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EX-31.2 - CERTIFICATION - PARLUX FRAGRANCES INCparl_ex312.htm
EX-31.1 - CERTIFICATION - PARLUX FRAGRANCES INCparl_ex311.htm
EX-32.1 - CERTIFICATION - PARLUX FRAGRANCES INCparl_ex321.htm
EX-21.1 - SUBSIDIARIES - PARLUX FRAGRANCES INCparl_ex211.htm
EX-32.2 - CERTIFICATION - PARLUX FRAGRANCES INCparl_ex322.htm
EX-23.1 - CONSENT - PARLUX FRAGRANCES INCparl_ex231.htm
EX-10.96 - FIRST AMENDMENT TO CREDIT AGREEMENT, - PARLUX FRAGRANCES INCparl_ex1096.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
———————
FORM 10-K
———————
 
þ
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the fiscal year ended: March 31, 2011
 
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 0-15491
 
PARLUX FRAGRANCES, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
DELAWARE
 
22-2562955
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
5900 N. Andrews Avenue, Suite 500, Fort Lauderdale, FL  33309
(Address of Principal Executive Offices) (Zip Code)

 Registrant’s Telephone Number, Including Area Code (954) 316-9008
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common stock (par value $0.01 per share)
 
The NASDAQ Stock Market LLC
(NASDAQ Global Select Market)
 
Securities registered pursuant to Section 12(g) of the Act:
 
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes ¨ No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. Yes ¨ No þ
 
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 þ No ¨
 
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 ¨ No ¨
 
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. ¨
 
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 the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934.
 
Large accelerated filer ¨    Accelerated filer ¨    Non-accelerated filer ¨    Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
 
As of September 30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $29,192,955 based on a closing sale price of $2.24 as reported on the National Association of Securities Dealers Automated Quotation System. Shares of common stock held by each executive officer and director and by each person who owns 5% or more of the outstanding common stock, based on Form 4, Schedule 13D and 13G filings, have been excluded since such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination of affiliate status for other purposes.
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at May 25, 2011
Common Stock, $ 0.01 par value per share
 
20,758,812 shares
 



 
 

 
PARLUX FRAGRANCES, INC.
 
TABLE OF CONTENTS
 
      PAGE  
         
PART I
         
Item 1.  Business.     1  
Item 1A.   Risk Factors.     9  
Item 1B. Unresolved Staff Comments.     16  
Item 2.  Properties.      16  
Item 3. Legal Proceedings.      17  
Item 4.  Removed and Reserved.     18  
           
PART II
           
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.     19  
Item 6. Selected Financial Data.     22  
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.     23  
Item 7A Quantitative and Qualitative Disclosures About Market Risk.     45  
Item 8. Financial Statements and Supplementary Data.     45  
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.     45  
Item 9A. Controls and Procedures.     45  
Item 9B. Other Information.     47  
           
PART III
           
Item.10. Directors, Executive Officers and Corporate Governance     48  
Item.11.  Executive Compensation     53  
Item.12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters     65  
Item.13. Certain Relationships and Related Transactions, and Director Independence     66  
Item.14. Principal Accounting Fees and Services     68  
           
PART IV
           
Item 15.  Exhibits, Financial Statement Schedules.     69  
 
 
 

 
 
PART I
 
ITEM 1.   BUSINESS.
 
Introduction
 
Parlux Fragrances, Inc. (referred to as “Parlux”, the “Company”, “us”, and “we”) is engaged in the business of creating, designing, manufacturing, distributing and selling prestige fragrances and beauty related products marketed primarily through specialty stores, national department stores and perfumeries on a worldwide basis. The fragrance market is generally divided into a prestige group (distributed primarily through department and specialty stores) and a mass market group (distributed primarily through chain drug stores, mass merchandisers, smaller perfumeries and pharmacies). Our fragrance products are positioned primarily in the prestige group.
 
During the fiscal year ended March 31, 2011, we engaged in the manufacture (through sub-contractors), distribution and sale of Paris Hilton, Jessica Simpson, Rihanna, Queen Latifah, Marc Ecko, Josie Natori, Nicole Miller, XOXO, Ocean Pacific (“OP”), and babyGUND fragrances and grooming items on an exclusive basis as a licensee or sublicensee.  During fiscal year ended March 31, 2011, we entered into an exclusive fragrance licensing agreement with Vince Camuto, Chief Designer and Chief Executive Officer of the Camuto Group.  During the fiscal year ended March 31, 2010, we entered into sublicensing agreements for the fragrance licenses of entertainers Rihanna and Kanye West.
 
We were incorporated as a Delaware corporation in 1984. Our common stock, par value $0.01, is listed on the National Association of Securities Dealers Automatic Quotation System (“Nasdaq”) Global Select Market under the symbol "PARL." For information concerning our financial condition, results of operations and related financial data, you should refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the “Financial Statements and Supplementary Data” sections of this Annual Report on Form 10-K. For information concerning gross sales by international region, you should refer to Note 13 of the Financial Statements and Supplementary Data section of this Annual Report on Form 10-K. You should also review and consider the risks relating to our business, operations, financial performance and cash flows that we describe below under “Risk Factors.”
 
Availability of Reports and Other Information
 
Our corporate website is www.parlux.com. We make available on this website, free of charge, access to our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A and amendments to those materials filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically submit such material to the Securities and Exchange Commission (the “SEC”). We also make available on our website copies of materials regarding our corporate governance policies and practices. You also may obtain a printed copy of the foregoing materials by sending a written request to: Corporate Secretary, Parlux Fragrances, Inc. 5900 N. Andrews Avenue, Suite 500, Fort Lauderdale, Florida 33309. In addition, the SEC’s website is http://www.sec.gov. The SEC makes available on this website, free of charge, reports, proxy and information statements and other information regarding issuers, such as us, that file electronically with the SEC. Information on our website or the SEC’s website is not part of this Annual Report on Form 10-K.
 
Recent Developments
 
Amendment and Restatement of Sublicense Agreement with Artistic Brands
 
On March 2, 2011, we entered into an amended and restated sublicense agreement (the "Sublicense") with Artistic Brands Development, LLC (formerly known as Iconic Fragrances, LLC ("Artistic Brands"), which amends and restates in its entirety that certain sublicense agreement, dated April 7, 2009, between Parlux and Artistic Brands.  Pursuant to the Sublicense, Parlux has the exclusive right and license to manufacture, promote, distribute and sell prestige fragrances and related products under the Kanye West name. The initial term of the sublicense expires on March 31, 2017, and is renewable for an additional three-year term if certain sales levels are met. Pursuant to the Sublicense, we assumed Artistic Brands' obligation to make royalty payments to the licensor, including any guaranteed minimum royalties.  We anticipate launching a new fragrance under this license in late fiscal year 2012.
 
 
1

 
 
Reb’l Fleur by Rihanna Fragrance Launch Video Premiere
 
On February 15, 2011, Parlux, Rihanna and Droga5, LLC (“Droga5”) released an interactive video website (rihannareblfleur.com) as the centerpiece of our marketing campaign for “Reb’l Fleur”, Grammy® award-winning recording artist Rihanna’s new brand fragrance. The website is entirely user-controlled and allows fans to explore both sides of Rihanna’s personality – Reb’l and Fleur - through a “palindromic” film and audio track that can be played at full-screen forwards, backwards, slow or at full speed using simple movements of a computer mouse.  Collaborating with Droga5, music video director, Dave Meyers, and choreographer, Tina Landon, choreographed each artist and camera movement to create a seamless story in each direction. Through the website interface, fans can express their own personality via social media, declaring to Facebook or Twitter whether they are a Reb’l or a Fleur, with unique URLs (goodfeelssobad.com and badfeelssogood.com) driving friends to the site for their own experience.

The Products
 
At present, our principal products are fragrances, which are distributed in a variety of sizes and packaging. In addition, beauty-related products such as body lotions, creams, shower gels, deodorants, soaps, and dusting powders complement the fragrance line. Our basic fragrance products generally retail at prices ranging from $25 to $110 per item.
 
We design and create fragrances using our own staff and independent contractors. We supervise the design of our packaging by independent contractors to create products appealing to the intended customer base. The creation and marketing of each product line is closely linked with the applicable brand name, its positioning and market trends for the prestige fragrance industry. This development process usually takes twelve to eighteen months to complete. During fiscal year 2011, we completed the design process, and launched production and distribution of PARIS HILTON “Tease”, and our new PARIS HILTON Passport fragrances “Paris Hilton in Paris”, “Paris Hilton in South Beach” and “Paris Hilton in Tokyo”, JESSICA SIMPSON “Fancy Nights”, RIHANNA “Reb’l Fleur”, QUEEN LATIFAH “Queen of Hearts”, and NICOLE MILLER “Nicole Miller” women’s fragrances, as well as MARC ECKO “UNLTD” and MARC ECKO “Blue” men’s fragrances.
 
During the last three fiscal years, the following brands have accounted for 10% or more of our sales:
 
   
Fiscal 2011
   
Fiscal 2010
   
Fiscal 2009
 
                   
PARIS HILTON (including accessories)
    60 %     42 %     55 %
GUESS? (license expired in December 2009)
    N/A       28 %     30 %
JESSICA SIMPSON
    19 %     15 %     13 %

Under a separate license agreement with Paris Hilton Entertainment, Inc. (“PHEI”), we developed a line of fashion watches, which retailed at prices ranging from $85 to $200 per item. We sold these watches to a limited number of U.S. retailers and international markets utilizing third party distributors. This license expired on June 30, 2010, and was not renewed.
 
In addition, we entered into various distribution agreements with PHEI for handbags, purses, wallets, and other small leather goods (“handbags”), which have been shipped in the U.S. and certain international markets, as well as cosmetics and sunglasses.  During the year ended March 31, 2008, we sublicensed the international rights for Paris Hilton handbags. Although we remained contingently liable for the minimum guaranteed royalty from our assignment of the license, we generated $0.2 million in fiscal year 2011, $0.4 million in each fiscal year 2010 and 2009, in sublicense revenue.  The handbag license expired on January 15, 2011, and was not renewed.  In addition, during January 2009, we sublicensed the worldwide exclusive licensing rights for Paris Hilton sunglasses through January 15, 2012, the expiration date of this license. Although we remain contingently liable for the minimum guaranteed royalty from our assignment of the license, we generated $0 million in fiscal year 2011 and $0.3 million in fiscal year 2010 in sublicense revenue. The sunglasses license is due to expire on January 15, 2012, and, if all obligations of the sublicense are met, we anticipate minimum revenues of $1.6 million under this sublicense for fiscal year 2012.  The license for Paris Hilton cosmetics expired on January 15, 2011, all remaining royalty obligations under this license were expensed in fiscal year 2010 and the license was not renewed.
 
 
2

 
 
Marketing and Sales
 
In the United States, we have our own fragrance sales and marketing staff, and utilize independent commissioned sales representatives for sales to domestic U.S. military bases and mail order distribution. We sell directly to retailers, primarily national and regional department stores, whom we believe will maintain the image of our products as prestige fragrances. Our products are sold in over 2,500 retail outlets in the United States. Additionally, we sell a number of our products to Perfumania, Inc. (“Perfumania”), which is a specialty retailer of fragrances with approximately 360 retail outlets principally located in manufacturers’ outlet malls and regional malls in the U.S. and in Puerto Rico, and to Quality King Distributors, Inc. (“Quality King”). Perfumania is a wholly-owned subsidiary of Perfumania Holdings, Inc.  The majority shareholders of Perfumania Holdings, Inc. are also the owners of Quality King, a privately-held, wholesale distributor of pharmaceuticals and beauty care products. Perfumania is one of our Company’s largest customers, and transactions with Perfumania are closely monitored by management. Any unusual trends or issues with Perfumania are brought to the attention of our Company’s Audit Committee and Board of Directors. During fiscal year 2007, Perfumania Holdings, Inc.’s majority shareholders acquired an approximate 12.2% ownership interest in our Company at that time (equivalent to 9.9% at March 31, 2011), and accordingly, transactions with Perfumania and Quality King are included as related party sales in the accompanying Consolidated Statements of Operations.
 
During the years ended March 31, 2011 and 2010, we sold a number of our products to Jacavi Beauty Supply, LLC (“Jacavi”), a fragrance distributor. Jacavi’s managing member is Rene Garcia. Rene Garcia owns approximately 8.4% of the outstanding stock of Perfumania Holdings, Inc. as of March 31, 2011, and is one of the principals of Artistic Brands.  On April 7, 2009, we entered into a sublicensing agreement with Artistic Brands for the exclusive rights to worldwide fragrance licenses for multiple Grammy® award winning and multi-platinum selling international entertainers Rihanna and Kanye West.  Also, on June 14, 2010, certain persons related to Mr. Garcia, the Garcia Group, acquired 2,718,728 shares of our common stock and filed a Schedule 13G  with the SEC on June 23, 2010. In that filing, the Garcia Group reported having beneficial ownership of a total of 2,995,527 shares, or approximately 14.7% of our outstanding shares as of June 14, 2010 (equivalent to 14.5% at March 31, 2011), excluding warrants owned by the Garcia Group. On March 4, 2011, the Garcia Group replaced their original joint filing by jointly filing a Schedule 13D with the SEC.  Other than the addition of certain warrants to purchase shares, which vested between the initial and subsequent filing dates, there were no changes in beneficial share ownership included in the updated joint filing. Sales to Jacavi are also included as related party sales in the accompanying Consolidated Statements of Operations.

Outside the United States, marketing and sales activities for all of our products are conducted through distribution agreements with independent distributors, whose activities are monitored by our international sales staff. We presently market our fragrances through distributors in Canada, Europe, the Middle East, Asia, Australia, Latin America, the Caribbean and Russia, covering over 80 countries. Net sales to unrelated international customers amounted to approximately 24%, 31%, and 37% of our total net sales during the fiscal years ended March 31, 2011, 2010 and 2009, respectively.
 
We advertise directly, and through cooperative advertising programs in association with major retailers, in fashion media on a national basis and through retailers’ statement enclosures and catalogues. We are required to spend certain minimum amounts for advertising under certain licensing agreements. See “Licensing Agreements” and Note 8B to the accompanying Consolidated Financial Statements.
 
Raw Materials
 
Raw materials and components (“raw materials”) for our fragrance products are available from sources in the United States, Europe, and the Far East. We source the raw materials, which are delivered from independent suppliers directly to third party contract manufacturers who produce and package the finished products, based on our estimates of anticipated needs for finished goods. As is customary in our industry, we do not have long-term agreements with our contract manufacturers.  We believe we have good relationships with our manufacturers and there are alternative sources available should one or more of these manufacturers be unable to produce at competitive prices.
 
To date, we have had little difficulty obtaining raw materials at competitive prices. There is no reason to believe that this situation will change in the near future, but there can be no assurance this will continue.
 
