Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended June 30, 2010

or

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

For the transition period from              to           

Commission File Number:  333-138342

Rafaella Apparel Group, Inc.

(Exact name of registrant as specified in its charter)

1411 Broadway, New York, New York 10018

(212) 403-0300

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

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

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

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

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

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

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

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

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

Table of Contents

RAFAELLA APPAREL GROUP, INC.

ANNUAL REPORT

JUNE 30, 2010

TABLE OF CONTENTS

i

Table of Contents

PART I

ITEM 1.             BUSINESS

GENERAL

Rafaella Apparel Group, Inc. (the “Company”) acquired substantially all of the assets of Rafaella Sportswear, Inc. in an acquisition consummated on June 20, 2005.  The Company, formerly known as Rafaella Corporation, 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.

Our Company

We are an established wholesaler, designer, sourcer, marketer and distributer of a full line of women’s career and casual sportswear separates within the United States.  We have been in the women’s apparel business since 1982 and market our products primarily under the Rafaella 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 lines to include core basics, fashion related separates and replenishment items with updated features and colors using a variety of natural and synthetic fabrics.  Using our design specifications, we outsource the manufacturing and production of our clothing line 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 over 3,900 individual retail locations.  Our customers include some of the largest retailers of women’s clothing in the United States.

Our Industry

The retail women’s apparel industry is highly competitive, with many providers of similar types of clothing as are designed and marketed by us.  In addition, there has been a consolidation in the industry, decreasing the number of retailers and the floor space available for our products.  Wholesalers of women’s apparel are subject to pricing pressures from both retailers and consumers, stemming from the increased competition for customers and economic cycles that impacts the spending of our consumers.

The women’s apparel industry in which we operate has historically been subject to cyclical variations, current general economic conditions, and perceived or anticipated future economic conditions.  The current economic environment, characterized by a dramatic decline in consumer discretionary spending, has materially and adversely affected the retail and wholesale apparel industry.  Discretionary purchases, such as women’s apparel, have been especially negatively impacted in the current economic environment.

Products

Our lines consist of core basics, fashion related separates and replenishment items with updated features and colors.  We design our products to appeal to our target market of women aged 30 to 55 in the United States.  Our products are divided into three broad categories based on size:  Missy, Petite and Woman.  The Missy category comprises of traditional sized clothing, whereas the Petite and Woman cater to smaller and larger framed women, respectively.  We also categorize our clothing lines as Career and Casual.  Career clothing consists of jackets, pants, skirts, shirts, blouses and sweaters designed to be worn primarily to work.  Casual clothing is designed to be worn primarily as weekend wear and consists of pants, skirts, knits, jackets, shirts and sweaters principally made of cotton based fabrics.  Recent fashion trends have led to a blurring of the distinctions between these categories, with women wearing Casual separates to work and Career separates for functions outside work.

Our branded 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 $80 per item, knits for $25 to $55 per item and jackets for $60 to $120 per item.  We believe that our products are of an equal or higher quality than those of our competition.

Seasonality

We present seasonal “lines” each year corresponding to the retail selling seasons, Spring, Summer, Fall and Holiday.  Each line consists of complementary styles of pants, sweaters, blouses, knits, jackets and skirts, which are sold as individual items, but which may be coordinated into complete outfits.  Each style 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 and linen, depending upon the season and clothing style.  Our lines are marketed principally under the Rafaella brand and private label brands of our customers.

1

Table of Contents

Design

Our design team, operating out of our headquarters in New York, is responsible for the development of new products and our seasonal lines according to our merchandising calendar.  The team includes a creative director along with staff designers and assistant designers, with computer aided design capabilities, in addition to a color and print specialist.  Each member of the team has responsibility for certain products, creating several groupings for a given season.

The design staff interprets emerging trends in fashion from European travel and trend services, and receives market feedback from our management and sales force, in order to stay abreast of new design concepts.  This information is used to develop preliminary expectations for the composition and silhouettes of the next line.  With this guidance, the design team develops initial sketches and design prototype garments reflecting line concepts and style ideas.  From these concepts, certain styles are selected for further development and the design team, in conjunction with management, begins to select colors and fabrics for the line.  Fabric samples are ordered in each pattern and color.  Using the sample fabrics, more refined prototype garments are made by our manufacturers.  These refined samples are used for display in the showroom during the applicable market week.  The line is further refined based on customer feedback during the market week.

Product Sourcing and Distribution

We contract for the manufacturing of our products exclusively with third-party manufacturers and do not own or operate any manufacturing facilities.  During fiscal 2010, our merchandise purchases were primarily sourced from manufacturers in Asia and also in the Middle East.  In the future, we may explore sourcing opportunities in other areas of the world.  Outsourcing our products allows us to maximize production flexibility, while avoiding significant capital expenditures, work-in-process inventory build-ups and costs associated with managing a larger production force.  Approximately 97% and 3% of our goods were manufactured in Asia and the Middle East, respectively.  Our three largest third-party manufacturers accounted for approximately 30%, 17% and 15% of our product purchases in fiscal 2010.

We utilize individual purchase orders specifying the price, quantity and design specifications of the merchandise to be produced; approximately 45% of our 2010 merchandise purchases were secured by letters of credit.  We do not have long-term, formal arrangements with our manufacturers, and we continually seek additional suppliers for our production needs to provide additional capacity and flexibility as needed.  Because we have been using many of the same manufacturers for several years, we believe we have established and maintained excellent relationships with high-quality manufacturers, fabric suppliers and agents.  These relationships facilitate our ability to control the quality of our products, achieve favorable pricing for production and 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, if necessary, can replace in a timely manner any supplier at a similar cost and quality.

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

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

We have a comprehensive quality control program that begins overseas to ensure that raw materials and finished goods meet our specifications for design, fit and quality.  Fabric purchases are inspected upon receipt at the manufacturers’ facilities, and prior to commencement of production.  Inspections are handled by representatives of our Hong Kong office as well as our manufacturers’ staffs.  Quality control inspectors also inspect finished goods before shipment to the United States, as well as once they reach the warehouse and distribution facilities that we utilize.  Management believes that our low return rate on defective merchandise is largely due to our rigorous quality control processes.

Through June 2010, we utilized a centralized distribution system, under which most merchandise was received, processed and distributed through our Bayonne, New Jersey facilities.  On June 17, 2010, we entered into a distribution agreement with a third party to provide warehousing, distribution and logistics services with respect to effectively all of our goods that are distributed in the Northeast.  Pursuant to this distribution agreement, such third party, through its warehouse facilities in New Jersey, will be the

2

Table of Contents

exclusive provider to us of all warehousing, distribution and logistics services with respect to effectively all of our goods distributed in the Northeast.  The agreement provides that we will utilize this service provider for a minimum volume of units to be determined with respect to each of our fiscal years during the term of the agreement, commencing with the 2011 fiscal year that began on July 1, 2010.  The term of this distribution agreement is for three years, subject to termination by the parties under certain circumstances, including but not limited to upon a material breach (subject to notice and cure), force majeure, or by either party for any reason upon no less than 180 days prior written notice.

Once merchandise is received, merchandise is inspected, packed and shipped to our customers via common carriers.  To facilitate the distribution process and control warehouse costs, all of our products, other than those ordered to support our replenishment and private label programs, are packaged into pre-established packages, or pre-packs, prior to being shipped to our distribution facilities.  Each pre-pack contains six, eight or ten garments, in a single style and color, and in a preset range of sizes.  We offer pre-pack size ranges in Missy, Petite and Woman.  Management believes the use of pre-packs helps minimize our distribution costs and reduce shipping errors and reduces our risk of unsold inventory in an undesirable assortment of sizes that may be difficult to sell at acceptable gross profit margins.

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

Sales, Marketing and Advertising

We maintain a direct sales force that operates out of our New York showroom.  Our direct sales force is compensated exclusively on a salaried basis; discretionary annual performance bonuses can be earned based upon the Company’s achievement of pre-determined financial performance targets.  This in-house sales force, together with management, accounted for approximately 99% of our fiscal 2010 sales.  Independent, non-exclusive sales representatives who are compensated exclusively on a commission basis accounted for approximately 1% of our fiscal 2010 sales.

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

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

Customers

Our principal customers are department and specialty stores.  The department and specialty stores channel represented approximately 69% of our total net sales in fiscal 2010 and the other approximately 31% of our total net sales in fiscal 2010 were to off-price retailers and private label customers.  While certain of our customers consist of separate department and specialty store chains or off-price retailers with common ownership, these customers have separate purchasing departments and are therefore viewed by us as separate customers.  Divisions of Macy’s, Belk, Kohl’s, and Bon-Ton, our four largest customers (when viewed on a common ownership basis), accounted for 31%, 20%, 12% and 11%, respectively, of our total net sales in fiscal 2010.

We believe we have strong relationships with our customers.  We have over 240 customers, representing over 3,900 individual retail store locations.  Our top ten customers (when viewed on common ownership basis) accounted for approximately 95% of net sales for fiscal 2010.  It has been our experience that many major retailers are continuing to consolidate their women’s apparel suppliers by purchasing from a select group of established brand name vendors, such as our company.  We are continuing to seek new relationships and expand our presence to new points of sale.

3

Table of Contents

Backlog

As of September 27, 2010 and September 25, 2009, we had unfilled customer orders of approximately $43.4 million and $36.2 million of merchandise, respectively.  The amount of unfilled customer orders at a particular time is affected by a number of factors, including product mix, the timing of receipt and processing of customer orders and the product manufacturing and shipping schedule, which is dependent to a certain extent on customer demand.  Accordingly, a comparison of unfilled orders from period to period is not necessarily meaningful and may not be indicative of eventual actual shipments.

Working Capital

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

Working capital requirements vary throughout the year.  Working capital typically increases during the first and third quarters of the fiscal year as inventory builds to support peak shipping/selling periods and, accordingly, typically decreases during the second and fourth quarters of the fiscal year as inventory is delivered/sold.  Cash provided by operating activities is typically higher in the second and fourth quarters of the fiscal year due to the reduced working capital requirements during that period.  To enable the Company to have adequate liquidity to conduct its operations, in June 2005 the 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 most recently on May 21, 2010, when the Company amended and restated the secured credit facility with HSBC, as agent and as a lender, and Cerberus Capital Management, L.P. as a lender and the term lender (the “Amended and Restated Financing Agreement”).

Competition

The United States retail apparel industry is highly competitive and fragmented.  Our competitors include numerous apparel designers, manufacturers, importers, licensors and our own customers’ private label programs, many of which are larger and have greater financial and marketing resources than are available to us.  We believe that the principal competitive factors in the industry are:

·                  consistent fit;

·                  product quality;

·                  styling;

·                  price;

·                  brand name and brand identity; and

·                  reliability of deliveries.

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

Trademarks

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

Information Systems

We have limited information technology resources and rely on third-party providers for telecommunications, Electronic Data Interchange (“EDI”) applications and other support.  Our financial and operational information and reporting needs are met by a software package written primarily for apparel companies and further customized for our needs by a third party software development

4

Table of Contents

and maintenance firm.  We own substantially all of our computer equipment and contract with third parties to maintain backup systems.

Our customers can elect to use EDI to trade and process orders with us on a simplified and expedited basis.  We use EDI with certain customers to provide advance-shipping notices, process orders and conduct billing operations.  In addition, certain other customers use EDI to communicate to us their weekly inventory requirements on a store-by-store basis.  As of June 30, 2010, we had 14 customers that use EDI to communicate with us.  In fiscal 2010, total sales to these customers were approximately 93% of our overall total sales.

