to comply withany new product requirements, operating procedures or policies, this couldadversely affect our operating results.

 

***Changing Customer Tastes***

 

Wehave designed our products primarily using basic styling with updated featuresand colors in order to minimize the impact of fashion trends.  However, fabric, color and other stylefactors are still critical in determining whether our products are purchased byconsumers 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***

 

Asan apparel company, we face competition on many fronts, including with respectto the following:

 

·                  establishingand maintaining favorable brand recognition;

·                  developingproducts that appeal to consumers;

·                  pricingproducts appropriately; and

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

 

TheUnited States apparel industry is highly fragmented and includes a number ofvery large brands and companies marketing multiple brands, many of which havegreater financial, technical and marketing resources, greater manufacturingcapacity and more extensive and established customer relationships than wedo.  We believe we have maintained pricesfor our branded

 

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productsin department and specialty stores 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 results of operations.

 

***Import Restrictions and Regulations***

 

Ourtransactions with our foreign suppliers are subject to the risks of doingbusiness abroad.  Imports into the UnitedStates are affected by, among other things, the cost and availability oftransportation of the products and the imposition of import duties andrestrictions.  The countries that wesource our products from may, from time to time, also impose restrictions ortake various economic actions, which could affect our ability to importproducts from such countries at the current or increased levels.  Imports into the United States can also besubjected to various additional restrictions and the assessment of punitiveantidumping duties or countervailing duties when goods are shipped to the U.S.at less than fair value (dumping) orwith certain 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 introducedin Congress which would hold China and other countries accountable for currencymanipulation through the assessment of additional duties (such as thoseavailable under the antidumping and countervailing duty laws).  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.

 

Variousprivate interests have proposed implementing a monitoring program coveringtextile imports from China.  Should theseproposals in the future be adopted and should they result in affirmativedeterminations of injury, they could result in additional restrictions orduties.

 

U.S.import quotas on apparel imported from China expired on December 31,2008.  On September 11, 2009, actingunder the authority of the China product safeguard provision (section 421 ofthe Trade Act of 1974, as amended), the U.S. President proclaimed that certainpassenger vehicle and light truck tires from China are being imported into theUnited States in such increased quantities or under such conditions as to causeor threaten to cause market disruption to the domestic producers of like ordirectly competitive products.  Thedetermination further provided for the imposition of additional import dutieson such products, for a period of three years, as a remedy.  It is possible that other U.S. domesticinterests may petition for similar relief in the form of additional importduties or other measures such as quotas. We cannot predict whether such action would be sought or approved.

 

Inaddition, various economic factors, including, but not limited to, the exchangerate between the U.S. and Chinese currencies, and increased cost for rawmaterials, labor and transportation, could materially impact the availabilityor cost at which we could import our products.

 

Newand proposed reporting requirements to be made at or prior to the time of entrymay also impact the speed and efficiency at which our goods may enter into thecommerce of the United States.  Theseinclude, among others, the new “10 + 2” security filing.  Increased time lags for the release ofimported product may also be the case with respect to ongoing governmentalinitiatives in the areas of supply chain security and product safety.

 

Wemonitor these and other trade related developments and continually seek tominimize our potential exposure to related risks through, among other measures,shifts of production among countries and manufacturers.

 

Inaddition to the factors outlined above, our import operations may be adverselyaffected by political or economic instability resulting in the disruption oftrade from exporting countries, any significant fluctuations in the value ofthe dollar against foreign currencies and restrictions on the transfer offunds.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

Themethods, estimates and judgments we use in applying our most criticalaccounting policies have a significant impact on the results we report in ourconsolidated financial statements.  Weevaluate our estimates and judgments on an ongoing basis.  We base our estimates on historicalexperience and on assumptions that we believe to be reasonable under thecircumstances.  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.

 

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Webelieve the following accounting policies are the most critical to us in thatthey are important to our financial statements and they require our mostdifficult, subjective or complex judgments in the preparation of ourconsolidated financial statements.

 

*Revenue Recognition*.  Revenue is recognized at the time titlepasses and risk of loss is transferred to customers.  Revenue is recorded net of estimateddiscounts, returns and allowances. Discounts are based on trade terms. Returns and allowances require pre-approval from management.  On a seasonal basis, we negotiate priceallowances with our customers as sales incentives or for the cost of certainpromotions.  We estimate these allowancesbased on historic trends, seasonal results, an evaluation of current economicconditions and retailer performance.

 

*Income Taxes*.  We are organized under Delaware law as acorporation and will be treated as a corporation for United States federal incometax purposes under the Internal Revenue Code of 1986, as amended, or theCode.  Our effective tax rate will varybased on the level of business conducted in those states in which we file, aswell as changes made to the tax rates by the state tax authorities.

 

Deferredtaxes are provided for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of assets and liabilities andtheir respective tax bases, as measured by enacted tax rates in effect inperiods when the deferred tax assets and liabilities are expected to be settledor realized.  We evaluate the probabilityof realizing our deferred tax assets on an on-going basis.  This evaluation includes estimating ourfuture taxable income for the years in which our deferred taxes are expected toreverse, which includes consideration of tax planning strategies.  We provide a valuation allowance if wedetermine it is more likely than not that we will not be able to realize ourdeferred tax assets.  A valuation allowanceof approximately $16.4 million relating to certain capital loss carry forwardsexisted as of June 30, 2010.

 

Weadopted the provisions of Accounting Standards Codification (“**ASC”)** 740, *Income Taxes*,formerly FASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes*, (“**FIN 48**”), onJuly 1, 2007.  As a result of thisadoption, we recognized an increase in liabilities for uncertain tax positionsof approximately $6.3 million with a corresponding increase in the deferred taxasset of $5.9 million representing the gross unrecognized tax benefits.  Upon adoption, $0.6 million of interest, netof $0.2 million tax benefit, was recorded to retained earnings.  We recognize interest expense related tounrecognized tax benefits in income tax expense.

 

*Receivables*.  Receivables consist of trade accountsreceivable and receivables that are assigned to a commercial factor, net ofdiscounts and allowances.  We factorcertain trade receivables, on a non-recourse basis with a commercial factor,except that we assume credit risk for those receivables that do not receivewritten approval from the factor.  Thefactor collects all cash remittances on receivables factored and assumes creditrisk on all sales that are approved in advance by the factor.  An allowance for sales discounts, returns,markdowns, co-op advertising and operational chargebacks is included as areduction to gross sales and receivables. Certain of these provisions result from seasonal negotiations withcustomers as well as historic deduction trends and the evaluation of currentmarket conditions.

 

*Inventories*.  Substantially all of the inventory wepurchased in fiscal year 2010 was produced in Asia.  Inventory costs include amounts paid topurchase piece goods and manufacture our products, duty, quota, inboundfreight, and costs associated with our Hong Kong subsidiary (which acts in thecapacity of a buying agent).  Inventoriesare stated at the lower of cost or market, with cost being determined at standardcosts, which approximate the first-in, first-out (FIFO) method.  Inventories consist of raw materials(primarily piece goods at our contractors), merchandise in transit and finishedgoods in warehouses.  We take ownershipof the finished goods when they are shipped and management records themerchandise in transit balance based on documentation provided by our Hong Kongsubsidiary.  For inventory markdowns, weestimate 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*.  Equipment and leaseholdimprovements 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.

 

Intangibleassets consist of the trademark and trade name, customer relationships of thePredecessor, and non-compete agreements with officers of the Predecessor,acquired on June 20, 2005.  Customerrelationships are amortized using straight-line and accelerated methods overtheir estimated useful lives of 7 and 15 years, respectively.  Non-compete agreements are amortized usingthe straight-line method over their estimated useful lives of 2 and 10years.  Both agreements are withDirectors of the Company.  Ownedtrademarks have been determined to have indefinite lives and are not subject toamortization.

 

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Ourpolicy is to evaluate depreciable and amortizable assets (fixed assets,customer relationships and non-compete agreements) for impairment wheneverevents or changes in circumstances indicate that the carrying amount of suchassets may not be recoverable from the undiscounted cash flows expected fromthe use of the asset.  These depreciable andamortizable assets are tested for impairment by comparing the carrying amountof the assets to their fair values.  Thisapproach is dependent upon future growth and trends.  Any impairment loss would be measured as theexcess of carrying amount over the fair value of the asset, determined on thebasis of discounted cash flows from the expected use of the asset.

 

Thetrademark and trade name, which have been determined to be indefinite livedassets, are tested for impairment at least annually or when changes incircumstances indicate that their carrying amount may not be recoverable, bycomparing the carrying amount of the assets to their fair value based on anincome approach using the relief-from-royalty method.  This method assumes that, in lieu of ownership,a firm would be willing to pay a royalty in order to exploit the relatedbenefits of these assets.  This approachis dependent upon a number of factors, including estimates of future growth andtrends, royalty rates for intellectual property, discount rates and othervariables.  We base our fair valueestimates on assumptions we believe are reasonable, but which are unpredictableand inherently uncertain.  Actual futureresults may differ from those estimates. If the estimated fair value of the assets is less than their carryingamount, an impairment loss is recognized equal to such difference.

 

*Contingencies and Litigation*.  Management evaluates contingent liabilitiesincluding threatened or pending litigation in accordance with ASC 450, *Contingencies*, and records accruals when the outcome ofthese matters is deemed probable and the liability may be reasonablyestimated.  Management makes theseassessments based on the facts and circumstances and in some instances based inpart on the advice of outside legal counsel. The Company records legal costs incurred in connection with a losscontingency as incurred.

 

*Stock-based Compensation.*  Effective July 1, 2006, the Companyadopted revised provisions under ASC 718, *Compensation — StockCompensation* and ASC 505-50, *Equity-Based Payments toNon-Employees*, which require companies to expense the fair value ofemployee stock options and other forms of stock based compensation.  The computation of the expenses associatedwith stock based compensation requires the use of a valuation model.  The Company currently uses the Black Scholesoption pricing model to calculate the fair value of its stock options.  The Black Scholes model requires assumptionsregarding the estimated length of time participants will retain their vestedstock options before exercising them and the estimated volatility of theCompany’s common stock over the expected term. Changes in the assumptions to reflect future stock price volatility andfuture stock award exercise experience could result in a change in theassumptions used to value awards in the future and may result in a materialchange to the fair value calculation of stock based awards.  There was no effect from the change ofapplying the original provisions of ASC 718 to the Company’s results ofoperations and cash flows for the fiscal year ended June 30, 2007, as aresult of the Company’s adoption of revised provisions under ASC 718 and ASC505-50, effective July 1, 2006. Compensation expense related to stock-based awards was not significantto the Company’s consolidated statement of operations for the years endedJune 30, 2010, 2009 and 2008.  Referto Note 3 of the Company’s consolidated financial statements for furtherinformation.

 

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**RESULTSOF OPERATIONS**

 

Thefollowing table summarizes the historical operations as a percentage of netsales for the years ended June 30, 2010, 2009 and 2008.

 
| ** **                                                           | ** ** | **Year Ended  June 30, 2010**          | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                           | ** ** | **(in thousands, except percentages)** | ** ** |
|                                                                 |       |                                                  |       |                                         |       |                                         |       |   |   |   |   |   |   |
| Net sales                                                            |       | $                                                     | 113,955    |                                         | 100.0      | %                                            | $          | 147,965 |   | 100.0 | % | $ | 177,990 |   | 100.0 | % |
| Cost of sales                                                        |       | 78,979                                                |       | 69.3                                         |       | 113,037                                      |       | 76.4 |   | 129,086 |   | 72.5 |   |
| Gross profit                                                         |       | 34,976                                                |       | 30.7                                         |       | 34,928                                       |       | 23.6 |   | 48,904 |   | 27.5 |   |
| Selling, general and administrative expenses                         |       | 28,313                                                |       | 24.8                                         |       | 30,199                                       |       | 20.4 |   | 32,513 |   | 18.3 |   |
| Intangible asset impairment                                          |       | —                                                |       | —                                       |       | 25,840                                       |       | 17.5 |   | 34,504 |   | 19.4 |   |
| Operating income (loss)                                              |       | 6,663                                                 |       | 5.8                                          |       | (21,111                                      | )          | (14.3 | ) | (18,113 | ) | (10.2 | ) |
| Interest expense, net                                                |       | 10,527                                                |       | 9.2                                          |       | 13,232                                       |       | 8.9 |   | 17,964 |   | 10.4 |   |
| Gain on senior secured note purchases                                |       | (8,036                                                | )          | (7.1                                         | )          | (25,632                                      | )          | (17.3 | ) | (3,124 | ) | (1.8 | ) |
| Interest expense (income) and other financing, net                   |       | 2,491                                                 |       | 2.2                                          |       | (12,400                                      | )          | (8.4 | ) | 14,840 |   | 8.3 |   |
| Income (loss) before provision for  (benefit from) income taxes |       | 4,172                                                 |       | 3.7                                          |       | (8,711                                       | )          | (5.9 | ) | (32,953 | ) | (18.5 | ) |
| Provision for (benefit from) income taxes                            |       | 3,269                                                 |       | 2.9                                          |       | 6,726                                        |       | 4.5 |   | (8,199 | ) | (4.6 | ) |
|                                                                 |       |                                                  |       |                                         |       |                                         |       |   |   |   |   |   |   |
| Net income (loss)                                                    |       | $                                                     | 903        |                                         | 0.8        | %                                            | $          | (15,437 | ) | (10.4 | )% | $ | (24,754 | ) | (13.9 | )% |

 

***Year ended June 30, 2010 compared to year ended June 30, 2009***

 

***Net sales***.  Net sales for the year ended June 30,2010 was $114.0 million.  As compared tonet sales of $148.0 million for the year ended June 30, 2009, net salesdecreased by approximately $34.0 million or 23%.  The reduction of net sales was principallydue to a reduction in gross sales of $38.3 million, related to a decrease involume (approximately 23%), and partially offset by an increase in averagegross revenue per unit (approximately 3%). The decrease in customer volume was primarily attributed to decreases indepartment store, private label and off-price sales. The increase in averagerevenue per unit was primarily attributed to improved sales mix, with moredepartment store and private label sales and less off-price sales, and anincrease in off-price sales per unit, partially offset by decreases indepartment store and private label sales per unit.  The decrease in gross sales was partiallyoffset by a $4.2 million decline in customer allowances, trade discounts andreturns for the year ended June 30, 2010 compared to the year ended June 30,2009.

 

***Gross profit***.  Gross profit for the year ended June 30,2010 was $35.0 million.  As a percentageof net sales, gross profit over this period was 30.7%.  As compared to the gross profit of $34.9million for the year ended June 30, 2009 (23.6% of net sales), grossprofit increased by $0.1 million or 0.1%. Gross profit as a percentage of net sales increased by approximately7.1% for the year ended June 30, 2010 compared to the year-ended June 30,2009.  Gross profit as a percentage ofnet sales was favorably impacted by an improvement in margins associated with off-pricecustomer sales, an increase in department store sales as a percentage to totalnet sales, a decrease in off-price customer sales as a percentage to total netsale and a decrease in inventory markdowns during the year ended June 30,2010 compared with the prior year.  Theincrease in gross profit as a percentage of net sales was partially offset byan increase in customer allowances and discounts as a percentage of net sales.

 

***Selling, general and administrative expenses***.  Selling, general and administrative expensesfor the year ended June 30, 2010 was $28.3 million.  As compared to selling, general andadministrative expenses of $30.2 million for the year ended June 30, 2009,there was a decrease of $1.9 million. The decrease in selling, general andadministrative expenses was primarily attributable to a decrease incompensation of $1.4 million.  Other decreases in selling, generaland administrative expenses included        .[outside design services of $0.6 million, warehouse and distribution costs of$0.5 million and advertising costs of $0.3 million] which was comprised ofreduction in salary expense of $2.3 million, driven by headcount reductionsduring the prior year, and a decrease in severance costs of $0.9 million,partially offset by an increase in bonus expense of $1.8 million. The severancecosts decreased to $0.1 million for the year ended June 30, 2010, ascompared to $1.1 million for the year ended June 30, 2009.  The severance costs for the year ended June 30,2010 related primarily to employee benefits incurred as a result of costsavings restructuring efforts implemented during June 2010.  As of June 30, 2010, the severance costsremain unpaid and are accrued within the accrued expenses and other currentliabilities line item of the Company’s consolidated balance sheet.  The severance costs are expected to be paidduring the first quarter of fiscal 2011. The severance costs of approximately $1.1 million for the year ended June 30,2009 related primarily to two former executive officers of the Company, ofwhich $0.6 million and $0.5 million were paid during the year ended June 30,2010 and 2009, respectively. Other decreases in selling, general andadministrative expenses included                .The decrease in selling, 

 

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generaland administrative expenses was partially offset by an increase in professionalfees of $1.7 million attributed to the amendment of the Company’s Credit Facilitywith HSBC, the Company’s efforts to repurchase its senior secured notes andcosts incurred in connection with the Nicole Miller matter. As a percentage ofnet sales, selling, general and administrative expenses were 24.8% for the yearended June 30, 2010 and 20.4% for the year ended June 30, 2009.

 

***Intangible asset impairment***.  No intangible asset impairment charge wasrecorded in the year ended June 30, 2010. An intangible asset impairment charge of $25.8 million was recorded forthe year ended June 30, 2009, related to the decline in the fair value ofthe Rafaella trademark intangible asset. No such charge was recorded for year ended June 30, 2010 as theCompany performed its annual impairment test of the trademark and trade nameand customer relationships during the fourth quarter of the fiscal year endedJune 30, 2010 and determined that there were no impairments or impairmentindicators present.  The Companyperformed an impairment test of the trademark and trade name and customerrelationships during the second and fourth quarters of the fiscal year endedJune 30, 2009 and determined that the trademark and trade name wasimpaired necessitating a charge of $23.4 million and $2.4 million,respectively.

 

***Operating income (loss)***.  Operating income for the year endedJune 30, 2010 was $6.7 million.  Ascompared to operating loss of $21.1 million for the year ended June 30,2009, operating income increased by $27.8 million.  The increase was due to the increase in grossprofit, the decreases in selling, general and administrative expenses andintangible asset impairment, as described above.

 

***Interest expense, net***.  Interest expense, net (cash interest andnon-cash interest associated with original issue discount and deferredfinancing costs) for the year ended June 30, 2010 was $10.5 million. Ascompared to interest expense, net of $13.2 million for the year ended June 30,2009, there was a decrease of $2.7 million or 20.4%.  The decrease of interest expense, net wasprimarily due to the reduction in our senior secured notes outstanding periodover period as a result of the senior secured notes purchases.

 

***Gain on senior secured notes purchases.***  Gain on senior secured notes purchases forthe year ended June 30, 2010 was $8.0 million. As compared to gain onsenior secured notes purchases of $25.6 million for the year ended June 30,2009, there was a decrease of $17.6 million or 68.6%.  The decrease in pre-tax gains (resulting fromthe difference between the carrying book value of the senior secured notes andthe amounts paid, net of deferred financing costs that were written-off) wasdue to the decrease in our senior secured notes purchases period over period.We purchased $3.5 million, $5.0 million, and $4.4 million of our senior securednotes on the open market in July 2009, November 2009, andDecember 2009, respectively, for the year ended June 30, 2010.  We purchased $28.5 million, $2.0 million,$4.0 million, and $4.4 million of our senior secured notes on the open marketin August 2008, March 2009, April 2009, and May 2009,respectively, for the year ended June 30, 2009.

 

***Interest******expense******(income)******andother financing, net.*** Interest expense and other financing, net for the year endedJune 30, 2010 was $2.5 million.  Ascompared to interest expense and other financing, net, gain of $12.4 millionfor the year ended June 30, 2009, interest increased by $14.9 million or120.1%.  The increase was primarilyattributed to a reduction of pre-tax gain on senior secured notes purchases asdiscussed above.  Refer to the “Liquidityand Capital Resources” section below for further discussion surrounding oursenior secured notes.

 

***Provision for (benefit from) income taxes***.  We recorded a provision for income taxes of$3.3 million for the year ended June 30, 2010, which represents aneffective income tax rate of approximately 78.4%.  The difference between the statutory federalincome tax rate of 34.0% and our effective income tax rate of 78.4% isprimarily attributable to the valuation allowance of $1.4 million that weestablished on a deferred tax asset attributable to the amortization of theCompany’s customer relationship intangible assets.  The underlying tax basis of the customerrelationships is capital in nature.  Theasset would generate a capital loss for income tax purposes upon disposition atits carrying value, 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 customer relationship deferred tax asset.

 

TheCompany remains subject to federal, state and local income tax examinations bytax authorities for all tax years beginning on or after January 1,2007.  Examination of the Company’s 2006federal income tax return by the Internal Revenue Service was completed, as wasa state tax audit for the 2006 and 2005 tax years.  No significantadjustments were proposed in connection with these examinations.  Subsequently, the related unrecognized taxbenefits were recognized.

 

Werecorded a provision for income taxes of $6.7 million for the year endedJune 30, 2009, which represents an effective income tax rate ofapproximately 77.2%.  The differencebetween the statutory federal income tax rate of 34.0% and our effective incometax rate of (77.2)% is primarily attributable to the valuation allowance of$9.9 million that we established for the deferred tax asset that resulted fromthe Rafaella trademark and trade name intangible asset impairment charge of$25.8 million, as described above.  Theunderlying tax basis of the trademark and trade name is capital in nature.  The asset would generate a capital loss forincome tax purposes upon disposition at its carrying value, which can only beused to offset capital gain income.  Wedetermined that the deferred tax asset is not more likely than not to berealized as there are no actual or projected capital gains available to offsetany future capital losses that might be generated from the Rafaella trademarkand trade name deferred tax asset.

 

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Inaddition, the Company does not expect to recognize an income tax benefit fromits customer relationship intangible assets and provided a deferred tax assetvaluation allowance of $0.8 million during the year ended June 30, 2009because the underlying tax basis of the customer relationships is capital innature.

 

***Net income (loss)***.  Net income for the year ended June 30,2010 was $0.9 million.  Net income as apercentage of net sales for the year ended June 30, 2010 was 0.8%.  As compared to a net loss of $15.4 millionfor the year ended June 30, 2009, net income increased by $16.3million.  This increase in net income wasa result of the changes in operating income, interest and income taxes, asdescribed above.

 

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

 

***Net sales***.  Net sales for the year ended June 30,2009 was $148.0 million.  As compared tonet sales of $178.0 million for the year ended June 30, 2008, net salesdecreased by approximately $30.0 million or 16.9%.  The reduction of net sales was principallydue to a reduction in gross sales of $28.5 million, related to a decrease involume (approximately 12%) and a decrease in average revenue per unit(approximately 2%).  The decrease incustomer volume was primarily attributed to decreases in department store andprivate label sales, offset by an increase in off-price sales.  The decrease in average revenue per unit wasprimarily attributed to off-price sales per unit, offset by an increase indepartment store sales per unit.

 

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

 

***Selling, general and administrative expenses***.  Selling, general and administrative expensesfor the year ended June 30, 2009 was $30.2 million.  As compared to selling, general andadministrative expenses of $32.5 million for the year ended June 30, 2008,there was a decrease of $2.3 million. Decreases included advertising expenses ($1.3 million), warehouse anddistribution costs ($0.8 million), provision for bad debt ($0.4 million), andcompensation ($0.6 million).  Thedecrease in compensation includes severance costs of approximately$1.1 million incurred during the quarterly period ended March 31,2009.  The severance costs were primarilyattributed to two former executive officers of the Company. The decrease waspartially offset by an increase in rent ($0.4 million).  As a percentage of net sales, selling,general and administrative expenses were 20.4% for the year ended June 30,2009 and 18.3% for the year ended June 30, 2008.

 

***Intangible asset impairment***.  Intangible asset impairment for the yearended June 30, 2009 was $25.8 million. As compared to intangible asset impairment of $34.5 million for the yearended June 30, 2008, there was a decrease of $8.7 million.  The Company performed an impairment test ofthe trademark and trade name and customer relationships during the second andfourth quarters of the fiscal year ended June 30, 2009 and determined thatthe trademark and trade name was impaired necessitating a charge of $23.4million and $2.4 million, respectively. The Company performed its annual impairment test of the trademark andtrade name and customer relationships 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 in both years was due todecreased sales and cash flows attributable to the Rafaella brand as a resultof reduced forecasts for future years given the current state of the U.S.apparel retail environment.

 

***Operating loss***.  Operating loss for the year endedJune 30, 2009 was $21.1 million.  Ascompared to operating loss of $18.1 million for the year ended June 30,2008, operating loss increased by $3.0 million. The increase was due to the decrease in gross profit offset by decreasesin selling, general and administrative expenses and intangible assetimpairment, as described above.

 

***Interest******expense******(income)******andother financing, net.*** Other financing, net for the year ended June 30, 2009 was $12.4million.  As compared to interest expenseof $14.8 million for the year ended June 30, 2008, interest decreased by$27.2 million or 183.6%.  The decreasewas primarily attributed to a pre-tax gain of approximately $25.6 million and$3.1 million, resulting from the difference between the carrying book value ofthe senior secured notes and the amount paid, net of deferred financing coststhat were written-off, in connection with our open market purchases in fiscal2009 and 2008, respectively; each of the other senior secured note repurchases(pursuant to certain excess cash flow repurchases and restricted paymentoffers) were at 101% of their principal amount at maturity.  The decrease in interest expense was alsoattributed to the reduction in our senior secured notes outstanding period overperiod.  In November 2008 andNovember 2007, we repurchased $598,000 and $221,000, respectively, ofsenior secured notes in connection with our excess cash flow offers.  We purchased $6,000,000 and $8,027,000 of oursenior secured notes on the open market in January 2008 andJune 2008, respectively.  Wepurchased $28,505,000, $2,000,000, $3,991,000 and $4,424,000 of our seniorsecured notes on the open market in August 2008, March 2009,April 2009, and May 2009, respectively.  As a result of these 

 

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seniorsecured note transactions, interest expense (cash interest and non-cashinterest associated with original issue discount and deferred financing costs)decreased $5.0 million period over period. The aggregate decrease of $27.5 million discussed above, was partiallyoffset by a reduction in interest income of $0.3 million period overperiod.  Refer to the “Liquidity andCapital Resources” section below for further discussion surrounding our seniorsecured notes.

 

***Provision for (benefit from) income taxes***.  We recorded a provision for income taxes of$6.7 million for the year ended June 30, 2009, which represents an effectiveincome tax rate of approximately 77.2%. The difference between the statutory federal income tax rate of 34.0%and our effective income tax rate of (77.2)% is primarily attributable to thevaluation allowance of $9.9 million that we established for the deferred taxasset that resulted from the Rafaella trademark and trade name intangible assetimpairment charge of $25.8 million, as described above.  The underlying tax basis of the trademark andtrade name is capital in nature.  Theasset would generate a capital loss for income tax purposes upon disposition atits carrying value, 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.