The lead time for certain of our raw materials inventory (up to 180 days) requires us to maintain at least a three to six-month supply of some items in order to ensure production schedules. These lead times are most affected for glass and plastic component orders, as many of our unique designs require the production of molds in addition to the normal production process. This may take 180 to 240 days, or longer, to receive in stock.  In addition, when we launch a new brand or Stock Keeping Unit (“SKU”), we frequently produce a six to nine-month supply to ensure adequate inventories if the new products exceed our forecasted expectations. Generally gross margins on our products outweigh the potential loss due to out-of-stock situations, and the additional carrying costs to maintain higher inventory levels. Also, the composition of our inventory at any given point can vary considerably depending on whether there is a launch of a new product, or a planned sale of a significant amount of product to one or more of our major distributors. However, if future sales do not reach forecasted levels, it could result in excess inventories and may cause us to decrease prices to reduce inventory levels.
 
 
3

 
 
Seasonality
 
Typical of the fragrance industry, we have our highest sales as our customers purchase our products in advance of the Mother’s and Father’s Day periods and the calendar year-end holiday season, which fall during our first fiscal quarter, and our third fiscal quarter. Lower than projected sales during these periods could have a material adverse effect on our operating results.
 
Industry Practices
 
It is an industry practice in the United States for businesses that market fragrances to department stores to provide the department stores with rights to return merchandise, primarily for multi-SKU gift sets produced and sold during the gift-giving seasons, discussed above.  Our fragrance products are subject to such return rights. It is our practice to establish reserves and provide allowances for product returns at the time of sale based on historical return patterns. We believe that such reserves and allowances are adequate based on experience; however, we cannot provide assurance that reserves and allowances will continue to be adequate or that returns will not increase. Consequently, if product returns are in excess of the reserves and allowances provided, net sales will be reduced during the quarterly period when such fact becomes known.
 
Customers
 
We concentrate our fragrance sales efforts in the United States in a number of national and regional department store retailers which include, among others, Belk, Bloomingdales, Bon Ton, Boscovs, Dillards, J.C. Penney, Macy’s, Neiman Marcus, Saks, and Sears. We also sell directly to perfumery and cosmetic retailers, including Perfumania, Sephora and Ulta.  Retail distribution has been targeted by brands to maximize potential revenue and minimize overlap between each of these distribution channels. During the three years ended March 31, 2011, our sales to Macy’s accounted for more than 10% of our sales. Sales to Macy’s for the years ended March 31, 2011, 2010 and 2009, were $27.6 million, $34.1 million, and $34.7 million, or 21%, 21%, and 22% of our total sales, respectively. The loss of either Macy’s or Perfumania as our customer would have a material adverse effect on our total sales and results of operations.
 
Our international sales efforts are carried out through distributors in over 80 countries, the main focus of which has been in Latin America, Canada, Europe, Asia, Australia, the Middle East, the Caribbean and Russia. These distributors sell our products to the local department stores, as well as to numerous perfumeries in the local markets.
 
Perfumania offers us the opportunity to sell our products in approximately 360 retail outlets and our terms with Perfumania take into consideration the relationship existing between the companies for approximately twenty years. Pricing and terms with Perfumania reflect (a) the volume of Perfumania’s purchases, (b) a policy of no returns from Perfumania, (c) minimal spending for advertising and promotion, (d) exposure of our products provided in Perfumania’s store windows, and (e) minimal distribution costs to fulfill Perfumania orders shipped directly to their distribution center. During the three years ended March 31, 2011, our net sales to Perfumania, which also accounted for more than 10% of our sales, were as follows:
 
 
For the Years Ended March 31,
 
 
2011
 
2010
 
2009
 
(in millions)
                 
Sales to Perfumania
  $ 47.5     $ 37.6     $ 41.5  
As a % of total net sales
    39 %     25 %     27 %
 
 
4

 

While our invoice terms to Perfumania are stated as net ninety (90) days, for more than fifteen years, management has granted longer payment terms taking into consideration the factors discussed above. We evaluate the credit risk involved, which is determined based on Perfumania’s reported results and comparable store sales performance. Management monitors the account activity to ensure compliance with their limits.
 
Net trade accounts receivable owed by Perfumania to us amounted to $12.7 million and $10.5 million at March 31, 2011 and 2010, respectively.  Between April 1, 2011, and May 25, 2011, we received $1.5 million from Perfumania in payment of its outstanding balance. Trade accounts receivable from Perfumania are non-interest bearing, and are paid in accordance with the terms established by management. See “Liquidity and Capital Resources” for further discussion of this receivable.
 
We continue to evaluate our credit risk and assess the collectability of the Perfumania receivables. Perfumania’s reported financial information, as well as our payment history with Perfumania, indicates that, historically, their first quarter ending approximately April 30, is Perfumania’s most difficult operating quarter as is the case with most U.S. based retailers. We have, in the past, received significant payments from Perfumania during the last three months of the calendar year, and have no reason to believe that this will not continue. Based on our evaluation, no allowances have been recorded as of March 31, 2011, and 2010. We will continue to evaluate Perfumania’s financial condition on an ongoing basis and consider the possible alternatives and effects, if any, on our business.
 
Foreign and Export Sales
 
We record sales, cost of sales, and other direct expenses in three main categories: Domestic, International and Related Parties.  Domestic includes sales generated by our Domestic Sales Division and generally includes sales to department and specialty stores in the United States that are not deemed to be related parties.  International covers all sales other than domestic and related party sales that are processed by way of our International Sales Division to international distributors that are not deemed to be related parties for the sale of products in markets outside of the United States.  Related parties are those parties that are known to us as having a related party relationship.  See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operation, and Note 2 to the accompanying Consolidated Financial Statements for additional information regarding related party transactions.  Because of the substantial margins generated by fragrance sales, some products intended for sale in certain international territories are re-exported to the United States, a common practice in the fragrance industry. Also, prior season gift sets, refurbished returns and other slow moving products, are sold at substantially discounted prices, and as such, can find their way into mass market channels. Additionally, where the licensor does not restrict distribution, sales are made in all markets deemed appropriate for the brand.  Our net sales to international customers were as follows:
 
 
For the Years Ended March 31,
 
 
2011
 
2010
 
2009
 
(in millions)
                 
Sales to international customers
  $ 29.7     $ 46.3     $ 55.8  
As a % of total net sales
    24 %     31 %     37 %
 
No individual international customer accounted for more than 10% of our sales during the three fiscal years ended March 31, 2011.
 
Licensing Agreements
 
See “The Products” above for further discussion of the relative importance of our licensing agreements.
 
VINCE CAMUTO: Effective June 4, 2010, we entered into an exclusive fragrance license agreement with Vince Camuto, Chief Designer and Chief Executive Officer of Camuto Group, to develop, manufacture and distribute prestige fragrances and related products under the Vince Camuto trademark. The initial term of the agreement expires on March 31, 2016, and is renewable for an additional five-year term if certain sales levels are met. We must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. We anticipate launching a new women’s fragrance under this license in the fall of 2011.
 
RIHANNA: Effective April 7, 2009, we entered into a sublicense agreement with Artistic Brands for the exclusive worldwide rights to develop, manufacture and distribute prestige fragrances and related products under the Rihanna name. The initial term of the agreement expires on the fifth anniversary of the first date products are shipped and is renewable for an additional three-year term if certain sales levels are met. Under the terms of the sublicense agreement, we assume the obligation to pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon minimum sales volume.  We launched the first fragrance under this license in late January 2011.
 
 
5

 
 
KANYE WEST: Effective April 7, 2009, we entered into a sublicense agreement with Artistic Brands for the exclusive worldwide rights to develop, manufacture and distribute prestige fragrances and related products under the Kanye West name.
 
On March 2, 2011, we entered into an amended and restated sublicense agreement with Artistic Brands.  The initial term of the sublicense expires on March 31, 2017, and is renewable for an additional three-year term if certain sales levels are met. Under the terms of the amended and restated sublicense agreement, we assume the obligation to pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume.  We anticipate launching a new fragrance under this license in late fiscal year 2012.
 
MARC ECKO: Effective November 5, 2008, we entered into an exclusive license agreement with Ecko Complex LLC, to develop, manufacture and distribute fragrances under the Marc Ecko trademarks. The initial term of the agreement expires on December 31, 2014, and is renewable for an additional three-year term if certain sales levels are met. We must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. We launched the first fragrance under this license in late September 2009. The license agreement was amended on November 2, 2010, which, among other items, reduced minimum royalty and advertising commitments.
 
QUEEN LATIFAH: Effective May 22, 2008, we entered into an exclusive license agreement with Queen Latifah Inc., to develop, manufacture and distribute prestige fragrances and related products under the Queen Latifah name. The initial term of the agreement expires on March 31, 2014, and is renewable for an additional five-year term if certain sales levels are met. We must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. We launched the first fragrance under this license in June 2009.
 
JOSIE NATORI: Effective May 1, 2008, we entered into an exclusive license agreement with J.N. Concepts, Inc., to develop, manufacture and distribute prestige fragrances and related products under the Josie Natori name. The initial term of the agreement expires on September 30, 2012, and is renewable for an additional three-year term if certain sales levels are met. We must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. We launched the first fragrance under this license in July 2009.  The license agreement was amended on December 10, 2010, which, among other items, reduced minimum royalty commitments.
 
NICOLE MILLER: Effective August 1, 2007, we entered into an exclusive license agreement with Kobra International, Ltd., to develop, manufacture and distribute prestige fragrances and related products under the Nicole Miller name. The initial term of the agreement expires on September 30, 2013, and is renewable for two additional terms of three years each, if certain sales levels are met. We must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. We launched a new fragrance under this license in April 2010. The license agreement was amended on January 17, 2011, which, among other items, reduced minimum royalty and advertising commitments.
 
JESSICA SIMPSON: Effective June 21, 2007, we entered into an exclusive license agreement with VCJS, LLC, to develop, manufacture and distribute prestige fragrances and related products under the Jessica Simpson name. The initial term of the agreement expires five years from the date of the first product sales and is renewable for an additional five years if certain sales levels are met. We must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. We launched the first fragrance under this agreement during August 2008.
 
PARIS HILTON: Effective June 1, 2004, we entered into an exclusive license agreement with Paris Hilton Entertainment, Inc. (“PHEI”), to develop, manufacture and distribute prestige fragrances and related products, on an exclusive basis, under the Paris Hilton name, which was renewed during fiscal year 2009.  The term of the agreement expires on June 30, 2014. The first Paris Hilton women’s fragrance was launched during November 2004, and was followed by a launch of a men’s fragrance in April 2005.
 
On January 26, 2005, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute watches and other time pieces under the Paris Hilton name. The initial term of the agreement expired on June 30, 2010, and was renewable for an additional five-year period. The first “limited edition” watches under this agreement were launched during December 2005 and a line of “fashion watches” were launched during spring 2006. We did not exercise our option to renew this license. As of March 31, 2011, we had sold all remaining inventory of the Paris Hilton brand watches in accordance with the provisions of the agreement.
 
 
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On May 11, 2005, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute cosmetics under the Paris Hilton name. The initial term of the agreement expired on January 15, 2011, and was renewable for an additional five-year period. No products were launched under this license. As the cosmetic license was due to expire in fiscal year 2011, all remaining royalty obligations were expensed in fiscal year 2010. We did not exercise our option to renew this license.
 
On May 13, 2005, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute handbags, purses, wallets and other small leather goods, under the Paris Hilton name. The initial term of the agreement expired on January 15, 2011, and was renewable for an additional five-year period. The first products under this agreement were launched during summer 2006.  During fiscal 2008, we sublicensed the international rights under this license. We remained contingently liable for the minimum guaranteed royalties due through the remainder of this agreement. We did not exercise our option to renew this license.  As of March 31, 2011, we had sold all remaining inventory of the Paris Hilton brand handbags in accordance with the provisions of the agreement.
 
On April 5, 2006, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute sunglasses under the Paris Hilton name. The initial term of the agreement expires on January 15, 2012, and is renewable for an additional five-year period. In January 2009, we entered into an agreement with Gripping Eyewear, Inc. (“GEI”), assigning the worldwide rights with PHEI, for the production and distribution of Paris Hilton sunglasses. We remain contingently liable for the minimum guaranteed royalties due through the remainder of this agreement. We do not anticipate any renewals of this license.
 
Under all of the PHEI agreements, we must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based on sales volume.
 
babyGUND: Effective April 6, 2005, we entered into an exclusive license agreement with GUND, Inc., to develop, manufacture and distribute children’s fragrances and related products on a worldwide basis under the babyGund trademark. The agreement continued through September 30, 2010, and was renewable for an additional two years if certain sales levels were met. We did not exercise our option to renew this license. As of March 31, 2011, we had sold all remaining babyGUND fragrance brand inventory in accordance with the provisions of the agreement.
 
XOXO: Effective January 6, 2005, we entered into a purchase and sale agreement with Victory International (USA), LLC (“Victory”), whereby we acquired the exclusive worldwide licensing rights (the “Fragrance License”), along with inventories, molds, designs and other assets, relating to the XOXO fragrance brand. The Fragrance License required the payment of a minimum royalty, whether or not any product sales were made, and spend of certain minimum amounts for advertising.
 
During June 2006, we negotiated renewal terms which, among other items, reduced minimum royalty requirements and extended the Fragrance License through June 30, 2010. We did not renew this license. As of March 31, 2011, we had sold all remaining XOXO fragrance brand inventory in accordance with the provisions of the agreement.
 
ANDY RODDICK: Effective December 8, 2004, we entered into an exclusive worldwide license agreement with Mr. Andy Roddick, to develop, manufacture and distribute prestige fragrances and related products under his name. The initial term of the agreement, as amended, expired on March 31, 2010, and was renewable for an additional three-year period, at the mutual agreement of both parties. The first fragrance under this agreement was produced during March 2008. Under the agreement, we were required to pay a minimum royalty, whether or not any product sales were made, and spend minimum amounts for advertising based on sales volume. This license expired on March 31, 2010, and was not renewed.
 
GUESS?:  Effective November 1, 2003, we entered into an exclusive license agreement with GUESS? and GUESS? IP HOLDER L.P., to develop, manufacture and distribute prestige fragrances and related products on a worldwide basis. This license expired on December 31, 2009, and was not renewed. The termination of this agreement resulted in the recording of significant costs. See Note 3 to the accompanying Consolidated Financial Statements for further discussion.
 
OCEAN PACIFIC: In August 1999, we entered into an exclusive worldwide licensing agreement with Ocean Pacific Apparel Corp., to manufacture and distribute men’s and women’s fragrances and other related products under the OP label. The initial term of the agreement extended through December 31, 2003, and was automatically renewed for two additional three-year periods, with the latest term ending December 31, 2009. We initially had six additional three-year renewal options, of which the first two contained automatic renewals at our option, and the last four required the achievement of certain minimum net sales. The license required the payment of minimum royalties, whether or not any product sales were made, which declined as a percentage of net sales as net sales volume increased, and the spending of certain minimum amounts for advertising based upon annual net sales of the products. This license expired on December 31, 2009, and was not renewed.
 