Imports, Import Restrictions and Other Government Regulations

Imports and Import Restrictions

Our transactions with our foreign suppliers are subject to the risks of doing business abroad.  Imports into the United States are affected by, among other things, the cost and availability of transportation, and the imposition of import duties and restrictions.  The countries that we source our products from may, from time to time, also impose restrictions or take various economic actions, which could affect our ability to import products from such countries at the current or increased levels.  Imports into the United States can also be subjected to various additional restrictions and the assessment of punitive antidumping duties or countervailing duties when goods are shipped to the U.S. at less than fair value (dumping) or with certain countervailing subsidies from the exporting nation.  In 2007, the U.S. Government altered a more than twenty-year policy by applying its antisubsidy laws to certain exports from China.  In addition, bills have been introduced in Congress which would hold China and other countries accountable for currency manipulation through the assessment of penal duties.  The effect of these changes could be an increase to the cost of goods imported by us from China.  The pendency of the above-described actions could have a disruptive effect on imports from the exporting country while the action is pending as a result of the potentially resulting uncertainty.  We cannot predict the likelihood or frequency of any such events occurring.

Other Government Regulation

We are subject to federal, state and local laws and regulations regarding our business.  These include the Consumer Product Safety Improvement Act, the Textile Fiber Product Identification Act, the Flammable Fabric Act and the rules and regulations of the Federal Trade Commission and the Consumer Product Safety Commission, or the CPSC, as well as similar laws and regulations under state requirements.  We believe that we are in compliance in all material respects with all applicable governmental regulations relating to our imported products.

Employees

As of June 30, 2010, we had approximately 154 employees, of whom approximately 48 were employed in New York, approximately 75 were employed in New Jersey, and approximately 31 were employed in Hong Kong.  We reduced our New Jersey workforce by approximately 70 employees subsequent to June 30, 2010 as a result of us entering into a distribution agreement with a third party to provide certain warehousing, distribution and logistics services.  We are 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 and have not experienced any interruption of our operations due to labor disputes with our employees.

ITEM 1A.               RISK FACTORS

Risks Related to Our Indebtedness

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

Our senior secured notes issued pursuant to our outstanding indenture mature on June 15, 2011. Management currently does not believe that we will have sufficient cash on hand, based on current cash flow projections, to repay the senior secured notes in June 2011 at principal or face value. We are currently exploring various alternatives with respect to refinancing, extending or otherwise restructuring the senior secured notes, although at the present time we do not have any arrangement or agreement to do so and there can be no assurances that we will be able to refinance, extend or restructure the senior secured notes on terms and conditions acceptable to the Company, or at all, or on a timely basis.  As a consequence of the fact that there is no assurance that the Company will be able to refinance, extend or restructure the senior secured notes on terms and conditions acceptable to the Company on a timely basis, there is substantial doubt that the Company can continue as a going concern.  Further, credit or financial market disruptions such

5

Table of Contents

as those that have recently been experienced in the United States and abroad may have a material adverse effect on our ability to refinance, extend or restructure our senior secured notes on a timely basis and on terms acceptable to us, if at all.  See Risk Factor directly below “We may not be able to continue as a going concern.”

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

Absent a successful refinancing, extension or restructuring of our senior secured notes on terms and conditions satisfactory to us and on a timely basis, which is not solely within our control, we do not expect our forecasted cash and credit availability to be sufficient to meet our repayment obligation with respect to the senior secured notes as they come due over the next twelve months. As a result, there is substantial doubt we can continue as a going concern. Our consolidated financial statements have been prepared on the basis of a going concern, which contemplates continuity of operations, the realization of assets and the satisfaction of liabilities in the normal course of business. If we were unable to continue as a going concern, we will need to liquidate our assets and we might receive significantly less than the values at which they are carried on our consolidated financial statements. See Note 2 (Basis of Presentation) to our consolidated financial statements included herein.  The accompanying consolidated financial statements do not include any adjustments related to the recoverability and classification of recorded assets or the amounts and classification of liabilities that might result from the uncertainty associated with our ability to meet our obligations as they come due.

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

Our Credit Facility expires on June 10, 2011, and unless we are able to refinance, extend or restructure our senior secured notes, we will not be able to refinance our Credit Facility, which expires five (5) days prior to the maturity of the indenture.  We rely upon access to the credit markets as a source of liquidity for the portion of our working capital requirements not provided by cash from operations. Accordingly, even if we are able to refinance, extend or restructure our indenture, market disruptions such as those that have recently been experienced in the United States and abroad may increase our cost of borrowing or adversely affect our ability to access sources of liquidity upon which we rely to finance our operations and satisfy our obligations as they become due. These disruptions include turmoil in the financial services industry, unprecedented volatility in the markets where our outstanding indebtedness trades, and general economic downturns. If we are unable to access credit at competitive rates, or if our short-term or long-term borrowing costs dramatically increase, our ability to finance our operations, meet our short-term obligations and implement our operating strategy could be adversely affected. All of the foregoing could have a material adverse effect on our ability to refinance all or any portion of the Credit Facility, and we may be unable to refinance the Credit Facility on terms acceptable to us, if at all.

Our substantial debt could adversely affect our financial health.

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

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

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

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

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

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

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

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

Our debt service requires a significant amount of cash.

To service our debt, we require a significant amount of cash.  Our ability to generate cash, make required payments or to refinance our obligations depends on our successful financial and operating performance.  We cannot provide assurance that our operating and financial performance, cash flow and capital resources will be sufficient for us to service our debt in the future.  Our

6

Table of Contents

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

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

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

·                  increased production labor and raw material costs.

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

Certain terms of our Credit Facility will require us to tie up significant cash resources.

Commencing on December 16, 2010, the terms of our Credit Facility require us to provide cash collateralization of 105% with respect to all outstanding letters of credit.  We typically have approximately $4 million of standby letters of credit outstanding at any time, and from time to time, based upon the most recent historical fiscal year, we may have up to an additional $8 million of letters of credit outstanding.  Accordingly, once this cash collateralization feature 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 collateralization requirement may significantly reduce our liquidity, which in turn may impose significant operating restrictions on the Company and may limit, or even prohibit, the Company from operating as it otherwise might in the absence of such cash collateralization requirements.

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

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

·                  declare dividends or redeem or repurchase capital stock;

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

·                  incur liens;

·                  make loans and investments;

·                  guarantee or incur additional debt;

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

·                  engage in mergers, acquisitions and other business combinations;

·                  sell assets;

·                  make capital expenditures;

·                  transact with affiliates; and

·                  alter the business we conduct.

In addition, the Credit Facility also includes the following financial covenants:

·                  a minimum working capital requirement;

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

·                  a cash collateral requirement.

Certain of these financial covenants become more restrictive over time.

A breach of any of these covenants or our inability to comply with the financial covenants could result in a default under the Credit Facility, which in turn could trigger a default under our senior secured notes.  If any default occurs under the indenture, the holders of the senior secured notes may elect to declare all outstanding borrowings, together with accrued interest and other amounts payable thereunder, to be immediately due and payable.  If the debt under the Credit Facility and/or the senior secured notes were to be accelerated, we cannot provide assurance that our assets would be sufficient to repay in full any indebtedness under the Credit Facility and the senior secured notes.

Risks Related to Our Business and Industry

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

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

7

Table of Contents

through reduced purchases of our products. In such circumstances, we may reduce prices on certain items, which would further adversely affect our profitability.

In addition, there could be a number of other effects from the ongoing economic downturn. The inability of key suppliers to access liquidity, or the insolvency of key suppliers, could lead to delivery delays or failures. Financial difficulties of our customers could adversely impact our results of operations. Finally, other counterparty failures, including banks and counterparties to other contractual arrangements, could negatively impact our business.

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

A number of apparel retailers have experienced financial difficulties over the past several years.  A significant adverse change in financial condition or results of operations or a customer’s bankruptcy filing or liquidation could cause us to limit or discontinue business with that customer, or limit our ability to collect amounts related to previous purchases by that customer, all of which could harm our financial condition, results of operations or our cash flow from operations, particularly given the concentration of our customers and if our third-party factor is unwilling to assume the credit risk on receivables from such customers or limits the amount of credit risk it is willing to take from such customers. Consistent with industry practices, we sell products to select customers on open account after completing an appropriate credit review of the customer.

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

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

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

A decision by any of our major customers, whether motivated by competitive conditions, financial difficulties (ours or theirs), change of ownership, change of management or otherwise, to decrease significantly the amount of merchandise purchased from us, to increase the use of their own private label brands for which we are not the manufacturer or sourcer, or to change its manner of doing business with us, could substantially reduce our revenues and materially adversely affect our operations and our ability to generate profits.

Competition in the apparel industry could reduce our sales and our profitability.

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

·                  establishing and maintaining favorable brand recognition;

·                  developing products that appeal to consumers;

·                  pricing products appropriately; and

·                  obtaining access to, and sufficient floor space in, retail stores.

The United States apparel industry is highly fragmented and includes a number of very large companies, many of which have greater financial, technical and marketing resources, greater sourcing and manufacturing capacity and more extensive and established customer relationships than we do.  The competitive responses encountered from these larger, more established apparel companies may be more aggressive and comprehensive than we anticipate and we may not be able to compete effectively in a 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 in their own sourcing and manufacturing of certain products.  Further, in response to the continued consolidation of our customers, our competitors may consolidate as well in order to increase their ability to service customers.  The competitive nature of the apparel industry may result in lower prices for our products and decreased gross profit margins, which may materially adversely affect our sales and financial condition.

Continued consolidation among our customers may harm our business.

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

8

Table of Contents

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

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

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

Prices in the United States apparel industry have been declining over the past several years primarily as a result of the movement of manufacturing operations offshore, the growth of the mass market retail channel of distribution, increased competition, consolidation in the retail apparel industry and the general economic slowdown of recent years.  Products manufactured offshore generally cost less to manufacture than those made domestically primarily because labor costs are lower offshore.  Many of our competitors also source their product requirements from developing countries, possibly from developing countries with lower costs than the developing countries from which we source our products, and those manufacturers may use these cost savings to reduce prices.  To remain competitive, we may have to adjust our prices from time to time in response to these industry-wide pricing pressures.  Moreover, increasing customer demands for allowances, incentives and other forms of economic support reduce our gross margins.  Our financial performance may be materially and adversely affected by these pricing pressures, if we are forced to reduce our prices and we cannot reduce our production costs, or if our production costs increase and we cannot increase our prices.

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

The apparel industry is subject to significant pricing pressure caused by many factors, including intense competition, consolidation in the retail industry, pressure from retailers to reduce the costs of products and changes in consumer spending patterns.  These factors may cause us to reduce our sales prices and increase the magnitude and frequency of our markdown allowances to our customers, which could cause our gross margin to decline if we are unable to appropriately manage inventory levels and/or otherwise offset price reductions with comparable reductions in our operating costs.  If our sales prices decline and we fail to sufficiently reduce our variable product costs or operating expenses, 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 customer tastes.

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

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

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

We need significant working capital to purchase inventory and are often required to post letters of credit when placing an order with one of our third-party manufacturers or fabric suppliers.  We expect to meet our working capital needs primarily through our operating cash flow but we may also utilize the Credit Facility, pursuant to which we have been able to obtain letters of credit and commencing on December 16, 2010, revolving direct debt advances up to $5,000,000.  If we are unable to meet the covenants in the Credit Facility and, as a result, are unable to have letters of credit issued on our behalf, or we are unable to extend or renew or refinance such facility on terms satisfactory to us, our ability to purchase inventory would be curtailed or eliminated, which would significantly affect our marketing and sales efforts, thus significantly harming our business.

9

Table of Contents

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

The United States apparel industry has historically been subject to cyclical variations, recessions in the general economy or uncertainties regarding future economic prospects that affect consumer spending habits which could negatively impact our business overall and specifically our sales, gross margins and profitability.  The success of our operations depends on consumer spending.  Consumer spending is impacted by a number of factors, including actual and perceived economic conditions affecting disposable consumer income (such as unemployment, wages and salaries), business conditions, interest rates, availability of credit and tax rates in the general economy and in the international, regional and local markets where our products are sold.  Any significant deterioration in general economic conditions, actual or perceived, or increases in interest rates could reduce the level of consumer spending and inhibit consumers’ use of credit.  In addition, war, terrorist activity or the threat of either may adversely affect consumer spending, and thereby have a material adverse effect on our financial condition and results of operations.