 

Inaddition, the Company does not expect to recognize an income tax benefit fromits customer relationship intangible assets and provided a deferred tax assetvaluation allowance of $0.8 million during the year ended June 30, 2009because the underlying tax basis of the customer relationships is capital innature.

 

Werecorded a benefit from income taxes of $8.2 million for the year endedJune 30, 2008, which represents an effective income tax rate benefit ofapproximately 24.9%.  We recorded a netbenefit, after valuation allowance, from income taxes primarily as a result ofthe $34.5 million impairment charge associated with the decline in the fairvalue of the Rafaella trademark and trade name intangible asset, as describedabove.  The difference between thestatutory federal income tax rate of 34.0% and our effective income tax rate of24.9% is primarily attributable to the valuation allowance of $4.3 million thatwe established for the deferred tax asset that resulted from the Rafaellatrademark and trade name intangible asset impairment.  The underlying tax basis of the trademark andtrade name is capital in nature.  Theasset would generate a capital loss for income tax purposes upon disposition atits carrying value, which can only be used to offset capital gain income.  We determined that the deferred tax asset isnot more likely than not to be realized as there are no actual or projectedcapital gains available to offset any future capital losses that might begenerated from the Rafaella trademark and trade name deferred tax asset.

 

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

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Historically,our primary liquidity and capital requirements have been to fund workingcapital for current operations, which consists of funding the buildup of inventoriesand receivables, and servicing our Credit Facility.  Our liquidity and capital requirements alsoinclude making interest payments on the senior secured notes.  The primary source of funds currently used tomeet our liquidity and capital requirements is funds generated from operations,and in the future, may also include direct borrowings under the Credit Facility(as defined below).

 

**Risks,Uncertainties, and Going Concern**

 

Ourliquidity outlook has changed since June 30, 2009 primarily as a result ofthe continued strain on current credit and capital market conditions and thenearing maturity dates of the Credit Facility and our senior secured notes in June 2011.  As a result, we believe that our forecastedcash and available credit capacity are not expected to be sufficient to meetour debt repayment obligations as they come due over the next twelve months. Inorder to enable us to meet our debt repayment obligations, we are currentlyseeking to refinance, extend or restructure our senior secured notes and ourCredit Facility. There can be no assurance that we will be able to do so onterms and conditions satisfactory to us within the period needed to meet theserepayment obligations. Our ability to refinance any of our existingindebtedness on commercially reasonable terms may be materially and adverselyimpacted by the current credit market conditions and our financial condition.Our inability to repay the Credit Facility and the senior secured notes underthe terms of the financing agreements would lead to an event of default whichwould constitute debt being callable by creditors. The uncertainty associatedwith our ability to repay our outstanding debt raises substantial doubt aboutour ability to continue as a going concern. If we were unable to continue as agoing concern, we will need to liquidate our assets and we might receivesignificantly less than the values at which they are carried on ourconsolidated financial statements.  Theaccompanying consolidated financial statements do not include any adjustmentsrelated to the recoverability and classification of recorded assets or theamounts and classification of liabilities that might result from theuncertainty associated with our ability to meet our debt obligations as theycome due.

 

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***Credit Facility***

 

OnJune 20, 2005, we entered into a secured revolving credit facilityagreement (as amended through May 21, 2010, the “**CreditFacility**”) with HSBC Bank USA, National Association.  The Company, Cerberus Capital Management,L.P. (“**Cerberus**”), as a lender and the termlender, HSBC Bank USA, National Association (“**HSBC**”or the “**Agent**”), as agent and as lender, theother lenders signatory thereto from time to time (the “**Lenders**”)and the other loan parties signatory thereto (together with Cerberus and HSBC,collectively the “**Loan Parties**”)entered into a certain Amended and Restated Financing Agreement dated as ofMay 21, 2010 (the “**Amended and RestatedFinancing Agreement**”) to amend and restate the Credit Facility.

 

TheAmended and Restated Financing Agreement, which matures on June 10, 2011,provides for (a) letters of credit of up to $20,000,000 to be provided byHSBC, (b) revolving direct debt advances of up to $5,000,000 on or afterDecember 16, 2010 to be provided by Cerberus (the Company will not beentitled to obtain any revolving direct debt advances prior toDecember 16, 2010), and (c) term loans of up to $5,000,000 to beprovided by Cerberus (the “**Term Loan Commitment**”).   The above letters of credit and revolvingdirect debt advances are subject to the additional conditions as noted below.

 

Underthe terms of the Amended and Restated Financing Agreement, the Company’sability to cause the issuance of letters of credit prior to December 16,2010 is limited to the lesser of (x) $20,000,000 and (y) subject toreserves required by HSBC, if any, and the availability reserve discussed below(i) the sum of (a) 70% of eligible receivables plus (b) 70% ofeligible factored receivables, plus (ii) the lesser of (I) the sum of(a) 50% of eligible inventory plus (b) 50% of outstanding eligibledocumentary letters of credit, and (II) the inventory advance cap, plus (iii) cashcollateral.  The inventory advance cap is(i) $10,000,000 from the effective date of the Amended and RestatedFinancing Agreement through and including September 30, 2010,(ii) $5,000,000 from October 1, 2010 through and includingDecember 15, 2010 and (iii) $0 thereafter.  The availability reserve is (a) $10,000,000through December 15, 2010 and (b) $0 on and after December 16,2010.  From and after December 16,2010, the Company’s ability to cause the issuance of letters of credit islimited to the lesser of $20,000,000 and the amount of cash collateraldeposited by the Company to cash collateralize letters of credit.  The Amended and Restated Financing Agreementfurther provides that standby letters of credit shall be limited to $4,011,000in the aggregate undrawn amount outstanding at any time.

 

Underthe terms of the Amended and Restated Financing Agreement, the Company’srevolving direct debt advances on or after December 16, 2010 is limited tothe lesser of (i) $5,000,000 and (ii) subject to reserves required byHSBC, if any, the sum of (x) 65% of eligible receivables plus (y) 65%of eligible factored receivables.

 

Theterm loans may be used solely to fund repayments or repurchases of the Company’soutstanding 111⁄4% Senior Secured Notes due June 2011 (the “**Notes**”); and the Company shall not repurchase any of theNotes except (a) with the proceeds of the term loans or (b) asotherwise required pursuant to the terms of the Notes indenture.  The term loans are secured by a first lien onall of the Company’s assets on a *pari passu*basis with all other obligations under the Amended and Restated FinancingAgreement, subject to the provisions of the Amended and Restated FinancingAgreement relating to the application of proceeds from the Company.  Any term loans, borrowed under the Term LoanCommitment, are also due and payable on June 10, 2011 or upon terminationof the Amended and Restated Financing Agreement.

 

TheAmended and Restated Financing Agreement provides that the minimum workingcapital requirement shall be $25,000,000 as of the end of the fiscal quarterending June 30, 2010 and $27,000,000 as of the end of the fiscal quartersending thereafter.  Working capital isdefined as the sum of cash, accounts receivable, and inventory, reduced bycurrent liabilities; the definition of current liabilities excludesindebtedness under the Company’s senior secured notes at any point on or afterJune 30, 2010.  With the exceptionof the fiscal quarters ending on June 30, 2010 and September 30,2010, the Company is required to maintain positive net income during eachperiod of two consecutive fiscal quarters (on a rolling basis).  The Company is permitted to incur up to a netloss of $1,300,000 during each of the two consecutive fiscal quarters (on arolling basis) ending on June 30, 2010 and September 30, 2010.  For purposes of determining compliance withthe net income financial covenant, the definition of net income excludesnoncash expenses associated with (i) amortization of customerrelationships and non-compete agreements, (ii) the accretion of the seniorsecured notes original issue discount, (iii) amortization of deferredfinancing costs, and (iv) impairment charges, if any, resulting from adecline in the value of the Company’s intangible assets.

 

TheAmended and Restated Financing Agreement sets forth the following cashcollateral requirements: (i) $5,500,000 from July 1, 2010 through andincluding July 31, 2010; (ii) $3,000,000 from October 1, 2010through and including October 31, 2010; and (iii) $2,000,000 fromNovember 1, 2010 through and including November 30, 2010.  Effective on and after December 16,2010, the Company is required to cash collateralize all outstanding letters ofcredit in an amount equal to one hundred and five percent (105%) of suchoutstanding letters of credit.  Acondition precedent to the issuance of any letter of credit on and afterDecember 16, 2010 is that the Company shall have deposited with HSBC cashcollateral in an amount equal to 105% of the undrawn face amount of each suchletter of credit.

 

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Asof June 30, 2010, the Company was in compliance with each of the financialcovenants.  A violation of the financialcovenants constitutes an event of default under the Amended and RestatedFinancing Agreement; such an event of default could result in all debt becomingdue and payable, and HSBC having the right to terminate the Credit Facility andits obligation to make advances thereunder. If the Company’s operations were to deteriorate beyond its forecastedresults, it could result in a debt covenant violation and the Company wouldneed another amendment.  If the Companywere unable to amend the terms of the Amended and Restated Financing Agreement,the Company’s financial condition and results of operations may be materiallyadversely affected.  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.

 

AtJune 30, 2010, there were no loans and $10.2 million of letters of creditoutstanding under the Amended and Restated Financing Agreement.  Theoutstanding letters of credit are comprised of letters of credit totaling $6.2million in connection with purchaseorders for merchandise from third-party manufacturers and standby letters ofcredit totaling $4.0 million issuedby HSBC, which serve as security for obligations under certain operatingleases, a customs bond and the GMAC Letter of Credit (refer to Note 4 toour consolidated financial statements forfurther discussion).  The Company’saggregate maximum availability for letters of credit approximated $3.6 million as of June 30, 2010(inclusive of $6.5 million of cash collateral deposited by the Company as ofperiod end).

 

TheCompany requires significant working capital to purchase inventory and is oftenrequired to post commercial letters of credit when placing orders with certainof its third-party manufacturers or fabric suppliers.  The 105% cash collateral requirement withrespect to all outstanding letters of credit which commences on December 16,2010 may significantly reduce our liquidity, which in turn may imposesignificant operating restrictions on the Company and may limit, or evenprohibit, the Company from operating as it otherwise might in the absence ofsuch cash collateralization requirements.

 

TheAmended and Restated Financing Agreement includes various other covenants with whichthe Company has to comply in order to maintain borrowing availabilityincluding, but not limited to, covenants limiting or restricting the Company’sability to incur indebtedness, incur liens, enter into mergers orconsolidations, dispose of assets, make investments, pay dividends andrepurchase capital stock, enter into transactions with affiliates or prepaycertain indebtedness.  In addition, theCompany is required to report various financial and non-financial informationperiodically to HSBC.  The Amended andRestated Financing Agreement also contains customary events of defaultincluding, but not limited to, payment defaults, covenant defaults,cross-defaults to the senior secured notes, material judgment defaults,inaccuracy of representations and warranties, bankruptcy and insolvency events,defects in HSBC’s security interest, change in control events, and certainevents which would have a material adverse effect.  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.

 

Pursuantto the Amended and Restated Financing Agreement, in the event the Company hasoutstanding direct debt advances on or after December 16, 2010, the Companyremits funds from the collection of receivables to pay down borrowingsoutstanding under the Amended and Restated Financing Agreement.  Under the Company’s factoring agreement, theCompany directs its customers to remit payments on accounts receivable to itsfactor.  At the request of HSBC, theCompany has directed its factor to remit the funds from the collection ofreceivables directly to an HSBC account to reduce borrowings outstanding underthe Amended and Restated Financing Agreement. Payments from customers in connection with the Company’s factoringarrangement are reflected in operating cash flows as collections ofreceivables.  Funds remitted under thisarrangement to reduce short-term borrowings are reflected in cash flows fromfinancing activities in the statement of cash flows.

 

TheAmended and Restated Financing Agreement provided for (i) an extension feeof $25,000 payable to HSBC, as Agent, payable upon execution, (ii) arevolving commitment closing fee payable to Cerberus of $125,000, which fee wasearned as of the effective date of the Amended and Restated Financing Agreementand payable upon the Termination Date (as such term is defined in the Amendedand Restated Financing Agreement), and (iii) term loan fees payable toCerberus, as term lender, of (a) a closing fee of $125,000, which fee wasearned as of the effective date of the Amended and Restated Financing Agreementand payable upon the Termination Date, and (b) a facility fee at a rateequal to one-quarter of one percent (0.25%) per annum on average daily unusedportion of the Term Loan Commitment earned on a monthly basis and payable uponthe Termination Date.  Borrowings underthe Amended and Restated Financing Agreement bear variable interest at theCompany’s option at either (i) a base rate or (ii) the Londoninterbank offered rate plus two and three quarters percent (2.75%) per annum(each as defined).  The Amended andRestated Financing Agreement provides for a monthly commitment fee of 0.25% perannum on the unused portion of the available commitments for revolving directdebt advances and letters of credit under the facility.

 

Theforegoing is a summary of the Amended and Restated Financing Agreement, anddoes not purport to be complete and is qualified in its entirety by the copy ofthe Amended and Restated Financing Agreement.

 

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***Senior Secured Notes***

 

OnJune 20, 2005, the Company received aggregate proceeds of $163,400,000from the issuance of 11.25% senior secured notes, face value $172,000,000pursuant to our indenture.  The noteswere issued at 95% of face value, resulting in an original issue discount of$8,600,000 that is being amortized under the effective interest method over theterm of the notes.  Senior secured notesprincipal amount outstanding at June 30, 2010 and 2009 is $71,861,000 and$84,743,000, respectively.  AtJune 30, 2010 and 2009, the unamortized original issue discount is$777,000 and $1,751,000, respectively. At June 30, 2010 and 2009, debt held in treasury approximated$65,537,000 and $52,655,000, respectively. The Company’s outstanding senior secured notes are recorded at carryingbook value at June 30, 2010 and 2009. At June 30, 2010 and 2009, the fair value of the senior securednotes, determined based upon quoted market prices, was approximately$48,147,000, and $16,101,000, respectively. The notes bear cash interest at11.25%.  After giving effect to the originalissue discount and costs associated with the issuance, the notes have aneffective interest rate of approximately 13.7%. The notes mature on June 15, 2011 and cash interest is payablesemiannually on June 15 and December 15 of each year, commencingDecember 15, 2005.  The notes arecollateralized by a second priority lien on substantially all of the assets ofthe Company.  The notes are subordinatedto amounts outstanding under the Credit Facility.

 

Within100 days after the end of each fiscal year, beginning with the fiscal yearended on June 30, 2006, the Company must make an offer to repurchase allor a portion of the notes at 101% of their principal amount at maturity plusaccrued and unpaid interest to the date of purchase, with 50% of excess cashflow, as defined, from the previous fiscal year.  Senior secured note aggregate principalamounts of $598,000, $221,000 and $17,429,000 were repurchased duringNovember 2008, 2007 and 2006, respectively, in connection with excess cashflow offers made by the Company.  TheNovember 2008, 2007 and 2006 repurchases of the notes, which were at 101%of their principal amount at maturity plus accrued and unpaid interest to thedate of purchase, approximated $631,000, $234,000 and $18.4 million,respectively.  We wrote-off $1.7 millionof unamortized original issue discount and deferred financing costs to interestexpense in connection with the November 2006 repurchase.  Unamortized original issue discount anddeferred financing costs associated with the November 2007 and 2008repurchases were not significant.

 

Anannual excess cash flow payment with respect to the fiscal year endingJune 30, 2010 will not be required.  This is based on the Company’sfinancial position as of June 30, 2010 and its results of operations andcash flows for the year then ended.

 

Inaddition to the excess cash flow repurchases, the Company also repurchased$16,062,000 of the senior secured notes at 101% of their principal amount atmaturity, plus accrued and unpaid interest, for approximately $16.3 million onJune 29, 2007.  We wrote-off $1.4million of unamortized original issue discount and deferred financing costs tointerest expense in connection with the June 29, 2007 senior secured noterepurchase.

 

TheCompany purchased, at a discount, $6.0 million and $8.0 million of outstandingsenior secured notes on the open market in January 2008 andJune 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 gain on senior secured note purchase during the fiscal year endedJune 30, 2008.

 

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

 

TheCompany purchased, at a discount, $3.5 million, $5.0 million and $4.4 millionof outstanding senior secured notes on the open market in July 2009,November 2009 and December 2009, respectively.  A pre-tax gain of approximately $8.0 million,resulting from the difference between the carrying book value of the seniorsecured notes and the amount paid, net of deferred financing costs that werewritten-off at the time of purchase, was recorded to gain on senior securednote purchase during the fiscal year ended June 30, 2010.

 

OnFebruary 22, 2010, the Company commenced a debt tender offer (“**Tender Offer**”) to purchase up to approximately 51% of itsoutstanding 11-1⁄4% Senior Secured Notes due 2011 (the “**Notes**”).  The consummation of the Tender Offer was conditionedupon, among other conditions, the valid tender by holders of Notes with aminimum aggregate principal amount at maturity of $17,975,000 (the “**Minimum Tender Amount**”). At 11:59 p.m., New York City time, on March 19, 2010 theTender Offer expired and the Minimum Tender Amount of Notes was nottendered.  Consequently, the Company didnot purchase any Notes pursuant to the Tender Offer.

 

Inconnection with the Tender Offer, on February 22, 2010, the Company alsoentered into an agreement (the “**Originally Restated CreditAgreement**”) with HSBC and Cerberus, as the term lender, to amend andrestate the Credit Facility, by and among

 

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HSBC,as agent and lender, the other lenders signatory thereto from time to time, theCompany, and the other loan parties signatory thereto.  The closing of the Originally Restated CreditAgreement was subject to, among other things, the consummation of the TenderOffer in accordance with its terms. As noted above, the Tender Offer was notconsummated, as the Minimum Tender Amount was not satisfied, and accordingly, aclosing did not occur with respect to the Originally Restated Credit Agreementand the Company’s Credit Facility remains in full force and effect.

 

Thesenior secured notes indenture contains various covenants with which theCompany has to comply, including, but not limited to, covenants limiting orrestricting the Company’s ability to incur indebtedness, incur liens, enterinto mergers or consolidations, dispose of assets, make investments, paydividends and repurchase capital stock or enter into transactions withaffiliates.  In addition, the Company isrequired to report various financial and non-financial information periodicallyto the trustee.  The senior secured notesindenture also contains customary events of default including, but not limitedto, payment defaults, cross-defaults to other indebtedness in excess of $7.5million, material judgment defaults, bankruptcy and insolvency events, defectsin security interests, and change in control events.  An event of default could result in all debtbecoming due and payable.

 

Asnoted in Note 9 and Note 10 to our consolidated financial statements, theCompany’s Amended and Restated Financing Agreement expires on June 10,2011 and the Company’s senior secured notes mature on June 15, 2011.  Management currently does not believe thatthe Company will have sufficient cash on hand, based on current cash flowprojections, to settle the senior secured notes in June 2011 at principalor face value.  If the Company is unableto secure additional financing, its business and results from operations,financial condition and cash flows may be materially adversely affected andimpact the Company’s ability to continue as a going concern.  Consequently, management is currently in theprocess of exploring alternative long-term financing.  There can be no assurance that any suchfinancing will be available with terms favorable to the Company or at all.

 

Wemay from time to time seek to purchase our outstanding senior secured notes inopen market purchases, privately negotiated transactions or otherwise.  These purchases, if any, will depend onprevailing market conditions based on our liquidity requirements, contractualrestrictions and other factors.  Theamount of purchases of our senior secured notes may be material and may involvesignificant amounts of cash and/or financing availability.  Under the American Recovery and ReinvestmentAct of 2009 (**“the Act”**), the Company willreceive temporary relief under the Delayed Recognition of Cancellation of DebtIncome (**“CODI”**) rules. The Act contains aprovision, at the election of a corporation, allowing a five-year deferral ofCODI for debt purchased in 2009 or 2010, followed by recognition of CODIratably over the succeeding five years.  However,an electing corporation may be required to accelerate its deferred CODI andrecognize currently into income upon certain triggering events such asimpairment transactions, corporate reorganizations and changes in taxstatus.  Absent an acceleration event,the Company will continue to defer the recognition of CODI pursuant to theprovisions set forth in the Act.  Theprovision applies for specified types of purchases, including the acquisitionof a debt instrument for cash and the exchange of one debt instrument foranother.

 

Wecontinually review the capital expenditure needs for the business as theyrelate to the business’ information systems, infrastructure, and in-storeexpenditures and we anticipate that capital expenditures may increase in futureperiods.  We also anticipate that we willincur costs, which may be substantial, to improve our infrastructure as aresult of being a public company and support key branding/marketinginitiatives.

 

Thefollowing table summarizes our net cash provided by or used in our operating,investing and financing activities for the years ended June 30, 2010, 2009and 2008:

 
| ** **                                     | ** ** | **Year Ended  June 30, 2010** | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                     | ** ** | **(in thousands)**                      | ** ** |
| Net cash provided by (used in):                |       |                                         |       |                                         |       |                                         |       |
| Operating activities                           |       | $                                            | 7,703      |                                         | $          | 13,252                                       |       | $ | 16,872 |   |
| Investing activities                           |       | (273                                         | )          | (1,083                                       | )          | (966                                         | )          |
| Financing activities                           |       | (4,518                                       | )          | (11,602                                      | )          | (10,165                                      | )          |
| **Net increase in cash and cash  equivalents** | ** ** | **$**                                        | **2,912**  | ** **                                   | **$**      | **567**                                      | ** ** | **$** | **5,741** | ** ** |

 

***Operating Activities***

 

Cashflows provided by operating activities for the years ended June 30, 2010,2009 and 2008 were $7.7 million, $13.3 million and $16.9 million,respectively.  The decrease in cash flowsprovided by operating activities from 2009 to 2010 is primarily attributed tothe reductions in cash flow relating to the sale of aged inventory in 2009versus 2010, partially offset by a reduction in interest paid, income taxes(net of refunds), and timing of payments associated with inventorypurchases.  The decrease in cash flowsprovided by operating activities from 2008 to 2009 is the result of thedecrease in our operating income (excluding non-cash items) and income taxespaid in connection with our August 2008 senior secured note open marketpurchase, offset by reductions in 

 

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paymentsassociated with interest, planned reductions in current season inventorypurchases resulting from anticipated reductions in sales and sales of agedinventory to off-price customers. For each of the years ended June 30,2010, 2009 and 2008, 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 $25.8 millionand $34.5 million was recorded during 2009 and 2008, respectively related tothe decline in the fair value of the Rafaella trademark and trade nameintangible asset.  In addition, during2010, 2009 and 2008, a non-cash gain of $8.0 million, $25.6 million and $3.1million, respectively was recorded in connection with the senior secured notespurchases.

 

***Investing Activities***

 

Netcash used in investing activities for the years ended June 30, 2010, 2009and 2008 were $0.3 million, $1.1 million, and $1.0 million, respectively.  In 2010, the cash usage was a result ofcomputer and software ($0.2 million) and machinery and equipment ($0.1 million)capital expenditures.  In 2009, the cashusage was a result of computer and software ($0.4 million) and machinery andequipment ($0.5 million) capital expenditures. In 2008, the cash usage was a result of computer and software ($0.5million), machinery and equipment ($0.3 million) and leasehold improvement($0.2 million) capital expenditures.

 

***Financing Activities***

 

Netcash used in financing activities for the years ended June 30, 2010, 2009and 2008 were $4.5 million, $11.6 million, and $10.2 million,respectively.  In 2010, 2009 and 2008,the use of cash was primarily for our senior secured note repurchases and openmarket purchases discussed above.

 

***Off-Balance Sheet Arrangements***

 

Asof June 30, 2010, we had outstanding letters of credit totaling $6.2million in connection with purchase orders for merchandise from third-partymanufacturers and standby letters of credit totaling $4.0 million issued byHSBC, which serve as security for obligations under certain operating leases, acustoms bond and the GMAC Letter of Credit (refer to the “Due From Factor”section below for further discussion).

 

Weenter into employment and consulting agreements with certain of our employeesfrom time to time.  These contractstypically provide for severance and other benefits.  Individually, none of the contracts areexpected to be material, although in the aggregate, our obligations under thesecontracts could be significant. Additionally, we have certain operating leases, which are disclosed inthe consolidated financial statements.

 

TheCompany has no other off-balance sheet arrangements.

 

**DueFrom Factor**

 

Historically,the Company factored a significant portion of its trade receivables, on anon-recourse basis, with GMAC Commercial Finance LLC (**“GMAC”**),a commercial factor.  In accordance with the terms of an Amended andRestated Collection Services Factoring Agreement dated December 16, 2008between GMAC and the Company, all accounts receivable of the Company then heldby GMAC were sold back to the Company effective as of such date.  OnDecember 19, 2008, the Company delivered to GMAC a notice of terminationof the GMAC arrangement pursuant to the terms thereof.  OnFebruary 5, 2009, as part of the termination of the GMAC arrangement, theCompany arranged for an irrevocable letter of credit in an aggregate amount of$2,000,000 (the **“Letter of Credit”**) for thebenefit of GMAC.  The Letter of Credit permits GMAC to draw amounts equalto amounts collected by GMAC, after January 6, 2009, if certain identifiedcustomers of the Company file a petition for relief from creditors under theUnited States Bankruptcy Code and claims are made for GMAC to return to thecustomer or its bankruptcy estate amounts GMAC has collected from suchcustomer.  The Letter of Credit was subsequently reduced to $65,000 inSeptember 2009 and expires on April 2, 2011, subject to extensionunder certain circumstances.

 

OnDecember 19, 2008, the Company entered into a factoring agreement withWells Fargo Trade Capital, LLC (**“Wells Fargo”**),a commercial factor, pursuant to which the Company may sell certain of itsreceivables to Wells Fargo on a non-recourse basis.  Wells Fargo willassume credit risk on all sales that are approved in advance.

 

Wecan not borrow from Wells Fargo and GMAC and the amounts due from Wells Fargoand GMAC are pledged to our revolving credit facility lenders as security foramounts outstanding under our revolving credit facility.