 
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FRED HAYMAN: In June 1994, we entered into an Asset Purchase Agreement with Fred Hayman Beverly Hills, Inc. (“FHBH”), purchasing substantially all of the assets and liabilities of the FHBH fragrance division. In addition, FHBH granted us an exclusive royalty free 55-year license to use FHBH’s United States Class 3 trademarks Fred Hayman®, 273®, Touch®, With Love® and Fred Hayman Personal Selections® and the corresponding international registrations. There are no minimum sales or advertising requirements.
 
On March 28, 2003, we entered into an exclusive agreement to sublicense the FHBH rights to Victory for a royalty of 2% of net sales, with a guaranteed minimum annual royalty of $50 thousand (the “FHBH Sublicense”). The initial term of the FHBH Sublicense was for five years, and is automatically renewable every five years at the sublicensee’s option. The FHBH Sublicense excluded the right to “273 Indigo” for men and women, the latest fragrance introduction for the FHBH brand, as well as all new FHBH product development rights.
 
On October 17, 2003, the parties amended the FHBH Sublicense, granting all new FHBH product development rights to the sublicensee. In addition, the guaranteed minimum annual royalty increased to $75 thousand and the royalty percentage on sales of new FHBH products was increased to 3% of net sales. We received licensing fees under this sublicense of $87 thousand in fiscal year ended March 31, 2011, and $75 thousand during each fiscal year ended March 31, 2010 and 2009.
 
We believe we are currently in compliance with all material obligations under the above agreements. There can be no assurance that we will be able to continue to comply with the terms of these agreements in the future.
 
Trademarks
 
We have exclusive licenses, as discussed above, to use trademark and tradename rights in connection with the packaging, marketing and distribution of our products, both in the United States and internationally where such products are sold. See “The Products” above for further discussion of the relative importance of these licenses.
 
In addition, we own the worldwide distribution rights to LIMOUSINE fragrances. There are no licensing agreements requiring the payment of royalties to us for this trademark. We do not anticipate distributing fragrance products under the LIMOUSINE brand in the near future.
 
Product Liability
 
We have insurance coverage for product liability in the amount of $2 million per policy period. We maintain an additional $10 million of coverage under an “umbrella” policy. We believe that the manufacturers of the products sold by us also carry product liability coverage and that we effectively are protected thereunder.
 
There are no pending and, to the best of our knowledge, no threatened product liability claims of a material nature. Over the past ten years, we have not been presented with any significant product liability claims. Based on this historical experience, management believes that its insurance coverage is adequate, but there can be no assurance that will be the case.
 
In connection with our previous Paris Hilton fashion watch business, we provided a one-year warranty on the watch mechanism and anticipate that repair service under the warranty would be handled by an outside third party, as necessary.
 
Government Regulations
 
A fragrance is defined as a “cosmetic” under the Federal Food, Drug and Cosmetics Act (the “FDC Act”). A fragrance must comply with the labeling requirements of the FDC Act, as well as the Fair Packaging and Labeling Act and related regulations. Under U.S. law, a product may be classified as both a cosmetic and a drug. If we produce such products, there would be additional regulatory requirements for products which are “drugs” including additional labeling requirements, registration of the manufacturer and the semi-annual update of a drug list.
 
 
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Effective March 11, 2005, we were required to comply with the labeling, durability and non-animal testing guidelines from the European Cosmetic Toiletry and Perfumery Association (“COLIPA”) Amendment No. 7, to distribute our products in the European Union (“EU”). We created “safety assessor approved” dossiers for all our products to be distributed in the EU, and have filed such documentation both domestically and with our agent in France. In addition to the EU specific requirements, we comply with all other significant international requirements.
 
We adhere to the Canadian Food and Drug Act (the “CFD Act”) and the Canadian Cosmetic Regulations (the “CCRs”). All cosmetics sold to consumers in Canada must meet the requirements of the CFD Act and the current CCRs, and all other applicable legislation to ensure that the products are safe to use and do not pose any health risk. The CCRs of the CFD Act requires that cosmetics sold in Canada must be manufactured, prepared, preserved, packed and stored under sanitary conditions. The manufacturer must notify Health Canada that it is selling the product in Canada and provide a list of the product’s ingredients.
 
We are not aware of any violations or issues with the regulations above, or any other significant regulations to which we may be subject.
 
Competition
 
The markets for fragrance and beauty related products and other accessories are highly competitive and sensitive to changing consumer preferences and demands. We believe that the quality of our products, as well as our ability to develop, distribute and market new products, will enable us to continue to compete effectively in the future and to continue to achieve positive product reception, position and inventory levels in retail outlets. We believe we compete primarily on the basis of product recognition and emphasis on providing in-store customer service. However, there are products, which are better known than the products distributed by us, and we do not presently have the extent of experience in the accessories market to compete effectively. There are also companies, which are substantially larger and more diversified. The top 30 beauty manufacturing companies, as listed in the August 2010 issue of “WWD Beauty Biz”, each have sales levels exceeding $1 billion and have substantially greater financial and marketing resources than we have, as well as greater name recognition, with the ability to develop and market products similar to, and competitive with, those distributed by us.
 
Employees
 
As of March 31, 2011, we had a total of 135 employees, consisting solely of full-time employees, all of which were located in the United States. Of these, 47 were engaged in worldwide sales activities, 56 in operations, marketing, administrative and finance functions and 32 in warehousing and distribution activities. None of our employees are covered by a collective bargaining agreement and we believe that our relationship with our employees is satisfactory. We also use the services of independent contractors in various capacities, including sales representatives both domestically and internationally, as well as temporary agency personnel to assist with seasonal distribution requirements.
 
ITEM 1A. RISK FACTORS.
 
Our business, financial condition, results of operations, and cash flows, and the prevailing market price and performance of our common stock, may be adversely affected by a number of factors, including the matters discussed below. Certain statements and information set forth in this Annual Report on Form 10-K, as well as other written or oral statements made from time to time by us or by our authorized officers on our behalf, constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. We intend our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions, strategies, future events or performance are not statements of historical facts and may be forward-looking.  Forward-looking statements involve estimates, assumptions and uncertainties.  Accordingly, any such statements are qualified in their entirety by reference to, and are accompanied by, the following important factors (in addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements.) You should note that forward-looking statements in this document speak only as of the date of this Annual Report on Form 10-K and we undertake no duty or obligation to update or revise our forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that the expectations, plans, intentions and projections reflected in our forward-looking statements are reasonable, such statements are subject to known and unknown risks, uncertainties and other factors, or combination of factors, that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The risks, uncertainties and other factors that our stockholders and prospective investors should consider include the following:
 
 
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 The Paris Hilton line is our primary source of revenue following the expiration of our GUESS? license.
 
During the year ended March 31, 2010, licensed Paris Hilton and GUESS? brand products generated approximately $68.4 million and $46.2 million, respectively, in gross sales. The Paris Hilton and GUESS? brands of fragrances and accessories accounted for approximately 42% and 28%, respectively, of our gross sales from continuing operations during the fiscal year ended March 31, 2010. The GUESS? license expired on December 31, 2009, and was not renewed. As a result, licensed Paris Hilton brand products accounted for the majority of our gross sales and constituted our primary source of revenue for the year ending March 31, 2011.  During the fiscal year ended March 31, 2011, licensed Paris Hilton brand products accounted for $80.1 million in gross sales or approximately 60% of our gross sales.  If Paris Hilton's appeal as a celebrity were to diminish it could result in a material reduction in our sales of licensed Paris Hilton brand products, and have a material adverse effect on our financial condition, results of operations, and operating cash flows. The Paris Hilton fragrance license is scheduled to expire on June 30, 2014.
 
If we are unable to acquire or license additional brands, secure additional distribution arrangements, or obtain the required financing for these agreements and arrangements, the growth of our business could be impaired.
 
Our business strategy contemplates growing our portfolio of licensed brands. Our future expansion through acquisitions or new product licensing arrangements, if any, is dependent on the availability of capital resources and working capital. We may be unsuccessful in identifying, negotiating, financing and consummating such acquisitions and licensing arrangements on commercially acceptable terms, or at all, which could hinder our ability to increase revenues and grow our portfolio of licensed brands and our business. Additionally, even if we are able to consummate such acquisitions and licensing arrangements, we may not be able to successfully integrate them with our existing operations and portfolio of licenses or generate the expected levels of increased revenue as a result of such acquisitions and licensing arrangements.
 
The development of new products by us involves considerable costs and any new product may not generate sufficient consumer interest and sales to become a profitable brand or to cover the costs of its development and subsequent promotions.
 
Generally, a significant number of new prestige fragrance products have been introduced annually on a worldwide basis. The beauty industry in general is highly competitive and consumer preferences change rapidly. The initial appeal of these new fragrances, launched for the most part in U.S. department stores, has fueled the growth of our industry. Department stores tend to lose sales to the mass market as a product matures. To counter the effect of lower department store sales, companies strategically introduce new products quickly, which requires additional spending for development, advertising and promotional expenses. Our success with new fragrance products depends on our products’ appeal to a broad range of consumers, whose preferences are subject to change and cannot be predicted with certainty, and on our ability to anticipate and respond to market trends through product innovation. In addition, a number of the new launches are with celebrities (either entertainers or athletes) which require substantial royalty commitments and whose careers and/or appeal could change dramatically, either positively or negatively, based on a single event. If one or more of our new product introductions were to be unsuccessful, or if the appeal of the celebrity related to a product were to diminish, it could result in a reduction in profitability and operating cash flows.
 
We depend on a relatively small number of customers for most of our revenue, therefore if any of our significant customers reduced their demand for our products or became financially unstable it may have a material adverse effect on our business.
 
We derive a significant portion of our revenue from two customers, Perfumania and Macy's.  During the fiscal years ended March 31, 2011, 2010 and 2009, we had sales of $47.5 million, $37.6 million, and $41.5 million, respectively, to Perfumania, which represented 39%, 25%, and 27%, respectively, of our total sales for these periods. During the fiscal years ended March 31, 2011, 2010 and 2009, we had sales of $27.6 million, $33.8 million, and $34.6 million, respectively, to Macy's, which represented 21%, 21%, and 22%, respectively, of our total sales. The loss of either Perfumania or Macy's as a customer, for any reason, could materially decrease our net sales and have an adverse effect on our results of operations.
 
The loss of or interruption in our arrangements with our manufacturers, suppliers and customers could have a material adverse affect on our sales, financial condition, and operating cash flow.
 
We generally do not have long-term or exclusive contracts with our domestic customers, certain international distributors or suppliers. Virtually all of our finished products are assembled from multiple components and manufactured by third parties. If we were to experience delays in the delivery of the finished products or the raw materials or components used to make such products, or if these suppliers were unable to supply such products, or if there were transportation problems between the suppliers and our distribution center, our sales, financial condition, and operating cash flow could be materially and adversely impacted. In addition, the loss of key distributors or customers, such as Macy’s or Perfumania, or a change in our relationship with such distributors or customers, could result in excess inventory and reduced sales, profitability, and operating cash flows.
 
 
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The fragrance and cosmetic industry is highly competitive, and if we are unable to compete effectively it could have a material adverse effect on our sales, financial condition, operating cash flow, and many other aspects of our business, prospects, results of operations and financial condition.
 
The fragrance and cosmetic industry is highly competitive and, at times, changes rapidly due to consumer preferences and industry trends. We compete primarily with global prestige fragrance companies, most of whom have significantly greater resources than we have and may be able to respond to changes in business and economic conditions more quickly or effectively than us. Competition in the fragrance and cosmetic industry is based on a number of factors including innovation and new product introductions, pricing of products, promotional activities and advertising, special events and electronic commerce initiatives. Our products compete for consumer recognition and shelf space with products that have achieved significant international, national and regional brand name recognition and consumer loyalty. Our products also compete with new products that often are accompanied by substantial promotional campaigns. In addition, these factors, as well as demographic trends, economic conditions and discount pricing strategies by competitors could result in increased competition and could have a material adverse effect on our profitability, operating cash flow, and many other aspects of our business, prospects, results of operations and financial condition.
 
Our net sales, operating income and inventory levels fluctuate on a seasonal basis and a decrease in sales or profit margins during our peak seasons could have a disproportionate effect on our financial condition and results of operations.
 
Our net sales and operating income fluctuate seasonally, with a significant portion of our operating income typically realized during peak holiday gift-giving seasons. Any decrease in sales or profit margins during these periods could have a disproportionate effect on our financial condition and results of operations. We provide allowances for sales returns based on our historical “sell-through” experience, economic trends and changes in our assessment of customer demand. Our customers generally request approval for the return of unsold items after a specific holiday gift-giving season and fluctuations in the allowance balance are generally higher after holiday gift-giving seasons. An increase in sales returns due to a change in economic conditions, or otherwise, may result in our estimated allowances being insufficient and may have a material adverse impact on our operations. Seasonal fluctuations also affect our inventory levels. We must carry a significant amount of inventory, especially before the holiday season selling period. If we are not successful in selling our inventory, we may have to write down our inventory or sell it at significantly reduced prices or we may not be able to sell such inventory at all, any of which could have a material adverse effect on our financial condition and results of operations.
 
The continued consolidation of the U.S. department store segment could have a material adverse effect on our sales, financial condition, and operating cash flow.
 
Over the last few years, the United States department store market has experienced a significant amount of consolidation, the most recent significant example of which is the consolidation of Macy’s various regional divisions into one centralized purchasing function. Such consolidations have resulted in us becoming increasingly dependent on key retailers, who have increased their bargaining strength and implemented measures such as store closings, increased inventory control and management changes, as well as changes in administrative and purchasing responsibilities. This consolidation trend has also resulted in an increased risk related to the concentration of our customers. The continued consolidation of department stores, whether successful or unsuccessful, could have a material adverse effect on our sales, financial condition, and operating cash flow.
 
Our customers’ inability or other failure to pay their accounts payable balance due to us could have a material adverse effect on our financial condition and results of operations.
 
We continuously monitor the collectability of our receivables by analyzing the aging of our accounts receivable, assessing our customers credit worthiness, and evaluating the impact of changes in economic conditions on our customers. While our invoice terms to Perfumania are stated as net ninety (90) days, for more than fifteen years, our management has granted longer payment terms to Perfumania. As of March 31, 2011 and 2010, Perfumania had an account balance of $12.7 million and $10.5 million, respectively, due to us. Trade accounts receivable from Perfumania are non-interest bearing, and are paid in accordance with the terms established by management. We continue to evaluate our Perfumania credit risk, based on Perfumania's reported results and comparable store sales performance, and assess the collectability of the Perfumania receivables. Based on our evaluation, no allowances for Perfumania receivables have been recorded as of March 31, 2011 and 2010. Significant changes in the factors that affect the collectability of our receivables, including the Perfumania receivables, could have a material adverse effect on our financial condition and results of operations.
 