Fluctuations in the price, availability and quality of fabrics or other raw materials, as well as the price 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, as well as the price of labor, used in our manufactured apparel could have a material adverse effect on our cost of sales or our ability to meet customer demands.  The prices for fabrics depend largely on the market prices for the raw materials used to produce them, particularly cotton.  The price and availability of the raw materials and, in turn, the fabrics used in our apparel may 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, reduce inventory available to us to meet customer demands, and increase costs. We may not be able to pass all or any portion of the higher raw materials prices and related transportation costs on to our customers.

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

We sell our products pursuant to individual purchase orders instead of long-term purchase commitments.  We typically do not enter into long-term contracts with customers.  Therefore, we rely on estimated demand forecasts, based upon formal and informal input from our customers and non-binding indications of our customers’ initial orders given during and shortly following market weeks, to determine how much material to purchase and product to manufacture.  Because our sales are based on purchase orders, our customers may cancel, delay or otherwise modify their purchase commitments with little or no consequence to them and with little or no notice to us.  In addition, we cannot provide assurance as to the quantities or timing required by our customers for our products. Whether in response to changes affecting the industry or a customer’s specific business pressures, any cancellation, delay or other modification in our customers’ orders could significantly reduce our revenue, cause our operating results to fluctuate from period 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 or may not be able to sell at all.

Many of our customers require our compliance with their vendor operating policies and procedures.

Many of our customers have developed extensive policies and procedures regarding virtually 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, very detailed and unique to each customer, requiring us to develop and maintain a system to ensure compliance with each customer’s individual manual of policies and procedures.  Although we have implemented a system that we believe is sufficient to ensure compliance with our customer’s shipping and packaging requirements, we cannot provide assurance that this system or any future system will adequately address customer requirements.  If we do not comply with these policies and procedures 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 to order additional products from us in the event we are consistently unable to comply with the relevant standards and procedures.

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

For fiscal 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 foreign sourcing and manufacturing, our business may be subject to risks, including the following:

·                  uncertainty caused by the elimination of import quotas and the possible imposition of additional quotas or antidumping or countervailing duties or other retaliatory or punitive trade measures;

·                  imposition of duties, taxes and other charges on imports;

10

Table of Contents

·                  significant devaluation of the dollar against foreign currencies;

·                  restrictions on the transfer of funds to or from foreign countries;

·                  political instability, military conflict or terrorism involving the United States or any of the countries where our products are manufactured, which could cause a delay in transportation or an increase in costs of transportation, raw materials or finished product or otherwise disrupt our business operations;

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

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

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

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

We use third-party manufacturers to assemble or produce all of our products.  We are dependent on the ability of these third-party manufacturers to adequately finance the assembly or production of goods ordered and maintain sufficient manufacturing capacity.  The use of third-party manufacturers to assemble or produce finished goods and the resulting lack of direct control could subject us to difficulty in obtaining timely delivery of products of acceptable quality.  We do not have long-term contracts with any of our manufacturers and an unexpected interruption in supply from any of our manufacturers could disrupt our operations until a suitable alternate manufacturer can be found and supply restored.  Even if an alternate manufacturer can be found promptly, such manufacturer may not be able to provide us with products or manufacturing services of a comparable quality, at an acceptable price or on a timely basis.  As a result, our business relationship with our customers purchasing such products, or any products incorporating such products or services, may be terminated, reduced or otherwise modified by such customer.  There can be no assurance that there will not be a disruption in the supply of our products from third-party manufacturers or, in the event of a disruption, that we would be able to substitute suitable alternate third-party manufacturers in a timely manner, or that a customer will not terminate, reduce or otherwise modify its business relationship with us as a result thereof.  The failure of any third-party manufacturer to perform, or the loss or reduction of supply from any third-party manufacturer, or the termination, reduction or modification of such customer business relationship, could have a material adverse effect on our business, results of operations and financial condition.

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

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

Due to our operations and our manufacturing relationships abroad, we are subject to numerous domestic and foreign laws and regulations affecting our business, such as those related to labor, employment, worker health and safety, antitrust and competition, environmental protection, consumer protection, import/export, and anti-corruption, including but not limited to the Foreign Corrupt Practices Act which generally prohibits giving anything of value intended to influence the awarding of government contracts or for performance of certain other governmental acts. Although we have put into place policies and procedures aimed 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 civil enforcement actions, any of which could have a material adverse effect on our business.

We cannot predict how import restrictions will impact our business.

Our transactions with our foreign suppliers are subject to the risks of doing business abroad.  Imports into the United States are affected by, among other things, the cost and availability of transportation of the products and the imposition of import duties and restrictions.  The countries that we source our products from may, from time to time, also impose restrictions or take various economic actions, which could affect our ability to import products from such countries at the current or increased levels.  Imports into the

11

Table of Contents

United States can also be subjected to various additional restrictions and the assessment of punitive antidumping duties or countervailing duties when goods are shipped to the U.S. at less than fair value (dumping) or with certain countervailable subsidies from the exporting nation.  In 2007, the U.S. Government altered a more than twenty-year policy by applying its antisubsidy laws to certain exports from China.  In addition, bills have been introduced in Congress which would hold China and other countries accountable for currency manipulation through the assessment of penal duties.  The effect of these changes could be an increase to the cost of goods imported by us from China.  The pendency of the above-described actions can have a disruptive effect on imports from the exporting country while the action is pending as a result of the potentially resulting uncertainty.  We cannot predict the likelihood or frequency of any such events occurring.

Various interests have proposed extending an expired monitoring program covering textile imports from Vietnam and expanding it to cover imports from China. Should these proposals in the future be adopted and should they result in affirmative determinations of injury, they could result in additional restrictions or duties.

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

In addition, various economic factors, including, but not limited to, the exchange rate between the U.S. and Chinese currencies, and increased cost for raw materials, labor and transportation, could materially impact the availability or cost at which we could import our products.

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

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

In addition to the factors outlined above, our import operations may be adversely affected by political or economic instability resulting in the disruption of trade from exporting countries, any significant fluctuations in the value of the dollar against foreign currencies and restrictions on the transfer of funds.

We may be unable to protect our trademarks and other intellectual property rights or expand our use of our trademark outside of the women’s sportswear market.

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

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

Competition for qualified personnel in the United States apparel industry is intense and we compete for these individuals with other companies having greater financial and other resources.  Our continued success will depend, in significant part, upon the continued services of our existing senior management team and on our continued ability to attract, retain and motivate qualified management, administrative and sales personnel to support our existing operations and our continued growth.  The loss of the services of our executive officers could adversely affect our future operating results, which depend to a substantial degree on their experience and knowledge of our business and their customer and vendor relationships.  We may not be able to replace any of our executive officers with sufficiently experienced and qualified personnel.  The temporary or permanent loss of the services of any member of our

12

Table of Contents

senior management team, or our inability to attract and retain other qualified personnel could have a material adverse effect on our business, results of operations and financial condition.

Disruption in our distribution center could adversely affect our results of operations.

We maintain one central distribution center that we have outsourced to a third party provider with whom we have a distribution agreement, but over which we otherwise have no control.  A serious disruption to our distribution center or to the flow of goods in or out of our center due to such third party’s failure or inability to provide the services for which we have contracted, or due to fire, earthquake, act of terrorism or any other cause, could materially impair our ability to distribute our products to customers in a timely manner or at a reasonable cost.  In addition, in the event of a fire, earthquake, or act of terrorism, we could also suffer damages to a significant portion of our inventory. We could incur significantly higher costs and longer lead times associated with distributing our products to our customers during the time that it takes for us to reopen or replace our distribution center, or to find another third party provider, as the case may be. As a result, any such disruption could have a material adverse effect on our business, results of operations and financial condition.

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

We are subject to the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Sarbanes-Oxley Act of 2002.  These requirements increase our costs and may place a strain on our resources.  The Sarbanes-Oxley Act requires that we maintain and certify that we have effective disclosure controls and procedures and internal control over financial reporting.  Pursuant to Section 404 of the Sarbanes-Oxley Act, our management is required to deliver a report that assesses the effectiveness of our internal control over financial reporting, although an attestation report of our registered public accounting firm on the operating effectiveness of such internal control is not required.  In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required as we may need to devote additional time and personnel to legal, financial and accounting activities to ensure our ongoing compliance with the public company reporting requirements.

In addition, the effort to prepare for these requirements and maintain effective internal controls may divert management’s attention from other business concerns, which could adversely affect our business, financial condition and results of operations.  In addition, we may need to hire additional accounting and financial staff and might not be able to do so in a timely fashion.  We are working to identify those areas in which changes should be made to our financial and management control systems to manage our growth and to ensure compliance with the requirements of the Exchange Act and the Sarbanes-Oxley Act, and to make such changes.  The costs associated therewith could be significant.

None.

We maintain our headquarters in a 30,000 square foot office facility at 1411 Broadway in New York, New York.  The headquarters houses our design studio and sales showroom, in addition to our sourcing, finance and administrative functions.  We sublease a portion of our headquarters to a third party.  The New York office lease and related sublease expire in January 2013.  Our warehouse and distribution facilities occupy approximately 182,000 square feet in Bayonne, New Jersey. We have surrendered a portion of the Bayonne facilities as of September 30, 2010 (approximately 114,000 square feet) pursuant to which the Company terminated its obligations under its lease without penalty.  We also sublease the remainder of our Bayonne facilities (approximately 68,000 square feet) to a third party.  The New Jersey lease and related sublease expire in January 2011.  Our product sourcing and production facilities occupy approximately 6,000 square feet in Kowloon Bay, Kowloon (Hong Kong).  The Hong Kong lease expires in November 2011.  The facilities are leased at market rents.  In addition, we lease third-party storage and distribution facilities on a month-to-month basis and pay a fee per item shipped by the third party on our behalf.  We own no real property or facilities.

During April 2009, Kobra International, Ltd. d/b/a Nicole Miller (“Nicole Miller”) commenced arbitration proceedings against the Company alleging that the Company’s decision to suspend performance as licensee under the parties’ License Agreement (the “License”) constituted an anticipatory breach and/or repudiation of the License.  Nicole Miller originally sought $1.5 million in purported damages.  On April 29, 2009, the Company filed papers denying Nicole Miller’s claims in their entirety, asserting that the suspension of performance was permitted by the License and asserting a counterclaim of $1.0 million alleging that Nicole Miller’s subsequent termination of the License was improper. On January 29, 2010, Nicole Miller asserted an additional $2.5 million in purported damages.  On or about May 25, 2010, the arbitrator issued a Final Award (the “Award”). The Award directed the Company to pay Nicole Miller approximately $0.6 million corresponding to compensation for guaranteed minimum royalties of $0.4 million and

13

Table of Contents

attorney’s fees and certain expenses of $0.2 million; $0.4 million and $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 the Award in full in May 2010. The Award is in full settlement of all claims submitted in connection with 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, individually and in the aggregate, will not have a material adverse impact on its financial position or results of operations, litigation is subject to inherent uncertainties.

PART II

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

No dividends have been declared on our common stock during the two most recent fiscal years or since June 30, 2010.  We do not intend to pay dividends on our common stock in the foreseeable future.  Payment of dividends is within the discretion of the Company’s board of directors and depends on various factors, including our net income, financial condition, cash requirements and other factors deemed relevant by our board of directors.  The amounts available to pay dividends are limited by the terms of the Financing Agreement, dated June 20, 2005, between the Company and HSBC Bank USA, National Association (“HSBC”) and the indenture governing our 11 ¼% Senior Secured Notes due 2011.  We must also obtain the affirmative vote or written consent of the holders of a majority of the then outstanding shares of Series A Preferred Stock in order (i) to make (or permit any subsidiary to make) any declaration, payment or setting aside for payment of any dividend or other distribution of any sort in respect of any of our capital stock other than the Series A Preferred Stock or (ii) to repurchase, redeem or acquire any outstanding stock of the Corporation other than the Series A Preferred Stock.