 

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**ContractualCash Obligations**

 

Thefollowing table sets forth our known contractual cash obligations for theperiods 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                               |       | $                                        | 71,861     |   | $ | 71,861 |   | $ | **—** |   | $ | **—** |   | $ | **—** |   |
| Interest on senior secured notes                   |       | 8,084                                    |       | 8,084 | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** |
| ASC 740 (formerly FIN 48) liabilities and interest |       | 121                                      |       | 11 |   | 110 | ** ** | **—** | ** ** | **—** | ** ** |
| Operating lease obligations                        |       | 4,063                                    |       | 1,798 |   | 2,265 | ** ** | **—** | ** ** | **—** | ** ** |
| Purchase obligations                               |       | 29,835                                   |       | 29,835 | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** |
| Total contractual cash obligations                 |       | $                                        | 113,964    |   | $ | 111,589 |   | $ | 2,375 |   | $ | **—** |   | $ | **—** |   |

 

Thistable does not reflect revolving direct debt advances of up to $5.0 million onor after December 16, 2010 to be provided under our Amended and RestatedFinancing Agreement.  The  Amended and Restated Financing Agreementmatures on June 10, 2011.

 

***Effects of Inflation***

 

Althoughour purchases from foreign manufacturers are made in U.S. dollars, mitigatingany foreign exchange rate risk on purchase commitments, we may be subject tohigher prices charged by our manufacturers to compensate for inflation or othermarket forces in such countries.

 

**RecentAccounting Pronouncements**

 

InJune 2009, the Financial Accounting Standards Board (“**FASB**”)issued the authoritative guidance to eliminate the historical GAAP hierarchyand establish only two levels of U.S. GAAP, authoritative andnon-authoritative. When launched on July 1, 2009, the FASB AccountingStandards Codification (“**ASC**”) becamethe single source of authoritative, nongovernmental GAAP, except forrules and interpretive releases of the SEC, which are sources ofauthoritative GAAP for SEC registrants. The subsequent issuances of newstandards will be in the form of Accounting Standards Updates that will beincluded in the ASC. This authoritative guidance was effective for financialstatements for interim or annual reporting periods ended afterSeptember 15, 2009. The Company adopted the new codification in the firstquarter of fiscal 2010 and it did not have any impact on the Company’sconsolidated financial statements.

 

InJune 2009, the FASB issued an amendment to the accounting and disclosurerequirements for the consolidation of variable interest entities (“**VIE**”) and the evaluation of when consolidation of a VIE isrequired. This amends the guidance for determining whether an entity is a VIEand establishes an additional reconsideration event for assessing whether anentity is, or continues to be, a VIE. The amendment modifies the requirementsfor determining whether an entity is the primary beneficiary of a VIE andrequires ongoing reassessments of whether an entity is the primary beneficiary.This amendment also enhances the disclosure requirements about an entity’sinvolvement with a VIE. This amendment is effective as of the beginning of eachreporting entity’s first annual reporting period that begins afterNovember 15, 2009, for interim periods within that first annual reportingperiod, and for interim and annual reporting periods thereafter. Earlierapplication is prohibited. The Company is evaluating the impact the adoption ofthis amendment will have on its consolidated financial statements.

 

InJune 2009, the FASB issued an amendment to the accounting and disclosurerequirements for transfers of financial assets. This amendment eliminates theconcept of qualifying special purpose entities for accounting purposes. Thisamendment limits the circumstances in which a financial asset, or a componentof a financial asset, should be derecognized when the entire asset is nottransferred, and establishes specific conditions for reporting the transfer ofa portion of a financial asset as a sale. This amendment also requires enhanceddisclosures about the transfer of financial assets and the transferor’scontinuing involvement with transferred financial assets.  The amendment is effective as of thebeginning of each reporting entity’s first annual reporting period that beginsafter November 15, 2009, for interim periods within that first annualreporting period and for interim and annual reporting periods thereafter. TheCompany is evaluating the impact the adoption of this amendment will have onits consolidated financial statements.

 

InMay 2009, the FASB issued a new provision on subsequent events whichrequired the disclosure of the date through which an entity has evaluatedsubsequent events for potential recognition or disclosure in the financialstatements and whether that date represents the date the financial statementswere issued or were available to be issued.  This standard also providesclarification about 

 

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circumstancesunder which an entity should recognize events or transactions occurring afterthe balance sheet date in its financial statements and the disclosures that anentity should make about events or transactions that occurred after the balancesheet date.  This standard was amended in February 2010, whereby theamendments eliminate the requirement for the disclosure of the date throughwhich subsequent events were evaluated. The amendments are effective uponissuance of the update, and the adoption of the amendments did not have anyimpact on the Company’s consolidated financial statements.

 

InSeptember 2006, the FASB issued authoritative guidance which defines fairvalue, establishes a framework for measuring fair value under GAAP and expandsfair value measurement disclosures. The guidance does not require new fairvalue measurements and is effective for financial statements issued for fiscalyears beginning after November 15, 2007 and interim periods within thosefiscal years. In February 2008, the FASB issued guidance which allows fora one-year delay of the effective date for fair value measurements for allnon-financial assets and liabilities, except for those that are recognized ordisclosed at fair value in the financial statements on a recurring basis. TheCompany delayed the effective date and applied the measurement provisions forall non-financial assets and liabilities that are recognized at fair value inthe consolidated financial statements on a non-recurring basis untilJuly 1, 2009. The Company’s non-recurring non-financial assets andliabilities include long-lived assets and intangible assets. The adoption ofthe guidance for financial assets and liabilities and for non-recurringnon-financial assets and liabilities did not have a significant impact on theCompany’s consolidated financial statements. In January 2010, the FASBissued amendments to disclosure and classification requirements for fair valuemeasurement and disclosures.  Theseamendments are effective for interim and annual reporting periods beginningafter December 15, 2009, except for the disclosures about purchases,sales, issuances, and settlements in the rollforward activity in Level 3 fairvalue measurements, which are effective for fiscal years beginning after December 15,2010, and for interim periods within those fiscal years.  The adoption of the amendments did not haveany impact on the Company’s consolidated financial statements.

 

InApril 2008, the FASB issued authoritative guidance which amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible asset.The intent of the authoritative guidance is to improve the consistency betweenthe useful life of a recognized intangible asset and the period of expectedcash flows used to measure the fair value of the asset. The authoritativeguidance is effective for fiscal years beginning after December 15, 2008,and early adoption is prohibited. The measurement provision will apply only tointangible assets acquired after the effective date. The Company adopted thisauthoritative guidance effective July 1, 2009.  The adoption of the guidance which amends thefactors to be considered in developing renewal or extension assumptions used todetermine the useful life of a recognized intangible asset did not have asignificant impact on the Company’s consolidated financial statements.

 

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

 

Marketrisk represents the risk of loss that may impact our financial position,results of operations or cash flows due to adverse changes in financial productmarket prices and rates.  We are exposedto market risks, including changes in interest rates and a reduction in thevalue of the dollar.

 

Marketrisks related to our operations result primarily from changes in interestrates.  Our interest rate exposurerelates primarily to our variable interest line of credit.  Borrowings under the credit facility bearvariable interest at the Company’s option at either (i) a base rate or(ii) the London interbank offered rate plus two and three-quarters percent(2.75%) per annum (each rate as defined in the Amended and Restated FinancingAgreement).  Our interest expense on theline of credit is based on variable rates, as discussed in Note 9 to ourconsolidated financial statements included elsewhere herein.  There were no loan borrowings or repaymentsunder the Amended and Restated Financing Agreement during the fiscal year endedJune 30, 2010.  At June 30,2010, there were no loans outstanding under the Amended and Restated FinancingAgreement.

 

Whenpurchasing apparel from foreign manufacturers, we use letters of credit thatrequire the payment in U.S. currency upon receipt of bills of lading for the productsand other documentation.  Prices arefixed in U.S. dollars at the time the purchase orders and/or letters of creditare issued, which mitigates the risk of a reduction in the value of the dollar.  However, purchase prices for the Company’sproducts may be impacted by fluctuations in the exchange rate between the U.S.dollar and the local currencies of the foreign manufacturers, which may havethe effect of increasing the Company’s cost of goods in the future.  Due to the number of currencies involved andthe fact that not all foreign currencies react in the same manner against theU.S. dollar, the Company cannot quantify in any meaningful way the potentialeffect of such fluctuations on future income. The Company does not engage in hedging activities with respect to suchexchange rate risk.

 

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

 

Financialstatements required by this item appear with an Index to Financial Statementsand Schedules, starting on page F-1 of this report.

 

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**ITEM 9.****                ****CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None.

 

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

 

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

 

TheCompany maintains disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Exchange Act), which aredesigned to ensure that information required to be disclosed by the Company inthe reports we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms, and that such information is accumulatedand communicated to our management, including its Chief Executive Officer andChief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

Asof the period ended June 30, 2010 (the **“EvaluationDate”**), 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’sAssessment of Internal Control Over Financial Reporting**

 

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange ActRules 13a-15(f) and 15d-15(f). Our internal control over financial reporting includes those policiesand procedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the Company are being madeonly in accordance with authorizations of management and directors of theCompany; and (iii) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of our assets thatcould have a material effect on the financial statements.

 

Internalcontrol over financial reporting is designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements prepared for external purposes in accordance withgenerally accepted accounting principles. Because of its inherent limitations, internal control over financialreporting 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.

 

Underthe supervision and with the participation of our Chief Executive Officer andChief Financial Officer, management conducted an evaluation of theeffectiveness of our internal control over financial reporting as ofJune 30, 2010 based on the framework in *InternalControl — Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission and in accordance with theinterpretive guidance issued by the SEC in Release No. 34-55929.  Based on that evaluation, managementconcluded that our internal control over financial reporting was effective asof June 30, 2010.

 

Thisannual report does not include an attestation report of our registered publicaccounting firm regarding internal control over financial reporting.  Management’s report was not subject toattestation by our registered public accounting firm pursuant to therules of the Securities and Exchange Commission that permit the Company toprovide only management’s report in this annual report.

 

**Changesin Internal Control Over Financial Reporting**

 

Therehave been no changes in our internal control over financial reporting that haveoccurred during our fiscal quarter ended June 30, 2010 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**ITEM 9B.               OTHERINFORMATION**

 

*Amendedand Restated Employment Agreement; Equity Incentive Award*

 

OnOctober 13, 2010, the Company entered into an Amended and RestatedEmployment Agreement with Richard Metzger in connection with the promotion of Mr. Metzgerto Executive Vice-President of Design of the Company.

 

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Priorto Mr. Metzger’s promotion, Mr. Metzger served as Vice-President ofDesign of the Company.  Mr. Metzger’samended agreement provides for, among other things, an increase in Mr. Metzger’s(i) annual base salary, from $315,000 to $375,000, and (ii) targetbonus, from 25% of his base salary to 50% thereof.  In addition, pursuant to the terms of hisamended agreement, Mr. Metzger will be entitled to receive an equity grantto be determined by the Company’s board of directors, subject to the terms andconditions of the Company’s Equity Incentive Plan and customary documentationwith respect thereto.

 

OnSeptember 16, 2010, the Company’s board of directors also approved thegrant of options to Mr. Metzger pursuant to the Company’s Equity IncentivePlan to purchase 111,111 shares of common stock of the Company, exercisable for$5.33 per share, to Mr. Metzger. One quarter of Mr. Metzger’s optionsvest on each of the first, second, third and fourth anniversaries of the grantdate.

 

Theforegoing summary of each of Mr. Metzger’s amended and restated employmentagreement and equity incentive award agreement does not purport to be completeand is qualified in its entirety by each such agreement, both of which areattached hereto as Exhibits 10.48 and 10.49 and incorporated herein byreference.

 

**PART III**

 

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

 

Thefollowing table sets forth certain information regarding the members of ourboard of directors and executive officers. All directors are elected annually and hold office until theirsuccessors are elected and qualified, or until their earlier removal orresignation.

 
| **Name**            | ** ** | **Age** | ** ** | **Position**                                         |
|---------------------|------------|---------|------------|------------------------------------------------------|
| Christa  Michalaros |       | 49      |       | Chief  Executive Officer and Director                |
| Lance  D. Arneson   |       | 35      |       | Chief  Financial Officer                             |
| Rosemary  Mancino   |       | 53      |       | President  of Sales & Planning              |
| Nichole  Vowteras   |       | 53      |       | Executive  Vice President of Sourcing and Production |
| Richard  Metzger    | ** ** | 42      |       | Executive  Vice President of Design                  |
| John  Kourakos      |       | 61      |       | Director,  Chairman of the Board                     |
| George  Kollitides  |       | 40      |       | Director                                             |
| Joel  H. Newman     |       | 69      |       | Director                                             |
| Ronald  Frankel     |       | 73      |       | Director                                             |
| Robert  Newman      |       | 66      |       | Director                                             |

 

**Christa Michalaros** became our Chief ExecutiveOfficer and one of our directors on April 25, 2006.  From 1999 to2005, Ms. Michalaros served as the President of the Tommy HilfigerWomenswear Division.  Before joiningTommy Hilfiger, Ms. Michalaros was at Liz Claiborne from 1981 to1999.  At Liz Claiborne, Ms. Michalaros moved up through the salesorganization in positions of increasing responsibility in their casual andcareer divisions.  Her last position at Liz Claiborne was the President ofLiz Claiborne Casual, a nearly one billon dollar division.  All of theaforementioned companies are principally in the business of women’s apparel.

 

**Lance D. Arneson** became our Chief FinancialOfficer in November 2009, and, prior to that time, was our Vice Presidentof Finance from April 2009 to October 2009 and our Controller fromDecember 2006 to March 2009. Prior to joining Rafaella as our Controller, Mr. Arneson was aSenior Manager with PricewaterhouseCoopers LLP (**“PwC”**)from September 2004 until joining the Company, and prior to that time,Mr. Arneson served as a Manager with PwC commencing in 2001.

 

**Rosemary Mancino** became our President of Sales &Planning on August 1, 2006. Ms. Mancino joined Rafaella with nearly 30 years of retail/apparelexperience.  Prior to joining Rafaella,Ms. Mancino was employed as Senior Vice President Sales, Retail Planningand In Store Services for five years by Tommy Hilfiger USA.  Prior to that she was employed by LizClaiborne for ten years, where her last position was serving as VicePresident/General Manager of Sales for the Liz Claiborne casual division.  All of the aforementioned companies areprincipally in the business of women’s apparel.

 

**Nichole Vowteras** became our Executive Vice President ofSourcing and Production on May 1, 2006. Prior to her joining Rafaella as Vice President—Sourcing and Production,Ms. Vowteras was employed as Vice President of Manufacturing for GarfieldMarks for 2.5 years, as Senior Vice President of Production forGuess, Inc. for one year and with Reebok for eight years, where her lastposition was serving as Vice President of Worldwide Sourcing.  All of the aforementioned companies areprincipally in the business of women’s apparel and footwear.

 

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**Richard Metzger**became our Executive Vice President of Designon October 13, 2010.  Mr. Metzgerpreviously served as Vice President of Design of the Company since October 2007.  A graduate of the Fashion Institute ofTechnology, Mr. Metzger has held senior design positions within thewomen’s apparel business for more than 20 years. Mr. Metzger started hiscareer at Liz Claiborne, moving on to senior design positions at AdrienneVittadini, Anne Klein, and Dana Buchman. In 1999, Mr. Metzger launched his own signature collection ofdesigner plus size apparel.  Mr. Metzgerhas also served as a design consultant to Hanes Brand’s “JMS” line, Saks FifthAvenue private brands, Heidi Weisel, and Essendi.  Prior to joining Rafaella, Mr. Metzgerwas the Creative Director at Hampshire Brands from 2006 to 2007 and the DesignDirector for Garfield Marks from 2001 to 2006. All of the aforementioned companies are principally in the business ofwomen’s apparel.

 

**John Kourakos** is Chairman of the Board of Directors andwas elected as a director in 2007. Mr. Kourakos has over 25 years of experience in the apparelindustry.  Most recently 2002 to 2004, hewas Group President of Warnaco’s Sportswear group which included the CalvinKlein Jeans, Calvin Klein Underwear and Chaps by Ralph Lauren divisions.  Prior to that, 1996 to 2001, he was Presidentof the Men’s Sportswear and Tommy Jeans divisions at Tommy Hilfiger.  Before joining Tommy Hilfiger, he wasPresident of Warnaco’s Calvin Klein Men’s and Women’s Underwear/Calvin KleinMen’s Accessories division from 1994 to 1996. Mr. Kourakos also served in a number of other key managementpositions including President of Calvin Klein Menswear at CalvinKlein, Inc., where he managed the men’s lines of Calvin Klein jeans,underwear and sportswear, and as Vice President of Sales for the Ralph LaurenWomenswear line and Executive Vice President of Merchandising for the CalvinKlein line at Bidermann Industries.

 

**George Kollitides** is one of our directors and was elected as adirector in 2005.  Mr. Kollitides isa Managing Director at Cerberus.  From2001 to 2003, Mr. Kollitides was President and Managing Director of TenXCapital Management, a special situations investor affiliated withCerberus.  Prior to joining TenX, Mr. Kollitidesactively invested in numerous private equity transactions for CattertonPartners, a middle market private equity group from 1998 to 2001.  Prior to joining Catterton, Mr. Kollitidesheld various positions of increasing responsibility at General Electric Capitalin the Equity, Corporate Finance, and Corporate Restructuring Groups, focusingon leveraged recapitalizations, reorganizations, change of control transactionsand minority equity investments from 1990 through 1997.  Mr. Kollitides received an MBA inFinance and Management of Organizations from Columbia Business School and a BAin Economics from Lafayette College.  Mr. Kollitidesalso serves on the board of directors of IAP Worldwide Services, Freedom Group, Inc.,Tier 1 Group and Control Solutions LLC.

 

**Joel H. Newman** was elected as a director in July 2009. Mr. Newman most recently served as Vice Chairman and ChiefOperating Officer of Kenneth Cole Productions, Inc. from 2006 until2007.  Prior to that, Mr. Newman spent more than a decade at TommyHilfiger Corporation (“**THC**”), holdinga variety of roles, finally as Executive Vice President of Finance andOperations of THC and Chief Operating Officer of Tommy HilfigerU.S.A., Inc., THC’s principal U.S. operating subsidiary.

 

**Ronald Frankel** is a member of our Board ofDirectors and was elected as a director in 2005 and he had been employed by ourpredecessor since co-founding Rafaella Sportswear, Inc. in 1982.  Prior to founding our predecessor,Mr. Frankel worked as an independent sales representative selling theBooth Bay and Mr. Thompson lines of women’s wear, worked as an in-housesales representative for YSL Sportswear and managed a start-up division atBodin Apparel, Inc, a women’s apparel company.  Mr. Frankel has held various positionsin the apparel industry for over 40 years.

 

**Robert Newman** is a member of our Board ofDirectors and was elected as a director in 2005 and he had been employed by ourpredecessor as Vice President of 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**

 

TheCompany has adopted a Code of Business Conduct, which applies to all employeesand officers of the Company and provides that, in the conduct of all corporateactivities, integrity and ethical conduct is expected.  In addition, the Code of Business Conductaddresses and provides guidance on a number of business-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 the Chief Financial Officer, Rafaella Apparel Group, Inc., 1411 Broadway,New York, New York 10018.

 

**AuditCommittee Financial Expert**

 

OurBoard of Directors has separately designated an audit committee and thefunctions of a traditional audit committee are carried out by three of themembers of the Board, Messrs. Kourakos, Kollitides and J. Newman, of whomMr. Kourakos and Mr. J. Newman are independent.  Our Board has determined that each member ofthe Board is financially literate but no determination has been made as to the abilityof any director to qualify as a “financial expert” within the meaning of theregulations 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.

 

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**ITEM 11.               EXECUTIVECOMPENSATION**

 

**COMPENSATIONDISCUSSION AND ANALYSIS**

 

***Overview***

 

ThisCompensation Discussion and Analysis, or CD&A, is intended to provideinformation regarding the Company’s executive compensation program andpractices.  This CD&A covers avariety of topics, including:  theCompany’s compensation philosophy regarding executive compensation, the role ofour Compensation Committee in setting the compensation of our executiveofficers, and executive compensation decisions for fiscal 2010.

 

***Compensation Philosophy***

 

TheCompany is committed to achieving long-term, sustainable growth and increasingstockholder value.  The Company’scompensation program for our executive officers is designed to support these objectivesand encourage strong financial performance on an annual basis by awardingannual performance bonuses, and on a long-term basis by linking a portion ofour executive officers’ total compensation to Company performance in the formof equity incentive compensation.  TheCompany’s compensation philosophy is to set our executive officers’compensation, which principally includes base salary, annual performance bonus,and long-term equity incentives, at levels that will attract, motivate, andretain superior executive talent in a highly competitive environment.

 

***Role of the Compensation Committee***

 

OurCompensation Committee sets the compensation of our executive officers,including the mix of base salary, annual performance bonus, and long-termequity incentives.  Our CompensationCommittee also sets the financial performance targets for our executiveofficers’ annual performance bonuses. Our Compensation Committee consists of Ms. Michalaros andMessrs. Kourakos, Kollitides and Frankel, of whom Mr. Kourakos isindependent.

 

Tomaintain the effectiveness of our executive officer compensation program, andkeep it consistent with our compensation philosophy, our Compensation Committeetakes into account the Company’s growth and profitability, individual executiveofficer performance, the nature and scope of each executive officer’sresponsibilities, and each officer’s effectiveness in supporting the Company’slong-term goals.  Our CompensationCommittee also considers the recommendations of our Chief Executive Officerregarding the base salary and annual performance bonus of our executiveofficers, other than her own.

 

***Total Compensation***

 

Insetting a total compensation target for each executive officer, we considerobjective and subjective factors, such as individual and Company performance,prior equity awards, potential future earnings from equity awards, retention,and motivation.

 

In2010, as set forth in more detail in the Summary Compensation Table, the totalcompensation of our Chief Executive Officer was $1,481,002; the totalcompensation of our Chief Financial Officer was $458,422; the totalcompensation of our President of Sales & Planning was $625,730; thetotal compensation of our Executive Vice President Sourcing and Production was$609,673 and the total compensation of our Vice-President of Design was$403,423.

 

***Base Salary***

 

Insetting our executive officers’ base salaries we take into considerationsubjective factors, such as the relative responsibilities of each executiveofficer, the cross-functional leadership roles, business contributions andexperience.

 

Asdiscussed further below under the heading Employment Agreements, our executiveofficers have employment agreements with the Company.  These employment agreements were entered intoby each of our executive officers upon becoming executive officers of theCompany, and provide the executive officers with threshold base salarylevels.  Each year, our CompensationCommittee evaluates whether it is appropriate to approve salaries in excess ofthe contractual minimums.  In 2010, weprovided our Chief Executive Officer, Chief Financial Officer, President ofSales & Planning, Executive Vice President Sourcing and Production,and Vice-President of Design, with base salaries of $700,000, $282,692, $400,000,$400,000, and $315,000, respectively.

 

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***Annual Performance Bonus***

 

Ourpractice is to make cash performance bonuses a significant component of ourexecutive officers’ total compensation. We believe this design aligns the interests of our executive officerswith the interests of our stockholders.

 

OurCompensation Committee approves a target bonus for each executive officer thatis based on a percentage of their base salaries.  In establishing these bonus targets, theCompensation Committee considers our executive officers’ potential totalcompensation in light of the Company’s compensation philosophy and market practices.  The executive officers can earn their targetbonuses based upon the Company’s achievement of pre-determined financialperformance targets.  Our CompensationCommittee has the discretion not to award performance bonuses, even if theCompany 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).

 

Ourexecutive officers can earn from 0% to 200% of their target performance bonusbased upon the Company’s achievement of pre-determined Earnings BeforeInterest, Taxes, Depreciation, and Amortization (“**EBITDA**”)targets established by the Compensation Committee.  We attempt to establish the financialperformance target(s) at challenging levels that are reasonably attainableif we meet our performance objectives. Due to confidentiality and the possibility of competitive harm to theCompany, we do not disclose the specific performance targets necessary for ourexecutive officers to receive the annual performance bonus described in thisparagraph.  Based upon the performance ofthe Company in 2010, each of our executive officers qualified for performancebonuses. We provided our Chief Executive Officer, Chief Financial Officer,President of Sales & Planning, Executive Vice President Sourcing andProduction, and Vice-President of Design, with performance bonuses of $700,000,$150,000, $200,000, $200,000, and $78,750, respectively. Based upon theperformance of the Company in 2009, none of our executive officers qualifiedfor performance bonuses (with the exception of Mr. Arneson, who received aperformance bonus of $14,000 based upon a determination by our CompensationCommittee independent of any EBITDA targets).

 

***Equity Incentives***

 

OurEquity Incentive Plan (the “**Plan**”) allowsfor various types of equity awards, including stock options and restricted stock.  Awards under our Plan have been granted toattract, motivate, and retain our executive officers.  Such awards have been granted in connectionwith each of the executive officers employment agreements. During fiscal 2010, Messrs. Arnesonand Kourakos received a stock option grant for 111,111 shares of common stockeach.

 

Allawards under our Plan must be approved by our Compensation Committee.  Our Compensation Committee determines thetype, timing, and amount of equity awards granted to each of our executiveofficers after considering their base salary and target performance bonus inrelation to the Company’s compensation philosophy.

 

Awardsgranted under the Plan have been limited to time-based stock options.  All of the awards vest in annual incrementsof 25% over the first four years of the grant, expire no later than ten yearsafter the grant date, and have an exercise price of $5.33 per share (theJune 20, 2005 redemption value of the redeemable convertible preferredstock).  No options were exercised duringfiscal 2010.

 

***Pension and retirement benefits***

 

Ournamed executive officers do not participate in any deferred benefit retirementplans such as a pension plan.

 

***Non-qualified deferred compensation***

 

Wedo not have any deferred compensation programs for our named executiveofficers.

 

***Other benefits***

 

Weprovide private health care insurance to some of our named executives.

 

***Perquisites and Other Benefits***

 

Pursuantto the Company’s 401(k) plan, the Company provides its executives the samelevel of matching contributions available to all eligible employees, subject tothe provisions of the 401(k) plan and Internal Revenue Servicelimitations.  Additional 

 

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informationon executive officer perquisites and other benefits can be found in thefootnotes to the Fiscal 2010****SummaryCompensation Table in this Form 10-K.

 

***Employment Agreements***

 

Employmentagreements for senior management are used by the Company to establish keyelements of the agreement between the Company and the executive, including theminimum periods of employment and the fundamental elements of compensation, aswell as the details of the individual arrangement that differ from the Company’sstandard plans and programs.  Theemployment agreements with executive officers are discussed in detail below, inthe section entitled “Compensation of Executive Officers—Employment Agreementsand Potential Payouts upon Termination or Change in Control.” Also, detailed inthat section are the potential payouts for each of the officers under thevariety of potential termination scenarios covered by the agreements.