 
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Consumers have reduced discretionary purchases of our products as a result of the general economic downturn, and may further reduce discretionary purchases of our products in the event of further economic decline, terrorism threats or other external factors.
 
Consumer spending is generally affected by a number of factors beyond our control, including general economic conditions, inflation, interest rates, energy costs and consumer confidence generally. Consumer purchases of discretionary items, such as fragrance products, tend to decline during recessionary periods, when disposable income is lower, and may impact sales of our products. As a result of the severe economic downturn, we have experienced a decline in sales since the quarter ended December 31, 2008. In addition, this general economic downturn has resulted in reduced traffic in our customers' stores which, in turn, resulted in reduced net sales to our customers. We face continued economic challenges in fiscal year 2011 because consumers continued to have less money for discretionary purchases as a result of job losses, foreclosures, bankruptcies, reduced access to credit and falling home prices, among other things. If current economic conditions continue or worsen, we could experience further declines in sales, profitability and operating cash flows due to reduced orders, payment delays, supply chain disruptions or other factors caused by the economic challenges faced by customers, prospective customers and suppliers. In addition, sudden disruptions in business conditions as a result of a terrorist attack, retaliation and the threat of further attacks or retaliation, war, adverse weather conditions or other natural disasters, or pandemic situations can have a short or, sometimes, long-term impact on consumer spending.
 
Our New Loan Agreement contains restrictive and financial covenants that could adversely affect our ability to borrow funds under the New Loan Agreement or adversely affect our business by limiting our flexibility.
 
Our New Loan Agreement contains certain restrictive and financial covenants. Among other things, these covenants limit our ability to:
 
 
·
incur additional indebtedness;
 
 
·
pay dividends;
 
 
·
create or incur liens; or
 
 
·
engage in mergers or acquisitions.
 
 Additionally, we have to maintain a minimum net liquidity balance throughout the term of the New Loan Agreement and in order to borrow funds under the New Loan Agreement.  If we fall below the net liquidity requirements at any point, the New Loan Agreement contains additional financial covenants relating to minimum consolidated EBITDA, minimum consolidated interest coverage ratios and maximum capital expenditure limits.  These covenants could place us at a disadvantage compared to some of our competitors which may have fewer restrictive and financial covenants and may not be required to operate under these restrictions.  Further, these covenants could have an adverse effect on our business by limiting our ability to take advantage of financing, merger and acquisitions or other opportunities.  Our ability to comply with financial covenants could be affected by events beyond our control.  If our actual results deviate significantly from our projections, we may not remain in compliance with the financial covenants and would not be allowed to borrow under the New Loan Agreement.  If we are not able to borrow under the New Loan Agreement or if our financing needs increase, we may have to seek an alternative or additional source of financing. If we were to fail to obtain an alternative or additional source of financing in such circumstances, we could experience cash flow difficulties and disruptions in our supply chain or be unable to pursue our business strategy or fund capital expenditures.
 
Failure to manage inventory effectively could negatively impact our operations.
 
The composition of our inventory at any given time may vary considerably depending on launches of new products, forecasted sales of significant amounts of our products during the peak holiday gift-giving seasons and as a result of termination or expiration of our fragrance licenses and sub-licenses. If we misjudge consumer preferences or demands or future sales do not reach forecasted levels, we could have excess inventory that may need to be held for a long period of time, written down, sold at prices lower than expected, or discarded in order to clear excess inventory at the end of a selling season. Conversely, if we underestimate consumer demand, we may not be able to provide products to our customers to meet their demand. Either event could have a material adverse impact on our business, financial condition and results of operations. The termination or expiration of our fragrance licenses may result in inventory which we may need to write down to the amounts which we estimate could be realized upon their sale or liquidation. During the year ended March 31, 2010, we recorded additional charges of $7.6 million to cost of sales to reduce the recorded value of inventories related to our GUESS? license as a result of the expiration of this license on December 31, 2009. In addition, inventory shrink (inventory theft or loss) rates can also significantly impact our business performance and financial results.
 
 
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The value of our long-lived assets, including brand licenses and trademarks, may be adversely affected if we experience declines in operating results or experience significant negative industry or economic trends.
 
The majority of our long-lived assets are the result of the acquisition of existing license brands or sublicensing opportunities. For newly launched brands our long-lived assets are generally the result of our investment in trademarking brand names and designs, and are generally not a material portion of our assets. At least on an annual basis, long-lived assets are reviewed for impairment. Impairment losses are recognized if expected undiscounted future cash flows of the long-lived assets are less than their carrying values. Future cash flows can be affected by changes in industry or market conditions. The assumptions used include an analysis by license, and by fragrance produced under each license, which may vary depending on the age of the product. Expected sales along with related costs of sales, direct expenses and certain allocated charges are projected through the end of each given license period. Expected sales estimates incorporate the age of a product and its market distribution. If actual operating results differ from management’s estimates, or if we experience the impact of negative industry or economic trends, write downs of our long-lived assets, including brand licenses and trademarks, may be required which could have a material adverse effect on our operating results.
 
If we are unable to protect our intellectual property rights, specifically trademarks and trade names, our ability to compete could be negatively impacted.
 
The market for our products depends to a significant extent upon the value associated with our trademarks and trade names. We own, or have licenses or other rights to use, the material trademark and trade name rights used in connection with the packaging, marketing and distribution of our major products both in the United States and in other countries where such products are principally sold; therefore, trademark and trade name protection is important to our business. Although most of our brand names are registered in the United States and in certain foreign countries in which we operate, we may not be successful in asserting trademark or trade name protection. In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States, especially in the product class that includes fragrance products.  The costs required to protect our trademarks and trade names may be substantial.
 
If other parties infringe on our intellectual property rights or the intellectual property rights that we license, the value of our brands in the marketplace may be diluted. Any infringement of our intellectual property rights would also likely result in a commitment of our time and resources to protect these rights through litigation or otherwise. Additionally, we may infringe or be accused of infringing on others’ intellectual property rights and one or more adverse judgments with respect to these intellectual property rights could negatively impact our ability to compete and could materially adversely affect our business, prospects, results of operations, financial condition or cash flows.
 
If we experience privacy breaches and liability for online content, it could negatively affect our reputation, credibility and business.
 
We rely on third-party computer hardware and software for our various social media tools and websites that we utilize as part of our marketing strategy. There is a growing concern over the security of personal information transmitted over the internet, consumer identity theft and user privacy. Despite the implementation of reasonable security measures by us and our third-party providers, these sites and systems may be susceptible to electronic or physical computer break-ins and security breaches. Any perceived or actual unauthorized disclosure of personally-identifiable information regarding our customers or website visitors could harm our reputation and credibility, impair our ability to attract website visitors and reduce our ability to attract and retain customers. Additionally, as the number of users of forums and social media features on our websites increases, we could be exposed to liability in connection with material posted on our websites by users and other third parties. Finally, we could incur significant costs in complying with the multitude of state, federal and foreign laws regarding unauthorized disclosure of personal information.
 
The loss of, or disruption in our distribution facility, could have a material adverse effect on our sales and our relationships with our customers.
 
We have one distribution facility, located in New Jersey, which is close to where our fragrance products are manufactured and packaged. The loss of, or any damage to, our New Jersey facility, as well as the inventory stored therein, would require us to find replacement facilities. In addition, weather conditions, such as inclement weather or other natural disasters, could disrupt our distribution operations. Certain of our components require purchasing lead times in excess of 180 days. If we cannot replace our distribution capacity and inventory in a timely, cost-efficient manner, it could reduce the inventory we have available for sale, adversely affecting our profitability and operating cash flows, as well as damaging relationships with our customers who are relying on deliveries of our products.
 
Our success depends, in part, on the quality and safety of our fragrance and related products.
 
Our success depends, in part, on the quality and safety of our fragrance and related products. If our products are found to be unsafe or defective, or if they otherwise fail to meet customers or consumers’ standards and expectations, our reputation could be adversely affected, our relationships with customers or consumers could suffer, the appeal of one or more of our brands could be diminished, our sales could be adversely affected and/or we may become subject to liability claims, any of which could result in a material adverse effect on our business, results of operations and financial condition.
 
 
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We are subject to risks related to our international operations.
 
We operate on a global basis, with sales in approximately 80 countries. Our international operations could be adversely affected by:
 
 
·
import and export license requirements;
 
 
·
trade restrictions;
 
 
·
changes in tariffs and taxes;
 
 
·
product registration, permitting and regulatory compliance;
 
 
·
restrictions on repatriating foreign profits back to the United States;
 
 
·
the imposition of foreign and domestic governmental controls;
 
 
·
changes in, or our unfamiliarity with, foreign laws and regulations;
 
 
·
difficulties in staffing and managing international operations;
 
 
·
changes in economic, social, legal and other conditions;
 
 
·
the volatility or weakening of the U.S. dollar against other currencies;
 
 
·
greater difficulty enforcing intellectual property rights and weaker laws protecting such rights; and
 
 
·
geo-political conditions, such as terrorist attacks, war or other military action, public health  problems and natural disasters.
 
Reductions in worldwide travel could hurt sales volumes in our duty-free related business.
 
We depend on consumer travel for sales to our “duty free” customers in airports and other locations throughout the world. Any reductions in travel, including as a result of general economic downturns, natural disasters, or acts of war or terrorism, or disease epidemics, could result in a material decline in sales and profitability for this channel of distribution, which could negatively affect our operating results, financial condition, and operating cash flow.
 
If we lose the services of our executive officers and senior management, it could have a negative impact on our business.
 
Our success is dependent upon the continued service and skills of our executive officers and senior management. If we lose the services of our executive officers and senior management, it could have a negative impact on our business because of their skills, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
 
 
14

 
 
If we lose our key personnel, or fail to attract and retain additional qualified experienced personnel, we will be unable to continue to develop our prestige fragrance products and attract and obtain new licensing partners.
 
We believe that our future success depends upon the continued contributions of our highly qualified sales, creative, marketing, and management personnel and on our ability to attract and retain those personnel. These individuals have developed strong reliable relationships with customers and suppliers. There can be no assurance that our current employees will continue to work for us or that we will be able to hire any additional personnel necessary for our growth. Our future success also depends on our continuing ability to identify, hire, train and retain other highly qualified managerial personnel. Competition for these employees can be intense. We may not be able to attract, assimilate or retain qualified managerial personnel in the future, and our failure to do so would limit the growth potential of our business and potential licensing partners may not be as attracted to our organization.
 
We may unknowingly infringe on others’ intellectual property rights which could result in litigation.
 
We may unknowingly produce and sell products in a country where another party has already obtained intellectual property rights. One or more adverse judgments with respect to these intellectual property rights could negatively impact our ability to compete and continue to sell products in the worldwide marketplace and may require the destruction of inventory produced under the infringed name, both of which would adversely affect profitability, and, ultimately operating cash flow.
 
We are involved in litigation from time to time in the ordinary course of business, which, if the outcome of such litigation is adverse to us, could materially adversely affect our business, results of operations, financial condition, and cash flows.
 
Given the nature of our business, we are involved in litigation from time to time in the ordinary course of business. Except as set forth under Part I, Item 3 - “Legal Proceedings”, we are not presently a party to any material legal proceedings, although legal proceedings could be filed against us in the future. No assurance can be given as to the final outcome of any legal proceedings or that the ultimate resolution of any legal proceedings will not have a material adverse effect on our business, results of operations, financial condition, and cash flows.
 
Our quarterly results of operations could fluctuate significantly due to retailing peaks related to gift giving seasons and delays in new product launches, which could adversely affect our stock price.
 
We may experience variability in net sales and net income on a quarterly basis as a result of a variety of factors, including timing of customer orders and returns, sell-through of our products by the retailer to the ultimate consumer or gift giver, delays in new product launches, as well as additions or losses of brands or distribution rights. Any resulting material reduction in our sales could have an adverse effect on our business, its profitability and operating cash flows, and correspondingly, the price of our common stock.
 
Our information systems and websites may be susceptible to outages and other risks.
 
We have information systems that support our business processes, including product development, marketing, sales, order processing, production, distribution, finance and intracompany communications throughout the world.  These systems may be susceptible to outages due to fire, floods, power loss, telecommunications failures, break-ins and similar events.  Despite the implementation of network security measures, our systems may be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering.  The occurrence of these or other events could disrupt or damage our information systems, result in the dissemination of confidential information and adversely affect our financial condition and results of operations.
 
Our business is subject to regulation in the United States and internationally.
 
The manufacturing, distribution, formulation, packaging and advertising of our fragrance and related products are subject to numerous federal, state and foreign governmental regulations. Compliance with these regulations is costly and difficult. If we fail to adhere, or are alleged to have failed to adhere, to any applicable federal, state or foreign laws or regulations, our business, prospects, results of operation, financial condition or cash flows may be adversely affected. In addition, our future results could be adversely affected by changes in applicable federal, state and foreign laws and regulations, or the interpretation or enforcement thereof, including those relating to product liability, trade rules and customs regulations, intellectual property, consumer laws, privacy laws and product regulation, as well as accounting standards and taxation requirements (including tax-rate changes, new tax laws and revised tax law interpretations).
 
 
15

 
 
Our stock price has been volatile.
 
The price of our common stock has been and likely will continue to be subject to wide fluctuations in response to a number of events, such as:
 
 
·
quarterly variations in operating results;
 
 
·
acquisitions, capital commitments or strategic alliances by us or our competitors;
 
 
·
legal and regulatory matters that are applicable to our business;
 
 
·
the operating and stock price performances of other companies that investors may deem comparable to us;
 
 
·
news reports relating to trends in our markets; and
 
 
·
the amount of shares constituting our public float.
 
In addition, the stock market in general has experienced significant price and volume fluctuations that often have been unrelated to the performance of specific companies. The broad market fluctuations may adversely affect the market price of our common stock.
 
ITEM 1B.  UNRESOLVED STAFF COMMENTS.
 
None.
 
ITEM 2.   PROPERTIES.
 
Our corporate headquarters are located at 5900 N. Andrews Avenue, Suite 500, Fort Lauderdale, FL 33309 and our distribution center is located in Keasbey, New Jersey.
 
On November 30, 2007, we entered into a sublease agreement, commencing during February 2008, for 19,072 square feet of office space in Fort Lauderdale, Florida, to serve as our new corporate headquarters. We moved into this space in February 2008. The sublease was for eight years, commencing on February 1, 2008, at an annual cost of approximately $0.6 million, increasing 3% per annum. On January 31, 2009, the sublease was terminated and we assumed the sublessor’s obligations under their lease directly with the landlord. The terms of the lease are substantially the same as our previous sublease.
 
On April 17, 2006, we leased 198,500 square feet of warehouse space in Keasbey, New Jersey. The lease was for a five-year term and had an initial annual cost of approximately $1.4 million, with minimal increases after the second and fourth year of the lease. We relocated substantially all of our fragrance warehousing and distribution activities to this facility, and established a backup information technology site in case of an unplanned disruption to our South Florida headquarters. On November 24, 2010, the Company amended the lease agreement and extended the lease term an additional four years through August 31, 2015.
 