The historical consolidated financial data included below and elsewhere in this Annual Report are not necessarily indicative of future performance.  The following selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and our audited consolidated financial statements and related notes included elsewhere in this Annual Report.

The summary selected historical financial data presented below is for the fiscal years ended June 30, 2010, 2009, 2008, 2007 and 2006.  This table should be read in conjunction with the Company’s consolidated financial statements and related notes appearing elsewhere in this Annual Report.

14

Table of Contents

RAFAELLA APPAREL GROUP, INC.

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

15

Table of Contents

The following is a discussion of our results of operations and financial condition.  This discussion should be read in conjunction with our audited consolidated financial statements and notes included elsewhere in this Annual Report.

NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

As you read this Annual Report, you should understand that these statements are no guarantees of 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 the Company’s actual financial results and could cause actual results to differ materially from those expressed in the forward-looking statements. Some important factors include, but are not limited to:

·                  our ability to continue as a going concern;

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

·                  our ability to refinance the Credit Facility;

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

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

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

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

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

·                  our ability to retain major customers at current or historical levels;

·                  competition and pricing pressures in apparel industry;

·                  our continued ability to anticipate customer and consumer tastes;

·                  ability to accurately forecast customer demand;

·                  fluctuations in the price, availability and quality of fabrics;

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

·                  our dependence upon third party manufacturing in foreign countries and the resulting fluctuations in cost of manufacturing apparel clothing;

16

Table of Contents

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

·                  protection of our brand and trademarks; and

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

COMPANY OVERVIEW

Our Company

We are an established wholesaler, designer, sourcer, marketer and distributer of a full line of women’s career and casual sportswear separates.  We have been in the women’s apparel business since 1982 and market our products primarily under the Rafaella 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 lines to include core basics, fashion related separates and replenishment items with updated features and colors using a variety of natural and synthetic fabrics.  Using our design specifications, we outsource the manufacturing and production of our clothing line to factories primarily in Asia and also the Middle East.  We sell our products directly to department, specialty and chain stores and off-price retailers.  During fiscal 2010, we have over 240 customers, representing over 3,900 individual retail locations.  Our customers include some of the largest retailers of women’s clothing in the United States.

Certain factors not solely within our control, including the nearing maturity dates of the Credit Facility and our senior secured notes and our uncertainty with respect to the refinancing thereof, raise substantial doubt about our ability to continue as a going concern.  We can give no assurance as to our ability to raise sufficient capital or revenues to meet our obligations or our ability to continue as a going concern.

Our Industry

The retail women’s apparel industry is highly competitive, with many providers of similar types of clothing as are designed and marketed by us.  In addition, there has been a consolidation in the industry, decreasing the number of retailers and the floor space available for our products.  Wholesalers of women’s apparel are subject to pricing pressures from both retailers and consumers, stemming from the increased competition for customers and economic cycles that impacts the spending of our consumers.

The women’s apparel industry in which we operate has historically been subject to cyclical variations, current general economic conditions, and perceived or anticipated future economic conditions.  The current economic environment, characterized by a dramatic decline in consumer discretionary spending, has materially and adversely affected the retail and wholesale apparel industry.  Discretionary purchases, such as women’s apparel, have been especially negatively impacted in the current economic environment.

Critical Trends; Performance Drivers

Primary Revenue Variables

Our revenues are impacted by the following factors:

·                  national and regional economic conditions;

·                  overall levels of consumer spending for apparel;

·                  demand by retailers for our brand and products;

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

·                  the accuracy of our forecast of demand for our products;

·                  the performance of our products within the prevailing retail environment;

·                  actions of our competitors;

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

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

Primary Expense Variables

Variations in our cost of sales are primarily due to:

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

17

Table of Contents

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

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

·                  pricing pressures due to competition for manufacturing sources;

·                  reductions in the value of our unsold inventories;

·                  fluctuations in energy prices which impact manufacturing costs and inbound transportation costs; and

·                  international economic and political conditions.

Variations in selling, general and administrative expenses are primarily due to:

·                  changes in headcount and salaries and related fringe benefits;

·                  costs associated with product development;

·                  changes in warehousing and distribution expenses associated with sales volumes, outbound transportation expenses impacted by changes in energy costs, and the need for third party storage or shipping services;

·                  costs associated with professional services;

·                  changes in PR and marketing expenses;

·                  changes in factoring costs and provisions for customer bad debts;

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

·                  costs associated with regulatory compliance.

Consolidation in the Industry

There has been, and continues to be, consolidation activity in the United States retail women’s apparel industry.  With the growing trend towards consolidation, we are increasingly dependent upon key retailers whose bargaining strength and share of our business is growing.  It is possible that these larger retailers may, 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 customers may consolidate with one or more of their other vendors and begin sourcing items from such vendors.  Consolidation may also result in store closures which could adversely impact our sales.

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

Changing Customer Tastes

We have designed our products primarily using basic styling with updated features and colors in order to minimize the impact of fashion trends.  However, fabric, color and other style factors are still critical in determining whether our products are purchased by consumers and consequently by our direct customers.  Consumer tastes can change rapidly.  We may not be able to anticipate, gauge or respond to changes in customer tastes in a timely manner.  If we misjudge the market for our products or product groups or if we fail to identify and respond appropriately to changing consumer demands, we may be faced with a significant amount of unsold finished goods inventory, which could have a material adverse affect on our expected operating results and decrease our sales and gross margins.  Conversely, if we predict consumer preferences accurately, we could experience increased sales and greater operating income because our selling, general and administrative expenses would remain at or near their current levels even with increased sales.

Competition

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

·                  establishing and maintaining favorable brand recognition;

·                  developing products that appeal to consumers;

·                  pricing products appropriately; and

·                  obtaining access to, and sufficient floor space in, retail stores.

The United States apparel industry is highly fragmented and includes a number of very large brands and companies marketing multiple brands, many of which have greater financial, technical and marketing resources, greater manufacturing capacity and more extensive and established customer relationships than we do.  We believe we have maintained prices for our branded

18

Table of Contents

products in department and specialty stores below comparable products offered by our branded competitors.  However, the future competitive responses encountered from these larger, more established apparel companies might be more aggressive and comprehensive than we anticipate and we may not be able to compete effectively.  For example, if our branded competitors were to match our prices for comparable products, we may be forced to lower our prices or endure lower sales as a result.  The competitive nature of the apparel industry may result in lower prices for our products and decreased gross profit margins, either of which may have a material adverse affect on our sales and results of operations.

Import Restrictions and Regulations

Our transactions with our foreign suppliers are subject to the risks of doing business abroad.  Imports into the United States are affected by, among other things, the cost and availability of transportation of the products and the imposition of import duties and restrictions.  The countries that we source our products from may, from time to time, also impose restrictions or take various economic actions, which could affect our ability to import products from such countries at the current or increased levels.  Imports into the United States can also be subjected to various additional restrictions and the assessment of punitive antidumping duties or countervailing duties when goods are shipped to the U.S. at less than fair value (dumping) or with certain countervailable subsidies from the exporting nation.  In 2007, the U.S. Government altered a more than twenty-year policy by applying its antisubsidy laws to certain exports from China.  Bills have been introduced in Congress which would hold China and other countries accountable for currency manipulation through the assessment of additional duties (such as those available under the antidumping and countervailing duty laws).  The effect of these changes could be an increase to the cost of goods imported by us from China.  The pendency of the above-described actions can have a disruptive effect on imports from the exporting country while the action is pending as a result of the potentially resulting uncertainty.  We cannot predict the likelihood or frequency of any such events occurring.

Various private interests have proposed implementing a monitoring program covering textile imports from China.  Should these proposals in the future be adopted and should they result in affirmative determinations of injury, they could result in additional restrictions or duties.

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

In addition, various economic factors, including, but not limited to, the exchange rate between the U.S. and Chinese currencies, and increased cost for raw materials, labor and transportation, could materially impact the availability or cost at which we could import our products.

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

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

In addition to the factors outlined above, our import operations may be adversely affected by political or economic instability resulting in the disruption of trade from exporting countries, any significant fluctuations in the value of the dollar against foreign currencies and restrictions on the transfer of funds.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements.  We evaluate our estimates and judgments on an ongoing basis.  We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances.  Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may vary from what we anticipate and different assumptions or estimates could change our reported results.

19

Table of Contents

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

Revenue Recognition.  Revenue is recognized at the time title passes and risk of loss is transferred to customers.  Revenue is recorded net of estimated discounts, returns and allowances.  Discounts are based on trade terms.  Returns and allowances require pre-approval from management.  On a seasonal basis, we negotiate price allowances with our customers as sales incentives or for the cost of certain promotions.  We estimate these allowances based on historic trends, seasonal results, an evaluation of current economic conditions and retailer performance.

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

Deferred taxes are provided for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases, as measured by enacted tax rates in effect in periods when the deferred tax assets and liabilities are expected to be settled or realized.  We evaluate the probability of realizing our deferred tax assets on an on-going basis.  This evaluation includes estimating our future taxable income for the years in which our deferred taxes are expected to reverse, which includes consideration of tax planning strategies.  We provide a valuation allowance if we determine it is more likely than not that we will not be able to realize our deferred tax assets.  A valuation allowance of approximately $16.4 million relating to certain capital loss carry forwards existed as of June 30, 2010.

We adopted the provisions of Accounting Standards Codification (“ASC”) 740, Income Taxes, formerly FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”), on July 1, 2007.  As a result of this adoption, we recognized an increase in liabilities for uncertain tax positions of approximately $6.3 million with a corresponding increase in the deferred tax asset of $5.9 million representing the gross unrecognized tax benefits.  Upon adoption, $0.6 million of interest, net of $0.2 million tax benefit, was recorded to retained earnings.  We recognize interest expense related to unrecognized tax benefits in income tax expense.

Receivables.  Receivables consist of trade accounts receivable and receivables that are assigned to a commercial factor, net of discounts and allowances.  We factor certain trade receivables, on a non-recourse basis with a commercial factor, except that we assume credit risk for those receivables that do not receive written approval from the factor.  The factor collects all cash remittances on receivables factored and assumes credit risk 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 a reduction to gross sales and receivables.  Certain of these provisions result from seasonal negotiations with customers as well as historic deduction trends and the evaluation of current market conditions.

Inventories.  Substantially all of the inventory we purchased in fiscal year 2010 was produced in Asia.  Inventory costs include amounts paid to purchase piece goods and manufacture our products, duty, quota, inbound freight, and costs associated with our Hong Kong subsidiary (which acts in the capacity of a buying agent).  Inventories are stated at the lower of cost or market, with cost being determined at standard costs, which approximate the first-in, first-out (FIFO) method.  Inventories consist of raw materials (primarily piece goods at our contractors), merchandise in transit and finished goods in warehouses.  We take ownership of the finished goods when they are shipped and management records the merchandise in transit balance based on documentation provided by our Hong Kong subsidiary.  For inventory markdowns, we estimate the percentage of finished goods we will not be able to sell in the normal course of business and the associated average loss per unit, and write down the value of these goods to the recovery value expected to be realized through off-price channels.

Long-lived Assets.  Equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization.  We capitalize improvements to the extent they increase the economic life of the asset.  Furniture, fixtures, and equipment are depreciated using the straight-line method over their estimated useful lives of 3 to 10 years.  Leasehold improvements are amortized over the shorter of the remaining lease term or the estimated useful lives of the assets.  Expenditures for maintenance and repairs are expensed in the period incurred.