 

**COMPENSATIONOF EXECUTIVE OFFICERS**

 

***Employment Agreements and Potential Payments upon a Termination orChange in Control***

 

Thefollowing is a description of the current employment arrangements between usand the named executive officers, including the specific circumstances relatingto termination of employment and change in control of the Company that willtrigger payments to each named executive officer and a calculation of theestimated payments to such officers as a result of the occurrence of suchevents had they occurred on June 30, 2010, the end of the Company’s lastfiscal year.

 

**ChristaMichalaros**

 

Wehave entered into an employment agreement with Christa Michalaros, our ChiefExecutive Officer, which commenced on April 25, 2006.  Under the terms of the agreement, the initialperiod was from April 25, 2006 through June 30, 2007; thereafter, theagreement and the employment relationship created thereunder will continue forconsecutive 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 or substantiallyall of the business and assets of the Company, whether by sale of assets,merger or otherwise to a person other than an Affiliate of Cerberus;(3) if specified by the Board in an Award Agreement at the time of grant,the consummation of an Initial Public Offering; or (4) the dissolution orliquidation of the Company.

 

UnderMs. Michalaros’ employment agreement, the following payments will be madeto her or her representatives if (1) she is terminated by the Company forCause (generally defined as conviction for the commission of a felony;dishonesty; refusal to follow directions of the Board; gross nonfeasance;breach of confidentiality or restrictive covenant provisions; or certain otherinstances of willful misconduct); (2) her employment terminates due to herdeath; (3) the Company terminates her employment due to her disability(meaning a determination by the Company in accordance with applicable law thatas a result of a physical or mental injury or illness, Ms. Michalaros isunable to perform the essential functions of her job with or without reasonableaccommodation for a period of (i) 90 consecutive days; or (ii) 180days in any one (1) year period); or (4) she resigns for any reason:

 

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

 

(b)                                 the unpaidportion of the Bonus, if any, relating to the fiscal year prior to the fiscalyear of her disability, 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 shemay have under the Company’s benefit plans and the Consolidated Omnibus BudgetReconciliation Act of 1986 (“**COBRA**”), andany rights she may have to indemnification pursuant to the agreement, theby-laws or certificate of incorporation of the Company, or otherwise under law,and any rights she may have under any directors and officers liability policiesmaintained by the Company or its affiliates.

 

ShouldMs. Michalaros terminate her employment by making an election not to renewthe term as provided in the agreement, she shall receive the payments set forthabove and the bonus for the fiscal year ending at the end of the term,determined in accordance with the terms of the agreement (assuming thisoccurred on the last day of fiscal 2010 the amount would have been $700,000),payable

 

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** **

ninety(90) days after the end of the fiscal year; provided that the Company in itssole discretion may elect, by written notice given no later than fifteen (15) daysprior to the end of the term, to pay to the Executive the incremental severancepayments set forth in sections (a) and (b) of the next paragraph inexchange for her (i) agreement to be subject to and legally bound by thenon-competition and property covenants set forth in the agreement and(ii) execution and nonrevocation of a valid release agreement in a formreasonably acceptable to the Company and Ms. Michalaros.

 

IfMs. Michalaros is terminated by the Company without Cause, or leaves heremploy for “Good Reason” as that term is defined in the agreement, or theCompany elects not to renew the term, in addition to the payments upontermination specified in the previous paragraph, Ms. Michalaros willreceive, upon execution without revocation of a valid release agreement in aform reasonably acceptable to the Company:

 

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

 

(b)                                 continued basesalary for twelve (12) months after the date of termination, payable on thelast business day of the month; and

 

(c)                                  a proratedbonus equal to the bonus earned as of the date of termination based on theachievement of prorated performance measures derived from the annual businessplan for the fiscal year of termination as measured on the date of termination,payable in a lump sum within thirty (30) days after the date of termination.

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

 

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(1)          Assumes the Company wouldnot elect to make certain discretionary payments.

 

(2)          Non-vested options areforfeited. Fair market value is currently calculated as below the exerciseprice, therefore it is assumed options would not be exercised.

 

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

 

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

 

(5)          The cash severance summaryassumes the executive did not receive a bonus.

 

**LanceD. Arneson**

 

Weentered into an amended and restated employment agreement with Lance D.Arneson, our Chief Financial Officer, dated as of November 2, 2009.

 

Mr. Arneson’samended and restated employment agreement provides, among other things for (i) anannual base salary of $300,000, and (ii) a target bonus of 50% of his basesalary.

 

Theagreement provides for payments to be made to Mr. Arneson upon certaintermination events.

 

UnderMr. Arneson’s employment agreement, the following payments will be made tohim or his representatives if (1) he is terminated by us for Cause(generally defined as conviction for the commission of a felony; dishonesty;refusal to follow directions of the Board; gross nonfeasance; breach ofconfidentiality or restrictive covenant provisions; or certain other instancesof willful misconduct); (2) his employment terminates due to his death;(3) the Company terminates his employment due to his disability (meaning adetermination by the Company in accordance with applicable law that as a resultof a physical or mental injury or illness,

 

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Mr. Arnesonis unable to perform the essential functions of his job with or withoutreasonable accommodation for a period of (i) 90 consecutive days; or(ii) 180 days in any one (1) year period); or (4) the he resignsfor any reason:

 

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

 

(b)                                 the unpaidportion of his bonus, if any, relating to the fiscal year prior to the fiscalyear of his death, disability, resignation or termination by the Company forCause;

 

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

 

(d)                                 any rights he mayhave under the Company’s benefit plans and COBRA.

 

Ifwe were to terminate Mr. Arneson without Cause, in addition to thepayments upon termination specified in (a) through (d), above,Mr. Arneson will receive, upon execution without revocation of a validrelease agreement in a form reasonably acceptable to the Company continued basesalary for six (6) months after the date of termination.

 
| **Component of  Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Company  without  Cause** | ** ** | **Termination  by the  Company  by Notice of  Intent not to  Renew** | ** ** | **Termination  upon the  Executive’s  Death or  Disability** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                  |       |                                                                                          |       |                                                                        |       |                                            |       |
| Cash Severance                      |       | —                                       | (1)        | —                                                |       | $                                                     | 150,000    |                                                                                          | $          | 150,000                                                                     | (1)        | —                                          |       | — |   |
| Stock  Options                      |       | —                                       | (2)        | —                                                |       | —                                                | (2)        | —                                                                                        | (2)        | —                                                                      | (3)        | —                                          | (4)        |
|                                     |            |                                              |            |                                                       |            |                                                       |            |                                                                                               |            |                                                                             |            |                                                 |            |  |  |

 

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(1)          The cash severance summaryassumes the executive did not receive a bonus.

 

(2)   Non-vested options areforfeited. Fair market value is currently calculated as below the exerciseprice, therefore it is assumed options would not be exercised.

 

(3)   Non-vested options areforfeited; vested options may be exercised by Ms. Michalaros’ representativeuntil one year or expiration. It is assumed options would not be exercisedcurrently due to the issue discussed in (2) above.

 

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

 

**NicholeVowteras**

 

Weentered into an employment agreement with Nichole Vowteras, our Executive VicePresident Sourcing and Production, which commenced on May 1, 2006. Underthe terms of the agreement, the term is from May 1, 2006 until heremployment is terminated by any of the methods discussed below. Ms. Vowteraswill also be entitled to certain payments under our Equity Incentive Plan inthe event a “Liquidity Event” occurs, which is defined as (1) any Personwho is (i) not an Affiliate of the Company or (ii) not Cerberus or anAffiliate of Cerberus becomes the beneficial owner, directly or indirectly, offifty percent (50%) or more of the combined voting power of the thenoutstanding voting securities of the Company; (2) the sale, transfer orother disposition of all or substantially all of the business and assets of theCompany, whether by sale of assets, merger or otherwise to a person other thanan Affiliate of Cerberus; (3) if specified by the Board in an AwardAgreement at the time of grant, the consummation of an Initial Public Offering;or (4) the dissolution or liquidation of the Company.

 

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

 

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

 

(b)                                 the unpaidportion of the bonus, if any, relating to the fiscal year prior to the fiscalyear of her death, disability, resignation or termination by the Company forCause, payable in accordance with the terms of the agreement;

 

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

 

(d)                                 any rights shemay have under the Company’s benefit plans and COBRA.

 

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IfMs. Vowteras is terminated by the Company without Cause, in addition tothe benefits described in the previous paragraph, she will receive, uponexecution without revocation of a valid release agreement in a form reasonablyacceptable to the Company, continued payment of her base salary for six monthsfollowing 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 are forfeited.Fair market value is currently calculated as below the exercise price,therefore it is assumed options would not be exercised.

 

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

 

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

 

**RosemaryMancino**

 

Weentered into an employment agreement with Rosemary Mancino, our President ofSales & Planning, which commenced on August 14, 2006. Under theterms of the agreement, the term is from August 14, 2006 until heremployment is terminated by any of the methods discussed below. Ms. Mancinowill also be entitled to certain payments under our Equity Incentive Plan inthe event a “Liquidity Event” occurs, which is defined as (1) any 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.

 

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

 

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

 

(b)                                 the unpaidportion of the bonus, if any, relating to the fiscal year prior to the fiscalyear of her death, disability, resignation or termination by the Company forCause, payable in accordance with the terms of the agreement;

 

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

 

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

 

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IfMs. Mancino is terminated by the Company without Cause, in addition to thebenefits described in the previous paragraph, she will receive, upon executionwithout revocation of a valid release agreement in a form reasonably acceptableto the Company, continued payment of her base salary for six months followingthe 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 is currently calculated as below the exerciseprice, therefore it is assumed options would not be exercised.

 

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

 

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

 

**RichardMetzger**

 

We entered into an amendedand restated employment agreement with Richard Metzger, our Executive VicePresident of Design, on October 13, 2010. Mr. Metzger’s amended andrestated employment agreement provides, among other things for (i) anannual base salary of $375,000 and (ii) a target bonus of 50% of his basesalary.

 

The agreement provides forpayments to be made to Mr. Metzger upon certain termination events.

 

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

 

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

 

(b)                                 the unpaidportion of his bonus, if any, relating to the fiscal year prior to the fiscalyear of his death, disability, resignation or termination by the Company forCause;

 

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

 

(d)                                 any rights hemay have under the Company’s benefit plans and COBRA.

 

If we were to terminateMr. Metzger without Cause, in addition to the payments upon terminationspecified in (a) through (d), above, Mr. Metzger will receive,upon execution without revocation of a valid release agreement in a form reasonablyacceptable to the Company continued base salary for six (6) months afterthe date of termination.

 

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| **Component of  Compensation** | ** ** | **Executive’s  Voluntary  Termination** | ** ** | **Termination  by the  Company  for Cause** | ** ** | **Termination  by the  Company  without  Cause** | ** ** | **Termination  by the  Company  by Notice of  Intent not to  Renew** | ** ** | **Termination  upon the  Executive’s  Death or  Disability** | ** ** | **Occurrence of  a Liquidity  Event** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                |       |                                         |       |                                                  |       |                                                  |       |                                                                                          |       |                                                                        |       |                                            |       |
| Cash  Severance                     |       | —                                       | (1)        | —                                                |       | $                                                     | 187,500    |                                                                                          | $          | 187,500                                                                     | (1)        | —                                          |       | — |   |
| Stock Options                       |       | —                                       | (2)        | —                                                |       |                                                  | —     | (2)                                                                                           |       | —                                                                      | (2)        | —                                          | (3)        | — | (4) |

 

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(1)          The cashseverance summary assumes the executive did not receive a bonus.

 

(2)   Non-vested options areforfeited. Fair market value is currently calculated as below the exerciseprice, therefore it is assumed options would not be exercised.

 

(3)   Non-vested options areforfeited; vested options may be exercised by Mr. Metzger’s representativeuntil one year or expiration. It is assumed options would not be exercisedcurrently due to the issue discussed in (2) above.

 

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

 

**CompensationCommittee Interlocks and Insider Participation**

 

OurCompensation Committee (the “**Compensation Committee**”)presently consists of Christa Michalaros, John Kourakos, George Kollitides andRonald Frankel. Christa Michalaros is our Chief Executive Officer. Messrs. Kourakos,Kollitides and Frankel are not under our employ. None of our executive officersserves as a member of the board of directors or compensation committee of anyother entity that has one or more executive officers serving as a member of ourboard of directors of our Compensation Committee.

 

**SummaryCompensation Table**

 

Thefollowing table sets forth the compensation of each of our chief executiveofficer and chief financial officer for fiscal 2010 and our three mostly highlycompensated executive officers in fiscal 2010 other than the chief executiveofficer and chief financial officer for each of fiscal 2008, 2009 and 2010, asapplicable.

 

**For theYear Ended June 30, 2010**

 
| **Name and Principal Position** | ** ** | **Year** | ** ** | **Salary ($)** | ** ** | **Bonus ($)** | ** ** | **Stock  Awards  ($)** | ** ** | **Option  Awards  ($) (1)** | ** ** | **Non-Equity  Incentive  Plan  Compensation  ($)** | ** ** | **Change in  Pension  Value and  Nonqualified  Deferred  Compensation  Earnings ($)** | ** ** | **All  Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|------------------------------------------------|------------|----------|------------|---------------------|------------|--------------------|------------|------------------------|------------|----------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|----------------|------------|
| Christa  Michalaros                            |       | 2010     |       | 700,000             |       | 700,000            |       | —                 |       | 19,387                           |       | —                                             |       | —                                                                                               |       | 61,615                            | (3)        | 1,481,002      |       |
| *Chief Executive Officer*                      |       | 2009     |       | 713,462             |       | —             |       | —                 |       | 23,264                           |       | —                                             |       | —                                                                                               |       | 61,679                            |       | 798,405        |       |
| * *                                       |       | 2008     |       | 700,000             |       | —             |       | —                 |       | 23,263                           |       | —                                             |       | —                                                                                               |       | 63,171                            |       | 786,434        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                             |       |                                               |       |                                                                                                 |       |                              |       |           |       |
| Lance  D. Arneson                              |       | 2010     |       | 282,692             |       | 150,000            |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 25,730                            | (2)        | 458,422        |       |
| *Chief Financial Officer*                      |       | 2009     |       | 200,481             |       | 14,000             |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 9,400                             |       | 223,881        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                             |       |                                               |       |                                                                                                 |       |                              |       |           |       |
| Nichole  Vowteras                              |       | 2010     |       | 400,000             |       | 200,000            |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 9,673                             | (2)        | 609,673        |       |
| *Executive Vice President*                     |       | 2009     |       | 407,693             |       | —             |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 11,258                            |       | 418,951        |       |
| *Sourcing and Production*                      |       | 2008     |       | 400,000             |       | —             |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 14,482                            |       | 414,482        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                             |       |                                               |       |                                                                                                 |       |                              |       |           |       |
| Rosemary  Mancino                              |       | 2010     |       | 400,000             |       | 200,000            |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 25,730                            | (2)        | 625,730        |       |
| *President Sales & Planning*          |       | 2009     |       | 407,693             |       | —             |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 24,782                            |       | 432,475        |       |
| * *                                       |       | 2008     |       | 400,000             |       | —             |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 26,897                            |       | 426,897        |       |
|                                           |       |     |       |                |       |               |       |                   |       |                             |       |                                               |       |                                                                                                 |       |                              |       |           |       |
| Richard  Metzger (4)                           |       | 2010     |       | 315,000             |       | 78,750             |       | —                 |       | —                           |       | —                                             |       | —                                                                                               |       | 9,673                             | (2)        | 403,423        |       |
| *Vice-President of Design*                     |       |     |       |                |       |               |       |                   |       |                             |       |                                               |       |                                                                                                 |       |                              |       |           |       |

 

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(1)          Stock option awardforfeitures during the fiscal year ended June 30, 2010 were 187,500. Referto Note 3 of the Company’s consolidated financial statements and the Company’sCritical Accounting Policies and Estimates discussion included withinManagement’s Discussion and Analysis of Financial Condition and Results ofOperations included elsewhere herein for further information on the assumptionsused to fair value the stock option awards.

 

(2)          Medical benefits paid forMr. Arneson, Ms. Vowteras, Ms. Mancino, and Mr. Metzgerwere $25,730, $9,673, $25,730, and $9,673, respectively.

 

(3)          Amount shown forMs. Michalaros includes the cost of car service ($61,615).

 

(4)          Mr. Metzger waspromoted to Executive Vice President of Design as of October 13, 2010. Inconnection therewith, the Company’s board of directors also approved the grantof options to Mr. Metzger pursuant to the Company’s Equity Incentive Planto purchase 111,111 shares of common stock of the Company, exercisable for$5.33 per share, to Mr. Metzger. One quarter of Mr. Metzger’s optionsvest on each of the first, second, third and fourth anniversaries of the grantdate.

 

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**Grantsof Plan-Based AwardsFor the Year Ended June 30, 2010**

 
| ** **        | ** ** | ** **          | ** ** | **Compensation**               | ** ** | **Estimated Future Payouts Under  Non-Equity Incentive Plan Awards** | ** ** | **Estimated Future Payouts Under  Equity Incentive Plan Awards** | ** ** | **Stock  Awards:  Number of  Shares of** | ** ** | **Option  Awards:  Number of  Securities** | ** ** | **Exercise  or  Base  Price  of  Option** | ** ** | **Grant Date  Fair Value  of Stock and** | ** ** |
|-------------------|------------|---------------------|------------|--------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Name**          | ** ** | **Grant Date** | ** ** | **Committee  Grant Date** | ** ** | **Threshold  ($)**                                                                                 | ** ** | **Target  ($)**                                                                                | ** ** | **Maximum  ($)**                                   | ** ** | **Threshold  (#)**                              | ** ** | **Target  (#)**                           | ** ** | **Maximum  (#)**                                             | ** ** | **Stock or  Units (#)** | ** ** | **Underlying  Options (#)** | ** ** | **Awards  ($/Sh)** | ** ** | **Option  Awards** | ** ** |
|              |       |                |       |                           |       |                                                                                               |       |                                                                                           |       |                                               |       |                                            |       |                                      |       |                                                         |       |   |   |   |   |   |   |   |   |
| Lance  D. Arneson |       | 5/21/2010           |       | 5/21/2010                      |       | —                                                                                             |       | —                                                                                         |       | —                                             |       | —                                          |       | 111,111                                   |       | —                                                       |       | — |   | — |   | 5.33 |   | $ | 10,164 |   |
|                   |            |                     |            |                                |            |                                                                                                    |            |                                                                                                |            |                                                    |            |                                                 |            |                                           |            |                                                              |            |  |  |  |  |  |  |  |  |  |

 

**OutstandingEquity Awards at Fiscal Year-EndAs of June 30, 2010**

 
| ** **          | ** ** | **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 |       | 444,444                                                                            |       | —                                                                               |       | — |   | 5.33 |   | 9/22/2016 |   | — |   | — |   | — |   | — |   |
| Lance  D. Arneson   |       | 15,560                                                                             |       | 95,551                                                                               | (1)        | — |   | 5.33 |   | 5/21/2020 |   | — |   | — |   | — |   | — |   |
|                |       |                                                                               |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nichole  Vowteras   |       | 111,111                                                                            |       | —                                                                               |       | — |   | 5.33 |   | 9/22/2016 |   | — |   | — |   | — |   | — |   |
| Rosemary  Mancino   |       | 111,111                                                                            |       | —                                                                               |       | — |   | 5.33 |   | 9/22/2016 |   | — |   | — |   | — |   | — |   |

 

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(1)   The shares subject to theoption for Mr. Arneson vest as follows: (i) 12,218 shares subject tothe option shall vest on November 2, 2010; and (ii) the remaining83,333 shares subject to the option shall vest in equal one-third (1/3) portionson each of the first, second and third anniversaries of November 2, 2010.

 

**COMPENSATIONCOMMITTEE REPORT**

 

TheCompensation Committee has reviewed and discussed the Compensation Discussionand Analysis included in this annual report on Form 10-K with managementand, based on such review and discussions, the Compensation Committeerecommended to our Board of Directors that the Compensation Discussion andAnalysis be included in this annual report.

 

TheCompensation Committee’s Report shall not be deemed incorporated by referenceby any general statement incorporating by reference this Form 10-K intoany filing under the Securities Act of 1933 or under the Securities ExchangeAct of 1934, except to the extent that the Company specifically incorporatesthis Compensation Committee’s Report by reference, and shall not otherwise bedeemed filed under such Acts.

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

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**Compensationof Directors**

 

Otherthan Messrs. Kourakos and J. Newman, none of our non employee directorsreceived any fee payments or equity grants.

 

Membersof our Board of Directors who are either our employees or affiliated withCerberus receive no separate compensation for serving on the Board ofDirectors.  All members of our Board ofDirectors are reimbursed for actual expenses incurred in connection withattendance at meetings of the Board of Directors and of committees of the Boardof Directors.

 

Inconnection with Joel H. Newman’s appointment, the Company and Mr. J.Newman entered into a letter agreement dated July 28, 2009 (the “**Letter Agreement**”).  Pursuant to the Letter Agreement,Mr. J. Newman’s total compensation as a member of the Board shall consistsolely of a director’s fee of $60,000 per annum, payable quarterly in advance,plus expenses.

 

Wehave entered into an agreement for Chairman of the Board of Directors with John Kourakos which commenced onOctober 1, 2007, and was amended on May 21, 2010.  Under the terms of the agreement, as amended,the initial period was from October 1, 2007 through September 30,2008; thereafter, the agreement will continue for consecutive twelve (12) monthperiods commencing on each October 1, as long as Mr. Kourakos shallcontinue to be elected as Chairman of the Board.  If Mr. Kourakos’s status as Chairman isterminated under circumstances in which he does not remain a director, theAgreement will terminate, and the Company will pay to Mr. Kourakos allcompensation and benefits to which Mr. Kourakos is entitled up through thedate of termination.

 

Mr. Kourakos’fee was $150,000 on an annualized basis from October 1, 2007 untilJune 30, 2008 and $200,000 per year commencing on July 1, 2008.  For fiscal year 2010, Mr. Kourakos waspaid aggregate fees of $200,000 and was reimbursed $15,569 in the aggregateprimarily attributable to health insurance.

 

Underthe terms of his agreement, Mr. Kourakos participates in the Company’sEquity Incentive Plan.  In connectiontherewith, the Company’s board of directors approved the grant of an option topurchase 111,111 shares of common stock of the Company, exercisable for $5.33per share, to Mr. Kourakos. Mr. Kourakos’ option vests as follows:73,327.28 on the grant date of May 21, 2010, 10,005.97 on October 1,2010, and the remaining 27,777.75 on October 1, 2011.

 

**Director Compensation**

 
| **Name**      | ** ** | **Fees Earned** | ** ** | **Option Awards ($)** | ** ** | **All Other Compensation (1)** | ** ** |
|---------------|------------|----------------------|------------|---------------------------------|------------|-----------------------------------------------|------------|
|          |       |                 |       |                            |       |                                          |       |
| John Kourakos |       | $                    |       | 200,000                         |       | $                                             |       | 10,164 |   | $ |   | 15,569 |   |
| Joel Newman   |       | $                    |       | 60,000                          |       | $                                             |       | — |   | $ |   | — |   |

 

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(1)   Includes reimbursementsprimarily attributable to health insurance.

 

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**ITEM 12.****              ****SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Thefollowing table sets forth information as of September 30, 2010 withrespect to the beneficial ownership of our issued and outstanding common stockand convertible preferred stock, excluding any grants made under our EquityIncentive Plan, none of which have vested or will vest in the next sixty days,by:

 

·       each person who is known by us to beneficially own5% or more of our issued and outstanding common stock and convertible preferredstock;

 

·       each member of our Board of Directors;

 

·       each of our executive officers named under “Management—Compensationof Executive Officers;” and

 

·       all members of our Board of Directors and our namedexecutive officers as a group.

 

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

 

 

| ** **                                                                                | ** ** | **Convertible Preferred Stock** | ** ** | **Common Stock**         | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------|------------|
| **Name and Address of Beneficial Owner (1)**                | ** ** | **Number of  Shares**                | ** ** | **Percentage  of Class** | ** ** | **Number of  Shares** | ** ** | **Percentage  of Class** | ** ** |
| Stephen Feinberg(2)(3)                                                                    |       | 7,500,000                                 |       | 100                           | %          | 7,500,000 |   | 75 | % |
| RSW 2005, Inc.(7)                                                                    |       | —                                    |       | —                        |       | 2,500,000 |   | 100 | % |
| Christa Michalaros(4)                                                                     |       | —                                    |       | —                        |       | 444,444 |   | 15.1 | % |
| Lance D. Arneson (8)                                                                      |       | —                                    |       | —                        |       | 27,778 |   | 1.1 | % |
| Rosemary Mancino(5)                                                                       |       | —                                    |       | —                        |       | 111,111 |   | 4.3 | % |
| Nichole Vowteras (6)                                                                      |       | —                                    |       | —                        |       | 111,111 |   | 4.3 | % |
| George Kollitides(3)                                                                      |       | —                                    |       | —                        |       | — |   | — |   |
| John Kourakos (9)                                                                         |       | —                                    |       | —                        |       | 83,333 |   | 3.2 | % |
| Joel H. Newman                                                                            |       | —                                    |       | —                        |       | — |   | — |   |
| Ronald Frankel(7)                                                                         |       | —                                    |       | —                        |       | 2,125,000 |   | 85.0 | % |
| Robert Newman(7)                                                                          |       | —                                    |       | —                        |       | 125,000 |   | 5.0 | % |
| Asher Haddad (7)                                                                          |       | —                                    |       | —                        |       | 250,000 |   | 10.0 | % |
| All members of our Board of Directors and  executive officers as a group (9 persons) |       | —                                    |       | —                        |       | 3,277,777 |   | 100 | % |

 

----

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

 

(2)   Acquisition Co., controlledby Cerberus, owns 100% of our convertible preferred stock, which preferred stockis convertible at its option into common stock equal to 75% of our commonstock, or approximately 68.2% of our outstanding fully-diluted commonstock.  Stephen Feinberg exercises solevoting and investment authority over all securities of our Company owned byAcquisition Co. Thus, pursuant to Rule 13d-3 under the Exchange Act,Stephen Feinberg is deemed to beneficially own 100% of our convertiblepreferred stock and, upon conversion, would beneficially own approximately68.2% of our common stock (after the exercise of all outstanding optionsgranted pursuant to our Equity Incentive Plan, whether vested or unvested).

 

(3)   The address for each ofStephen Feinberg and George Kollitides is c/o Cerberus Capital Management,L.P., 299 Park Avenue, New York, New York 10171.

 

(4)   Includes vested options for444,444 shares of common stock granted pursuant to Ms. Michalaros’employment agreement with us.

 

(5)   Includes vested options for111,111 shares of common stock granted pursuant to Ms. Mancino’semployment agreement with us.