We currently maintain a lease for our former corporate headquarters and distribution center in Ft. Lauderdale, Florida. During May 2006, we entered into a five-year lease on the 99,000 square foot property, commencing October 1, 2006, at an initial annual cost of approximately $0.9 million, increasing approximately 3% per annum. On January 29, 2009, we entered into a sublease agreement to sublease 40,000 square feet of space in the facility at the approximate per square foot cost as we have under our lease. The sublease commenced on April 1, 2009, and will terminate on September 30, 2011, which is our lease expiration date.
 
 
16

 
 
ITEM 3.
  LEGAL PROCEEDINGS.
 
Litigation
 
On June 21, 2006, we were served with a stockholder derivative action (the “Derivative Action”) filed in the Circuit Court of the Seventeenth Judicial Circuit in and for Broward County, Florida by NECA-IBEW Pension Fund, purporting to act derivatively on behalf of the Company.
 
The Derivative Action named Parlux Fragrances, Inc. as a defendant, along with Ilia Lekach, Frank A. Buttacavoli, Glenn Gopman, Esther Egozi Choukroun, David Stone, Jaya Kader Zebede and Isaac Lekach, each of whom at that date was one of our directors. The Derivative Action related to the June 2006 proposal from PF Acquisition of Florida LLC (“PFA”), which was owned by Ilia Lekach, to acquire all of our outstanding shares of common stock for $29.00 ($14.50 after our June 16, 2006, “Stock Split”) per share in cash (the “Proposal”).
 
The original Derivative Action sought to remedy the alleged breaches of fiduciary duties, waste of corporate assets, and other violations of law and sought injunctive relief from the Court appointing a receiver or other truly neutral third party to conduct and/or oversee any negotiations regarding the terms of the Proposal, or any alternative transaction, on behalf of Parlux and its public shareholders, and to report to the Court and plaintiff’s counsel regarding the same. The Derivative Action alleged that the unlawful plan to attempt to buy out the public shareholders of Parlux without having proper financing in place, and for inadequate consideration, violated applicable law by directly breaching and/or aiding the other defendants’ breaches of their fiduciary duties of loyalty, candor, due care, independence, good faith and fair dealing, causing the complete waste of corporate assets, and constituting an abuse of control by the defendants. Before any response to the original complaint was due, counsel for plaintiffs indicated that an amended complaint would be filed. That First Amended Complaint (the "Amended Complaint") was served on August 17, 2006.
 
The Amended Complaint continued to name the then Board of Directors as defendants along with Parlux, as a nominal defendant. The Amended Complaint was largely a collection of claims previously asserted in a 2003 derivative action, which the plaintiffs in that action, when provided with additional information, simply elected not to pursue. It added to those claims, assertions regarding a 2003 buy-out effort and an abandoned buy-out effort of PFA. It also contained allegations regarding the prospect that our stock might be delisted because of a delay in meeting SEC filing requirements.
 
We and the other defendants engaged Florida securities counsel, including the counsel who successfully represented us in the previous failed derivative action, and on September 18, 2006, moved to dismiss the Amended Complaint. A Second Amended Complaint was filed on October 26, 2006, which added alleged violations of securities laws, which we moved to dismiss on December 1, 2006. A hearing on the dismissal was held on March 8, 2007. On March 22, 2007, the motion to dismiss was denied and the defendants were provided twenty (20) days to respond, and a response was filed on March 29, 2007. During fiscal year 2008, there followed extremely limited discovery.  A number of the factual allegations upon which the various complaints were based have fallen away, simply by operation of time. We were then advised that one of the two plaintiffs was withdrawing from the case. No explanation was given. The remaining plaintiff then spent several months obtaining documents. We believe the documents provide no support for any of the claims.
 
We then sought to take the deposition of the remaining plaintiff, who lives in Seattle. He declined to travel due to a long-standing “fear of flying” and filed a motion on August 4, 2008, for a protective order from the Court. The Court denied the motion and required him to appear in Florida for his deposition. As a consequence of this ruling, his counsel then informed us that this plaintiff, too, was withdrawing from the case due to this travel requirement, leaving no plaintiff. We were then served with a motion on September 15, 2008, to further amend the complaint by inserting a new plaintiff. Our counsel opposed that motion on the grounds that a person not a party to the case has no standing to move to amend the complaint. A hearing on that motion was held on December 19, 2008, and the motion to amend was denied by the Court.
 
The plaintiff's counsel was given leave to amend the complaint and intervene on behalf of a new plaintiff. Counsel also moved to amend the complaint yet again. After a lengthy hearing, the Court permitted the new plaintiff to intervene and to file a Third Amended Complaint on July 29, 2009.
 
 
17

 
 
The Third Amended Complaint claims damages to us based on allegations of (1) insider trading; (2) failing to have proper internal controls resulting in delays in the filing of an Annual Report on Form 10-K for 2006 and a Quarterly Report on Form 10-Q for June 2006 and (3) intentionally stifling our independent outside auditors in the commencement of our Sarbanes-Oxley review.
 
Based on preliminary review and discussions with the directors and detailed discussions with our counsel, we believe that there are meaningful defenses to the claims although discovery will be required to reach a final conclusion as to these matters. An answer was filed to the Third Amended Complaint on September 14, 2009, essentially denying the substantive allegations.
 
Discovery has commenced. A number of depositions were taken of the brokerage firms through which the stock trades were conducted by the then Board of Directors. Two representatives of our former independent outside auditors, as well as one of our consultants have been deposed. A deposition of the new plaintiff was completed in February 2010. The new plaintiff had no personal knowledge of any of the basic factual allegations and was simply unhappy that our stock declined in value.  Depositions of our Board of Directors, both former and current, named in the suit were commenced.  No completion date has been scheduled and there has been no effort by the plaintiff to complete their depositions.
 
On January 19, 2010, the plaintiff filed a motion for leave to file under seal a motion for partial summary judgment. That motion was granted. The motion for partial summary judgment was filed and was initially scheduled for hearing on June 25, 2010. That hearing was postponed until September 17, 2010, and then postponed again until January 7, 2011. The hearing scheduled for January 7, 2011, was postponed as well.  A hearing has been scheduled for June 9, 2011.  The motion seeks a ruling that one of our directors engaged in insider trading.  A comprehensive opposing memorandum has been filed on behalf of the director. It directly rebuts the facts upon which the motion was based.
 
Based on the manner in which this case has been conducted to date, and based on the investigations into the earlier complaint we feel the Third Amended Complaint is without merit and subject to challenge and to an effective defense.
 
The plaintiffs have informally initiated settlement inquiries.  Discussions with us and the insurer were undertaken by counsel.   No decision has been reached by the Company as to a response.
 
While management is unable to predict with certainty the outcome of the legal proceeding described above, based on current knowledge management believes that the ultimate outcome of these matters will not have a material effect on our financial position or results of operations.
 
Other
 
To the best of our knowledge, there are no other proceedings threatened or pending against us, which, if determined adversely to us, would have a material effect on our financial position or results of operations and cash flows.
 
ITEM 4.   REMOVED AND RESERVED.
 
 
 
18

 
 
PART II
 
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
Our Common Stock, par value $0.01 per share, commenced trading on the National Association of Securities Dealers Automatic Quotation System (“Nasdaq”) National Small Cap market on February 26, 1987, and commenced trading on the Nasdaq National Market on October 24, 1995 under the symbol "PARL." On August 1, 2006, the Nasdaq National Market changed its name to the Nasdaq Global Market, with some of its members, including Parlux, being listed on Nasdaq’s Global Select Market.
 
The following chart, as reported by the National Association of Securities Dealers, Inc., shows the high and low sales prices for our securities available for each quarter of the last two years.
 
   
Common Stock
 
   
High
   
Low
 
Quarter – Fiscal Year 2010:
           
First (April/June) 2009
    2.57       0.77  
Second (July/Sept.) 2009
    2.50       1.52  
Third (Oct./Dec.) 2009
    2.61       1.88  
Fourth (Jan./Mar.) 2010
    2.18       1.52  
Quarter – Fiscal Year 2011:
               
First (April/June) 2010
    2.41       1.68  
Second (July/Sept.) 2010
    2.34       1.69  
Third (Oct./Dec.) 2010
    2.96       2.09  
Fourth (Jan./Mar.) 2011
    3.79       2.85  
 
On May 25, 2011, the closing price of our common stock was $3.50 per share as reported by Nasdaq. As of May 25, 2011, there were approximately 50 holders of record of our common stock, which does not include common stock held in street name.
 
We have not paid a cash dividend on our common stock nor do we contemplate paying any dividend in the near future. Our loan agreement with General Electric Capital Corporation (“GE Capital”) restricts payment of dividends without prior approval.  See Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations –Overview and Note 7 to the accompanying Consolidated Financial Statements included with this filing for a discussion of the GE Capital loan agreement.
 
 
19

 
 
The following chart outlines the Company’s equity compensation plan information as of March 31, 2011.
 
Plan Category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
 
Weighted-average exercise price of outstanding options, warrants and rights
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column)
Equity compensation plans approved by security holders
 
 
3,086,625
 (1)
 
 
$4.03
 
 
 
6,513,200
 (2)
Equity compensation plans not approved by security holders
   
4,020,000
 (3)
   
$4.98
     
 
Total
   
7,106,625
     
$4.68
     
6,513,200
 
———————
(1)
Represents 1,086,625 shares to be issued upon the exercise of outstanding options under our 2007 Stock Incentive Plan (the “2007 Plan”) and our 2000 Stock Option Plan (which expired on June 7, 2010), which were approved by our stockholders on October 11, 2007, and October 12, 2000, respectively, and 2,000,000 shares to be issued upon the exercise of warrants granted in connection with the Artistic Brands licenses, which was approved by our stockholders on December 18, 2009. See Note 10 to the accompanying Consolidated Financial Statements included with this filing for further discussion.
 
(2)
Represents 513,200 shares available for grant under our 2007 Plan, which were approved by our stockholders as discussed in footnote 1 above, and 6,000,000 shares, which may be issued upon the exercise of warrants that may be issued in the future, if and when the sublicense agreement is entered into for Shawn “Jay Z” Carter and a fourth artist in connection with the Artistic Brands licenses, which was approved by our stockholders on December 18, 2009. See Note 10 to the accompanying Consolidated Financial Statements included with this filing for further discussion.
 
(3)
Represents warrants to purchase 20,000 shares granted in connection with previous annual Board of Directors’ compensation. In addition, it represents warrants granted on April 7, 2009, to purchase 4,000,000 shares of our common stock in connection with the Artistic Brands licenses.  See Note 10 to the accompanying Consolidated Financial Statements included with this filing for further discussion.
 
On November 3, 2008, we announced the authorization and implementation of a buy-back program of up to 1,000,000 shares of the Company’s common stock. This authorization is part of our existing share buy-back program originally approved and announced in January 2007. There is no expiration date specified for this program. We did not repurchase any of our common stock during the quarter ended March 31, 2011. (see “Liquidity and Capital Resources” in Item 7 for further discussion).

 
20

 

STOCKHOLDER RETURN PERFORMANCE: FIVE YEAR GRAPH
 
Set forth below is a performance graph comparing the cumulative total return on our common stock with the cumulative total return on the Standard and Poors 500 Index, and the Standard and Poors Personal Products 500 Index for the fiscal years of 2006 through 2011.
 
 
Cumulative Total Return
 
      3/06       3/07       3/08       3/09       3/10       3/11  
                                                 
Parlux Fragrances, Inc.
  $ 100.0     $ 34.60     $ 18.23     $ 5.33     $ 12.40     $ 19.47  
S&P 500
  $ 100.0     $ 111.83     $ 106.15     $ 65.72     $ 98.43     $ 113.83  
S&P Personal Products
  $ 100.0     $ 126.26     $ 132.38     $ 67.78     $ 141.54     $ 149.09  

 
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ITEM 6.   SELECTED FINANCIAL DATA.
 
The following data has been derived from audited consolidated financial statements, adjusted for the two-for-one stock split effected on June 16, 2006, for stockholders of record on May 31, 2006. Consolidated balance sheets at March 31, 2011 and 2010, and the related consolidated statements of operations and cash flows for each of the three years in the period ended March 31, 2011, and notes thereto appear elsewhere in this Annual Report on Form 10-K. Historical results are not necessarily indicative of the results that may be expected for any future period.
 
Statement of Operations Data:
 
For the Years Ended March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007(3)
 
   
(in thousands of dollars, except number of shares and per share data)
 
Continuing Operations:
                             
Net sales
  $ 123,006     $ 148,102     $ 151,155     $ 153,696     $ 134,365  
Costs/operating expenses (4)
    120,533       171,611       157,958       145,096       177,601  
Operating income (loss)
    2,473       (23,509 )     (6,803 )     8,600       (42,742 )
Income (loss) from continuing operations (4)
    1,242       (14,759 )     (4,284 )     5,011       (27,864 )
Income from discontinued operations (1)
                      25       30,746  
Net income (loss)
  $ 1,242     $ (14,759 )   $ (4,284 )   $ 5,036     $ 2,882  
Income (loss) per share:
                                       
Basic:
                                       
Continuing operations
  $ 0.06     $ (0.73 )   $ (0.21 )   $ 0.26     $ (1.53 )
Discontinued operations
                            1.69  
Total
  $ 0.06     $ (0.73 )   $ (0.21 )   $ 0.26     $ 0.16  
Diluted: (2)
                                       
Continuing operations
  $ 0.06     $ (0.73 )   $ (0.21 )   $ 0.24     $ (1.53 )
Discontinued operations
                            1.69  
Total
  $ 0.06     $ (0.73 )   $ (0.21 )   $ 0.24     $ 0.16  
Weighted average number of shares outstanding:
                                       
Basic
    20,497,701       20,330,395       20,537,624       19,344,953       18,154,190  
Diluted
    20,653,305       20,330,395       20,537,624       20,603,256       18,154,190  
———————
(1)
Represents operations relating to the Perry Ellis brand, which was sold during December 2006.
 
(2)
The number of shares utilized in the calculation of diluted loss per share from continuing operations, discontinued operations and net income were the same as those used in the basic calculation of earnings per share for the years ended March 31, 2010, 2009 and 2007, as we incurred a loss from continuing operations for each of those periods.
 
(3)
Concurrent with the Stock Split in fiscal year 2007, we modified the outstanding warrants, doubling the number of warrants and reducing the exercise price in half to reflect the Stock Split. Since the warrant terms did not contain an anti-dilution provision, we were required to record share-based compensation expense in the amount of $16.2 million, reflecting the change in the warrants’ fair value immediately before and after the Stock Split. This non-cash charge was included in operation expenses for the year ended March 31, 2007. We also recorded a tax benefit of $5.2 million as a result of the charge, which reduced income tax expense for the period.
 