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

20

Table of Contents

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

The trademark and trade name, which have been determined to be indefinite lived assets, are tested for impairment at least annually or when changes in circumstances indicate that their carrying amount may not be recoverable, by comparing the carrying amount of the assets to their fair value based on an income 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 related benefits of these assets.  This approach is dependent upon a number of factors, including estimates of future growth and trends, royalty rates for intellectual property, discount rates and other variables.  We base our fair value estimates on assumptions we believe are reasonable, but which are unpredictable and inherently uncertain.  Actual future results may differ from those estimates.  If the estimated fair value of the assets is less than their carrying amount, an impairment loss is recognized equal to such difference.

Contingencies and Litigation.  Management evaluates contingent liabilities including threatened or pending litigation in accordance with ASC 450, Contingencies, and records accruals when the outcome of these matters is deemed probable and the liability may be reasonably estimated.  Management makes these assessments based on the facts and circumstances and in some instances based in part on the advice of outside legal counsel.  The Company records legal costs incurred in connection with a loss contingency as incurred.

Stock-based Compensation.  Effective July 1, 2006, the Company adopted revised provisions under ASC 718, Compensation — Stock Compensation and ASC 505-50, Equity-Based Payments to Non-Employees, which require companies to expense the fair value of employee stock options and other forms of stock based compensation.  The computation of the expenses associated with stock based compensation requires the use of a valuation model.  The Company currently uses the Black Scholes option pricing model to calculate the fair value of its stock options.  The Black Scholes model requires assumptions regarding the estimated length of time participants will retain their vested stock options before exercising them and the estimated volatility of the Company’s common stock over the expected term.  Changes in the assumptions to reflect future stock price volatility and future stock award exercise experience could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock based awards.  There was no effect from the change of applying the original provisions of ASC 718 to the Company’s results of operations and cash flows for the fiscal year ended June 30, 2007, as a result of the Company’s adoption of revised provisions under ASC 718 and ASC 505-50, effective July 1, 2006.  Compensation expense related to stock-based awards was not significant to the Company’s consolidated statement of operations for the years ended June 30, 2010, 2009 and 2008.  Refer to Note 3 of the Company’s consolidated financial statements for further information.

21

Table of Contents

RESULTS OF OPERATIONS

The following table summarizes the historical operations as a percentage of net sales for the years ended June 30, 2010, 2009 and 2008.

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 to net sales of $148.0 million for the year ended June 30, 2009, net sales decreased by approximately $34.0 million or 23%.  The reduction of net sales was principally due to a reduction in gross sales of $38.3 million, related to a decrease in volume (approximately 23%), and partially offset by an increase in average gross revenue per unit (approximately 3%).  The decrease in customer volume was primarily attributed to decreases in department store, private label and off-price sales. The increase in average revenue per unit was primarily attributed to improved sales mix, with more department store and private label sales and less off-price sales, and an increase in off-price sales per unit, partially offset by decreases in department store and private label sales per unit.  The decrease in gross sales was partially offset by a $4.2 million decline in customer allowances, trade discounts and returns 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 percentage of net sales, gross profit over this period was 30.7%.  As compared to the gross profit of $34.9 million for the year ended June 30, 2009 (23.6% of net sales), gross profit increased by $0.1 million or 0.1%.  Gross profit as a percentage of net sales increased by approximately 7.1% for the year ended June 30, 2010 compared to the year-ended June 30, 2009.  Gross profit as a percentage of net sales was favorably impacted by an improvement in margins associated with off-price customer sales, an increase in department store sales as a percentage to total net sales, a decrease in off-price customer sales as a percentage to total net sale and a decrease in inventory markdowns during the year ended June 30, 2010 compared with the prior year.  The increase in gross profit as a percentage of net sales was partially offset by an increase in customer allowances and discounts as a percentage of net sales.

Selling, general and administrative expenses.  Selling, general and administrative expenses for the year ended June 30, 2010 was $28.3 million.  As compared to selling, general and administrative 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 and administrative expenses was primarily attributable to a decrease in compensation of $1.4 million.  Other decreases in selling, general and 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 of reduction in salary expense of $2.3 million, driven by headcount reductions during 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 severance costs decreased to $0.1 million for the year ended June 30, 2010, as compared 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 cost savings restructuring efforts implemented during June 2010.  As of June 30, 2010, the severance costs remain unpaid and are accrued within the accrued expenses and other current liabilities line item of the Company’s consolidated balance sheet.  The severance costs are expected to be paid during 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, of which $0.6 million and $0.5 million were paid during the year ended June 30, 2010 and 2009, respectively. Other decreases in selling, general and administrative expenses included                . The decrease in selling,

22

Table of Contents

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

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

Operating income (loss).  Operating income for the year ended June 30, 2010 was $6.7 million.  As compared 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 gross profit, the decreases in selling, general and administrative expenses and intangible asset impairment, as described above.

Interest expense, net.  Interest expense, net (cash interest and non-cash interest associated with original issue discount and deferred financing costs) for the year ended June 30, 2010 was $10.5 million. As compared 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 was primarily due to the reduction in our senior secured notes outstanding period over period as a result of the senior secured notes purchases.

Gain on senior secured notes purchases.  Gain on senior secured notes purchases for the year ended June 30, 2010 was $8.0 million. As compared to gain on senior 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 from the difference between the carrying book value of the senior secured notes and the amounts paid, net of deferred financing costs that were written-off) was due 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 secured notes on the open market in July 2009, November 2009, and December 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 market in August 2008, March 2009, April 2009, and May 2009, respectively, for the year ended June 30, 2009.

Interest expense (income) and other financing, net.  Interest expense and other financing, net for the year ended June 30, 2010 was $2.5 million.  As compared to interest expense and other financing, net, gain of $12.4 million for the year ended June 30, 2009, interest increased by $14.9 million or 120.1%.  The increase was primarily attributed to a reduction of pre-tax gain on senior secured notes purchases as discussed above.  Refer to the “Liquidity and Capital Resources” section below for further discussion surrounding our senior 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 an effective income tax rate of approximately 78.4%.  The difference between the statutory federal income tax rate of 34.0% and our effective income tax rate of 78.4% is primarily attributable to the valuation allowance of $1.4 million that we established on a deferred tax asset attributable to the amortization of the Company’s customer relationship intangible assets.  The underlying tax basis of the customer relationships is capital in nature.  The asset would generate a capital loss for income tax purposes upon disposition at its carrying value, which can only be used to offset capital gain income.  We determined that the deferred tax asset is not more likely than not to be realized as there are no actual or projected capital gains available to offset any future capital losses that might be generated from the customer relationship deferred tax asset.

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

We recorded a provision for income taxes of $6.7 million for the year ended June 30, 2009, which represents an effective income 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 the valuation allowance of $9.9 million that we established for the deferred tax asset that resulted from the Rafaella trademark and trade name intangible asset impairment charge of $25.8 million, as described above.  The underlying tax basis of the trademark and trade name is capital in nature.  The asset would generate a capital loss for income tax purposes upon disposition at its carrying value, which can only be used to offset capital gain income.  We determined that the deferred tax asset is not more likely than not to be realized as there are no actual or projected capital gains available to offset any future capital losses that might be generated from the Rafaella trademark and trade name deferred tax asset.

23

Table of Contents

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

Net income (loss).  Net income for the year ended June 30, 2010 was $0.9 million.  Net income as a percentage of net sales for the year ended June 30, 2010 was 0.8%.  As compared to a net loss of $15.4 million for the year ended June 30, 2009, net income increased by $16.3 million.  This increase in net income was a result of the changes in operating income, interest and income taxes, as described 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 to net sales of $178.0 million for the year ended June 30, 2008, net sales decreased by approximately $30.0 million or 16.9%.  The reduction of net sales was principally due to a reduction in gross sales of $28.5 million, related to a decrease in volume (approximately 12%) and a decrease in average revenue per unit (approximately 2%).  The decrease in customer volume was primarily attributed to decreases in department store and private label sales, offset by an increase in off-price sales.  The decrease in average revenue per unit was primarily attributed to off-price sales per unit, offset by an increase in department store sales per unit.

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

Selling, general and administrative expenses.  Selling, general and administrative expenses for the year ended June 30, 2009 was $30.2 million.  As compared to selling, general and administrative 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 and distribution costs ($0.8 million), provision for bad debt ($0.4 million), and compensation ($0.6 million).  The decrease in compensation includes severance costs of approximately $1.1 million incurred during the quarterly period ended March 31, 2009.  The severance costs were primarily attributed to two former executive officers of the Company. The decrease was partially 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 year ended June 30, 2009 was $25.8 million.  As compared to intangible asset impairment of $34.5 million for the year ended June 30, 2008, there was a decrease of $8.7 million.  The Company performed an impairment test of the trademark and trade name and customer relationships during the second and fourth quarters of the fiscal year ended June 30, 2009 and determined that the trademark and trade name was impaired necessitating a charge of $23.4 million and $2.4 million, respectively.  The Company performed its annual impairment test of the trademark and trade name and customer relationships during the fourth quarter of the fiscal year ended June 30, 2008 and determined that the trademark and trade name was impaired necessitating a charge of $34.5 million.  The impairment in both years was due to decreased sales and cash flows attributable to the Rafaella brand as a result of reduced forecasts for future years given the current state of the U.S. apparel retail environment.

Operating loss.  Operating loss for the year ended June 30, 2009 was $21.1 million.  As compared 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 decreases in selling, general and administrative expenses and intangible asset impairment, as described above.

Interest expense (income) and other financing, net.  Other financing, net for the year ended June 30, 2009 was $12.4 million.  As compared to interest expense of $14.8 million for the year ended June 30, 2008, interest decreased by $27.2 million or 183.6%.  The decrease was 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 of the senior secured notes and the amount paid, net of deferred financing costs that were written-off, in connection with our open market purchases in fiscal 2009 and 2008, respectively; each of the other senior secured note repurchases (pursuant to certain excess cash flow repurchases and restricted payment offers) were at 101% of their principal amount at maturity.  The decrease in interest expense was also attributed to the reduction in our senior secured notes outstanding period over period.  In November 2008 and November 2007, we repurchased $598,000 and $221,000, respectively, of senior secured notes in connection with our excess cash flow offers.  We purchased $6,000,000 and $8,027,000 of our senior secured notes on the open market in January 2008 and June 2008, respectively.  We purchased $28,505,000, $2,000,000, $3,991,000 and $4,424,000 of our senior secured notes on the open market in August 2008, March 2009, April 2009, and May 2009, respectively.  As a result of these

24

Table of Contents

senior secured note transactions, interest expense (cash interest and non-cash interest 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 partially offset by a reduction in interest income of $0.3 million period over period.  Refer to the “Liquidity and Capital Resources” section below for further discussion surrounding our senior secured notes.

Provision for (benefit from) income taxes.  We recorded a provision for income taxes of $6.7 million for the year ended June 30, 2009, which represents an effective income 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 the valuation allowance of $9.9 million that we established for the deferred tax asset that resulted from the Rafaella trademark and trade name intangible asset impairment charge of $25.8 million, as described above.  The underlying tax basis of the trademark and trade name is capital in nature.  The asset would generate a capital loss for income tax purposes upon disposition at its carrying value, which can only be used to offset capital gain income.  We determined that the deferred tax asset is not more likely than not to be realized as there are no actual or projected capital gains available to offset any future capital losses that might be generated from the Rafaella trademark and trade name deferred tax asset.