 

(6)   Includes vested options for111,111 shares of common stock granted pursuant to Ms. Vowteras’employment agreement with us.

 

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

 

(8)   Includes vested options for27,778 shares of common stock but does not include non-vested options for83,333 shares of common stock, all of which were granted pursuant to Mr. Arneson’semployment agreement with us.

 

(9)   Includes vested options for83,333 shares of common stock but does not include non-vested options for27,778 shares of common stock, all of which were granted pursuant to Mr. Kourakos’sagreement with us.

 

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**EquityCompensation Plan Information (1)**

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

 

----

(1)   A description of the EquityCompensation Plan is set forth under Note 3 to the Consolidated FinancialStatements.

 

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

 

*ControllingStockholder*

 

Inconnection with the June 20, 2005 acquisition, Acquisition Co., anaffiliate of Cerberus, contributed $40.0 million of equity capital to us,acquiring convertible preferred stock convertible into approximately 68.2% ofour common stock on a fully-diluted basis (after the exercise of alloutstanding options granted pursuant to our Equity Incentive Plan, whethervested or unvested).  See “SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.”

 

*Stockholders’Agreement*

 

Inconnection with an April 15, 2005 Securities Purchase Agreement, asamended, we entered into a Stockholders’ Agreement with Acquisition Co. and ourpredecessor.  This Stockholders Agreementprovides that we will have a Board of Directors that will consist of sevendirectors, four of whom are designated by Acquisition Co., two of whom aredesignated by RSW 2005, Inc., which is controlled by Ronald Frankel, andone of whom is designated jointly by Acquisition Co. and RSW 2005, Inc.Our Board of Directors currently consists of six directors, four of whom weredesignated by Acquisition Co. and two of whom were designated by ourpredecessor or RSW 2005, Inc.  TheStockholders’ Agreement also contains certain restrictions on transfers bystockholders of their capital stock and tag-along rights, drag-along rights anda right of first refusal with respect to certain permitted transfers.

 

*CreditFacility*

 

Cerberusis a party to the Amended and Restated Financial Agreement as a lender and theterm lender.  Pursuant to the terms ofthe Amended and Restated Financial Agreement, Cerberus provides (i) revolvingdirect debt advances of up to $5,000,000 on or after December 16, 2010 and(ii) term loans of up to $5,000,000.

 

Theterm loans provided by Cerberus are to be used solely to fund repayments orrepurchases of the Company’s senior secured notes; and the Company shall notrepurchase any of the notes except (a) with the proceeds of the term loansor (b) as otherwise required pursuant to the terms of the notesindenture.  The term loans are secured by a first lien on all of theCompany’s assets on a *pari passu*basis with all other obligations under the Amended and Restated FinancingAgreement, subject to the provisions of the Amended and Restated FinancingAgreement relating to the application of proceeds from the Company.

 

TheAmended and Restated Financing Agreement provided for (i) a revolvingcommitment closing fee payable to Cerberus of $125,000, which fee was earned asof the effective date of the Amended and Restated Financing Agreement andpayable upon the Termination Date (as such term is defined in the Amended andRestated Financing Agreement), and (ii) term loan fees payable toCerberus, as term lender, of (a) a closing fee of $125,000, which fee wasearned as of the effective date of the Amended and Restated Financing Agreementand payable upon the Termination Date, and (b) a facility fee at a rateequal to one-quarter of one percent (0.25%) per annum on average daily unusedportion of the Term Loan Commitment earned on a monthly basis and payable uponthe Termination Date.  Borrowings under the Amended and Restated FinancingAgreement bear variable interest at the Company’s option at either (i) abase rate or (ii) the London interbank offered rate plus two and threequarters percent (2.75%) per annum (each as defined therein).  The Amendedand Restated Financing Agreement provides for a monthly commitment fee of 0.25%per annum on the unused portion of the available commitments for revolvingdirect debt advances and letters of credit under the facility.

 

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** **

**RelatedParty Transactions Policy and Procedure**

 

Ourfinance department is primarily responsible for developing and implementingprocesses and controls to obtain information from our directors, executiveofficers and significant stockholders regarding related party transactions andthen determining, based on the facts and circumstances, whether we or arelated-party has a direct or indirect material interest in our transactions.  Our audit committee does not have a writtenpolicy regarding the approval of related party transactions but will apply itsreview procedures to potential related-person transactions as a part of itsstandard operating procedures.  In thecourse of management’s and the audit committee’s review, the following matterswill be considered:

 

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

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

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

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

·      any othermatters management or the audit committee deems appropriate.

 

SinceJuly 1, 2009, the beginning of the Company’s most recent fiscal year, wehave not been a party to any transaction or series of similar transactions,other than as described above, in which the amount involved exceeded or willexceed $120,000 and in which any current director, executive officer, holder ofmore than 5% of our capital stock, or any member of the immediate family of anyof the foregoing, had or will have a direct or indirect material interest.

 

**DirectorIndependence**

 

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

 

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

 

Thefollowing table presents fees for services rendered by PricewaterhouseCoopersLLP relating to the years ended June 30, 2010 and 2009.

 
| ** **            | ** ** | **Year Ended  June 30, 2010** | ** ** | **Year Ended  June 30, 2009** | ** ** |
|-----------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **            | ** ** | **(in thousands)**                      | ** ** |
| Audit fees(1)         |       | $                                            | 572        |                                         | $          | 446 |   |
| Audit-related fees(2) | ** ** | 17                                           |       | 35                                           |       |
| Tax fees(3)           | ** ** | 110                                          |       | 183                                          |       |
| All other fees(4)     | ** ** | 2                                            |       | 1                                            |       |
| Total                 |       | $                                            | 701        |                                         | $          | 665 |   |

 

----

(1)   Fees for audit of annualfinancial statements, statutory audit and review of quarterly financialstatements.

 

(2)   Fees for professionalservices for consultations.  The fees infiscal 2010 related to an amendment to the Company’s Amended and RestatedFinancing Agreement and filing of Form 12b-25. The fees in fiscal 2009 related to the Company’s implementation of aprovision within ASC 740, *Income Taxes,*formerlyFASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes — an interpretation of FASB Statement No. 109*.

 

(3)   Fees related to professionalservices 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)   Fees for permissible workprovided by PricewaterhouseCoopers LLP that do not meet any of theabove-category descriptions.  The feesrelate to the use of Comperio, PricewaterhouseCoopers LLP’s accounting researchsoftware.

 

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Underthe Audit Committee’s Charter, the committee has the sole authority forappointing, compensating, retaining and overseeing the work of the Company’sindependent auditors.  In addition, thecommittee has the sole authority to approve all engagement fees and terms andall permissible non-audit services to be provided by the independent auditors.Subsequent to the Company’s Registration Statement on Form S-4 filedFebruary 9, 2007, the committee has approved each such audit and non-auditservice to be provided by the Company’s independent auditors.  The committee has also adopted polices andprocedures for pre-approving certain services performed by the independentauditors.  The committee has pre-approvedthe use of the independent auditors for specific types of services that fallwithin categories of non-audit services, including various tax services.  The percentage of fees paid foraudit-related, tax and all other fees that were approved by the Audit Committeewas 100% in fiscal 2010.  Management ofthe Company reviews the nature of the professional services to be rendered bythe independent auditors with the committee during each committee meeting.

 

**PART IV**

 

**ITEM 15.****              ****EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

** **

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

 

(1)           Financial Statements

 
| ** **                                                                                                             | **Page** |
|------------------------------------------------------------------------------------------------------------------------|----------|
| Report of Independent Registered Public Accounting  Firm                                                               | F-2      |
| Consolidated Balance Sheets at June 30, 2010 and  2009                                                            | F-3      |
| Consolidated Statements of Operations for the years  ended June 30, 2010, 2009, and 2008                          | F-4      |
| Consolidated Statements of Stockholders’ Equity  (Deficit) for the years ended June 30, 2010, 2009, and 2008 | F-5      |
| Consolidated Statements of Cash Flows for the years  ended June 30, 2010, 2009, and 2008                          | F-6      |
| Notes to Consolidated Financial Statements                                                                             | F-7      |

 

(2)           Financial StatementSchedules

 

None.

 

(3)           List of Exhibits

 

Theexhibits listed in the Exhibit Index, which appears immediately followingand is incorporated herein by reference, are filed as part of this annualreport on Form 10-K.

 

**(b)****          ****Exhibits**

 

Seethe Exhibit Index below.

 

**(c)****          ****SeparateFinancial Statements and Schedules**

 

None.

 

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**EXHIBIT INDEX**

 

**Form 10-Kfor Fiscal Year Ended June 30, 2010**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                             |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                  |
| 2.1*             |       | Securities  Purchase Agreement, dated April 15, 2005, among RA Cerberus  Acquisition, LLC, Rafaella Sportswear, Inc., Verrazano, Inc.,  Ronald Frankel and Rafaella Corporation                         |
|             |       |                                                                                                                                                                                                                        |
| 2.2*             |       | Amendment  No. 1 to the Securities Purchase Agreement, dated May 27, 2005                                                                                                                                         |
|             |       |                                                                                                                                                                                                                        |
| 2.3*             |       | Contribution  Agreement, dated June 20, 2005, among Rafaella Sportswear, Inc. and  Rafaella Apparel Group, Inc.                                                                                              |
|             |       |                                                                                                                                                                                                                        |
| 3.1*             |       | Amended  and Restated Certificate of Incorporation of Rafaella Apparel  Group, Inc.                                                                                                                                    |
|             |       |                                                                                                                                                                                                                        |
| 3.2*             |       | Bylaws  of Rafaella Corporation                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                        |
| 3.3*             |       | Certificate  of Incorporation of Verrazano, Inc.                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                        |
| 3.4*             |       | Bylaws  of Verrazano, Inc.                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                        |
| 4.1*             |       | Stockholder’s  Agreement, dated June 20, 2005, among Rafaella Apparel Group, Inc.,  RA Cerberus Acquisition, LLC, Rafaella Sportswear, Inc. and  the principals set forth therein             |
|             |       |                                                                                                                                                                                                                        |
| 4.2*             |       | Indenture  for the 11 1/4% Senior Secured Notes  due 2011, dated June 20, 2005, among Rafaella Apparel  Group, Inc., the guarantors named therein and The Bank of New York, as  trustee and collateral agent |
|             |       |                                                                                                                                                                                                                        |
| 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  11 1/4% 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.                                                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.26            |       | Amendment  No. 1 to Financing Agreement, dated March 31, 2006, among Rafaella  Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA, National  Association and Israel Discount Bank of New York.                                                                                                                                                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.27            |       | Amendment  No. 2 to Financing Agreement, dated December 31, 2006, among  Rafaella Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA,  National Association and Israel Discount Bank of New York.                                                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.28            |       | Amendment  No. 6 to Financing Agreement, dated September 30, 2008, among  Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC Bank USA,  National Association, previously filed as Exhibit 10.28 to Rafaella’s  Quarterly Report on Form 10-Q for the quarterly period ending  September 30, 2008, and herein incorporated by reference.                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.29            |       | Amended  and Restated Collection Services Factoring Agreement, dated as of  December 16, 2008, between Rafaella Apparel Group, Inc. and GMAC  Commercial Finance LLC, previously filed as Exhibit 10.29 to Rafaella’s  Current Report on Form 8-K, filed December 16, 2008, and herein  incorporated by reference.                                                                                                   |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                     |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.30            |       | Factoring  Agreement (Collection), dated December 19, 2008, between Rafaella  Apparel Group, Inc. and Wells Fargo Trade Capital, LLC, previously filed  as Exhibit 10.29 to Rafaella’s Current Report on Form 8-K, filed  December 16, 2008, and herein incorporated by reference.                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.31            |       | Factoring  Agreement (Collection), dated December 19, 2008, between  Verrazano, Inc. and Wells Fargo Trade Capital, LLC, previously filed as  Exhibit 10.29 to Rafaella’s Current Report on Form 8-K, filed  December 16, 2008, and herein incorporated by reference.                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.32            |       | Amendment  No. 7 to Financing Agreement, dated December 16, 2008, among  Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC Bank USA,  National Association, previously filed as Exhibit 10.32 to Rafaella’s  Quarterly Report on Form 10-Q for the quarterly period ending  December 31, 2008, and herein incorporated by reference.                                   |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33            |       | Amendment  No. 8 to Financing Agreement, dated February 10, 2009, among  Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC Bank USA,  National Association, previously filed as Exhibit 10.33 to Rafaella’s  Quarterly Report on Form 10-Q for the quarterly period ending  December 31, 2008, and herein incorporated by reference.                                   |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.34            |       | Amendment  No. 9 to Financing Agreement, dated September 25, 2009, among  Rafaella Apparel Group, Inc., Verrazano, Inc. and HSBC Bank USA,  National Association, previously filed as Exhibit 99.1 to Rafaella’s  Current Report on Form 8-K filed October 1, 2009, and herein  incorporated by reference.                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.35            |       | Employment  Agreement dated as of April 3, 2009, between Rafaella Apparel  Group, Inc. and Lance Arneson, previously filed as Exhibit 99.1 to  Rafaella’s Current Report on Form 8-K, filed June 9, 2009, and  herein incorporated by reference.                                                                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.36            |       | Letter  Agreement dated as of July 28, 2009, between Rafaella Apparel  Group, Inc. and Joel H. Newman, previously filed as Exhibit 99.1 to  Rafaella’s Current Report on Form 8-K, filed July 28, 2009, and  herein incorporated by reference.                                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.37            |       | Amended  and Restated Employment Agreement, dated as of November 2, 2009, by and  among Rafaella Apparel Group, Inc. and Lance D. Arneson, previously  filed as Exhibit 10.37 to Rafaella’s Current Report on Form 8-K,  filed November 6, 2009, and herein incorporated by reference.                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.38            |       | Amended  and Restated Financing Agreement, dated as of February 22, 2010, among  Rafaella Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA,  National Association and the other lenders signatory thereto from time to  time, previously filed as Exhibit 10.38 to Rafaella’s Quarterly Report  on Form 10-Q, filed February 22, 2010, and herein incorporated by  reference. |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.39            |       | Amendment  to the Factoring Agreement between Rafaella Apparel Group, Inc. and  Wells Fargo Trade Capital, LLC, dated February 18, 2010, previously  filed as Exhibit 10.39 to Rafaella’s Current Report on Form 8-K,  filed March 4, 2010, and herein incorporated by reference.                                                                                                     |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.40            |       | Amendment  to the Factoring Agreement between Verrazano Inc. and Wells Fargo Trade  Capital, LLC, dated February 18, 2010, previously filed as  Exhibit 10.39 to Rafaella’s Current Report on Form 8-K, filed  March 4, 2010, and herein incorporated by reference.                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.41            |       | Form of  Amended and Restated Agreement for Chairman of Board of Directors, dated as  of May 21, 2010, between Rafaella Apparel Group, Inc. and John  Kourakos, previously filed as Exhibit 10.38 to Rafaella’s Quarterly  Report on Form 10-Q, filed May 24, 2010, and herein incorporated by  reference.                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.42            |       | Amended  and Restated Financing Agreement, dated as of May 21, 2010, among  Rafaella Apparel Group, Inc., Verrazano, Inc., HSBC Bank USA,  National Association and the other lenders signatory thereto from time to  time, previously filed as Exhibit 10.39 to Rafaella’s Quarterly Report  on Form 10-Q, filed May 24, 2010, and herein incorporated by  reference.           |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.43            |       | Reaffirmation  of Trademark Collateral Security Agreement, dated May 21, 2010, among  Rafaella Apparel Group, Inc. and HSBC Bank USA, National Association,  previously filed as Exhibit 10.40 to Rafaella’s Quarterly Report on  Form 10-Q, filed May 24, 2010, and herein incorporated by  reference.                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.44            |       | Reaffirmation  of Stock Pledge Agreement, dated May 21, 2010, among Rafaella Apparel  Group, Inc. and HSBC Bank USA, National Association, previously filed as  Exhibit 10.41 to Rafaella’s Quarterly Report on Form 10-Q, filed  May 24, 2010, and herein incorporated by reference.                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.45            |       | Rafaella  Apparel Group, Inc. Equity Incentive Plan Award Agreement between the  Company and John Kourakos, previously filed as Exhibit 10.42 to  Rafaella’s Current Report on Form 8-K, filed June 17, 2010, and  herein incorporated                                                                                                                                                     |

 

52

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                           |
|             |       | by  reference.                                                                                                                                                                                                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                           |
| 10.46            |       | Rafaella  Apparel Group, Inc. Equity Incentive Plan Award Agreement between the  Company and Lance D. Arneson, previously filed as Exhibit 10.43 to  Rafaella’s Current Report on Form 8-K, filed June 17, 2010, and  herein incorporated by reference.                               |
|             |       |                                                                                                                                                                                                                                                                                                           |
| 10.47            |       | Logistics  and Distribution Services Agreement by and between Rafaella Apparel  Group, Inc. and IDS USA Inc., dated as of June 17, 2010, previously  filed as Exhibit 10.1 to Rafaella’s Current Report on Form 8-K,  filed June 23, 2010, and herein incorporated by reference. |
|             |       |                                                                                                                                                                                                                                                                                                           |
| 10.48**          |       | Amended  and Restated Employment Agreement, dated as of October 13, 2010, by and  among Rafaella Apparel Group, Inc. and Richard Metzger.                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                           |
| 10.49**          |       | Rafaella  Apparel Group, Inc. Equity Incentive Plan Award Agreement between the  Company and Richard Metzger.                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                           |
| 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                                                                                                                                                                     |

 

----

*      Previously filed as an exhibit to the RegistrationStatement on Form S-4 (Reg. No.: 333-138342) originally filed with theSEC on November 1, 2006.

 

**   Filed herewith.

 

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
| October 13,  2010 | **RAFAELLA  APPAREL GROUP, INC****.** |
|------------------------|--------------------------------------------|
|                   |                                       |   |
|                   |                                       |   |
|                   | By:                                        | /s/  Christa Michalaros |
|                   |                                       | Christa  Michalaros |
|                   |                                       | Chief  Executive Officer and Director |
|                   |                                       | (Principal  Executive Officer) |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 

| **Signature**              | ** ** | **Title**                                     | ** ** | **Date**               |
|----------------------------|------------|-----------------------------------------------|------------|------------------------|
|                       |       |                                          |       |                   |
| **/s/ Christa Michalaros** |       | Chief  Executive Officer and Director         | ** ** | October 13,  2010 |
|                       |       | (Principal  Executive Officer)                |       |                   |
| **Christa Michalaros**     | ** ** | ** **                                    | ** ** | ** **             |
| ** **                 | ** ** | ** **                                    | ** ** | ** **             |
| ** **                 |       | Chief  Financial Officer                      | ** ** | October 13,  2010 |
| **/s/ Lance D. Arneson**   |       | (Principal  Financial and Accounting Officer) | ** ** |                   |
|                       |       |                                          |       |                   |
| **Lance D. Arneson**       |       |                                          |       |                   |
| ** **                 | ** ** | ** **                                    | ** ** | ** **             |
| **/s/ John Kourakos**      |       | Director,  Chairman of the Board              | ** ** | October 13,  2010 |
|                       |       |                                          |       |                   |
| **John Kourakos**          | ** ** | ** **                                    | ** ** | ** **             |
| ** **                 | ** ** | ** **                                    | ** ** | ** **             |
| **/s/George Kollitides**   |       | Director                                      | ** ** | October 13,  2010 |
|                       |       |                                          |       |                   |
| **George Kollitides**      | ** ** | ** **                                    | ** ** | ** **             |
| ** **                 | ** ** | ** **                                    | ** ** | ** **             |
| **/s/ Joel Newman**        |       | Director                                      | ** ** | October 13,  2010 |
|                       |       |                                          |       |                   |
| **Joel Newman**            | ** ** | ** **                                    | ** ** | ** **             |
| ** **                 | ** ** | ** **                                    | ** ** | ** **             |
| **/s/ Ronald Frankel**     |       | Director                                      | ** ** | October 13,  2010 |
|                       |       |                                          |       |                   |
| **Ronald Frankel**         | ** ** | ** **                                    | ** ** | ** **             |
| ** **                 | ** ** | ** **                                    | ** ** | ** **             |
| **/s/ Robert Newman**      |       | Director                                      | ** ** | October 13,  2010 |
|                       |       |                                          |       |                   |
| **Robert Newman**          | ** ** | ** **                                    | ** ** | ** **             |

 

**SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANTTO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTEREDSECURITIES PURSUANT TO SECTION 12 OF THE ACT**

Noannual report or proxy material has been or will be distributed to theshareholders.

 

54

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**RafaellaApparel Group, Inc. and Subsidiaries**

**ConsolidatedFinancial Statements**

 

**Table ofContents**

 
| ** **                                                                                                              | **Page** |
|-------------------------------------------------------------------------------------------------------------------------|----------|
| Audited  Financial Statements                                                                                           |     |
|                                                                                                                    |     |
| Report  of Independent Registered Public Accounting Firm                                                                | F-2      |
| Consolidated  Balance Sheets at June 30, 2010 and 2009                                                             | F-3      |
| Consolidated  Statements of Operations for the years ended June 30, 2010, 2009, and  2008                          | F-4      |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the years ended  June 30, 2010, 2009, and 2008 | F-5      |
| Consolidated Statements of Cash Flows for the years  ended June 30, 2010, 2009, and 2008                           | F-6      |
| Notes to Consolidated Financial Statements                                                                              | F-7      |

 

F-1

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Table ofContents

 

**Report ofIndependent Registered Public Accounting Firm**

 

Tothe Board of Directors and Stockholders of Rafaella Apparel Group, Inc.:

 

In our opinion, the accompanyingconsolidated balance sheets and the related consolidated statements ofoperations, stockholder’s equity (deficit) and cash flows present fairly, inall material respects, the financial position of Rafaella Apparel Group, Inc.and its subsidiaries (the “Company”) at June 30, 2010 and June 30,2009, and the results of their operations and their cash flows for each of thethree years in the period ended June 30, 2010 in conformity withaccounting principles generally accepted in the United States of America. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

The accompanying financialstatements have been prepared assuming that the Company will continue as agoing concern. As discussed in Note 2 to the financial statements, the Company’ssenior secured notes mature in June 2011 and the Company does not expectits forecasted cash and credit availability to be sufficient to meet its debtrepayment obligations under the senior secured notes which raises substantialdoubt about its ability to continue as a going concern. Management’s plans inregard to these matters are also described in Note 2. The consolidatedfinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 

As discussed in Note 2 tothe consolidated financial statements, the Company changed the manner in whichit accounts for uncertain tax positions in its fiscal year 2008. The Companyadopted the provisions of ASC 740, Income Taxes on July 1, 2007.