(4)
During the year ended March 31, 2010, we recorded additional charges of $7.6 million to cost of sales to reduce the recorded value of our GUESS? brand inventories, due to the expiration of the GUESS?  license on December 31, 2009, to amounts which we estimated could be realized upon their sale or liquidation. In addition, during the year ended March 31, 2010, we wrote-off approximately $1.7 million of collateral material related to the GUESS? brand products, which was recorded as advertising and promotional expense. Please refer to “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a more detailed discussion of the expiration of the GUESS? license.
 
 
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Balance Sheet Data:
 
March 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(in thousands)
 
                               
Current assets
  $ 103,994     $ 103,373     $ 128,674     $ 122,333     $ 114,065  
Current liabilities
    10,975       14,532       26,220       15,040       34,605  
Working capital
    93,019       88,841       102,454       107,293       79,460  
Trademarks and licenses, net
    4,195       4,654       1,885       2,770       3,913  
Long-term borrowings, net
                      543       1,537  
Total assets
    112,706       114,332       136,704       131,148       144,896  
Total liabilities
    10,975       14,532       26,220       15,583       36,142  
Stockholders’ equity
  $ 101,731     $ 99,800     $ 110,484     $ 115,565     $ 108,755  
 
ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
The following discussion should be read in conjunction with Part I, including matters set forth in the “Risk Factors” section of this Annual Report on Form 10-K, and our Consolidated Financial Statements and notes thereto included elsewhere in this Form 10-K.

Overview
 
Parlux Fragrances, Inc. is engaged in the business of creating, designing, manufacturing, distributing and selling prestige fragrances and beauty related products marketed primarily through specialty stores, national department stores and perfumeries on a worldwide basis. The fragrance market is generally divided into a prestige group (distributed primarily through department and specialty stores) and a mass market group (primarily chain drug stores, mass merchandisers, smaller perfumeries and pharmacies). Our fragrance products are positioned primarily in the prestige group.
 
As a result of the economic downturn over the past several years and the impact of the expiration of the GUESS? license on December 31, 2009, we have incurred significant net losses of $14.8 million and $4.3 million for the years ended March 31, 2010 and 2009, respectively. During the fiscal year ended March 31, 2011, the economy began to improve and, coupled with the cost-cutting initiatives we implemented in prior years resulted in our reporting net income of $1.2 million. Net cash used in operations during the year ended March 31, 2009, was $13.1 million, while net cash provided by operations during the years ended March 31, 2011 and 2010, was $3.6 million and $13.9 million, respectively. As reflected in the accompanying Consolidated Balance Sheets as of March 31, 2011 and 2010, we had unrestricted cash and cash equivalents of approximately $20.5 million and $17.6 million, respectively, and positive working capital of $93.0 million at March 31, 2011, and $88.8 million at March 31, 2010.
 
During fiscal years 2009 and 2010, we implemented a number of cost reduction initiatives including a targeted reduction in staff, along with a reduction in committed advertising and promotional spending, and reduced our production levels. The reductions during fiscal year 2010 were partially offset by approximately $1.7 million in advertising and promotional expense relating to the write-off of our remaining GUESS? collateral material. During fiscal year 2011, management continued to implement various operational efficiencies and monitor all facets of our operations.
 
On February 16, 2010, we repaid the remaining outstanding principal balance plus interest and fees under our Loan and Security Agreement (the “Loan Agreement”) with Regions, and the Loan Agreement, as amended, was terminated.  On June 25, 2010, we entered into a Loan Agreement, as amended April 15, 2011, (the “New Loan Agreement”) with GE Capital.  The New Loan Agreement is a revolving credit facility that provides a credit line of up to $20.0 million, depending upon the availability of a borrowing base and certain reserves established by GE Capital from time to time, at an interest rate equal to the highest of (a) the prime rate, (b) the federal funds rate plus 3.0%, or (c) the LIBOR rate over one minus any Euro dollar reserve requirement (the “Eurodollar Rate”),  in each case plus 3.50%; or the Eurodollar Rate plus 4.50%, at our option except in certain circumstances including defaults in the payment of any amounts under the revolving credit facility or the unavailability of the LIBOR rate. The term of the revolving credit facility under the New Loan Agreement is two years.  See “Liquidity and Capital Resources” and Note 7 to the accompanying Consolidated Financial Statements for further discussion.  As of March 31, 2011, we had not borrowed any amounts under our New Loan Agreement.
 
Management believes that the actions taken, along with the credit facility under the New Loan Agreement will continue to provide us an opportunity to improve liquidity and profitability, and our new financing will be sufficient to meet our current operating and seasonal needs. However, if we were to expand operations through acquisitions, new licensing arrangements or both, we may need to obtain additional financing.  There can be no assurances that we could obtain additional financing or what the terms of such financing, if available, would be. In addition, the current business environment may increase the difficulty of obtaining additional financing, if necessary.
 
 
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We distribute certain brands through Perfumania, a specialty retailer of fragrances in the United States and Puerto Rico, and Quality King. Perfumania is a wholly-owned subsidiary of Perfumania Holdings, Inc.  The majority shareholders of Perfumania Holdings, Inc. are also the owners of Quality King, a privately-held, wholesale distributor of pharmaceuticals and beauty care products. Perfumania is one of our largest customers, and transactions with Perfumania are closely monitored by management, and any unusual trends or issues are brought to the attention of our Audit Committee and Board of Directors. During fiscal year 2007, Perfumania Holdings, Inc.’s majority shareholders acquired an approximate 12.2% ownership interest in our Company at that time (equivalent to 9.9% at March 31, 2011), and accordingly, transactions with Perfumania and Quality King are included as related party sales in the accompanying Consolidated Statements of Operations.
 
During the years ended March 31, 2011 and 2010, we sold a number of our products to Jacavi, a fragrance distributor. Jacavi’s managing member is Rene Garcia. Rene Garcia owns approximately 8.4% of the outstanding stock of Perfumania Holdings, Inc. as of March 31, 2011, and is one of the principals of Artistic Brands. Also, on June 14, 2010, certain persons related to Mr. Garcia, the Garcia Group, acquired 2,718,728 shares of our common stock and filed a Schedule 13G with the SEC on June 23, 2010.  In that filing, the Garcia Group reported having beneficial ownership of a total of 2,995,527 shares, or approximately 14.7% of our outstanding shares as of June 14, 2010 (equivalent to 14.5% as of March 31, 2011), excluding warrants owned by the Garcia Group. On March 4, 2011, the Garcia Group replaced their original joint filing by jointly filing a Schedule 13D with the SEC.  Other than the addition of certain warrants to purchase shares, which vested between the initial and subsequent filing dates, there were no changes in beneficial share ownership included in the updated joint filing. Sales to Jacavi are also included as related party sales in the accompanying Consolidated Statement of Operations for the years ended March 31, 2011 and 2010.
 
During the fiscal year ended March 31, 2011, we engaged in the manufacture (through sub-contractors), distribution and sale of Paris Hilton, Jessica Simpson, Rihanna, Queen Latifah, Marc Ecko, Josie Natori, Nicole Miller, XOXO, Ocean Pacific (“OP”), and babyGUND fragrances and grooming items on an exclusive basis as a licensee. We also hold a sublicensing agreement for the fragrance license of entertainer Kanye West, whose first product is expected to launch late in fiscal 2012 and a fragrance license agreement with Vince Camuto, Chief Designer and Chief Executive Officer of Camuto Group, whose first product is expected to launch in the fall of 2011.
 
The Paris Hilton and Jessica Simpson brands of fragrances and accessories accounted for approximately 60% and 19%, respectively, of our gross sales during the fiscal year ended March 31, 2011, and 42% and 15%, respectively, of our gross sales during the year ended March 31, 2010.  The GUESS? license expired on December 31, 2009, and was not renewed. As a result, licensed Paris Hilton brand products accounted for the majority of our gross sales and constituted our primary source of revenue for the year ended March 31, 2011. If Paris Hilton's appeal as a celebrity were to diminish, it could result in a material reduction in our sales of licensed Paris Hilton brand products, adversely affecting our results of operations and operating cash flows. The Paris Hilton fragrance license is scheduled to expire on June 30, 2014.
 
As a result of the expiration of our GUESS? fragrance license on December 31, 2009, during the year ended March 31, 2010, we recorded additional charges of $7.6 million to cost of sales to reduce the recorded value of such inventories to the amounts which we estimated could be realized upon their sale or liquidation. In addition, during the year ended March 31, 2010, we wrote-off approximately $1.7 million of collateral material related to the GUESS? brand products, which was recorded as advertising and promotional expense.
 
The reduction in sales of GUESS? products was partially offset by increased sales of fragrances launched during fiscal year 2011, including our Paris Hilton fragrances, Tease and the Passport Series, Jessica Simpson fragrance, Fancy Nights, and Marc Ecko fragrances, Ecko Blue and UNLTD by Marc Ecko.  In addition, we launched a new fragrance under our recently signed Rihanna sublicense in January 2011.
 
We expanded our product licenses under the Paris Hilton brand into the accessory market in 2005, specifically, watches, handbags, purses, small leather goods, cosmetics and sunglasses. We believed such products, which have similar distribution channels to our fragrance products, could strengthen our position with our current customers and distributors while providing incremental sales volume. Our sales under such accessory licenses have not offset the minimum annual royalties paid to the licensor. During the year ended March 31, 2008, we sublicensed the international rights for handbags, purses, wallets, and other small leather goods. We generated $0.2 million in fiscal year 2011, $0.4 million in fiscal year 2010, and $0.4 million in fiscal year 2009 in sublicense revenue. In addition, during January 2009, we sublicensed the worldwide exclusive licensing rights for Paris Hilton sunglasses through January 15, 2012, and remain contingently liable for the minimum guaranteed royalty from our assignment of the license. We generated $0 million and $0.3 million in fiscal years 2011 and 2010, respectively, in sublicense revenue. As of March 31, 2010, we determined that the license for Paris Hilton cosmetics, which was due to expire on January 15, 2011, was no longer a viable business line and all remaining royalty obligations were accrued and expensed in fiscal year 2010.
 
 
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Critical Accounting Policies and Estimates
 
SEC Financial Reporting Release No. 60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies (“FRR 60”), suggests companies provide additional disclosure and commentary on those accounting policies considered most critical. FRR 60 considers an accounting policy to be critical if it is important to the company’s financial condition and results, and requires significant judgment and estimates on the part of management in its application. We believe the accounting policies described below represent our critical accounting policies as contemplated by FRR 60. See Note 1 to the accompanying Consolidated Financial Statements for a detailed discussion on the application of these and other accounting policies.
 
Accounting for Long-Lived Assets. The majority of our long-lived assets are the result of the acquisition of existing license brands. For newly launched brands or sublicensing opportunities our long-lived assets are generally the result of our investment in trademarking brand names and designs, and are generally not a material portion of our assets. The value of our long-lived assets, including brand licenses and trademarks, is exposed to future adverse changes if we experience declines in operating results or experience significant negative industry or economic trends. On an annual basis, long-lived assets are reviewed for impairment, or sooner, if events or circumstances have occurred that indicate a potential impairment. Impairment losses are recognized if expected undiscounted future cash flows of the long-lived assets are less than their carrying values. Future cash flows can be affected by changes in industry or market conditions. The assumptions used include an analysis by license, and by fragrance produced under each license, which may vary depending on the age of the product. Expected sales along with related costs of sales, direct expenses and certain allocated charges are projected through the end of each given license period. Expected sales estimates incorporate the age of a product and its market distribution. Although certain products may not be widely distributed, we may have certain distribution channels, such as specialty discount stores, where the product is in demand. Direct expenses, including cost of goods and royalties, vary by product, but generally range from 35% to 50%. Allocated charges include selling and distribution costs, marketing expenses and depreciation of molds. Although these costs vary by brand, management anticipates that these costs would range between 15% and 25%. The net unamortized balance of our trademarks, licenses and sublicenses at March 31, 2011, is approximately $4.2 million. Management does not anticipate any further material write down will be required going forward, however, if actual results differ from management’s estimates, or if the economic environment should deteriorate, additional write downs may be required which could have a material adverse effect on our operating results.
 
Allowance for Sales Returns. As is customary in the prestige fragrance industry, we grant certain of our unrelated U.S. department store customers the right to return a product or receive a markdown allowance for product that does not “sell-through” to consumers. At the time of sale, we record a provision for estimated product returns or markdowns based on our level of sales, historical “sell-through” experience, current economic trends and changes in our assessment of customer demand. We make detailed estimates at the product and customer level, which are then aggregated to arrive at a consolidated provision for product returns and markdowns and are reviewed periodically as facts and circumstances warrant. Such provisions and markdown allowances are recorded as a reduction of net sales. Because there is considerable judgment used in evaluating the allowance for returns and markdowns, it is reasonably likely that actual experience will differ from our estimates. If, for example, customer demand for our products is lower than estimated or a proportionately greater amount of sales is made to prestige department stores and/or specialty beauty stores, additional provisions for returns or markdowns may be required resulting in a charge to income in the period in which the determination was made. Similarly, if customer demand for our products is higher than estimated, a reduction of our provision for returns or markdowns may be required resulting in an increase to income in the period in which the determination was made. Sales returns generally follow seasonal gift-giving periods such as Mother’s Day, Christmas, etc. In addition, the global economic downturn of the past few years has also led retailers to reduce inventory levels thereby increasing returns after the major gift-giving seasons. All other customers have no right to return products unless they are damaged or otherwise unsellable.
 
The allowance for sales returns was $1.7 million and $2.3 million at March 31, 2011 and 2010, respectively.  It generally takes between two to three-months for us to receive such returns. Historically, our estimated allowances have been sufficient to cover the amount of returns subsequently received. However, an increase in sales returns due to a change in economic conditions, or otherwise, could have a material impact on our operating results.
 
 
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Allowances for Doubtful Accounts Receivable. We maintain allowances for doubtful accounts to cover anticipated uncollectible accounts receivable, and we evaluate our accounts receivable to determine if they will ultimately be collected. This evaluation includes significant judgments and estimates, including a customer-by-customer review for large accounts. If the financial condition of our customers, or any one customer, deteriorates resulting in an impairment of their ability to pay, additional allowances may be required.
 
The allowance for doubtful accounts receivable was $0.9 million and $0.7 million at March 31, 2011 and 2010, respectively. We continuously monitor the collectability of our receivables by analyzing the aging of our accounts receivable, assessing our customers credit worthiness, and evaluating the impact of the changes in economic conditions. Historically, our estimated allowances have been sufficient to cover our uncollectible receivables. However, significant changes in the circumstances that affect the collectability of our receivables could have a material impact on our cash flows and operating results.
 
We have had an ongoing relationship with Perfumania for approximately twenty years. All activities with Perfumania are reported as related party activities, due to certain common stockholders. Management evaluates the credit risk involved, which is determined based on Perfumania’s reported results and comparable store sales performance. Our management holds discussions with Perfumania’s management on a regular on-going basis in order to monitor their activity. On an annual basis, as well as quarterly, sales projections to Perfumania are reviewed along with a planned payment program, in order to ensure that Perfumania’s receivable balance is maintained at acceptable levels. Based upon these facts, management believes that no reserves are required for the receivable due from Perfumania.
 