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

We recorded a benefit from income taxes of $8.2 million for the year ended June 30, 2008, which represents an effective income tax rate benefit of approximately 24.9%.  We recorded a net benefit, after valuation allowance, from income taxes primarily as a result of the $34.5 million impairment charge associated with the decline in the fair value of the Rafaella trademark and trade name intangible asset, as described above.  The difference between the statutory federal income tax rate of 34.0% and our effective income tax rate of 24.9% is primarily attributable to the valuation allowance of $4.3 million that we established for the deferred tax asset that resulted from the Rafaella trademark and trade name intangible asset impairment.  The underlying tax basis of the trademark and trade name is capital in nature.  The asset would generate a capital loss for income tax purposes upon disposition at its carrying value, which can only be used to offset capital gain income.  We determined that the deferred tax asset is not more likely than not to be realized as there are no actual or projected capital gains available to offset any future capital losses that might be generated 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 a percentage of net sales for the year ended June 30, 2009 was 10.4%.  As compared to net loss of $24.8 million for the year ended June 30, 2008, net loss decreased by $9.3 million.  This decrease in net loss was a result of the changes in operating loss, interest and income taxes, as described above.

LIQUIDITY AND CAPITAL RESOURCES

Historically, our primary liquidity and capital requirements have been to fund working capital for current operations, which consists of funding the buildup of inventories and receivables, and servicing our Credit Facility.  Our liquidity and capital requirements also include making interest payments on the senior secured notes.  The primary source of funds currently used to meet 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

Our liquidity outlook has changed since June 30, 2009 primarily as a result of the continued strain on current credit and capital market conditions and the nearing maturity dates of the Credit Facility and our senior secured notes in June 2011.  As a result, we believe that our forecasted cash and available credit capacity are not expected to be sufficient to meet our debt repayment obligations as they come due over the next twelve months. In order to enable us to meet our debt repayment obligations, we are currently seeking to refinance, extend or restructure our senior secured notes and our Credit Facility. There can be no assurance that we will be able to do so on terms and conditions satisfactory to us within the period needed to meet these repayment obligations. Our ability to refinance any of our existing indebtedness on commercially reasonable terms may be materially and adversely impacted by the current credit market conditions and our financial condition. Our inability to repay the Credit Facility and the senior secured notes under the terms of the financing agreements would lead to an event of default which would constitute debt being callable by creditors. The uncertainty associated with our ability to repay our outstanding debt raises substantial doubt about our ability to continue as a going concern. If we were unable to continue as a going concern, we will need to liquidate our assets and we might receive significantly less than the values at which they are carried on our consolidated financial statements.  The accompanying consolidated financial statements do not include any adjustments related to the recoverability and classification of recorded assets or the amounts and classification of liabilities that might result from the uncertainty associated with our ability to meet our debt obligations as they come due.

25

Table of Contents

Credit Facility

On June 20, 2005, we entered into a secured revolving credit facility agreement (as amended through May 21, 2010, the “Credit Facility”) with HSBC Bank USA, National Association.  The Company, Cerberus Capital Management, L.P. (“Cerberus”), as a lender and the term lender, HSBC Bank USA, National Association (“HSBC” or the “Agent”), as agent and as lender, the other 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 of May 21, 2010 (the “Amended and Restated Financing Agreement”) to amend and restate the Credit Facility.

The Amended 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 by HSBC, (b) revolving direct debt advances of up to $5,000,000 on or after December 16, 2010 to be provided by Cerberus (the Company will not be entitled to obtain any revolving direct debt advances prior to December 16, 2010), and (c) term loans of up to $5,000,000 to be provided by Cerberus (the “Term Loan Commitment”).   The above letters of credit and revolving direct debt advances are subject to the additional conditions as noted below.

Under the terms of the Amended and Restated Financing Agreement, the Company’s ability 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 to reserves required by HSBC, if any, and the availability reserve discussed below (i) the sum of (a) 70% of eligible receivables plus (b) 70% of eligible factored receivables, plus (ii) the lesser of (I) the sum of (a) 50% of eligible inventory plus (b) 50% of outstanding eligible documentary letters of credit, and (II) the inventory advance cap, plus (iii) cash collateral.  The inventory advance cap is (i) $10,000,000 from the effective date of the Amended and Restated Financing Agreement through and including September 30, 2010, (ii) $5,000,000 from October 1, 2010 through and including December 15, 2010 and (iii) $0 thereafter.  The availability reserve is (a) $10,000,000 through 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 is limited to the lesser of $20,000,000 and the amount of cash collateral deposited by the Company to cash collateralize letters of credit.  The Amended and Restated Financing Agreement further provides that standby letters of credit shall be limited to $4,011,000 in the aggregate undrawn amount outstanding at any time.

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

The term loans may be used solely to fund repayments or repurchases of the Company’s outstanding 11¼% Senior Secured Notes due June 2011 (the “Notes”); and the Company shall not repurchase any of the Notes except (a) with the proceeds of the term loans or (b) as otherwise required pursuant to the terms of the Notes indenture.  The term loans are secured by a first lien on all of the Company’s assets on a pari passu basis with all other obligations under the Amended and Restated Financing Agreement, subject to the provisions of the Amended and Restated Financing Agreement relating to the application of proceeds from the Company.  Any term loans, borrowed under the Term Loan Commitment, are also due and payable on June 10, 2011 or upon termination of the Amended and Restated Financing Agreement.

The Amended and Restated Financing Agreement provides that the minimum working capital requirement shall be $25,000,000 as of the end of the fiscal quarter ending June 30, 2010 and $27,000,000 as of the end of the fiscal quarters ending thereafter.  Working capital is defined as the sum of cash, accounts receivable, and inventory, reduced by current liabilities; the definition of current liabilities excludes indebtedness under the Company’s senior secured notes at any point on or after June 30, 2010.  With the exception of the fiscal quarters ending on June 30, 2010 and September 30, 2010, the Company is required to maintain positive net income during each period of two consecutive fiscal quarters (on a rolling basis).  The Company is permitted to incur up to a net loss of $1,300,000 during each of the two consecutive fiscal quarters (on a rolling basis) ending on June 30, 2010 and September 30, 2010.  For purposes of determining compliance with the net income financial covenant, the definition of net income excludes noncash expenses associated with (i) amortization of customer relationships and non-compete agreements, (ii) the accretion of the senior secured notes original issue discount, (iii) amortization of deferred financing costs, and (iv) impairment charges, if any, resulting from a decline in the value of the Company’s intangible assets.

The Amended and Restated Financing Agreement sets forth the following cash collateral requirements: (i) $5,500,000 from July 1, 2010 through and including July 31, 2010; (ii) $3,000,000 from October 1, 2010 through and including October 31, 2010; and (iii) $2,000,000 from November 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 of credit in an amount equal to one hundred and five percent (105%) of such outstanding letters of credit.  A condition precedent to the issuance of any letter of credit on and after December 16, 2010 is that the Company shall have deposited with HSBC cash collateral in an amount equal to 105% of the undrawn face amount of each such letter of credit.

26

Table of Contents

As of June 30, 2010, the Company was in compliance with each of the financial covenants.  A violation of the financial covenants constitutes an event of default under the Amended and Restated Financing Agreement; such an event of default could result in all debt becoming due and payable, and HSBC having the right to terminate the Credit Facility and its obligation to make advances thereunder.  If the Company’s operations were to deteriorate beyond its forecasted results, it could result in a debt covenant violation and the Company would need another amendment.  If the Company were unable to amend the terms of the Amended and Restated Financing Agreement, the Company’s financial condition and results of operations may be materially adversely affected.  Due to the inherent uncertainties in making estimates and assumptions, there can be no assurance that the Company will satisfy either of its financial covenants in future periods.

At June 30, 2010, there were no loans and $10.2 million of letters of credit outstanding under the Amended and Restated Financing Agreement.  The outstanding letters of credit are comprised of letters of credit totaling $6.2 million in connection with purchase orders for merchandise from third-party manufacturers and standby letters of credit totaling $4.0 million issued by HSBC, which serve as security for obligations under certain operating leases, a customs bond and the GMAC Letter of Credit (refer to Note 4 to our consolidated financial statements for further discussion).  The Company’s aggregate 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 of period end).

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

The Amended and Restated Financing Agreement includes various other covenants with which the Company has to comply in order to maintain borrowing availability including, but not limited to, covenants limiting or restricting the Company’s ability to incur indebtedness, incur liens, enter into mergers or consolidations, dispose of assets, make investments, pay dividends and repurchase capital stock, enter into transactions with affiliates or prepay certain indebtedness.  In addition, the Company is required to report various financial and non-financial information periodically to HSBC.  The Amended and Restated Financing Agreement also contains customary events of default including, 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 certain events which would have a material adverse effect.  An event of default could result in all debt becoming due and payable, and HSBC having the right to terminate the Credit Facility and its obligation to make advances under it.

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

The Amended and Restated Financing Agreement provided for (i) an extension fee of $25,000 payable to HSBC, as Agent, payable upon execution, (ii) a revolving commitment closing fee payable to Cerberus of $125,000, which fee was earned as of the effective date of the Amended and Restated Financing Agreement and payable upon the Termination Date (as such term is defined in the Amended and Restated Financing Agreement), and (iii) term loan fees payable to Cerberus, as term lender, of (a) a closing fee of $125,000, which fee was earned as of the effective date of the Amended and Restated Financing Agreement and payable upon the Termination Date, and (b) a facility fee at a rate equal to one-quarter of one percent (0.25%) per annum on average daily unused portion of the Term Loan Commitment earned on a monthly basis and payable upon the Termination Date.  Borrowings under the Amended and Restated Financing Agreement bear variable 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 as defined).  The Amended and Restated Financing Agreement provides for a monthly commitment fee of 0.25% per annum on the unused portion of the available commitments for revolving direct debt advances and letters of credit under the facility.

The foregoing is a summary of the Amended and Restated Financing Agreement, and does not purport to be complete and is qualified in its entirety by the copy of the Amended and Restated Financing Agreement.

27

Table of Contents

Senior Secured Notes

On June 20, 2005, the Company received aggregate proceeds of $163,400,000 from the issuance of 11.25% senior secured notes, face value $172,000,000 pursuant to our indenture.  The notes were 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 the term of the notes.  Senior secured notes principal amount outstanding at June 30, 2010 and 2009 is $71,861,000 and $84,743,000, respectively.  At June 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 carrying book value at June 30, 2010 and 2009.  At June 30, 2010 and 2009, the fair value of the senior secured notes, determined based upon quoted market prices, was approximately $48,147,000, and $16,101,000, respectively. The notes bear cash interest at 11.25%.  After giving effect to the original issue discount and costs associated with the issuance, the notes have an effective interest rate of approximately 13.7%.  The notes mature on June 15, 2011 and cash interest is payable semiannually on June 15 and December 15 of each year, commencing December 15, 2005.  The notes are collateralized by a second priority lien on substantially all of the assets of the Company.  The notes are subordinated to amounts outstanding under the Credit Facility.

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

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

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

The Company purchased, at a discount, $6.0 million and $8.0 million of outstanding senior secured notes on the open market in January 2008 and June 2008, respectively.  A pre-tax gain of approximately $3.1 million, resulting from the difference between the carrying book value of the senior secured notes and the amount paid, net of deferred financing costs that were written-off at the time of purchase, was recorded to gain on senior secured note purchase during the fiscal year ended June 30, 2008.

The Company purchased, at a discount, $28.5 million, $2.0 million, $4.0 million and $4.4 million of outstanding senior secured notes on the open market in August 2008, March 2009, April 2009, and May 2009, respectively.  A pre-tax gain of approximately $25.6 million, resulting from the difference between the carrying book value of the senior secured notes and the amount paid, net of deferred financing costs that were written-off at the time of purchase, was recorded to gain on senior secured note purchase during the fiscal year ended June 30, 2009.

The Company purchased, at a discount, $3.5 million, $5.0 million and $4.4 million of 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 senior secured notes and the amount paid, net of deferred financing costs that were written-off at the time of purchase, was recorded to gain on senior secured note purchase during the fiscal year ended June 30, 2010.