 

 

PricewaterhouseCoopersLLP

NewYork, NY

 

October 13,2010

 

F-2

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Table ofContents

 

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

**ConsolidatedBalance Sheets**

**(In thousands, except number of shares)**

 
| ** **                                                                                                                                                                                        | ** ** | **June 30,  2010** | ** ** | **June 30,  2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Assets**                                                                                                                                                                                        |       |                    |       |                    |       |
| Current assets:                                                                                                                                                                                   |       |                    |       |                    |       |
| Cash and cash equivalents                                                                                                                                                                         |       | $                       | 20,610     |                    | $          | 17,698 |   |
| Receivables, net                                                                                                                                                                                  |       | 10,854                  |       | 11,550                  |       |
| Inventories                                                                                                                                                                                       |       | 13,595                  |       | 12,334                  |       |
| Deferred income taxes                                                                                                                                                                             |       | 2,047                   |       | 1,080                   |       |
| Other current assets                                                                                                                                                                              |       | 4,094                   |       | 5,557                   |       |
| Total current assets                                                                                                                                                                              |       | 51,200                  |       | 48,219                  |       |
| Equipment and leasehold improvements, net                                                                                                                                                         |       | 1,165                   |       | 1,703                   |       |
| Intangible assets, net                                                                                                                                                                            |       | 31,331                  |       | 35,265                  |       |
| Deferred financing costs, net                                                                                                                                                                     |       | —                  |       | 2,199                   |       |
| Other assets                                                                                                                                                                                      |       | 45                      |       | 93                      |       |
| Total assets                                                                                                                                                                                      |       | $                       | 83,741     |                    | $          | 87,479 |   |
|                                                                                                                                                                                              |       |                    |       |                    |       |
| **Liabilities, Redeemable  Convertible Preferred Stock and Stockholders’ Equity (Deficit)**                                                                                                  |       |                    |       |                    |       |
| Current liabilities:                                                                                                                                                                              |       |                    |       |                    |       |
| Accounts payable                                                                                                                                                                                  |       | $                       | 9,282      |                    | $          | 7,810 |   |
| Accrued expenses and other current liabilities                                                                                                                                                    |       | 4,444                   |       | 2,168                   |       |
| Current portion of senior secured notes                                                                                                                                                           |       | 71,084                  |       | —                  |       |
| Total current liabilities                                                                                                                                                                         |       | 84,810                  |       | 9,978                   |       |
| Senior secured notes                                                                                                                                                                              |       | —                  |       | 82,992                  |       |
| Income taxes                                                                                                                                                                                      |       | 5,058                   |       | 1,770                   |       |
| Deferred rent                                                                                                                                                                                     |       | 434                     |       | 422                     |       |
| Other liabilities                                                                                                                                                                                 |       | 200                     |       | —                  |       |
| Total liabilities                                                                                                                                                                                 |       | 90,502                  |       | 95,162                  |       |
| Commitments and contingencies                                                                                                                                                                     |       |                    |       |                    |       |
| Redeemable convertible preferred stock—$.01 par  value; redemption value $5.33 per share plus 10% per annum;  7,500,000 shares authorized; 7,500,000 shares issued and outstanding |       | 60,110                  |       | 56,110                  |       |
| Stockholders’ equity (deficit):                                                                                                                                                              |       |                    |       |                    |       |
| Common stock—$.01 par value; 11,111,111 shares  authorized; 2,500,000 shares issued and outstanding                                                                                |       | 25                      |       | 25                      |       |
| Additional paid in capital                                                                                                                                                                        |       | 307                     |       | 288                     |       |
| Deemed dividend, in excess of predecessor basis                                                                                                                                                   |       | (26,022                 | )          | (26,022                 | )          |
| Retained earnings (deficit)                                                                                                                                                                       |       | (41,181                 | )          | (38,084                 | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                         |       | (66,871                 | )          | (63,793                 | )          |
| Total liabilities, redeemable convertible  preferred stock and stockholders’ equity (deficit)                                                                                                |       | $                       | 83,741     |                    | $          | 87,479 |   |

 

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

 

F-3

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Table of Contents

 

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

**ConsolidatedStatements of Operations**

**(In thousands)**

 
| ** **                                                      | ** ** | **Year Ended  June 30, 2010** | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                            |       |                                         |       |                                         |       |                                         |       |
| Net sales                                                       |       | $                                            | 113,955    |                                         | $          | 147,965                                      |       | $ | 177,990 |   |
| Cost of sales                                                   |       | 78,979                                       |       | 113,037                                      |       | 129,086                                      |       |
| Gross profit                                                    |       | 34,976                                       |       | 34,928                                       |       | 48,904                                       |       |
| Selling, general and administrative expenses                    |       | 28,313                                       |       | 30,199                                       |       | 32,513                                       |       |
| Intangible asset impairment                                     |       | —                                       |       | 25,840                                       |       | 34,504                                       |       |
| Operating income (loss)                                         |       | 6,663                                        |       | (21,111                                      | )          | (18,113                                      | )          |
| Interest expense, net                                           |       | 10,527                                       |       | 13,232                                       |       | 17,964                                       |       |
| Gain on senior secured note purchases                           |       | (8,036                                       | )          | (25,632                                      | )          | (3,124                                       | )          |
| Interest expense (income) and other financing, net              |       | 2,491                                        |       | (12,400                                      | )          | 14,840                                       |       |
| Income (loss) before provision for (benefit from)  income taxes |       | 4,172                                        |       | (8,711                                       | )          | (32,953                                      | )          |
| Provision for (benefit from) income taxes                       |       | 3,269                                        |       | 6,726                                        |       | (8,199                                       | )          |
| Net income (loss)                                               |       | 903                                          |       | (15,437                                      | )          | (24,754                                      | )          |
| Dividends accrued on redeemable convertible  preferred stock    |       | 4,000                                        |       | 4,000                                        |       | 4,000                                        |       |
| Net income (loss) available to common stockholders              |       | $                                            | (3,097     | )                                            | $          | (19,437                                      | )          | $ | (28,754 | ) |

 

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

 

F-4

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Table ofContents

 

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

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

**(In thousands, 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, 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 ASC 740 (formerly FIN 48)                  |       |                  |       |                         |       |                                                       |       |                                 |       | (381         | )          | (381 | ) |
| Balance at June 30, 2008                          |       | 2,500,000             |       | 25                           |       | 264                                                        |       | (26,022                              | )          | (18,647      | )          | (44,380 | ) |
| Net loss                                               |       |                  |       |                         |       |                                                       |       |                                 |       | (15,437      | )          | (15,437 | ) |
| Accretion of preferred stock to redemption  value |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| Stock-based compensation expense                       |       |                  |       |                         |       | 24                                                         |       |                                 | ** ** | ** **   |       | 24 |   |
| Balance at June 30, 2009                          |       | 2,500,000             |       | 25                           |       | 288                                                        |       | (26,022                              | )          | (38,084      | )          | (63,793 | ) |
| Net income                                             |       |                  |       |                         |       |                                                       |       |                                 |       | 903          |       | 903 |   |
| Accretion of preferred stock to redemption  value |       |                  |       |                         |       |                                                       |       |                                 |       | (4,000       | )          | (4,000 | ) |
| Stock-based compensation expense                       |       |                  |       |                         |       | 19                                                         |       |                                 | ** ** | ** **   |       | 19 |   |
| Balance at June 30, 2010                          |       | 2,500,000             |       | $                            | 25         |                                                       | $          | 307                                  |       | $            | (26,022    | ) | $ | (41,181 | ) | $ | (66,871 | ) |

 

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

 

F-5

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Table ofContents

 

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

**ConsolidatedStatements of Cash Flows**

**(In thousands)**

 
| ** **                                                                                | ** ** | **Year Ended  June 30, 2010** | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                                                      |       |                                         |       |                                         |       |                                         |       |
| Cash flows provided by operating activities:                                              |       |                                         |       |                                         |       |                                         |       |
| Net income (loss)                                                                         |       | $                                            | 903        |                                         | $          | (15,437                                      | )          | $ | (24,754 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                         |       |                                         |       |                                         |       |
| Amortization of deferred finance charges                                                  |       | 1,095                                        |       | 1,386                                        |       | 1,755                                        |       |
| Accretion of original issue discount                                                      |       | 751                                          |       | 835                                          |       | 1,041                                        |       |
| Depreciation and amortization                                                             |       | 4,745                                        |       | 4,671                                        |       | 4,504                                        |       |
| Stock-based compensation expense                                                          |       | 19                                           |       | 24                                           |       | 23                                           |       |
| Income taxes                                                                              |       | 2,321                                        |       | 4,305                                        |       | (10,236                                      | )          |
| Deferred rent                                                                             |       | 12                                           |       | 38                                           |       | 64                                           |       |
| Gain on senior secured note purchases                                                     |       | (8,036                                       | )          | (25,632                                      | )          | (3,124                                       | )          |
| Intangible asset impairment                                                               |       | —                                       |       | 25,840                                       |       | 34,504                                       |       |
| Changes in operating assets and liabilities:                                              |       |                                         |       |                                         |       |                                         |       |
| Accounts receivable                                                                       |       | 696                                          |       | 3,736                                        |       | 5,499                                        |       |
| Inventories                                                                               |       | (1,261                                       | )          | 20,915                                       |       | 11,126                                       |       |
| Other current assets                                                                      |       | 2,924                                        |       | (4,534                                       | )          | 1,163                                        |       |
| Accounts payable                                                                          |       | 1,421                                        |       | (2,739                                       | )          | (3,336                                       | )          |
| Accrued expenses and other current liabilities                                            |       | 1,865                                        |       | (110                                         | )          | (1,351                                       | )          |
| Other assets                                                                              |       | 48                                           |       | (46                                          | )          | (6                                           | )          |
| Other liabilities                                                                         |       | 200                                          |       | —                                       |       | —                                       |       |
| Net cash provided by operating activities                                                 |       | 7,703                                        |       | 13,252                                       |       | 16,872                                       |       |
| Cash flows used in investing activities:                                                  |       |                                         |       |                                         |       |                                         |       |
| Purchase of equipment and leasehold improvements                                          |       | (273                                         | )          | (1,083                                       | )          | (966                                         | )          |
| Net cash used in investing activities                                                     |       | (273                                         | )          | (1,083                                       | )          | (966                                         | )          |
| Cash flows used in financing activities:                                                  |       |                                         |       |                                         |       |                                         |       |
| Repurchase of senior secured notes                                                        |       | (4,363                                       | )          | (11,552                                      | )          | (10,135                                      | )          |
| Deferred financing costs                                                                  |       | (155                                         | )          | (50                                          | )          | (30                                          | )          |
| Net cash used in financing activities                                                     |       | (4,518                                       | )          | (11,602                                      | )          | (10,165                                      | )          |
| Net increase (decrease) in cash and cash  equivalents                                     |       | 2,912                                        |       | 567                                          |       | 5,741                                        |       |
| Cash and cash equivalents, beginning of period                                            |       | 17,698                                       |       | 17,131                                       |       | 11,390                                       |       |
| Cash and cash equivalents, end of period                                                  |       | $                                            | 20,610     |                                         | $          | 17,698                                       |       | $ | 17,131 |   |
| Supplemental disclosures of cash flow information:                                        |       |                                         |       |                                         |       |                                         |       |
| Cash paid during the period for:                                                          |       |                                         |       |                                         |       |                                         |       |
| Interest                                                                                  |       | $                                            | 8,701      |                                         | $          | 11,232                                       |       | $ | 15,538 |   |
| Income taxes                                                                              |       | 481                                          |       | 7,203                                        |       | 548                                          |       |
| Supplemental disclosures of non-cash financing  activities:                               |       |                                         |       |                                         |       |                                         |       |
| Accretion of preferred stock to redemption value                                          |       | $                                            | 4,000      |                                         | $          | 4,000                                        |       | $ | 4,000 |   |

 

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

 

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**RafaellaApparel Group, Inc.**

**Notes toConsolidated Financial Statements**

 

**1.****                                     ****Descriptionof Business and Acquisition**

 

RafaellaApparel Group, Inc., together with its subsidiaries (the **“Company”**), is a wholesaler, designer, sourcer, marketer anddistributer of a full line of women’s career and casual sportswear separatessold primarily under the Rafaella brand and private label brands of ourcustomers.  The Company’s products aresold to department and specialty stores and off-price retailers locatedthroughout the United States of America.

 

TheCompany, a Delaware corporation, was formed to effect the acquisition ofRafaella Sportswear, Inc. (the **“Predecessor”**)by RA Cerberus Acquisition, LLC.  OnJune 20, 2005, pursuant to a Securities Purchase Agreement datedApril 15, 2005, as amended, the Company issued redeemable convertiblepreferred stock (the **“Preferred Stock”**)to RA Cerberus Acquisition, LLC for $40,000,000 (Note 11).  Immediately prior to the issuance of thePreferred Stock, the Predecessor contributed substantially all of its assets tothe Company in exchange for 100% of the Company’s common stock (10,000,000shares) and the assumption of certain liabilities related to the contributedassets.  Immediately following theissuance of the Preferred Stock, the Company issued $172,000,000 Senior SecuredNotes (Note 10) and entered into a $62,500,000 revolving credit facility (Note9).  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.

 

TheJune 20, 2005 transaction was accounted for as a purchase of thePredecessor’s business in accordance with FASB Accounting StandardsCodification (“**ASC**”) 805, *BusinessCombinations*, and the Emerging Issues Task Force IssueNo. 88-16, *Basis in Leveraged Buyout Transactions*.  As the stockholders of the 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).

 

ASC280, *Segment Reporting*, established standardsfor reporting information about operating segments.  Operating segments are defined as componentsof an enterprise for which separate financial information is available andevaluated regularly by the chief operating decision-maker, or decision-makinggroup, in deciding how to allocate resources and in assessing performance.  The Company is organized as, and operates in,one reportable segment:  the designing,sourcing, and marketing of a full line of women’s career and casual sportswearseparates.  The Company’s chief operatingdecision-maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial informationpresented on a consolidated basis, accompanied by information about revenue bycustomer, for purposes of evaluating financial performance and allocatingresources.  The Company’s operations andassets are primarily located in the United States of America.

 

**2.****                                     ****SignificantAccounting Policies**

 

**Basisof presentation**

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern which contemplates continuity ofoperations, the realization of assets and the satisfaction of liabilities inthe normal course of business. As a result of the continued strain on currentcredit and capital market conditions and the nearing maturity dates of theCredit Facility and the senior secured notes in June 2011, the Companybelieves that the forecasted cash and available credit capacity are notexpected to be sufficient to meet its debt repayment obligations as they comedue over the next twelve months. In order to enable the Company to meet itsdebt repayment obligations, the Company is currently seeking to refinance,extend or restructure its senior secured notes and Credit Facility. There canbe no assurance that the Company will be able to do so on terms and conditionssatisfactory to it within the period needed to meet these repaymentobligations. The Company’s ability to refinance any of the existingindebtedness on commercially reasonable terms may be materially and adverselyimpacted by the current credit market conditions and the Company’s financialcondition. The Company’s inability to repay under the terms of the financingagreements would lead to an event of default which would constitute debt beingcallable by creditors. The uncertainty associated with the Company’s ability torepay the outstanding debt raises substantial doubt about the Company’s abilityto continue as a going concern. If the Company were unable to continue as agoing concern, the Company would need to liquidate its assets and the Companymight receive significantly less than the values at which they are carried onits consolidated financial statements. The accompanying consolidated financial statements do not include anyadjustments related to the recoverability and classification of recorded assetsor the amounts and classification of liabilities that might result from theuncertainty associated with the Company’s ability to meet its debt obligationsas they come due.

 

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**Basisof consolidation**

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have beeneliminated in consolidation.

 

**Use ofestimates**

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period.  Estimates by theirnature are based on judgments and available information.  Therefore, actual results could differmaterially 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.

 

**Cashand cash equivalents**

 

Cashand cash equivalents include overnight deposits with banks, which areunrestricted as to withdrawal or use, and have an original maturity of threemonths or less.  Interest income,included within interest expense, net that was earned on the Company’s cash andcash equivalents amounted to $4,000, $54,000, and $310,000, for the years endedJune 30, 2010, 2009 and 2008, respectively.

 

**Receivables**

 

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

 

**Inventories**

 

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

 

**Long-livedassets**

 

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

 

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

 

TheCompany’s policy is to evaluate depreciable and amortizable assets (fixedassets, customer relationships and non-compete agreements) for impairmentwhenever events or changes in circumstances indicate that the carrying amountof such assets 

 

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maynot be recoverable from the undiscounted cash flows expected from the use ofthe asset.  These depreciable andamortizable assets are tested for impairment by comparing the carrying amountof the assets to their fair values.  Thisapproach is dependent upon future growth and trends.  Any impairment loss would be measured as theexcess of carrying amount over the fair value of the asset, determined on thebasis of discounted cash flows from the expected use of the asset.

 

Thetrademark and trade name, which have been determined to be indefinite livedassets, are tested for impairment at least annually or when changes in circumstancesindicate that their carrying amount may not be recoverable, by comparing thecarrying amount of the assets to their fair values based on an income approachusing the relief-from-royalty method. This method assumes that, in lieu of ownership, a firm would be willingto pay a royalty in order to exploit the related benefits of these assets.  This approach is dependent upon a number offactors, including estimates of future growth and trends, royalty rates for intellectualproperty, discount rates and other variables. The Company bases its fair value estimates on assumptions it believesare reasonable, but which are unpredictable and inherently uncertain.  Actual future results may differ from thoseestimates.  If the estimated fair valueof the assets is less than their carrying amount, an impairment loss isrecognized equal to such difference.

 

**Deferredfinancing costs**

 

Costsassociated with obtaining long-term financing are deferred and amortized, underthe effective interest method, over the terms of the related debt.  Amortization of these costs is included ininterest expense.  Deferred financingcost of $1,461,000 is recorded as part of other current assets line item of theCompany’s consolidated balance sheet as of June 30, 2010.

 

**Revenuerecognition**

 

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

 

**Cost ofsales**

 

Costof sales includes expenses to acquire and produce goods for sale, includingproduct costs, freight, import costs, third party inspection activity, andprovisions 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**

 

TheCompany 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, 2010, 2009 and 2008 were approximately$933,000, $1,643,000, and $2,302,000, respectively.  Non cooperative advertising expensesapproximated $13,000, $132,000 and $225,000 for the years ended June 30,2010, 2009 and 2008.

 

**Shippingand handling costs**

 

TheCompany includes shipping and handling costs associated with inbound freight incost of sales.  Shipping and handlingcosts associated with outbound freight are included in selling, general andadministrative expenses and for the years ended June 30, 2010, 2009 and2008 amounted to approximately $366,000, $300,000, and $332,000, respectively.

 

**Incometaxes**

 

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

 

TheCompany adopted the provisions of **ASC** 740, *Income Taxes*, formerly FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes” (“**FIN 48**”), onJuly 1, 2007.  As a result of thisadoption, the Company recognized an increase in liabilities for uncertain taxpositions of approximately $6.3 million with a corresponding increase in thedeferred tax asset of $5.9 

 

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millionrepresenting 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 expense relatedto unrecognized tax benefits in income tax expense.

 

**Recentaccounting pronouncements**

 

InJune 2009, the Financial Accounting Standards Board (“**FASB**”)issued the authoritative guidance to eliminate the historical GAAP hierarchyand establish only two levels of U.S. GAAP, authoritative andnon-authoritative. When launched on July 1, 2009, the FASB AccountingStandards Codification (“**ASC**”) becamethe single source of authoritative, nongovernmental GAAP, except forrules and interpretive releases of the SEC, which are sources ofauthoritative GAAP for SEC registrants. The subsequent issuances of newstandards will be in the form of Accounting Standards Updates that will beincluded in the ASC. This authoritative guidance was effective for financialstatements for interim or annual reporting periods ended afterSeptember 15, 2009. The Company adopted the new codification in the firstquarter of fiscal 2010 and it did not have any impact on the Company’sconsolidated financial statements.

 

InJune 2009, the FASB issued an amendment to the accounting and disclosurerequirements for the consolidation of variable interest entities (“**VIE**”) and the evaluation of when consolidation of a VIE isrequired. This amends the guidance for determining whether an entity is a VIEand establishes an additional reconsideration event for assessing whether anentity is, or continues to be, a VIE. The amendment modifies the requirementsfor determining whether an entity is the primary beneficiary of a VIE andrequires ongoing reassessments of whether an entity is the primary beneficiary.This amendment also enhances the disclosure requirements about an entity’sinvolvement with a VIE.  This amendmentis effective as of the beginning of each reporting entity’s first annualreporting period that begins after November 15, 2009, for interim periodswithin that first annual reporting period, and for interim and annual reportingperiods thereafter. Earlier application is prohibited. The Company isevaluating the impact the adoption of this amendment will have on itsconsolidated financial statements.

 

InJune 2009, the FASB issued an amendment to the accounting and disclosurerequirements for transfers of financial assets. This amendment eliminates theconcept of qualifying special purpose entities for accounting purposes. Thisamendment limits the circumstances in which a financial asset, or a componentof a financial asset, should be derecognized when the entire asset is nottransferred, and establishes specific conditions for reporting the transfer ofa portion of a financial asset as a sale. This amendment also requires enhanceddisclosures about the transfer of financial assets and the transferor’scontinuing involvement with transferred financial assets.  The amendment is effective as of thebeginning of each reporting entity’s first annual reporting period that beginsafter November 15, 2009, for interim periods within that first annualreporting period and for interim and annual reporting periods thereafter. TheCompany is evaluating the impact the adoption of this amendment will have onits consolidated financial statements.

 

InMay 2009, the FASB issued a new provision on subsequent events whichrequired the disclosure of the date through which an entity has evaluatedsubsequent events for potential recognition or disclosure in the financialstatements and whether that date represents the date the financial statementswere issued or were available to be issued.  This standard also providesclarification about circumstances under which an entity should recognize eventsor transactions occurring after the balance sheet date in its financialstatements and the disclosures that an entity should make about events ortransactions that occurred after the balance sheet date.  This standardwas amended in February 2010, whereby the amendments eliminate the requirementfor the disclosure of the date through which subsequent events were evaluated.The amendments are effective upon issuance of the update, and the adoption ofthe amendments did not have any impact on the Company’s consolidated financialstatements.

 

InSeptember 2006, the FASB issued authoritative guidance which defines fairvalue, establishes a framework for measuring fair value under GAAP and expandsfair value measurement disclosures. The guidance does not require new fairvalue measurements and is effective for financial statements issued for fiscalyears beginning after November 15, 2007 and interim periods within thosefiscal years. In February 2008, the FASB issued guidance which allows fora one-year delay of the effective date for fair value measurements for allnon-financial assets and liabilities, except for those that are recognized ordisclosed at fair value in the financial statements on a recurring basis. TheCompany delayed the effective date and applied the measurement provisions forall non-financial assets and liabilities that are recognized at fair value inthe consolidated financial statements on a non-recurring basis untilJuly 1, 2009. The Company’s non-recurring non-financial assets andliabilities include long-lived assets and intangible assets. The adoption ofthe guidance for financial assets and liabilities and for non-recurringnon-financial assets and liabilities did not have a significant impact on theCompany’s consolidated financial statements. In January 2010, the FASB issued amendments to disclosure andclassification requirements for fair value measurement and disclosures.  These amendments are effective for interimand annual reporting periods beginning after December 15, 2009, except forthe disclosures about purchases, sales, issuances, and settlements in therollforward activity in Level 3 fair value measurements, which are effectivefor fiscal years beginning after December 15, 2010, and for interimperiods within those fiscal years.  Theadoption of the amendments did not have any impact on the Company’sconsolidated financial statements.

 

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InApril 2008, the FASB issued authoritative guidance which amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible asset.The intent of the authoritative guidance is to improve the consistency betweenthe useful life of a recognized intangible asset and the period of expectedcash flows used to measure the fair value of the asset. The authoritativeguidance is effective for fiscal years beginning after December 15, 2008,and early adoption is prohibited. The measurement provision will apply only tointangible assets acquired after the effective date. The Company adopted thisauthoritative guidance effective July 1, 2009.  The adoption of the guidance which amends thefactors to be considered in developing renewal or extension assumptions used todetermine the useful life of a recognized intangible asset did not have a significantimpact on the Company’s consolidated financial statements.

 

**3.****                                     ****Stock-basedcompensation**

 

Stock-basedcompensation awards are accounted for in accordance with ASC 718, *Compensation — Stock Compensation.*The Rafaella ApparelGroup, 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.

 

Underthe Plan, unvested awards become immediately vested upon the occurrence of aLiquidity Event.  A Liquidity Event, asdefined in the Plan, is (i) a change in control, (ii) the sale,transfer or other disposition of all or substantially all of the business andassets, (iii) the consummation of an initial public offering, or(iv) the dissolution or liquidation of the Company.  Common stock acquired through the exercise ofstock option grants or vesting of restricted stock issued under the Plan maynot be sold, disposed of or otherwise transferred by a participant of the Planprior to a Liquidity Event without the consent of Cerberus Capital Management,L.P. (**“Cerberus”**), a shareholder of theCompany.

 

Underthe Plan, prior to a Liquidity Event, the Company has the right, but not theobligation, to purchase from a participant and to cause the participant to sellto the Company, common stock acquired through the exercise of stock optiongrants or vesting of restricted stock issued following the participant’s(i) death, (ii) termination of employment with the Company as aresult of disability, (iii) termination of employment by the Companywithout cause, (iv) termination of employment by the Company for cause, or(v) termination of employment with the Company for any other reason.  The purchase price for shares under clauses(i), (ii), or (iii) above is the greater of (a) the purchase pricepaid for such shares by the participant and (b) the fair market value ofsuch 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.

 

TheCompany uses the Black-Scholes option pricing model to determine the fair valueof stock-option awards.  Theweighted-average estimated fair value of stock options granted during the yearended June 30, 2010 was $0.09.  Fairvalue was estimated using the Black-Scholes option pricing model with thefollowing assumptions: (i) dividend yield - 0%, (ii) expectedvolatility - 50%, (iii) risk-free interest rate — 2.10%, and (iv) expectedlife - 4 years.  There were no stockoptions granted during the years ended June 30, 2009 and 2008.

 

Asummary of stock option plan activity during the fiscal year endedJune 30, 2010 is presented below:

 
| ** **                              | ** ** | **Shares** | ** ** | **Weighted  Average  Remaining  Contractual Life  (in years)** | ** ** |
|-----------------------------------------|------------|------------|------------|--------------------------------------------------------------------------|------------|
| Options outstanding, July 1, 2009  |       | 965,277    |       |                                                                     |       |
| Grants                                  |       | 222,222    |       |                                                                     |       |
| Forfeitures                             |       | (187,500   | )          |                                                                     |       |
| Options outstanding, June 30, 2010 |       | 999,999    |       | 7.4                                                                      |       |
| Options exercisable, June 30, 2010 |       | 866,664    |       | 6.8                                                                      |       |

 

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Asof June 30, 2010, 444,444 stock options are subject to the call rightprovisions described above.  Subsequentto a Liquidity Event, the call right provisions lapse, except for employeesterminated for cause.  As a result of thecall right provisions, the stock option awards do not substantively vest priorto the occurrence of a Liquidity Event. Accordingly, stock-based compensation expense will not be recognizeduntil it is probable that a Liquidity Event will occur.  As of June 30, 2010, it was not probablethat a Liquidity Event will occur. Unrecognized compensation costs related to these options approximated$258,000 at June 30, 2010.

 

TheCompany recorded compensation expense related to 555,555 stock options, notsubject to the call right provisions described above, of approximately $19,000,$24,000, and $23,000 during the years ended June 30, 2010, 2009 and 2008,respectively.  As of June 30, 2010,the 555,555 stock options not subject to the call right provisions were fullyvested and, accordingly, there is no unrecognized compensation costs related tothese options.

 

TheCompany is obligated to pay certain cash payments equal to three-tenths of apercent (0.3%) of the Appreciated Value of the Company in connection with SaleTransactions and three-tenths of a percent (0.3%) of the Net Dividends paidother than in connection with a Sale Transaction (each term as defined) inconnection with an agreement entered into among the Company and a formeremployee.  As the cash payments arecontingent in nature, compensation expense will not be recognized until it isprobable that such payments will occur. As of June 30, 2010, it was not probable that a Sale Transaction ora Net Dividend payment will occur.

 

**4.****                                     ****Receivables**

 

Receivablesconsist of (in thousands):

 
| ** **                                                  | ** ** | **June 30, 2010** | ** ** | **June 30, 2009** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                                        |       |                        |       |                        |       |
| Due from factor                                             |       | $                           | 13,771     |                        | $          | 18,260 |   |
| Trade receivables                                           |       | 4,731                       |       | 1,712                       |       |
|                                                        |       | 18,502                      |       | 19,972                      |       |
| Less: Allowances for sales returns, discounts, and  credits |       | (7,648                      | )          | (8,422                      | )          |
|                                                        |       | $                           | 10,854     |                        | $          | 11,550 |   |

 

Historically,the Company factored a significant portion of its trade receivables, on anon-recourse basis, with GMAC Commercial Finance LLC (**“GMAC”**),a commercial factor.  In accordance with the terms of an Amended andRestated Collection Services Factoring Agreement dated December 16, 2008between GMAC and the Company, all accounts receivable of the Company then heldby GMAC were sold back to the Company effective as of such date.  OnDecember 19, 2008, the Company delivered to GMAC a notice of terminationof the GMAC arrangement pursuant to the terms thereof.  OnFebruary 5, 2009, as part of the termination of the GMAC arrangement, theCompany arranged for an irrevocable letter of credit in an aggregate amount of$2,000,000 (the **“Letter of Credit”**) for thebenefit of GMAC.  The Letter of Credit permits GMAC to draw amounts equalto amounts collected by GMAC, after January 6, 2009, if certain identifiedcustomers of the Company file a petition for relief from creditors under theUnited States Bankruptcy Code and claims are made for GMAC to return to thecustomer or its bankruptcy estate amounts GMAC has collected from suchcustomer.  The Letter of Credit was subsequently reduced to $65,000 inSeptember 2009 and expires on April 2, 2011, subject to extensionunder certain circumstances.

 

OnDecember 19, 2008, the Company entered into a factoring agreement withWells Fargo Trade Capital, LLC (**“Wells Fargo”**),a commercial factor, pursuant to which the Company may sell certain of itsreceivables to Wells Fargo on a non-recourse basis.  Wells Fargo willassume credit risk on all sales that are approved in advance.