Inventory Write-downs. Inventories are stated at the lower of cost (using the first-in, first-out method) or market. The cost of inventories includes product costs, inbound freight and handling charges, including an allocation of our applicable overhead in an amount of $3.8 million and $3.2 million at March 31, 2011 and 2010, respectively.
 
The lead time for certain of our raw materials and components inventory (up to 180 days) requires us to maintain at least a three to six-month supply of some items in order to ensure production schedules. These lead times are most affected for glass and plastic component orders, as many of our unique designs require the production of molds in addition to the normal production process. This may take 180 to 240 days, or longer, to receive in stock. In addition, when we launch a new brand or SKU, we frequently produce a six to nine-month supply to ensure adequate inventories if the new products exceed our forecasted expectations. Generally gross margins on our products outweigh the potential loss due to out-of-stock situations, and the additional carrying costs to maintain higher inventory levels. Also, the composition of our inventory at any given point can vary considerably depending on whether there is a launch of a new product, or a planned sale of a significant amount of product to one or more of our major distributors. However, if future sales do not reach forecasted levels, it could result in excess inventories and may cause us to decrease prices to reduce inventory levels.
 
We classify our inventory into three major categories: finished goods, raw materials, and components and packaging materials. Finished goods include items that are ready for sale to our customers, or essentially complete and ready for use in value sets or other special offers. Raw materials consist of fragrance oils or bulk. Components and packaging materials (such as bottles, caps, boxes, etc.) are the individual elements used to manufacture our finished goods. The levels of our inventory maintained vary depending on the age of a brand, its commercial success and market distribution. We normally carry higher levels of new products and older products for which demand remains high. Older, slower moving products are periodically reviewed, and inventory levels adjusted, based upon expected future sales. If inventory levels exceed projected demand, our management determines whether a product requires a markdown in order to sell the inventory at discounted prices. Our management also reviews whether there are any excess components which should be marked down or scrapped due to decreased product demand.
 
 
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Our inventories and write-downs, by major categories, as of March 31, 2011 and 2010, are as follows:
 
 
March 31, 2011
 
 
Finished
Goods
 
Components
and Packaging
Material
 
Raw
Material
 
Total
 
 
(in millions)
 
Inventories
  $ 21.4     $ 14.5     $ 2.3     $ 38.2  
Less write-downs                  
    0.3       0.4       0.1       0.8  
Net inventories
  $ 21.1     $ 14.1     $ 2.2     $ 37.4  
                                 
 
March 31, 2010
 
 
Finished
Goods
 
Components
and Packaging
Material
 
Raw
Material
 
Total
 
 
(in millions)
 
Inventories
  $ 28.2     $ 22.2     $ 2.6     $ 53.0  
Less write-downs
    4.9       6.0       0.3       11.2  
Net inventories
  $ 23.3     $ 16.2     $ 2.3     $ 41.8  
 
We perform a review of our inventory on a quarterly basis, unless events or circumstances indicate a need for review more frequently. The write-down of inventory results from the application of an analytical approach that incorporates a comparison of our sales expectations to the amount of inventory on hand. Other qualitative reasons for writing down selected inventory may include, but are not limited to, product expiration, licensor restrictions, damages, and general economic conditions. As of March 31, 2011 and 2010, of our total inventories of $38.2 million and $53.0 million, respectively, management determined that approximately $5.9 million and $9.5 million, respectively, of the finished goods inventory was either selling slower than anticipated or showed signs of deterioration. This inventory was written-down by $0.3 million and $4.9 million in fiscal year 2011 and 2010, respectively. Components and packaging materials are reviewed in light of estimated future sales for finished goods or damages sustained during the production of finished goods. As of March 31, 2011 and 2010, approximately $1.7 million and $7.7 million, respectively, were identified as problematic and the inventory was written-down by $0.4 million and $6.0 million, respectively.  Raw materials are usually scrapped due to spoilage or stability issues.  As of March 31, 2011 and 2010, approximately $0.1 million and $0.3 million were identified as problematic and the inventory was written-down by $0.1 million and $0.3 million, respectively.
 
Our license with GUESS? expired on December 31, 2009, and was not renewed.  As of March 31, 2010, the Company recorded charges of $7.6 million, which was included in the $11.2 million write-down noted above, to cost of sales – expired license, in the accompanying Consolidated Statements of Operations for the year ended March 31, 2010, to reduce the recorded value of such inventories to the amounts, which we estimated could be realized upon their sale or liquidation.
 
During the years ended March 31, 2011, 2010 and 2009, the carrying value of certain inventory was reduced by $0.8 million, $11.2 million (including $7.6 million relating to GUESS? products), and $0.2 million, respectively, which was recorded in cost of goods sold in the accompanying Consolidated Statements of Operations. Based upon this review, management has determined that its inventory is stated at the lower of cost or market value, however, if we are not successful in selling our inventory, we may need to write down our inventory further or sell it at significantly reduced prices or we may not be able to sell such inventory at all, which could have a material adverse affect on our financial condition and results of operations.
 
 
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Demonstration and Cooperative Advertising Allowances. We record allowances for demonstration chargebacks and cooperative advertising costs. The demonstration chargebacks are recorded based on demonstration programs with specific U.S. department stores. The allowance for demonstration chargebacks was $0.9 million and $0.6 million at March 31, 2011 and 2010, respectively. Fluctuations in the allowance balance are generally higher after gift-giving seasons and are estimated based on a three-month period. Cooperative advertising, which is under the direct control of our customer and includes a percentage rebate or deduction based on net sales to the customer, is accrued and recorded as a reduction of net sales at the time of sale. Cooperative advertising with our customers, which is under our direct control, and at our option, including catalogue and other forms of print advertising, are included in advertising and promotional expenses in the accompanying Consolidated Statements of Operations. The costs associated with the specific advertisements are recorded as incurred, and when applicable, are applied against trade accounts receivable. The allowance for cooperative advertising was $0.4 million and $0.5 million at March 31, 2011 and 2010, respectively. Historically, our estimated allowances have been sufficient to cover the amount of our chargebacks and cooperative advertising costs.
 
Income Taxes and Valuation Allowance. If warranted, we record a valuation allowance to reduce deferred tax assets to the amount that is more-likely-than-not to be realized. We consider projected future taxable income and ongoing tax planning strategies in assessing the valuation allowance. In the event we determine that we may not be able to realize all or part of our deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to earnings in the period of such determination, which such adjustment could be material.
 
The accounting for uncertainty in income taxes recognized in the financial statements prescribes a recognition threshold of more-likely-than-not and a measurement attribute on all tax positions taken or expected to be taken in a tax return in order to be recognized in the financial statements. In making this assessment, a company must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based solely on the technical merits of the position and must assume that the tax position will be examined by appropriate taxing authority that would have full knowledge of all relevant information. Once the recognition threshold is met, the tax position is then measured to determine the actual amount of benefit to recognize in the financial statements. In addition, the recognition threshold of more-likely-than-not must continue to be met in each reporting period to support continued recognition of the tax benefit. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the financial reporting period in which that threshold is no longer met. We did not recognize a liability for unrecognized tax benefits or adjust any recorded liabilities for uncertain tax positions.  As of the years ended March 31, 2011 and 2010, there was no material liability for income tax associated with unrecognized tax benefits. We do not anticipate any material adjustments relating to unrecognized tax benefits within the next twelve months, however, the outcome of tax matters is uncertain and unforeseen results can occur.
 
Stock-Based Compensation. We recognize the cost of share-based compensation expense in the accompanying Consolidated Financial Statements for stock options and warrants granted, based on the fair values of the awards at the date of grant over the vesting period. We use the Black-Scholes valuation model to determine the compensation expense. When estimating forfeitures, we consider an analysis of actual option forfeitures, as well as management judgment. The forfeiture rate used when calculating the value of stock options granted in 2011 and 2010 was approximately 7% and 5%, respectively.
 
During the fiscal years ended 2011, 2010 and 2009, we have not made any changes of these critical accounting policies, nor have we made any material changes in any of the critical accounting estimates underlying these accounting policies.
 
Recent Accounting Updates
 
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06 (“ASU No. 2010-06”), Improving Disclosure about Fair Value Measurements, under Topic 820, Fair Value Measurements and Disclosures, to improve and provide new disclosures for recurring and nonrecurring fair value measurements under the three-level hierarchy of inputs for transfers in and out of Levels 1 (quoted prices in active markets for identical assets or liabilities) and 2 (significant other observable inputs), and activity in Level 3 (significant unobservable inputs). This update also clarifies existing disclosures of the level of disaggregation for the classes of assets and liabilities and the disclosure about inputs and valuation techniques. ASU No. 2010-06 new disclosures and clarification of existing disclosures is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for financial statements issued for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of ASU No. 2010-06, as it relates to new disclosures and clarifications of existing disclosures did not have a material impact on our consolidated financial statements.  We do not expect the adoption of ASU No. 2010-06, as it relates to certain disclosures of activity in Level 3 fair value measurements to have a material impact on our consolidated financial statements.
 
 
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Significant Trends
 
A significant number of new prestige fragrance products continue to be introduced on a worldwide basis. The beauty industry, in general, is highly competitive and consumer preferences often change rapidly.  The initial appeal of these new fragrances, launched for the most part in U.S. department stores, fuels the growth of our industry.  Department stores generally lose sales to the mass market as a product matures.  To counter the effect of lower department store sales, companies introduce new products, which requires additional spending for development and advertising and promotional expenses.  In addition, a number of the new launches are with celebrities (mainly entertainers and athletes), which require substantial royalty commitments, and whose careers and/or appeal could change drastically, both positively and negatively, based on a single event.  If one or more of our new product introductions is unsuccessful, or the appeal of a celebrity that is tied to any of our fragrances diminishes, it could result in a substantial reduction in profitability and operating cash flows.
 
Certain U.S. department store retailers have consolidated operations resulting in the closing of retail stores, as well as implementing various inventory control initiatives. The result of these consolidation efforts include lower inventories maintained by the retailers and higher levels of returns after each gift-giving holiday season.   Store closings, inventory control initiatives, and the current global economic conditions may continue to adversely affect our sales in the short-term. In response to the above conditions, we implemented a number of cost reduction initiatives, beginning in fiscal year 2009 and continuing in fiscal years 2010 and 2011, including a targeted reduction in staff, along with a reduction in committed advertising and promotional spending, and reduced our production levels.
 
Since late 2008, U.S. department store retailers experienced a major reduction in consumer traffic, resulting in decreased sales. In response, the retailers offered consumers deep discounts on most of their products. As is customary in the fragrance industry, these discounts, for the most part, were not offered on fragrances and cosmetics. This resulted in an overall reduction in sales of these products.
 
Historically, as is the case for most fragrance companies, our sales have been influenced by seasonal trends generally related to holiday or gift-giving periods. Substantial sales often occur during the final month of each quarter.  There can be no assurance that these sales trends will support planned objectives in future periods and may negatively affect our financial condition and results in future periods.
 
In light of the downturn in the global economy, we have performed a quarterly review of our intangible long-lived assets during the years ended March 31, 2011, 2010 and 2009.  This review was based upon the estimated future undiscounted net cash flows for the remaining period of each license.  Based upon our review, no impairment charges were deemed necessary.
 
 During the last three fiscal years we launched the following fragrances:
 
Fiscal year ended March 31, 2011:
 
·  
Paris Hilton Tease
 
·  
Paris Hilton – The Passport Series
 
·  
Jessica Simpson Fancy Nights
 
·  
Queen Latifah Queen of Hearts
 
·  
Marc Ecko Blue for Men
 
·  
UNLTD by Marc Ecko
 
·  
Nicole Miller for Women (new license)
 
·  
Rihanna Reb’l Fleur (new license)
 
 
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Fiscal year ended March 31, 2010:
 
·  
Paris Hilton Siren
 
·  
Jessica Simpson Fancy Love
 
·  
Queen Latifah Queen (new license)
 
·  
Marc Ecko for Men (new license)
 
·  
Josie Natori for Women (new license)
 
Fiscal year ended March 31, 2009:
 
·  
GUESS? by Marciano for Men
 
·  
Paris Hilton Fairy Dust
 
·  
Jessica Simpson Fancy (new license)
 
As noted in our discussion of sales, below, excluding GUESS? brand net sales, our net sales for the year ended March 31, 2011, increased 16%, as compared to the prior year.
 
It is always difficult to predict sales levels, and is even more difficult in a challenging economic environment. We continue to take steps to control our expenses by maintaining or reducing operating expenses, where feasible.  We have returned to the basics of controlled, in-store promotional activity, and have significantly reduced major new license introductions.  We have launched new brand names under existing licenses and sublicenses, as noted above.  These activities were far less costly than the launch of a new license fragrance.  We are cautiously optimistic that we are positioned for a profitable fiscal year 2012 with our expected product mix and revised cost structure.
 
Results of Operations
 
During the year ended March 31, 2011, we experienced a 17% decrease in overall sales, as compared to the prior year ended March 31, 2010. The decrease was primarily due to the expiration of our GUESS? brand license and the continued negative impact of the global economic climate.  GUESS? brand net sales for the year ended March 31, 2010, were approximately $43.0 million.  If we exclude these GUESS? brand net sales from the same prior year period net sales, our overall net sales increased over the prior year period by 16%.  Although overall sales increased early during this past holiday season, during December 2010 our domestic department stores business, once again, encountered a difficult retail market.  Domestic retailers continue to carefully monitor inventory stock levels, which, in turn, affects both order levels as well as post-holiday returns.  Nevertheless, the expense controls and reduced spending discussed above, resulted in net income of $1.2 million for the year ended March 31, 2011, as compared to a net loss of $(14.8) million for the prior year.
 
 
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Our license with GUESS? expired on December 31, 2009, and was not renewed.  During the years ended March 31, 2011 and 2010, we transferred $1.4 million and $4.6 million, respectively, of GUESS? brand inventory to GUESS? and/or its new fragrance licensee at its net carrying value. This transfer of inventory, along with the cost of sales for the brand, have been classified as “Sales-expired license” and “Cost of sales-expired license” in the accompanying  Consolidated Statements of Operations for the years ended March 31, 2011 and 2010.  During the year ended March 31, 2010, we recorded charges of $7.6 million to cost of sales to reduce the recorded value of such inventories to the amounts which we estimated could be realized upon their sale or liquidation. In addition, during the year ended March 31, 2010, we wrote-off approximately $1.7 million of collateral material related to the GUESS? brand products, which was recorded as advertising and promotional expense.