On February 22, 2010, the Company commenced a debt tender offer (“Tender Offer”) to purchase up to approximately 51% of its outstanding 11-¼% Senior Secured Notes due 2011 (the “Notes”).  The consummation of the Tender Offer was conditioned upon, among other conditions, the valid tender by holders of Notes with 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 the Tender Offer expired and the Minimum Tender Amount of Notes was not tendered.  Consequently, the Company did not purchase any Notes pursuant to the Tender Offer.

In connection with the Tender Offer, on February 22, 2010, the Company also entered into an agreement (the “Originally Restated Credit Agreement”) with HSBC and Cerberus, as the term lender, to amend and restate the Credit Facility, by and among

28

Table of Contents

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

The senior secured notes indenture contains various covenants with which the Company has to comply, including, but not limited to, covenants limiting or restricting the Company’s ability to incur indebtedness, incur liens, enter into mergers or consolidations, dispose of assets, make investments, pay dividends and repurchase capital stock or enter into transactions with affiliates.  In addition, the Company is required to report various financial and non-financial information periodically to the trustee.  The senior secured notes indenture also contains customary events of default including, but not limited to, payment defaults, cross-defaults to other indebtedness in excess of $7.5 million, material judgment defaults, bankruptcy and insolvency events, defects in security interests, and change in control events.  An event of default could result in all debt becoming due and payable.

As noted in Note 9 and Note 10 to our consolidated financial statements, the Company’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 that the Company will have sufficient cash on hand, based on current cash flow projections, to settle the senior secured notes in June 2011 at principal or face value.  If the Company is unable to secure additional financing, its business and results from operations, financial condition and cash flows may be materially adversely affected and impact the Company’s ability to continue as a going concern.  Consequently, management is currently in the process of exploring alternative long-term financing.  There can be no assurance that any such financing will be available with terms favorable to the Company or at all.

We may from time to time seek to purchase our outstanding senior secured notes in open market purchases, privately negotiated transactions or otherwise.  These purchases, if any, will depend on prevailing market conditions based on our liquidity requirements, contractual restrictions and other factors.  The amount of purchases of our senior secured notes may be material and may involve significant amounts of cash and/or financing availability.  Under the American Recovery and Reinvestment Act of 2009 (“the Act”), the Company will receive temporary relief under the Delayed Recognition of Cancellation of Debt Income (“CODI”) rules. The Act contains a provision, at the election of a corporation, allowing a five-year deferral of CODI for debt purchased in 2009 or 2010, followed by recognition of CODI ratably over the succeeding five years.  However, an electing corporation may be required to accelerate its deferred CODI and recognize currently into income upon certain triggering events such as impairment transactions, corporate reorganizations and changes in tax status.  Absent an acceleration event, the Company will continue to defer the recognition of CODI pursuant to the provisions set forth in the Act.  The provision applies for specified types of purchases, including the acquisition of a debt instrument for cash and the exchange of one debt instrument for another.

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

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

Operating Activities

Cash flows 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 flows provided by operating activities from 2009 to 2010 is primarily attributed to the reductions in cash flow relating to the sale of aged inventory in 2009 versus 2010, partially offset by a reduction in interest paid, income taxes (net of refunds), and timing of payments associated with inventory purchases.  The decrease in cash flows provided by operating activities from 2008 to 2009 is the result of the decrease in our operating income (excluding non-cash items) and income taxes paid in connection with our August 2008 senior secured note open market purchase, offset by reductions in

29

Table of Contents

payments associated with interest, planned reductions in current season inventory purchases resulting from anticipated reductions in sales and sales of aged inventory to off-price customers. For each of the years ended June 30, 2010, 2009 and 2008, significant non-cash items included amortization of deferred finance charges, accretion of original issue discount, depreciation and amortization, and the provision for deferred income taxes.  A non-cash impairment charge of $25.8 million and $34.5 million was recorded during 2009 and 2008, respectively related to the decline in the fair value of the Rafaella trademark and trade name intangible asset.  In addition, during 2010, 2009 and 2008, a non-cash gain of $8.0 million, $25.6 million and $3.1 million, respectively was recorded in connection with the senior secured notes purchases.

Investing Activities

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

Financing Activities

Net cash used in financing activities for the years ended June 30, 2010, 2009 and 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 open market purchases discussed above.

Off-Balance Sheet Arrangements

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

We enter into employment and consulting agreements with certain of our employees from time to time.  These contracts typically provide for severance and other benefits.  Individually, none of the contracts are expected to be material, although in the aggregate, our obligations under these contracts could be significant.  Additionally, we have certain operating leases, which are disclosed in the consolidated financial statements.

The Company has no other off-balance sheet arrangements.

Due From Factor

Historically, the Company factored a significant portion of its trade receivables, on a non-recourse basis, with GMAC Commercial Finance LLC (“GMAC”), a commercial factor.  In accordance with the terms of an Amended and Restated Collection Services Factoring Agreement dated December 16, 2008 between GMAC and the Company, all accounts receivable of the Company then held by GMAC were sold back to the Company effective as of such date.  On December 19, 2008, the Company delivered to GMAC a notice of termination of the GMAC arrangement pursuant to the terms thereof.  On February 5, 2009, as part of the termination of the GMAC arrangement, the Company arranged for an irrevocable letter of credit in an aggregate amount of $2,000,000 (the “Letter of Credit”) for the benefit of GMAC.  The Letter of Credit permits GMAC to draw amounts equal to amounts collected by GMAC, after January 6, 2009, if certain identified customers of the Company file a petition for relief from creditors under the United States Bankruptcy Code and claims are made for GMAC to return to the customer or its bankruptcy estate amounts GMAC has collected from such customer.  The Letter of Credit was subsequently reduced to $65,000 in September 2009 and expires on April 2, 2011, subject to extension under certain circumstances.

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

We can not borrow from Wells Fargo and GMAC and the amounts due from Wells Fargo and GMAC are pledged to our revolving credit facility lenders as security for amounts outstanding under our revolving credit facility.

30

Table of Contents

Contractual Cash Obligations

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

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

Effects of Inflation

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

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued the authoritative guidance to eliminate the historical GAAP hierarchy and establish only two levels of U.S. GAAP, authoritative and non-authoritative. When launched on July 1, 2009, the FASB Accounting Standards Codification (“ASC”) became the single source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. The subsequent issuances of new standards will be in the form of Accounting Standards Updates that will be included in the ASC. This authoritative guidance was effective for financial statements for interim or annual reporting periods ended after September 15, 2009. The Company adopted the new codification in the first quarter of fiscal 2010 and it did not have any impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities (“VIE”) and the evaluation of when consolidation of a VIE is required. This amends the guidance for determining whether an entity is a VIE and establishes an additional reconsideration event for assessing whether an entity is, or continues to be, a VIE. The amendment modifies the requirements for determining whether an entity is the primary beneficiary of a VIE and requires ongoing reassessments of whether an entity is the primary beneficiary. This amendment also enhances the disclosure requirements about an entity’s involvement with a VIE. This amendment is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company is evaluating the impact the adoption of this amendment will have on its consolidated financial statements.

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for transfers of financial assets. This amendment eliminates the concept of qualifying special purpose entities for accounting purposes. This amendment limits the circumstances in which a financial asset, or a component of a financial asset, should be derecognized when the entire asset is not transferred, and establishes specific conditions for reporting the transfer of a portion of a financial asset as a sale. This amendment also requires enhanced disclosures about the transfer of financial assets and the transferor’s continuing involvement with transferred financial assets.  The amendment is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company is evaluating the impact the adoption of this amendment will have on its consolidated financial statements.

In May 2009, the FASB issued a new provision on subsequent events which required the disclosure of the date through which an entity has evaluated subsequent events for potential recognition or disclosure in the financial statements and whether that date represents the date the financial statements were issued or were available to be issued.  This standard also provides clarification about

31

Table of Contents

circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date.  This standard was amended in February 2010, whereby the amendments eliminate the requirement for the disclosure of the date through which subsequent events were evaluated. The amendments are effective upon issuance of the update, and the adoption of the amendments did not have any impact on the Company’s consolidated financial statements.

In September 2006, the FASB issued authoritative guidance which defines fair value, establishes a framework for measuring fair value under GAAP and expands fair value measurement disclosures. The guidance does not require new fair value measurements and is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. In February 2008, the FASB issued guidance which allows for a one-year delay of the effective date for fair value measurements for all non-financial assets and liabilities, except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company delayed the effective date and applied the measurement provisions for all non-financial assets and liabilities that are recognized at fair value in the consolidated financial statements on a non-recurring basis until July 1, 2009. The Company’s non-recurring non-financial assets and liabilities include long-lived assets and intangible assets. The adoption of the guidance for financial assets and liabilities and for non-recurring non-financial assets and liabilities did not have a significant impact on the Company’s consolidated financial statements. In January 2010, the FASB issued amendments to disclosure and classification requirements for fair value measurement and disclosures.  These amendments are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward activity in Level 3 fair value 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 have any impact on the Company’s consolidated financial statements.

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

ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Market risks related to our operations result primarily from changes in interest rates.  Our interest rate exposure relates primarily to our variable interest line of credit.  Borrowings under the credit facility bear variable 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 Financing Agreement).  Our interest expense on the line of credit is based on variable rates, as discussed in Note 9 to our consolidated financial statements included elsewhere herein.  There were no loan borrowings or repayments under the Amended and Restated Financing Agreement during the fiscal year ended June 30, 2010.  At June 30, 2010, there were no loans outstanding under the Amended and Restated Financing Agreement.

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

ITEM 8.                  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

32

Table of Contents

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

None.

ITEM 9A(T).         CONTROLS & PROCEDURES

Management’s Evaluation of Disclosure Controls and Procedures

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

As of the period ended June 30, 2010 (the “Evaluation Date”), an evaluation of the effectiveness of the Company’s disclosure controls and procedures was conducted under the supervision of, and reviewed by, our Chief Executive Officer and Chief Financial Officer.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the Evaluation Date.

Management’s Assessment of Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f).  Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

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

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2010 based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and in accordance with the interpretive guidance issued by the SEC in Release No. 34-55929.  Based on that evaluation, management concluded that our internal control over financial reporting was effective as of June 30, 2010.

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

Changes in Internal Control Over Financial Reporting

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

ITEM 9B.               OTHER INFORMATION

Amended and Restated Employment Agreement; Equity Incentive Award

On October 13, 2010, the Company entered into an Amended and Restated Employment Agreement with Richard Metzger in connection with the promotion of Mr. Metzger to Executive Vice-President of Design of the Company.

33

Table of Contents

Prior to Mr. Metzger’s promotion, Mr. Metzger served as Vice-President of Design of the Company.  Mr. Metzger’s amended agreement provides for, among other things, an increase in Mr. Metzger’s (i) annual base salary, from $315,000 to $375,000, and (ii) target bonus, from 25% of his base salary to 50% thereof.  In addition, pursuant to the terms of his amended agreement, Mr. Metzger will be entitled to receive an equity grant to be determined by the Company’s board of directors, subject to the terms and conditions of the Company’s Equity Incentive Plan and customary documentation with respect thereto.

On September 16, 2010, the Company’s board of directors also approved the grant of options to Mr. Metzger pursuant to the Company’s Equity Incentive Plan 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 options vest on each of the first, second, third and fourth anniversaries of the grant date.

The foregoing summary of each of Mr. Metzger’s amended and restated employment agreement and equity incentive award agreement does not purport to be complete and is qualified in its entirety by each such agreement, both of which are attached hereto as Exhibits 10.48 and 10.49 and incorporated herein by reference.

PART III

ITEM 10.               DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The following table sets forth certain information regarding the members of our board of directors and executive officers.  All directors are elected annually and hold office until their successors are elected and qualified, or until their earlier removal or resignation.