 

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

 

Forthe years ended June 30, 2010, 2009 and 2008, the provision for salesreturns, discounts and credits charged to earnings was $31,020,000,$35,223,000, and $34,364,000, respectively, and decreased by authorizeddeductions taken by customers of $31,794,000, $34,247,000, and $33,836,000,respectively.

 

**5.****                                     ****Inventories**

 

Inventoriesare summarized as follows (in thousands):

 

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| ** **                        | ** ** | **June 30, 2010** | ** ** | **June 30, 2009** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                              |       |                        |       |                        |       |
| Piece goods (held by contractors) |       | $                           | 319        |                        | $          | 266 |   |
| Finished goods:                   |       |                        |       |                        |       |
| In warehouse                      |       | 5,768                       |       | 6,761                       |       |
| In transit                        |       | 7,508                       |       | 5,307                       |       |
|                              |       | $                           | 13,595     |                        | $          | 12,334 |   |

 

**6.****                                     ****Equipmentand Leasehold Improvements**

 

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

 
| ** **                                      | ** ** | **June 30, 2010** | ** ** | **June 30, 2009** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                                            |       |                        |       |                        |       |
| Furniture, fixtures and equipment               |       | $                           | 2,004      |                        | $          | 2,083 |   |
| Leasehold improvements                          |       | 295                         |       | 375                         |       |
|                                            |       | 2,299                       |       | 2,458                       |       |
| Less: Accumulated depreciation and amortization |       | (1,134                      | )          | (755                        | )          |
|                                            |       | $                           | 1,165      |                        | $          | 1,703 |   |

 

Depreciationand amortization expense of equipment and leasehold improvements for the yearsended June 30, 2010, 2009 and 2008 were approximately $541,000, $462,000,and $168,000, respectively.  Furniture,fixture and equipment includes capitalized software.  The unamortized software costs as of June 30,2010 and 2009 were approximately $508,000 and $468,000, respectively.  Included in above depreciation andamortization expense is amortization expense of software costs for the yearsended June 30, 2010, 2009, and 2008, of approximately $152,000, $116,000,and $52,000, respectively.

 

**7.****                                     ****IntangibleAssets**

 

Intangibleassets resulting from the June 20, 2005 acquisition, consist of the followingas of June 30, 2010 and 2009 (in thousands):

 
| ** **                     | ** ** | **Estimated  Lives** | ** ** | **2010** | ** ** | **2009** | ** ** |
|--------------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Customer relationships         |       | 7, 15 years          |       | $        | 43,525     |     | $          | 43,525 |   |
| Less: Accumulated amortization |       |                 |       | (21,037  | )          | (17,359  | )          |
|                           |       |                 |       | 22,488   |       | 26,166   |       |
|                           |       |                 |       |     |       |     |       |
| Non-compete agreements         |       | 2, 10 years          |       | 3,067    |       | 3,067    |       |
| Less: Accumulated amortization |       |                 |       | (1,781   | )          | (1,525   | )          |
|                           |       |                 |       | 1,286    |       | 1,542    |       |
|                           |       |                 |       |     |       |     |       |
| Trademark and trade name       |       | Indefinite life      |       | 7,557    |       | 7,557    |       |
| Total intangible assets        |       |                 |       | $        | 31,331     |     | $          | 35,265 |   |

 

TheCompany’s indefinite-lived intangible assets consist of the Rafaella trademarkand trade name, as the Company believes these assets will contribute to cashflows indefinitely.  These assets havebeen in existence since the Company’s inception 25 years ago, and there is noforeseeable limit on the period of time over which they are expected tocontribute to cash flows.  In accordancewith ASC 350, *Intangibles — Goodwill andOthers*, the Company’s trademark and trade name are reviewed at leastannually for impairment.  The Companyperformed its annual impairment test of the trademark and trade name during thefourth quarter of the fiscal year ended June 30, 2010 and determined thatthere were no impairments.  The Companyperformed an impairment test of the trademark and trade name during the secondand fourth quarters of the fiscal year ended June 30, 2009 and the fourthquarter of the fiscal year ended June 30, 2008 and determined that thetrademark and trade name was impaired necessitating a charge of $23.4 million,$2.4 million, and $34.5 million, respectively. The impairment charges of $25.8 million and $34.5 million are includedwithin operating loss for the years ended June 30, 2009 and 2008,respectively.  The Company re-evaluatedthe useful lives of the trademark and trade name and customer relationships asof June 30, 2009 and determined that the impairment and othercircumstances did not warrant revised estimates of useful lives.  Both non-compete agreements are withDirectors of the Company.  Theamortization expense related to intangible assets for the years endedJune 30, 2010, 2009 and 2008 was approximately $3,934,000, $4,209,000, and$4,336,000, respectively.

 

Estimatedamortization expense for the next five years is as follows:

 

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| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2011       |       | $                       | 3,661      |   |
| 2012       |       | 3,401                   |       |
| 2013       |       | 2,874                   |       |
| 2014       |       | 2,661                   |       |
| 2015       |       | 2,483                   |       |
|            |            |                         |            |  |

 

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

 

**8.****                                     ****AccruedExpenses and Other Current Liabilities**

 

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

 
| ** **                        | ** ** | **June 30, 2010** | ** ** | **June 30, 2009** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Accrued interest expense          |       | $                           | 359        |                        | $          | 424 |   |
| Accrued bonuses                   |       | 2,011                       |       | 190                         |       |
| Accrued compensation and benefits |       | 473                         |       | 919                         |       |
| Accrued professional fees         |       | 615                         |       | 111                         |       |
| Other accrued liabilities         |       | 986                         |       | 524                         |       |
|                              |       | $                           | 4,444      |                        | $          | 2,168 |   |

 

**9.****                                     ****Short-termBorrowings**

 

OnJune 20, 2005, the Company entered into a secured revolving creditfacility agreement (as amended through May 21, 2010, the “**Credit Facility**”) with HSBC Bank USA, NationalAssociation.  The Company, CerberusCapital Management, L.P. (“**Cerberus**”), asa lender and the term lender, HSBC Bank USA, National Association (“**HSBC**” or the “**Agent**”), asagent and as lender, the other lenders signatory thereto from time to time (the“**Lenders**”) and the other loan partiessignatory thereto (together with Cerberus and HSBC, collectively the “**Loan Parties**”) entered into a certain Amended and RestatedFinancing Agreement dated as of May 21, 2010 (the “**Amended andRestated Financing Agreement**”) to amend and restate the CreditFacility.

 

TheAmended and Restated Financing Agreement, which matures on June 10, 2011,provides for (a) letters of credit of up to $20,000,000 to be provided byHSBC, (b) revolving direct debt advances of up to $5,000,000 on or afterDecember 16, 2010 to be provided by Cerberus (the Company will not beentitled to obtain any revolving direct debt advances prior toDecember 16, 2010), and (c) term loans of up to $5,000,000 to beprovided by Cerberus (the “**Term Loan Commitment**”).  The above letters of credit and revolvingdirect debt advances are subject to the additional conditions as noted below.

 

Underthe terms of the Amended and Restated Financing Agreement, the Company’sability to cause the issuance of letters of credit prior to December 16,2010 is limited to the lesser of (x) $20,000,000 and (y) subject toreserves required by HSBC, if any, and the availability reserve discussed below(i) the sum of (a) 70% of eligible receivables plus (b) 70% ofeligible factored receivables, plus (ii) the lesser of (I) the sum of(a) 50% of eligible inventory plus (b) 50% of outstanding eligibledocumentary letters of credit, and (II) the inventory advance cap, plus(iii) cash collateral.  Theinventory advance cap is (i) $10,000,000 from the effective date of theAmended and Restated Financing Agreement through and includingSeptember 30, 2010, (ii) $5,000,000 from October 1, 2010 throughand including December 15, 2010 and (iii) $0 thereafter.  The availability reserve is (a) $10,000,000through December 15, 2010 and (b) $0 on and after December 16,2010.  From and after December 16,2010, the Company’s ability to cause the issuance of letters of credit islimited to the lesser of $20,000,000 and the amount of cash collateraldeposited by the Company to cash collateralize letters of credit.  The Amended and Restated Financing Agreementfurther provides that standby letters of credit shall be limited to $4,011,000in the aggregate undrawn amount outstanding at any time.

 

Underthe terms of the Amended and Restated Financing Agreement, the Company’srevolving direct debt advances on or after December 16, 2010 is limited tothe lesser of (i) $5,000,000 and (ii) subject to reserves required byHSBC, if any, the sum of (x) 65% of eligible receivables plus (y) 65%of eligible factored receivables.

 

Theterm loans may be used solely to fund repayments or repurchases of the Company’soutstanding 111⁄4% Senior Secured Notes due June 2011 (the “**Notes**”); and the Company shall not repurchase any of theNotes except (a) with the proceeds of the term loans or (b) asotherwise required pursuant to the terms of the Notes indenture.  The term loans are secured by a first lien onall of the Company’s assets on a *pari passu*basis with all other obligations under the Amended and Restated FinancingAgreement, subject to 

 

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theprovisions of the Amended and Restated Financing Agreement relating to theapplication of proceeds from the Company. Any term loans, borrowed under the Term Loan Commitment, are also dueand payable on June 10, 2011 or upon termination of the Amended andRestated Financing Agreement.

 

TheAmended and Restated Financing Agreement provides that the minimum workingcapital requirement shall be $25,000,000 as of the end of the fiscal quarterending June 30, 2010 and $27,000,000 as of the end of the fiscal quartersending thereafter.  Working capital isdefined as the sum of cash, accounts receivable, and inventory, reduced bycurrent liabilities; the definition of current liabilities excludes indebtednessunder the Company’s senior secured notes at any point on or after June 30,2010.  With the exception of the fiscalquarters ending on June 30, 2010 and September 30, 2010, the Companyis required to maintain positive net income during each period of twoconsecutive fiscal quarters (on a rolling basis).  The Company is permitted to incur up to a netloss of $1,300,000 during each of the two consecutive fiscal quarters (on arolling basis) ending on June 30, 2010 and September 30, 2010.  For purposes of determining compliance withthe net income financial covenant, the definition of net income excludesnoncash expenses associated with (i) amortization of customerrelationships and non-compete agreements, (ii) the accretion of the seniorsecured notes original issue discount, (iii) amortization of deferredfinancing costs, and (iv) impairment charges, if any, resulting from adecline in the value of the Company’s intangible assets.

 

TheAmended and Restated Financing Agreement sets forth the following cashcollateral requirements: (i) $5,500,000 from July 1, 2010 through andincluding July 31, 2010; (ii) $3,000,000 from October 1, 2010through and including October 31, 2010; and (iii) $2,000,000 fromNovember 1, 2010 through and including November 30, 2010.  Effective on and after December 16,2010, the Company is required to cash collateralize all outstanding letters ofcredit in an amount equal to one hundred and five percent (105%) of suchoutstanding letters of credit.  Acondition precedent to the issuance of any letter of credit on and afterDecember 16, 2010 is that the Company shall have deposited with HSBC cashcollateral in an amount equal to 105% of the undrawn face amount of each suchletter of credit.

 

Asof June 30, 2010, the Company was in compliance with each of the financialcovenants.  A violation of the financialcovenants constitutes an event of default under the Amended and RestatedFinancing Agreement; such an event of default could result in all debt becomingdue and payable, and HSBC having the right to terminate the Credit Facility andits obligation to make advances thereunder. If the Company’s operations were to deteriorate beyond its forecastedresults, it could result in a debt covenant violation and the Company wouldneed another amendment.  If the Companywere unable to amend the terms of the Amended and Restated Financing Agreement,the Company’s financial condition and results of operations may be materiallyadversely affected.  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.

 

AtJune 30, 2010, there were no loans and $10.2 million of letters of creditoutstanding under the Amended and Restated Financing Agreement.  Theoutstanding letters of credit are comprised of letters of credit totaling $6.2million in connection with purchaseorders for merchandise from third-party manufacturers and standby letters ofcredit totaling $4.0 million issuedby HSBC, which serve as security for obligations under certain operatingleases, a customs bond and the GMAC Letter of Credit (refer to Note 4 forfurther discussion).  The Company’saggregate maximum availability for letters of credit approximated $3.6 million as of June 30, 2010(inclusive of $6.5 million of cash collateral deposited by the Company as ofperiod end).

 

TheCompany requires significant working capital to purchase inventory and is oftenrequired to post commercial letters of credit when placing orders with certainof its third-party manufacturers or fabric suppliers.  In addition, standby letters of credittotaling $4.0 million issued by HSBC, which serve as security for obligationsunder certain operating leases, a customs bond and the GMAC Letter of Credit,are outstanding as of June 30, 2010.

 

TheAmended and Restated Financing Agreement includes various other covenants withwhich the Company has to comply in order to maintain borrowing availabilityincluding, but not limited to, covenants limiting or restricting the Company’sability to incur indebtedness, incur liens, enter into mergers orconsolidations, dispose of assets, make investments, pay dividends andrepurchase capital stock, enter into transactions with affiliates or prepaycertain indebtedness.  In addition, theCompany is required to report various financial and non-financial informationperiodically to HSBC.  The Amended andRestated Financing Agreement also contains customary events of defaultincluding, but not limited to, payment defaults, covenant defaults, cross-defaultsto the senior secured notes, material judgment defaults, inaccuracy ofrepresentations and warranties, bankruptcy and insolvency events, defects inHSBC’s security interest, change in control events, and certain events whichwould have a material adverse effect.  Anevent of default could result in all debt becoming due and payable, and HSBChaving the right to terminate the Credit Facility and its obligation to makeadvances under it.

 

Pursuantto the Amended and Restated Financing Agreement, in the event the Company hasoutstanding direct debt advances on or after December 16, 2010, theCompany remits funds from the collection of receivables to pay down borrowingsoutstanding under the Amended and Restated Financing Agreement.  Under the Company’s factoring agreement, theCompany directs its

 

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customersto remit payments on accounts receivable to its factor.  At the request of HSBC, the Company hasdirected its factor to remit the funds from the collection of receivablesdirectly to an HSBC account to reduce borrowings outstanding under the Amendedand Restated Financing Agreement. Payments from customers in connection with the Company’s factoringarrangement are reflected in operating cash flows as collections ofreceivables.  Funds remitted under thisarrangement to reduce short-term borrowings are reflected in cash flows fromfinancing activities in the statement of cash flows.

 

Therewere no loan borrowings or repayments under the Amended and Restated FinancingAgreement during the fiscal year ended June 30, 2010.  Loan borrowings and repayments under theAmended and Restated Financing Agreement were $13.8 million and $13.8 million,respectively, during the fiscal year ended June 30, 2009.  Loan borrowings and repayments under theAmended and Restated Financing Agreement were $12.8 million and $12.8 million,respectively, during the fiscal year ended June 30, 2008.

 

TheAmended and Restated Financing Agreement provided for (i) an extension feeof $25,000 payable to HSBC, as Agent, payable upon execution, (ii) arevolving commitment closing fee payable to Cerberus of $125,000, which fee isearned as of the effective date of the Amended and Restated Financing Agreementand payable upon the Termination Date (as such term is defined in the Amendedand Restated Financing Agreement), and (iii) term loan fees payable toCerberus, as term lender, of (a) a closing fee of $125,000, which fee isearned as of the effective date of the Amended and Restated Financing Agreementand payable upon the Termination Date, and (b) a facility fee at a rateequal to one-quarter of one percent (0.25%) per annum on average daily unusedportion of the Term Loan Commitment earned on a monthly basis and payable uponthe Termination Date.  Borrowings underthe Amended and Restated Financing Agreement bear variable interest at theCompany’s option at either (i) a base rate or (ii) the Londoninterbank offered rate plus two and three quarters percent (2.75%) per annum(each as defined).  The Amended andRestated Financing Agreement provides for a monthly commitment fee of 0.25% perannum on the unused portion of the available commitments for revolving directdebt advances and letters of credit under the facility.

 

Theforegoing is a summary of the Amended and Restated Financing Agreement, anddoes not purport to be complete and is qualified in its entirety by the copy ofthe Amended and Restated Financing Agreement.

 

**10.****                              ****SeniorSecured Notes**

 

OnJune 20, 2005, the Company received aggregate proceeds of $163,400,000from the issuance of 11.25% senior secured notes, face value $172,000,000.  The notes were issued at 95% of face value,resulting in an original issue discount of $8,600,000 that is being amortizedunder the effective interest method over the term of the notes.  Senior secured notes principal amountoutstanding at June 30, 2010 and 2009 is $71,861,000 and $84,743,000,respectively.  At June 30, 2010 and2009, debt held in treasury approximated $65,537,000 and $52,655,000, respectively.  At June 30, 2010 and 2009, theunamortized original issue discount is $777,000 and $1,751,000,respectively.  The Company’s seniorsecured notes are recorded at carrying book value at June 30, 2010 and2009.  At June 30, 2010 and 2009, the fair value of the seniorsecured notes, determined based upon quoted market prices, was approximately$48,147,000 and $16,101,000, respectively.  The notes bear cash interestat 11.25%.  After giving effect to theoriginal issue discount and costs associated with the issuance, the notes havean effective interest rate of approximately 13.7%.  The notes mature on June 15, 2011 andcash interest is payable semiannually on June 15 and December 15 ofeach year, commencing December 15, 2005. The notes are collateralized by a second priority lien on substantiallyall of the assets of the Company.  Thenotes are subordinated to amounts outstanding under the Amended and RestatedFinancing Agreement.

 

Within100 days after the end of each fiscal year, beginning with the fiscal yearended on June 30, 2006, the Company must make an offer to repurchase allor a portion of the notes at 101% of their principal amount at maturity plusaccrued and unpaid interest to the date of purchase, with 50% of excess cashflow, as defined, from the previous fiscal year.  Senior secured note aggregate principalamounts of $598,000, $221,000 and $17,429,000 were repurchased duringNovember 2008, 2007 and 2006, respectively, in connection with excess cashflow offers made by the Company.  TheNovember 2008, 2007 and 2006 repurchases of the notes, which were at 101%of their principal amount at maturity plus accrued and unpaid interest to thedate of purchase, approximated $631,000, $234,000 and $18.4 million,respectively.  The Company wrote-off $1.7million of unamortized original issue discount and deferred financing costs tointerest expense in connection with the November 2006 repurchase.  Unamortized original issue discount anddeferred financing costs associated with the November 2008 and 2007repurchases were not significant.

 

Anannual excess cash flow payment with respect to the fiscal years endingJune 30, 2010 and 2009 were not required.  This is based on theCompany’s financial position and its results of operations and cash flows forthe years then ended.

 

Inaddition to the excess cash flow repurchases, the Company also repurchased$16,062,000 of the senior secured notes at 101% of their principal amount atmaturity, plus accrued and unpaid interest, for approximately $16.3 million onJune 29, 2007.  The Companywrote-off $1.4 million of unamortized original issue discount and deferredfinancing costs to interest expense in connection with the June 29, 2007senior secured note repurchase.

 

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TheCompany purchased, at a discount, $6.0 million and $8.0 million of outstandingsenior secured notes on the open market in January 2008 andJune 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, was recordedto interest expense during the fiscal year ended June 30, 2008.

 

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

 

TheCompany purchased, at a discount, $3.5 million, $5.0 million, and $4.4 millionof outstanding senior secured notes on the open market in July 2009, November 2009,and December 2009, respectively.  Apre-tax gain of approximately $8.0 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 gain on senior secured note purchase during thefiscal year ended June 30, 2010.

 

Asnoted in Note 9, the Company’s senior Amended and Restated Financing Agreementexpires on June 10, 2011 and the Company’s senior secured notes mature onJune 15, 2011.  Management currentlydoes not believe that the Company will have sufficient cash on hand, based oncurrent cash flow projections, to settle the senior secured notes in June 2011at principal or face value.  If theCompany is unable to secure additional financing, its business and results fromoperations, financial condition and cash flows may be materially adverselyaffected and impact the Company’s ability to continue as a going concern.  Consequently, management is currently in theprocess of exploring alternative long-term financing.  There can be no assurance that any suchfinancing will be available with terms favorable to the Company or at all.

 

OnFebruary 22, 2010, the Company commenced a debt tender offer (“**Tender Offer**”) to purchase up to approximately 51% of itsoutstanding 11-1⁄4% Senior Secured Notes due 2011 (the “**Notes**”).  The consummation of the Tender Offer wasconditioned upon, among other conditions, the valid tender by holders of Noteswith a minimum aggregate principal amount at maturity of $17,975,000 (the “**Minimum Tender Amount**”). At 11:59 p.m., New York City time, on March 19, 2010 theTender Offer expired and the Minimum Tender Amount of Notes was nottendered.  Consequently, the Company didnot purchase any Notes pursuant to the Tender Offer.

 

Inconnection with the Tender Offer, on February 22, 2010, the Company alsoentered into an agreement (the “**Originally RestatedAgreement**”) with HSBC and Cerberus Capital Management, L.P. (“**Cerberus**”), as the term lender, to amend and restate theCredit Facility, by and among HSBC, as agent and lender, the other lenderssignatory thereto from time to time, the Company, and the other loan partiessignatory thereto.  The closing of theOriginally Restated Credit Agreement was subject to, among other things, theconsummation of the Tender Offer in accordance with its terms.  As noted above, the Tender Offer was notconsummated, as the Minimum Tender Amount was not satisfied, and accordingly, aclosing did not occur with respect to the Originally Restated Credit Agreementand the Company’s Credit Facility remains in full force and effect.

 

Thesenior secured notes indenture contains various covenants with which theCompany has to comply, including, but not limited to, covenants limiting orrestricting the Company’s ability to incur indebtedness, incur liens, enterinto mergers or consolidations, dispose of assets, make investments, paydividends and repurchase capital stock or enter into transactions withaffiliates.  In addition, the Company is required to report variousfinancial and non-financial information periodically to the trustee.  Thesenior secured notes indenture also contains customary events of defaultincluding, but not limited to, payment defaults, cross-defaults to otherindebtedness in excess of $7.5 million, material judgment defaults, bankruptcyand insolvency events, defects in security interests, and change in controlevents.  An event of default could result in all debt becoming due andpayable.

 

**11.****                              ****RedeemableConvertible Preferred Stock**

 

OnJune 20, 2005, the Company issued 7,500,000 shares of redeemableconvertible 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 is declaredwith respect to the common stockholders.

 

ThePreferred Stock is redeemable at the option of the holder upon the earlier of(i) a change in control of the Company, as defined in the certificate ofincorporation, (ii) June 20, 2010, if no principal amounts of thesenior secured notes are outstanding, and (iii) December 20, 2011, ifprincipal amounts of the senior secured notes are outstanding.  The 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

 

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redemptionof the Preferred Stock is outside the control of the Company, the PreferredStock is classified outside of stockholders’ equity (deficit) on theconsolidated balance sheets.  For each ofthe years ended June 30, 2010, 2009, and 2008, the Company accreted$4,000,000 towards the Preferred Stock.

 

ThePreferred Stock is convertible into common stock on a one for one basis.  Such conversion ratio is subject toadjustment in the event of additional issuances of common stock at prices lessthan the original conversion price.

 

**12.****                              ****IncomeTaxes**

 

Theprovision for (benefit from) income taxes consists of the following (inthousands):

 
| ** **      | ** ** | **Year Ended  June 30, 2010** | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|-----------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **      | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** |
| Current:        |       |                                         |       |                                         |       |                                         |       |
| Federal         |       | $                                            | 409        |                                         | $          | 1,664                                        |       | $ | 1,714 |   |
| State and local |       | 516                                          |       | 644                                          |       | 322                                          |       |
| Foreign         |       | 23                                           |       | —                                       |       | —                                       |       |
|            |       | 948                                          |       | 2,308                                        |       | 2,036                                        |       |
| Deferred:       |       |                                         |       |                                         |       |                                         |       |
| Federal         |       | 2,246                                        |       | 4,000                                        |       | (9,462                                       | )          |
| State and local |       | 75                                           |       | 418                                          |       | (773                                         | )          |
|            |       | 2,321                                        |       | 4,418                                        |       | (10,235                                      | )          |
|            |       | $                                            | 3,269      |                                         | $          | 6,726                                        |       | $ | (8,199 | ) |

 

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

 
| ** **                                            | ** ** | **Year Ended  June 30, 2010** | ** ** | **Year Ended  June 30, 2009** | ** ** | **Year Ended  June 30, 2008** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                            | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** |
| Statutory federal income tax rate                     |       | 34.0                                         | %          | 34.0                                         | %          | 34.0                                         | %          |
| State and local income taxes, net of federal  benefit |       | 14.7                                         |       | (9.1                                         | )          | 3.5                                          |       |
| Foreign income taxes, net of federal benefit          |       | 0.4                                          |       | —                                       |       | —                                       |       |
| Valuation allowance                                   |       | 30.0                                         |       | (109.5                                       | )          | (11.2                                        | )          |
| ASC 740, formerly FIN 48, interest and liabilities    |       | (0.7                                         | )          | 7.4                                          |       | (1.4                                         | )          |
| Effective tax rate                                    |       | 78.4                                         | %          | (77.2                                        | )%         | 24.9                                         | %          |

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amount used for income tax purposes.

 

Thecomponents of deferred taxes as of June 30, 2010 and 2009 are as follows(in thousands):

 
| ** **                                 | ** ** | **June 30,  2010** | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | ** **              | ** ** | ** **              | ** ** |
| Deferred tax assets:                       |       |                    |       |                    |       |
| Inventories                                |       | $                       | 784        |                    | $          | 728 |   |
| Accrued expenses and other liabilities     |       | 1,316                   |       | 508                     |       |
| Interest                                   |       | 5                       |       | 15                      |       |
| Deferred financing costs and other assets  |       | 136                     |       | 262                     |       |
| Intangible assets                          |       | 17,285                  |       | 15,917                  |       |
| Stock-based compensation                   |       | 119                     |       | 111                     |       |
| Other                                      |       | 77                      |       | 81                      |       |
| Total deferred tax assets                  |       | 19,722                  |       | 17,622                  |       |
| Valuation allowance on deferred tax assets |       | (16,403                 | )          | (14,995                 | )          |
| Deferred tax liabilities:                  |       |                    |       |                    |       |
| Senior secured notes                       |       | (6,099                  | )          | (2,950                  | )          |
| Depreciation                               |       | (121                    | )          | (169                    | )          |
| Total deferred tax liabilities             |       | (6,220                  | )          | (3,119                  | )          |
| Net deferred taxes                         |       | $                       | (2,901     | )                       | $          | (492 | ) |

 

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Duringthe years ended June 30, 2009 and 2008, the Company established avaluation allowance of $9.9 million and $4.3 million, respectively, for thedeferred tax asset that resulted from the Rafaella trademark and trade nameintangible asset impairments (Note 7).  Theunderlying tax basis of the trademark and trade name is capital in nature.  The asset would generate a capital loss forincome tax purposes upon disposition at its carrying value, which can only beused to offset capital gain income.  TheCompany determined that the deferred tax asset is not more likely than not tobe realized as there are no actual or projected capital gains available tooffset any future capital losses that might be generated from the Rafaellatrademark and trade name deferred tax asset. In addition, the Company does not expect to recognize an income taxbenefit from its customer relationship intangible assets and provided adeferred tax asset valuation allowance of $1.4 million and $0.8 million duringthe years ended June 30, 2010 and 2009, respectively, because the underlyingtax basis of the customer relationships is capital in nature. Any federaloperating losses generated for the periods ended June 30, 2010 and 2009may be carried back, the benefit of which is reflected in current taxesreceivable. Current taxes receivable approximated $2.9 million and $5.4 millionas of June 30, 2010 and 2009, respectively, and are included in otherassets on the consolidated balance sheets. State net operating loss carryforwards of $3.6 million were used duringthe fiscal year ended June 30, 2010. As of June 30, 2010 and 2009, there were no federal operating losscarryforwards. As of June 30, 2010, there were state operating losscarryforwards of $2.3 million, which will expire in 2030.