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

Lance D. Arneson became our Chief Financial Officer in November 2009, and, prior to that time, was our Vice President of Finance from April 2009 to October 2009 and our Controller from December 2006 to March 2009.  Prior to joining Rafaella as our Controller, Mr. Arneson was a Senior 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/apparel experience.  Prior to joining Rafaella, Ms. Mancino was employed as Senior Vice President Sales, Retail Planning and In Store Services for five years by Tommy Hilfiger USA.  Prior to that she was employed by Liz Claiborne for ten years, where her last position was serving as Vice President/General Manager of Sales for the Liz Claiborne casual division.  All of the aforementioned companies are principally in the business of women’s apparel.

Nichole Vowteras became our Executive Vice President of Sourcing 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 Garfield Marks for 2.5 years, as Senior Vice President of Production for Guess, Inc. for one year and with Reebok for eight years, where her last position was serving as Vice President of Worldwide Sourcing.  All of the aforementioned companies are principally in the business of women’s apparel and footwear.

34

Table of Contents

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

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

George Kollitides is one of our directors and was elected as a director in 2005.  Mr. Kollitides is a Managing Director at Cerberus.  From 2001 to 2003, Mr. Kollitides was President and Managing Director of TenX Capital Management, a special situations investor affiliated with Cerberus.  Prior to joining TenX, Mr. Kollitides actively invested in numerous private equity transactions for Catterton Partners, a middle market private equity group from 1998 to 2001.  Prior to joining Catterton, Mr. Kollitides held various positions of increasing responsibility at General Electric Capital in the Equity, Corporate Finance, and Corporate Restructuring Groups, focusing on leveraged recapitalizations, reorganizations, change of control transactions and minority equity investments from 1990 through 1997.  Mr. Kollitides received an MBA in Finance and Management of Organizations from Columbia Business School and a BA in Economics from Lafayette College.  Mr. Kollitides also 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 Chief Operating Officer of Kenneth Cole Productions, Inc. from 2006 until 2007.  Prior to that, Mr. Newman spent more than a decade at Tommy Hilfiger Corporation (“THC”), holding a variety of roles, finally as Executive Vice President of Finance and Operations of THC and Chief Operating Officer of Tommy Hilfiger U.S.A., Inc., THC’s principal U.S. operating subsidiary.

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

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

Code of Business Conduct

The Company has adopted a Code of Business Conduct, which applies to all employees and officers of the Company and provides that, in the conduct of all corporate activities, integrity and ethical conduct is expected.  In addition, the Code of Business Conduct addresses 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 Code of Ethics, free of charge, by submitting a request in writing to the attention of the Chief Financial Officer, Rafaella Apparel Group, Inc., 1411 Broadway, New York, New York 10018.

Audit Committee Financial Expert

Our Board of Directors has separately designated an audit committee and the functions of a traditional audit committee are carried out by three of the members of the Board, Messrs. Kourakos, Kollitides and J. Newman, of whom Mr. Kourakos and Mr. J. Newman are independent.  Our Board has determined that each member of the Board is financially literate but no determination has been made as to the ability of any director to qualify as a “financial expert” within the meaning of the regulations adopted by the Securities and Exchange Commission.  However, based on their backgrounds and their understanding of the Company’s business, the Board of Directors believes that the members of the Audit Committee will be able to provide effective oversight for the Company’s financial reporting process and its relationship with its independent accountants.

35

Table of Contents

ITEM 11.               EXECUTIVE COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

Overview

This Compensation Discussion and Analysis, or CD&A, is intended to provide information regarding the Company’s executive compensation program and practices.  This CD&A covers a variety of topics, including:  the Company’s compensation philosophy regarding executive compensation, the role of our Compensation Committee in setting the compensation of our executive officers, and executive compensation decisions for fiscal 2010.

Compensation Philosophy

The Company is committed to achieving long-term, sustainable growth and increasing stockholder value.  The Company’s compensation program for our executive officers is designed to support these objectives and encourage strong financial performance on an annual basis by awarding annual performance bonuses, and on a long-term basis by linking a portion of our executive officers’ total compensation to Company performance in the form of equity incentive compensation.  The Company’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, and retain superior executive talent in a highly competitive environment.

Role of the Compensation Committee

Our Compensation Committee sets the compensation of our executive officers, including the mix of base salary, annual performance bonus, and long-term equity incentives.  Our Compensation Committee also sets the financial performance targets for our executive officers’ annual performance bonuses.  Our Compensation Committee consists of Ms. Michalaros and Messrs. Kourakos, Kollitides and Frankel, of whom Mr. Kourakos is independent.

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

Total Compensation

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

In 2010, as set forth in more detail in the Summary Compensation Table, the total compensation of our Chief Executive Officer was $1,481,002; the total compensation of our Chief Financial Officer was $458,422; the total compensation of our President of Sales & Planning was $625,730; the total 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

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

As discussed further below under the heading Employment Agreements, our executive officers have employment agreements with the Company.  These employment agreements were entered into by each of our executive officers upon becoming executive officers of the Company, and provide the executive officers with threshold base salary levels.  Each year, our Compensation Committee evaluates whether it is appropriate to approve salaries in excess of the contractual minimums.  In 2010, we provided our Chief Executive Officer, Chief Financial Officer, President of Sales & 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.

36

Table of Contents

Annual Performance Bonus

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

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

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

Equity Incentives

Our Equity Incentive Plan (the “Plan”) allows for various types of equity awards, including stock options and restricted stock.  Awards under our Plan have been granted to attract, motivate, and retain our executive officers.  Such awards have been granted in connection with each of the executive officers employment agreements. During fiscal 2010, Messrs. Arneson and Kourakos received a stock option grant for 111,111 shares of common stock each.

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

Awards granted under the Plan have been limited to time-based stock options.  All of the awards vest in annual increments of 25% over the first four years of the grant, expire no later than ten years after the grant date, and have an exercise price of $5.33 per share (the June 20, 2005 redemption value of the redeemable convertible preferred stock).  No options were exercised during fiscal 2010.

Pension and retirement benefits

Our named executive officers do not participate in any deferred benefit retirement plans such as a pension plan.

Non-qualified deferred compensation

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

Other benefits

We provide private health care insurance to some of our named executives.

Perquisites and Other Benefits

Pursuant to the Company’s 401(k) plan, the Company provides its executives the same level of matching contributions available to all eligible employees, subject to the provisions of the 401(k) plan and Internal Revenue Service limitations.  Additional

37

Table of Contents

information on executive officer perquisites and other benefits can be found in the footnotes to the Fiscal 2010 Summary Compensation Table in this Form 10-K.

Employment Agreements

Employment agreements for senior management are used by the Company to establish key elements of the agreement between the Company and the executive, including the minimum periods of employment and the fundamental elements of compensation, as well as the details of the individual arrangement that differ from the Company’s standard plans and programs.  The employment agreements with executive officers are discussed in detail below, in the section entitled “Compensation of Executive Officers—Employment Agreements and Potential Payouts upon Termination or Change in Control.” Also, detailed in that section are the potential payouts for each of the officers under the variety of potential termination scenarios covered by the agreements.

COMPENSATION OF EXECUTIVE OFFICERS

Employment Agreements and Potential Payments upon a Termination or Change in Control

The following is a description of the current employment arrangements between us and the named executive officers, including the specific circumstances relating to termination of employment and change in control of the Company that will trigger payments to each named executive officer and a calculation of the estimated payments to such officers as a result of the occurrence of such events had they occurred on June 30, 2010, the end of the Company’s last fiscal year.

Christa Michalaros

We have entered into an employment agreement with Christa Michalaros, our Chief Executive Officer, which commenced on April 25, 2006.  Under the terms of the agreement, the initial period was from April 25, 2006 through June 30, 2007; thereafter, the agreement and the employment relationship created thereunder will continue for consecutive one (1) year periods commencing on each July 1.  The agreement provides for payments to be made to Ms. Michalaros upon certain termination events.  Ms. Michalaros will also be entitled to certain payments under our Equity Incentive Plan in the event a “Liquidity Event” occurs, which is defined as (1) any Person who is (i) not an Affiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberus becomes the beneficial owner, directly or indirectly, of fifty percent (50%) or more of the combined voting power of the then outstanding voting securities of the Company; (2) the sale, transfer or other disposition of all or substantially all 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 or liquidation of the Company.

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

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

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

(c)                                  certain expenses reimbursable pursuant to the agreement that have been incurred but not yet reimbursed at the date of termination; and

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

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

38

Table of Contents

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

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

(a)                                  payment for accrued unused vacation days, payable within thirty (30) days after the date of termination;

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

(c)                                  a prorated bonus equal to the bonus earned as of the date of termination based on the achievement of prorated performance measures derived from the annual business plan 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.

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

(2)          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.

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

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

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

Lance D. Arneson

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

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

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

Under Mr. Arneson’s employment agreement, the following payments will be made to 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 of confidentiality or restrictive covenant provisions; or certain other instances of willful misconduct); (2) his employment terminates due to his death; (3) the Company terminates his employment due to his disability (meaning a determination by the Company in accordance with applicable law that as a result of a physical or mental injury or illness,

39

Table of Contents

Mr. Arneson is unable to perform the essential functions of his job with or without reasonable accommodation for a period of (i) 90 consecutive days; or (ii) 180 days in any one (1) year period); or (4) the he resigns for any reason:

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

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

(c)                                  certain expenses reimbursable pursuant to the agreement that have been incurred but not yet reimbursed at the date of termination; and

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

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

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

(2)   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.

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

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

Nichole Vowteras

We entered into an employment agreement with Nichole Vowteras, our Executive Vice President Sourcing and Production, which commenced on May 1, 2006. Under the terms of the agreement, the term is from May 1, 2006 until her employment is terminated by any of the methods discussed below. Ms. Vowteras will also be entitled to certain payments under our Equity Incentive Plan in the event a “Liquidity Event” occurs, which is defined as (1) any Person who is (i) not an Affiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberus becomes the beneficial owner, directly or indirectly, of fifty percent (50%) or more of the combined voting power of the then outstanding voting securities of the Company; (2) the sale, transfer or other disposition of all or substantially all 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 or liquidation of the Company.

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

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

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

(c)                                  certain expenses reimbursable pursuant to the agreement that have been incurred but not yet reimbursed at the date of termination; and

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

40

Table of Contents

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

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

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

Rosemary Mancino

We entered into an employment agreement with Rosemary Mancino, our President of Sales & Planning, which commenced on August 14, 2006. Under the terms of the agreement, the term is from August 14, 2006 until her employment is terminated by any of the methods discussed below. Ms. Mancino will also be entitled to certain payments under our Equity Incentive Plan in the event a “Liquidity Event” occurs, which is defined as (1) any Person who is (i) not an Affiliate of the Company or (ii) not Cerberus or an Affiliate of Cerberus becomes the beneficial owner, directly or indirectly, of fifty percent (50%) or more of the combined voting power of the then outstanding voting securities of the Company; (2) the sale, transfer or other disposition of all or substantially all 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 or liquidation of the Company.

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

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

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

(c)                                  certain expenses reimbursable pursuant to the agreement that have been incurred but not yet reimbursed at the date of termination; and

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

41

Table of Contents

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

(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 are forfeited; vested options may be exercised by Ms. Mancino’s representative until one year or expiration. It is assumed options would not be exercised currently due to the issue discussed in (2) above.

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

Richard Metzger

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

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

Under Mr. Metzger’s amended and restated employment agreement, the following payments will be made to 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 of confidentiality or restrictive covenant provisions; or certain other instances of willful misconduct); (2) his employment terminates due to his death; (3) the Company terminates his employment due to his disability (meaning a determination by the Company in accordance with applicable law that as a result of a physical or mental injury or illness, Mr. Metzger is unable to perform the essential functions of his job with or without reasonable accommodation for a period of (i) 90 consecutive days; or (ii) 180 days in any one (1) year period); or (4) the he resigns for any reason:

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

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

(c)                                  certain expenses reimbursable pursuant to the agreement that have been incurred but not yet reimbursed at the date of termination; and

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

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

42

Table of Contents