 

TheCompany remains subject to federal, state and local income tax examinations bytax authorities for all tax years beginning on or after January 1, 2007.Examination of the Company’s 2006 federal income tax return by the InternalRevenue Service was completed, as was a state tax audit for the 2006 and 2005tax years.  No significant adjustments were proposed in connection withthese examinations.  Subsequently, therelated unrecognized tax benefits were recognized. The Company recognizesinterest expense related to unrecognized tax benefits in income taxexpense.  As of June 30, 2010 and2009, accrued interest approximated $15,000 and $27,000, respectively.  Interest expense related to unrecognized taxbenefits recorded in income tax expense for the fiscal year ended June 30,2010 was not significant.  For the fiscalyear ended June 30, 2009, interest income related to the reversal ofunrecognized tax benefits recorded in income tax expense approximated $0.7million.  For the fiscal year endedJune 30, 2008, interest expense related to unrecognized tax benefitsrecorded in income tax expense approximated $0.3 million.

 

Areconciliation of the beginning and ending amount of unrecognized tax benefitsfor the years ended June 30, 2010 and 2009 is as follows:

 

**ASC740, formerly FIN 48, Tabular Reconciliation (in thousands)**

 
| ** **                                           | ** ** | **2010**   | ** ** | **2009**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross unrecognized tax benefits at July 1,      |       | $          | 169        |       | $          | 6,091 |   |
| Gross increases related to prior year tax  positions |       | 2          |       | 31         |       |
| Gross decreases related to prior year tax  positions |       | (76        | )          | (5,953     | )          |
| Gross unrecognized tax benefits at June 30,     |       | $          | 95         |       | $          | 169 |   |

 

Asof June 30, 2010 and 2009, the Company had approximately $0.1 million and$0.2 million, respectively, of unrecognized tax benefits that, if recognized,would affect the effective tax rate.  The$6.0 million gross decrease in 2009 related to the reversal of prior year taxpositions recorded upon adoption of FIN 48. As a result of this reversal, the Company recognized a decrease inliabilities with a corresponding decrease in the deferred tax assetrepresenting the gross unrecognized tax benefits.  This reversal did not have an impact on theCompany’s June 30, 2009 consolidated statement of operations.

 

**13.****                              ****Concentrationof Credit Risk and Major Customers**

 

TheCompany maintains its cash accounts in one commercial bank located in both NewYork and Hong Kong.  The New York cashbalances are insured by the Federal Deposit Insurance Corporation (FDIC) up to$250,000 per bank.

 

Receivablesarise in the normal course of business. Management minimizes its credit risk with respect to trade receivablessold to its factor.  For tradereceivables not factored, management monitors the creditworthiness of suchcustomers and reviews the outstanding receivables at period end, as well asuncollected account experience and establishes an allowance for doubtfulaccounts as deemed necessary.  Bad debtexpense was not significant for the fiscal year ended June 30, 2010, andapproximated $0.1 million and $0.6 million for the years ended June 30,2009 and 2008.

 

Forthe fiscal year ended June 30, 2010, sales to four customers approximated$34.8 million, $23.3 million, $14.2 million, and $12.1 million of the Company’sconsolidated net sales.  For the fiscalyear ended June 30, 2009, sales to three customers

 

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approximated$42.0 million, $29.2 million, and $18.5 million of the Company’s consolidatednet sales.  For the fiscal year endedJune 30, 2008, sales to three customers approximated $37.3 million, $35.9million, and $32.4 million of the Company’s consolidated net sales.  Accounts receivable, net of allowances, fromthree customers approximated $3.7 million, $1.8 million and $1.6 million atJune 30, 2010. Accounts receivable, net of allowances, from two customersapproximated $2.5 million and $1.8 million at June 30, 2009.

 

**14.****                              ****Commitmentsand Contingencies**

 

DuringApril 2009, Kobra International, Ltd. d/b/a Nicole Miller (“**Nicole Miller**”) commenced arbitration proceedings againstthe Company alleging that the Company’s decision to suspend performance aslicensee under the parties’ License Agreement (the “**License**”)constituted an anticipatory breach and/or repudiation of the License.  Nicole Miller originally sought $1.5 millionin purported damages.  On April 29,2009, the Company filed papers denying Nicole Miller’s claims in theirentirety, asserting that the suspension of performance was permitted by theLicense and asserting a counterclaim of $1.0 million alleging that NicoleMiller’s subsequent termination of the License was improper.  On January 29, 2010, Nicole Millerasserted an additional $2.5 million in purported damages.  On or about May 25, 2010, the arbitratorissued a Final Award (the “**Award**”). The Award directed the Company to pay Nicole Miller approximately $0.6 millioncorresponding to the compensation for guaranteed minimum royalties of $0.4million and attorney’s fees and certain expenses of $0.2 million; $0.4 millionand $0.2 million of expense was recorded by the Company during the years ended June 30,2010 and 2009, respectively, in connection with the Award. The Company paid theAward in full in May 2010. The Award is in full settlement of all claimssubmitted in connection with the arbitration proceedings. In addition, theCompany incurred $0.2 million and $0.1 million in legal fees in connection withthe Nicole Miller loss contingency, during the fiscal years ended June 30,2010 and 2009, respectively. These charges have been recorded as a part of theselling, general and administrative expenses line item of the consolidatedstatements of operations.

 

Additionally,the Company, from time to time, is party to various legal proceedings.  While management, including external counsel,currently believes that the ultimate outcome of these proceedings, individuallyand in the aggregate, will not have a material adverse impact on its financialposition or results of operations, litigation is subject to inherentuncertainties. The Company records legal costs incurred in connection with suchloss contingency as incurred as a part of the selling, general andadministrative expenses line item of the consolidated statements of operations.

 

TheCompany enters into employment and consulting agreements with certain of itsemployees from time to time.  These contracts typically provide forseverance and other benefits.  During the fiscal year ended June 30,2010, the Company incurred severance costs of approximately $0.1 million as aresult of a restructuring plan, which the Company expects to be paid out duringthe first quarter of fiscal 2011.  Referto Note 18 for further discussion. During the fiscal year ended June 30,2009, the Company incurred severance costs of approximately $1.1 million. The severance costs are primarily attributed to two former executive officersof the Company. As of June 30, 2009, $0.6 million of such expenses wereaccrued and were paid in full during the fiscal year ended June 30, 2010.

 

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

 
| **Years ending June 30,** | ** ** | **(in thousands)** | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| 2011                                     |       | $                       | 1,798      |   |
| 2012                                     |       | 1,444                   |       |
| 2013                                     |       | 821                     |       |
| 2014                                     |       | —                  |       |
| 2015                                     |       | —                  |       |
| Thereafter                               |       | —                  |       |
|                                     |       | $                       | 4,063      |   |

 

Rentexpense for the years ended June 30, 2010, 2009 and 2008 was approximately$2,515,000, $2,625,000, and $2,188,000, respectively.

 

TheCompany was contingently liable for open letters of credit of approximately$10.2 million and $10.1 million as of June 30, 2010, and 2009,respectively.

 

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**15.****                              ****RetirementPlan**

 

TheCompany has a defined contribution retirement plan which covers all employeesand provides for eligible employees to make elective contributions of up to 15%of their salary.  Company matchingcontributions to the plan for the years ended June 30, 2009 and 2008, wereapproximately $132,000 and $198,000, respectively.  There were no matching contributions to theplan for the year ended June 30, 2010.

 

**16.****                              ****FairValue of Financial Instruments**

 

Thefair value of cash and cash equivalents, receivables and accounts payableapproximate their carrying value due to their short-term maturities.  At June 30, 2010 and 2009, the fair valueof the senior secured notes, determined based upon quoted market prices, wasapproximately $48,147,000 and $16,101,000, respectively.

 

**17.****                              ****ExitActivities**

 

Duringthe first quarter of the fiscal year ended June 30, 2010, the Companydecided to exit one of its warehouses located in Bayonne, NJ. The warehouse iscurrently under lease until January 2011 and has been utilized sinceJuly 2007 for warehousing and distribution activities. As a result of thedecision to exit this warehouse, the Company assessed the recoverability of thelong-term assets associated with the facility. These assets include leaseholdimprovements to the warehouse facility as well as racking used for inventorystorage. As a result of this analysis, the Company wrote down the value of itsleasehold improvements and fixed assets located at this warehouse byapproximately $0.3 million (net) during the first quarter of the fiscal yearended June 30, 2010. Based on the applicable authoritative guidance forexit and disposal activities, the Company met the cease-use criteria for thewarehouse being exited in the second quarter of the fiscal year ended June 30,2010. In the second quarter, a charge for approximately $0.2 million for theestimated costs to be incurred to satisfy rental commitments under the lease,offset by sublease rental rates, was recorded.

 

Duringthe fourth quarter of the fiscal year ended June 30, 2010, the Companydecided to sublease a portion of the existing office facility in New York, NY.The office facility is currently under lease until January 2013 and hasbeen utilized since June 2005 as the Company headquarters. Based on theapplicable authoritative guidance for exit and disposal activities, the Companymet the cease-use criteria for the space being exited as of June 30, 2010.In the fourth quarter, a charge for approximately $0.1 million for theestimated costs to be incurred to satisfy rental commitments under the lease,offset by sublease rental rates, was recorded.

 

Thesecharges have been recorded as a part of the selling, general and administrativeexpenses line item of the consolidated statements of operations.

 

**18.****                              ****Restructuringand Other Charges**

 

Duringthe fourth quarter of the fiscal year ended June 30, 2010, the Company’smanagement approved, committed to, and initiated a restructuring plan,resulting from a cost savings initiative, by announcing its closure of the mainwarehouse located in Bayonne, NJ to discontinue its warehouse, distribution andlogistics operations.  In connection withthe exit plan, the Company reduced its workforce by approximately 70employees.  As a result of the decisionto exit this warehouse the Company assessed the recoverability of the long-termassets associated with the facility. These assets include distributionequipment used for inventory.  Thewrite-down of fixed assets resulting from this analysis was not significant forthe fiscal year ended June 30, 2010. The Company recorded restructuringcharges for severance and employee benefits of approximately $0.2 millionduring the fourth quarter of the fiscal year ended June 30, 2010.  The Company expects all severance andemployee benefits costs to be paid out during the first quarter of fiscal2011.  These charges have been recordedas a part of the selling, general and administrative expenses line item of theconsolidated statements of operations.

 

**19.****                              ****SubsequentEvents**

 

TheCompany has performed an evaluation of subsequent events through the filing ofthis annual report, and has determined that no material subsequent events haveoccurred other than as described below.

 

*Amendedand Restated Employment Agreement; Equity Incentive Award*

 

OnOctober 13, 2010, the Company entered into an Amended and RestatedEmployment Agreement with Richard Metzger in connection with the promotion of Mr. Metzgerto Executive Vice-President of Design of the Company.

 

Priorto Mr. Metzger’s promotion, Mr. Metzger served as Vice-President ofDesign of the Company.  Mr. Metzger’samended agreement provides for, among other things, an increase in Mr. Metzger’s(i) annual base salary, from $315,000 to $375,000, 

 

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and(ii) target bonus, from 25% of his base salary to 50% thereof.  In addition, pursuant to the terms of hisamended agreement, Mr. Metzger will be entitled to receive an equity grantto be determined by the Company’s board of directors, subject to the terms andconditions of the Company’s Equity Incentive Plan and customary documentationwith respect thereto.

 

OnSeptember 16, 2010, the Company’s board of directors also approved thegrant of options to Mr. Metzger pursuant to the Company’s Equity IncentivePlan to purchase 111,111 shares of common stock of the Company, exercisable for$5.33 per share, to Mr. Metzger. One quarter of Mr. Metzger’s optionsvest on each of the first, second, third and fourth anniversaries of the grantdate.

 

Theforegoing summary of each of Mr. Metzger’s amended and restated employmentagreement and equity incentive award agreement does not purport to be completeand is qualified in its entirety by each such agreement, both of which areattached hereto as Exhibits 10.48 and 10.49 and incorporated herein by reference.

 

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

 
| ** **        | ** ** | **Quarter ended**  | ** ** |
|-------------------|------------|-------------------------|------------|
| ** **        | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,  2009(1)** | ** ** | **September 30,  2009(1)** | ** ** |
| ** **        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales         |       | $                       | 25,948     |   | $ | 33,398 |   | $ | 25,208 |   | $ | 29,401 |   |
| Gross profit      |       | 8,652                   |       | 10,927 |   | 6,545 |   | 8,852 |   |
| Net income (loss) |       | (1,543                  | )          | 975 |   | 324 |   | 1,147 |   |
|                   |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **        | ** ** | **Quarter ended**        | ** ** |
|-------------------|------------|-------------------------------|------------|
| ** **        | ** ** | **June 30,  2009(2)(3)** | ** ** | **March 31,  2009(2)** | ** ** | **December 31,  2008(3)** | ** ** | **September 30,  2008(2)** | ** ** |
| ** **        | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales         |       | $                             | 23,838     |   | $ | 34,555 |   | $ | 40,675 |   | $ | 48,897 |   |
| Gross profit      |       | 5,524                         |       | 9,802 |   | 7,419 |   | 12,183 |   |
| Net income (loss) |       | 132                           |       | (276 | ) | (25,444 | ) | 10,151 |   |
|                   |            |                               |            |  |  |  |  |  |  |  |  |  |  |

 

----

(1)         The Company recorded gainsof approximately $3.3 million and $1.6 million, net of tax, in connection withthe senior secured note purchases (described in Note 10) during the quarterlyperiods ended December 31, 2009 and September 2009, respectively.

 

(2)         The Company recorded gainsof approximately $3.9 million, $1.0 million, and $10.6 million, net of tax, inconnection with the senior secured note purchases (described in Note 10) duringthe quarterly periods ended June 30, 2009, March 31, 2009 andSeptember 30, 2008, respectively.

 

(3)         The Company recordedimpairment charges of $2.4 million and $23.4 million during the quarters endedJune 30, 2009 and December 31, 2008, respectively related to thedecline in the fair value of the Rafaella trademark and trade name intangibleasset (described in Note 7).  Theimpairment charge is reflected within selling, general and administrativeexpenses.

 

**21.****                              ****ConsolidatingFinancial Statements**

 

InJune 2005, the Company issued 11.25% Senior Secured Notes that are fully,unconditionally, jointly and severally guaranteed on a senior secured basis byVerrazano, Inc. (**“Verrazano”**), awholly-owned subsidiary of the Company.  Verrazano was formed in 2004 and commencedoperations in 2005.  The followingcondensed consolidating financial information as of June 30, 2010 and2009, and for the years ended June 30, 2010, 2009 and 2008 is provided inlieu of separate financial statements for the Company and Verrazano.

 

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

**Condensed Consolidating Balance Sheet**

**As of June 30, 2010**

**(In thousands)**

 
| ** **                                                                                              | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                                                              | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| **Assets**                                                                                              | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Current assets:                                                                                         |       |                             |       |          |       |                                                 |       |       |       |
| Cash and equivalents                                                                                    |       | $                                | 19,240     |          | $          | 1,368                                                |       | $          | 2          |   | $ | 20,610 |   |
| Receivables, net                                                                                        |       | 9,800                            |       | 1,054         |       | —                                               |       | 10,854     |       |
| Inventories                                                                                             |       | 11,300                           |       | 2,295         |       | —                                               |       | 13,595     |       |
| Deferred income taxes                                                                                   |       | 1,952                            |       | 95            |       | —                                               |       | 2,047      |       |
| Other current assets                                                                                    |       | 5,199                            |       | 15,285        |       | (16,390                                              | )          | 4,094      |       |
| Total current assets                                                                                    |       | 47,491                           |       | 20,097        |       | (16,388                                              | )          | 51,200     |       |
| Equipment and leasehold improvements, net                                                               |       | 1,050                            |       | —        |       | 115                                                  |       | 1,165      |       |
| Intangible assets, net                                                                                  |       | 30,687                           |       | 644           |       | —                                               |       | 31,331     |       |
| Deferred financing costs, net                                                                           |       | —                           |       | —        |       | —                                               |       | —     |       |
| Investment in subsidiaries                                                                              |       | 17,901                           |       | —        |       | (17,901                                              | )          | —     |       |
| Other assets                                                                                            |       | —                           |       | —        |       | 45                                                   |       | 45         |       |
| Total assets                                                                                            |       | $                                | 97,129     |          | $          | 20,741                                               |       | $          | (34,129    | ) | $ | 83,741 |   |
|                                                                                                    |       |                             |       |          |       |                                                 |       |       |       |
| **Liabilities, Redeemable  Convertible Preferred Stock and Stockholders’ Equity (Deficit)**        | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                    |       |                             |       |          |       |                                                 |       |       |       |
| Accounts payable                                                                                        |       | $                                | 7,488      |          | $          | 1,755                                                |       | $          | 39         |   | $ | 9,282 |   |
| Accrued expenses and other liabilities                                                                  |       | 19,651                           |       | 3             |       | (15,210                                              | )          | 4,444      |       |
| Current portion of senior secured notes                                                                 |       | 71,084                           |       | —        |       | —                                               |       | 71,084     |       |
| Total current liabilities                                                                               |       | 98,223                           |       | 1,758         |       | (15,171                                              | )          | 84,810     |       |
| Senior secured notes                                                                                    |       | —                           |       | —        |       | —                                               |       | —     |       |
| Income taxes                                                                                            |       | 5,058                            |       | —        |       | —                                               |       | 5,058      |       |
| Deferred rent                                                                                           |       | 409                              |       | —        |       | 25                                                   |       | 434        |       |
| Other liabilities                                                                                       |       | 200                              |       | —        |       | —                                               |       | 200        |       |
| Total liabilities                                                                                       |       | 103,890                          |       | 1,758         |       | (15,146                                              | )          | 90,502     |       |
| Commitments and contingencies                                                                           |       |                             |       |          |       |                                                 |       |       |       |
| Redeemable convertible stock                                                                            |       | 60,110                           |       | —        |       | —                                               |       | 60,110     |       |
| Stockholders’ equity (deficit):                                                                    |       |                             |       |          |       |                                                 |       |       |       |
| Common stock                                                                                            |       | 25                               |       | 8,741         |       | (8,741                                               | )          | 25         |       |
| Additional paid in capital                                                                              |       | 307                              |       | —        |       | —                                               |       | 307        |       |
| Deemed dividend, in excess of predecessor basis                                                         |       | (26,022                          | )          | —        |       | —                                               |       | (26,022    | )          |
| Retained earnings (deficit)                                                                             |       | (41,181                          | )          | 10,242        |       | (10,242                                              | )          | (41,181    | )          |
| Total stockholders’ equity (deficit)                                                               |       | (66,871                          | )          | 18,983        |       | (18,983                                              | )          | (66,871    | )          |
| Total liabilities**,  redeemable convertible preferred stock** and stockholders’ equity  (deficit) |       | $                                | 97,129     |          | $          | 20,741                                               |       | $          | (34,129    | ) | $ | 83,741 |   |

 

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

**Condensed Consolidating Balance Sheet**

**As of June 30, 2009**

**(In thousands)**

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

 

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

**Condensed Consolidating Statement of Operations**

**Year ended June 30, 2010**

**(In thousands)**

 
| ** **                                                           | ** ** | **Rafaella  Apparel Group** | ** ** | **Verrazano** | ** ** | **Non-guarantor  Subsidiary and  Eliminations** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|---------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                           | ** ** | ** **                       | ** ** | ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net sales                                                            |       | $                                | 99,781     |          | $          | 14,174                                               |       | $          | —     |   | $ | 113,955 |   |
| Cost of sales                                                        |       | 67,266                           |       | 11,851        |       | (138                                                 | )          | 78,979     |       |
| Gross profit                                                         |       | 32,515                           |       | 2,323         |       | 138                                                  |       | 34,976     |       |
| Selling, general and administrative expenses                         |       | 26,663                           |       | 1,650         |       | —                                               |       | 28,313     |       |
| Intangible asset impairment                                          |       | —                           |       | —        |       | —                                               |       | —     |       |
| Operating income (loss)                                              |       | 5,852                            |       | 673           |       | 138                                                  |       | 6,663      |       |
| Interest expense, net                                                |       | 10,527                           |       | —        |       | —                                               |       | 10,527     |       |
| Gain on senior secured note purchases                                |       | (8,036                           | )          | —        |       | —                                               |       | (8,036     | )          |
| Interest expense and other financing, net                            |       | 2,491                            |       | —        |       | —                                               |       | 2,491      |       |
| Income (loss) before provision for (benefit  from) income taxes |       | 3,361                            |       | 673           |       | 138                                                  |       | 4,172      |       |
| Provision for (benefit from) income taxes                            |       | 2,882                            |       | 364           |       | 23                                                   |       | 3,269      |       |
| Equity in earnings of subsidiaries                                   |       | 424                              |       | —        |       | (424                                                 | )          | —     |       |
| Net income (loss)                                                    |       | $                                | 903        |          | $          | 309                                                  |       | $          | (309       | ) | $ | 903 |   |

 

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

**Condensed Consolidating Statement of Operations**

**Year ended June 30, 2009**

**(In thousands)**

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

 

F-25

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Table ofContents

 

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

**Condensed Consolidating Statement of Operations**

**Year ended June 30, 2008**

**(In thousands)**

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

 

F-26

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Table ofContents

 

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

**Condensed Consolidating Statement of Cash Flows**

**Year ended June 30, 2010**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Rafaella  Apparel  Group** | ** ** | **Verrazano** | ** ** | **Non-  guarantor  Subsidiary  and  Eliminations** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------|------------|----------------------------------------------------|------------|-----------|------------|
|                                                                               |       |                         |       |          |       |                                               |       |      |       |
| Cash flows provided by operating activities:                                       |       |                         |       |          |       |                                               |       |      |       |
| Net income                                                                         |       | $                            | 903        |          | $          | 309                                                |       | $         | (309       | ) | $ | 903 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                         |       |          |       |                                               |       |      |       |
| Amortization of deferred finance charges                                           |       | 1,095                        |       | —        |       | —                                             |       | 1,095     |       |
| Accretion of original issue discount                                               |       | 751                          |       | —        |       | —                                             |       | 751       |       |
| Depreciation and amortization                                                      |       | 4,357                        |       | 330           |       | 58                                                 |       | 4,745     |       |
| Equity in earnings of subsidiaries                                                 |       | (424                         | )          | —        |       | 424                                                |       | —    |       |
| Stock-based compensation expense                                                   |       | 19                           |       | —        |       | —                                             |       | 19        |       |
| Income taxes                                                                       |       | 2,376                        |       | (55           | )          | —                                             |       | 2,321     |       |
| Deferred rent                                                                      |       | 24                           |       | —        |       | (12                                                | )          | 12        |       |
| Gain on senior secured notes purchase                                              |       | (8,036                       | )          | —        |       | —                                             |       | (8,036    | )          |
| Changes in operating assets and liabilities:                                       |       |                         |       |          |       |                                               |       |      |       |
| Accounts receivable                                                                |       | (786                         | )          | 1,482         |       | —                                             |       | 696       |       |
| Inventories                                                                        |       | (3                           | )          | (1,258        | )          | —                                             |       | (1,261    | )          |
| Other current assets                                                               |       | 3,125                        |       | 640           |       | (841                                               | )          | 2,924     |       |
| Accounts payable                                                                   |       | 1,632                        |       | (221          | )          | 10                                                 |       | 1,421     |       |
| Accrued expenses and other current liabilities                                     |       | 1,307                        |       | (89           | )          | 647                                                |       | 1,865     |       |
| Other assets                                                                       |       | 47                           |       | —        |       | 1                                                  |       | 48        |       |
| Other liabilities                                                                  |       | 200                          |       | —        |       | —                                             |       | 200       |       |
| Net cash provided by operating activities                                          |       | 6,587                        |       | 1,138         |       | (22                                                | )          | 7,703     |       |
| Cash flows used in investing activities:                                           |       |                         |       |          |       |                                               |       |      |       |
| Purchase of equipment and leasehold improvements                                   |       | (269                         | )          | —        |       | (4                                                 | )          | (273      | )          |
| Net cash used in investing activities                                              |       | (269                         | )          | —        |       | (4                                                 | )          | (273      | )          |
| Cash flows used in financing activities:                                           |       |                         |       |          |       |                                               |       |      |       |
| Deferred financing cost                                                            |       | (155                         | )          | —        |       | —                                             |       | (155      | )          |
| Repurchase of senior secured notes                                                 |       | (4,363                       | )          | —        |       | —                                             |       | (4,363    | )          |
| Net cash used in financing activities                                              |       | (4,518                       | )          | —        |       | —                                             |       | (4,518    | )          |
| Net decrease in cash and cash equivalents                                          |       | 1,800                        |       | 1,138         |       | (26                                                | )          | 2,912     |       |
| Cash and cash equivalents, beginning of period                                     |       | 17,440                       |       | 230           |       | 28                                                 |       | 17,698    |       |
| Cash and cash equivalents, end of period                                           |       | $                            | 19,240     |          | $          | 1,368                                              |       | $         | 2          |   | $ | 20,610 |   |

 

F-27

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Table ofContents

 

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

**Condensed Consolidating Statement of Cash Flows**

**Year ended June 30, 2009**

**(In thousands)**

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

 

F-28

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Table ofContents

 

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

**Condensed Consolidating Statement of Cash Flows**

**Year ended June 30, 2008**

**(In thousands)**

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

 

F-29

----