Our gross margins may not be comparable to other entities that include all of the costs related to their distribution network in costs of goods sold, since we allocate a portion of these distribution costs to costs of goods sold and include the remaining unallocated amounts as selling and distribution expenses. Selling and distribution expenses for the years ended March 31, 2011, 2010 and 2009, included $3.9 million, $4.4 million, and $4.9 million, respectively, relating to the cost of warehouse operations not allocated to inventories and other related distribution expenses (excluding shipping expenses which are recorded as cost of goods sold). A portion of these costs is allocated to inventory in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

Comparisons of the year ended March 31, 2011 to March 31, 2010, and of the year ended March 31, 2010 to March 31, 2009.
 
Net Sales
 
   
For the Years Ended March 31,
 
   
2011
   
%
Change
   
2010
   
%
Change
   
2009
 
     (in millions)  
Domestic sales
  $ 40.7       (14 )%   $ 47.6       (12 )%   $ 53.9  
International sales
    29.7       (36 )%     46.3       (17 )%     55.8  
Unrelated customer sales
    70.4       (25 )%     93.9       (14 )%     109.7  
Related parties sales
    51.2       3 %     49.6       20 %     41.5  
Sales – expired license
    1.4       (69 )%     4.6       100 %      
Total net sales
  $ 123.0       (17 )%   $ 148.1       (2 )%   $ 151.2  
———————
*
% change is based on unrounded numbers
 
During fiscal year 2011, net sales decreased 17% to $123.0 million, as compared to $148.1 million for the prior year. The decrease was primarily due to the expiration of our GUESS? brand license resulting in a decrease in net sales of $43.0 million, as well as a $5.7 million reduction in our sales of Queen Latifah brand fragrances (originally launched in the prior year), as compared to the prior year, and the continued weak global economic climate. The decrease was partially offset by an increase in Paris Hilton and Jessica Simpson brand fragrances gross sales of $12.2 million and $1.8 million, respectively, as compared to the prior year, as well as gross sales from our new Rihanna brand fragrance, Reb’l Fleur, of approximately $9.3 million.
 
Excluding GUESS? brand sales, our net sales for the year ended March 31, 2011, increased  16%, as compared to the prior year.
 
Net sales to unrelated customers, which represented 57% of our total net sales for fiscal year 2011, decreased 25% to $70.4 million, as compared to $93.9 million for the prior year, primarily due to a decrease in sales in both our international and domestic markets.  Net sales to the U.S. department store sector decreased 14% to $40.7 million for fiscal year 2011, as compared to $47.6 million for the prior year, while net sales to international distributors decreased 36% to $29.7 million from $46.3 million for the prior year. The decrease in both domestic and international net sales was primarily due to the expiration of the GUESS? license and the continued weak global economic conditions. These decreases were partially offset by increases of our Paris Hilton and Jessica Simpson fragrances, along with the launch of our new Rihanna brand fragrance.
 
 
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 Net sales to related parties, which represented 42% of our total sales for fiscal year 2011, increased 3% to $51.2 million, as compared to $49.6 million for the prior year.  The increase was primarily due to an increase in gross sales of our Paris Hilton brand fragrances to Perfumania resulting in gross sales of $37.5 million, as compared to $27.2 million in the prior year.  In addition to our sales to Perfumania, we had net sales of $3.7 million for fiscal year 2011 to Jacavi, a fragrance distributor, also classified as a related party, as compared to $3.0 million in the prior year.  See “Liquidity and Capital Resources” and Note 2 to the accompanying Consolidated Financial Statement for further discussion of related parties.
 
During fiscal year 2010, net sales decreased 2% to $148.1 million, as compared to $151.2 million for the prior year. The decrease in net sales was primarily due to an increase of $6.9 million in our sales returns and allowances, as compared to the prior year, resulting from the holiday season and the continuing effect of the global economic environment. During the holiday season, U.S. department store retailers continued to experience reductions in consumer traffic, resulting in lower sales, a decrease in retail re-orders, and an increase in subsequent returns.  During fiscal year 2010, the decrease in net sales was partially offset by additional net sales of $4.6 million from the transition of the GUESS? brand products sold to its new fragrance licensee, at cost, as a result of the expiration of the GUESS? fragrance license, which is classified as Sales-expired license in the accompanying Consolidated Statements of Operations. Excluding these sales, our net sales would have decreased by 5%.  See Note 3 to the accompanying Consolidated Financial Statements for further discussion.
 
Net sales to unrelated customers, which represented 63% of our total net sales for fiscal year 2010, decreased 14% to $93.9 million, as compared to $109.7 million for the prior year, primarily due to a decrease in international and domestic sales, resulting from the global economic conditions. Net sales to the U.S. department store sector decreased 12% to $47.6 million for fiscal year 2010, as compared to $53.9 million for the prior year, while net sales to international distributors decreased 17% to $46.3 million from $55.8 million for the prior year. The decrease in our domestic market was primarily due to an increase in sales returns and allowances resulting from a difficult retail climate with store retailers drastically reducing inventory levels due to declining consumer traffic, as well as the GUESS? license transition, as discussed above. Our sales of GUESS? products to all of our customers, except for sales to GUESS? and its new fragrance licensee, ceased during the quarter ended December 31, 2009. The decrease in domestic sales was partially offset by the sales of our new Jessica Simpson fragrance, Fancy Love, our new Paris Hilton fragrance, Siren, and our new Queen Latifah fragrance, Queen, resulting in an increase in gross sales of $12.7 million, $8.7 million, and $13.7 million, respectively, and sales of our new Marc Ecko men’s fragrance, Ecko, resulting in an increase in gross sales of $7.0 million.  The decrease in international net sales was primarily due to a shift in our focus from international to domestic sales, as our new licenses were initially launched in the domestic channel, where these new products have more appeal. The continuing challenging global economic environment also negatively affected our sales.
 
Net sales to related parties, which represented 34% of our total net sales for fiscal year 2010, increased 20% to $49.6 million, as compared to $41.5 million for the prior year. The increase is primarily due to an increase in gross sales of $9.6 million of GUESS? brand fragrances to Perfumania. In addition to our sales to Perfumania and Quality King, we had net sales of $3.0 million to Jacavi. See Note 2 to the accompanying Consolidated Financial Statements for further discussion of related party transactions.
 
                Cost of Goods Sold and Gross Margin
 
   
For the Years Ended March 31,
 
   
2011
   
%
Change *
   
2010
   
%
Change *
   
2009
 
    (in millions)  
Unrelated customers
  $ 29.4       (35 )%   $ 44.9       (12 )%   $ 51.3  
As a % of unrelated customer net sales
    42 %             48 %             47 %
Related parties
    24.0       (18 )%     29.2       51 %     19.3  
As a % of related parties net sales
    47 %             59 %             46 %
Cost of sales – expired license
    1.4       (88 )%     11.9       100 %      
As a % of expired license net sales
    100 %             257 %             0 %
Total cost of goods sold
  $ 54.8       (36 )%   $ 86.0       22 %   $ 70.6  
As a % of net sales
    45 %             58 %             47 %
                                         
Gross Margin
  $ 68.2       10 %   $ 62.1       (23 )%   $ 80.6  
As a % of net sales
    55 %             42 %             53 %
———————
*
% change is based on unrounded numbers
 
 
32

 
 
During fiscal year 2011, our overall cost of goods sold decreased as a percentage of net sales to ­­45%, as compared to 58% for the prior year. Cost of goods sold as a percentage of net sales to unrelated customers and related parties was 42% and 47%, respectively, in 2011, as compared to 48% and 59%, respectively, for the prior year. During fiscal year 2011, the cost of goods sold to unrelated customers decreased, as a percentage of unrelated customers net sales, due to the expiration of the GUESS? license.  In the prior year, we offered additional incentives to reduce our GUESS? inventory, which resulted in reduced margins on those sales.
 
Our sales to U.S. department store customers generally have a higher margin than sales to international distributors. As is common in the industry, we offer international customers more generous discounts, which are generally offset by reduced advertising expenditures for those sales, as the international distributors are responsible for advertising in their own territories. International distributors have no rights to return merchandise. In addition, in accordance with US GAAP, certain promotional activities, such as gifts with purchase, are included in our cost of goods sold.  As the timing and level of promotional activities vary based on product launches and the seasonality of major gift-giving holidays, we experience fluctuations in our cost of sales percentage and gross margins.
 
During fiscal year 2010, our overall cost of goods sold increased as a percentage of net sales to 58%, as compared to 47% for the prior year. Cost of goods sold as a percentage of net sales to unrelated customers and related parties was 48% and 59%, respectively, in 2010, as compared to 47% and 46%, respectively, for the prior year.  During fiscal year 2010, sales of slower moving merchandise to our unrelated international customers resulted in lower margins, as compared to the prior year. This was partially offset by our newly launched products sold primarily in our domestic market which resulted in higher margins. During fiscal year 2010, cost of goods sold to related parties increased primarily due to an increase in related party sales of slower-moving merchandise and excess inventory, which resulted in lower margins. In addition, due to the expiration of our GUESS? license, we offered additional incentives in order to reduce our GUESS? inventory and incurred additional cost of goods sold of $11.9 million, from the transition of the GUESS? brand products sold to its new fragrance licensee, including $4.6 million from the sale of the products, at cost. Included therein is a provision of $7.6 million for the write-down of the remaining GUESS? inventory resulting from the expiration of the GUESS? fragrance license, which is classified as Cost of sales-expired license in the accompanying Consolidated Statements of Operations. See Note 3 to the accompanying Consolidated Financial Statements for further discussion.
 
During fiscal year 2011, our gross margin increased 10% to $68.2 million from $62.1 million for the prior year, increasing as a percentage of net sales to 55% from 42%.  The increase as compared to the prior year was primarily due to the expiration of the GUESS? license.  During fiscal year 2010, we incurred additional cost of goods sold of $11.9 million, from the transition of the GUESS? brand products sold to its new fragrance licensee, which includes a provision of $7.6 million for the write-down of the remaining GUESS? inventory resulting from the expiration of the GUESS? fragrance license, and was classified as Cost of sales-expired license in the accompanying Consolidated Statements of Operations.
 
Operating Expenses
 
   
For the Years Ended March 31,
 
   
2011
   
%
Change *
   
2010
   
%
Change *
   
2009
 
   
(in millions)
 
Advertising and promotional
  $ 32.7       (27 )%   $ 44.9       (1 )%   $ 45.4  
As a % of net sales
    27 %             30 %             30 %
Selling and distribution
    12.3       (13 )%     14.2       (11 )%     15.9  
As a % of net sales
    10 %             10 %             11 %
Royalties
    10.3       (23 )%     13.4       3 %     13.0  
As a % of net sales
    8 %             9 %             9 %
General and administrative
    8.1       (21 )%     10.3       (2 )%     10.6  
As a % of net sales
    7 %             7 %             7 %
Depreciation and amortization
    2.3       (20 )%     2.9       15 %     2.5  
As a % of net sales
    2 %             2 %             2 %
Total operating expenses
  $ 65.7       (23 )%   $ 85.7       (2 )%   $ 87.4  
As a % of net sales
    53 %             58 %             58 %
———————
*
% change is based on unrounded numbers
 
 
33

 
 
In fiscal year 2011, total operating expenses decreased 23% to $65.7 million, from $85.7 million in the prior year, decreasing as a percentage of net sales to 53% from 58%.  In fiscal year 2010, total operating expenses decreased 2% to $85.7 million from $87.4 million, remaining constant as a percentage of net sales at 58%.  However, certain individual components of our operating expenses discussed below experienced more significant changes than others.
 
Advertising and Promotional Expenses
 
Advertising and promotional expenses decreased 27% to $32.7 million for the year ended March 31, 2011, as compared to $44.9 million for the prior year, decreasing as a percentage of net sales to 27% from 30%. The decrease was primarily due to targeted reductions in advertising costs and a decrease in promotional activities and marketing fees relating to the expired GUESS? license, partially offset by an increase in in-store demonstration costs both in U.S. department stores and internationally.  In addition, during fiscal year 2010, we wrote-off and destroyed approximately $1.7 million of collateral material related to the GUESS? brand products, which was recorded as advertising and promotional expense. In anticipation of the launch of our new brand, Rihanna’s Reb’l Fleur, our advertising and promotional spending increased during our fourth quarter ended March 31, 2011.  However, in keeping with our ongoing cost-control efforts, we focused our spending on social media initiatives rather than traditional advertising outlets such as print and media.  This included the production of a special viral video launched on an interactive website which as of May 25, 2011, generated over 1.0 million views.  The initial results of this focused initiative have been very positive.
 
Advertising and promotional expenses decreased 1% to $44.9 million for the year ended March 31, 2010, as compared to $45.4 million for the prior year, remaining constant as a percentage of net sales at 30%. The decrease in advertising and promotional expense is primarily due to targeted reductions in advertising and demonstration costs of $2.7 million, as compared to the prior year. The decrease was partially offset by an increase in promotional expense relating to the launches of the Jessica Simpson fragrance, Fancy Love, and the Paris Hilton fragrance, Siren, in June 2009, as well as our product launches of the new fragrances under our Queen Latifah, Josie Natori, and Marc Ecko licenses during the second quarter of fiscal year 2010, as compared to the launch of three fragrances, Jessica Simpson fragrance, Fancy, and Paris Hilton fragrance, Fairy Dust, in the fall of 2008 and GUESS? by Marciano for Men in February 2009 in the prior year. In addition, during fiscal year 2010 we wrote-off approximately $1.7 million of collateral material related to the GUESS? brand products upon expiration of this license, which was recorded as advertising and promotional expense.
 
Selling and Distribution Costs
 
Selling and distribution costs decreased 13% to $12.3 million for the year ended March 31, 2011, as compared to $14.2 million for the prior year, remaining constant as a percentage of net sales at 10%. The decrease in selling and distribution costs was primarily due to a decrease in sales personnel and the related benefits and insurance expenses in our domestic market, as compared to the prior year.   During the prior year, we incurred additional selling expenses with the launch of three newly licensed brands and two new fragrances from existing brand licenses, as compared to two newly licensed brands and six new fragrances from existing brand licenses in fiscal year 2011.  In addition, we incurred lower warehouse operational costs of $3.9 million, for the year ended March 31, 2011, as compared to $4.4 million in the prior year.  This decrease was primarily due to our cost-cutting measures and improved inventory control.
 
Selling and distribution costs decreased 11% to $14.2 million for the year ended March 31, 2010, as compared to $15.9 million for the prior year, decreasing as a percentage of net sales to 10% from 11%. The decrease in selling and distribution costs was primarily due to a decrease in sales personnel, and the related benefits and insurance expenses both in our domestic and international markets, and a decrease in individual sales representative commissions in our international markets. In addition, we incurred lower warehouse operational costs of $4.4 million, as compared to $4.9 million, in the prior year.
 
Royalties
 
Royalties decreased 23% to $10.3 million for the year ended March 31, 2011, as compared to $13.4 million for the prior year, decreasing as a percentage of net sales to 8% from 9%.  The overall decrease in royalties expense reflects lower sales for the year ended March 31, 2011, as compared to the prior year.  Royalties were further reduced during fiscal year 2011, as we accrued and expensed during the fourth quarter of fiscal year 2010, the remaining royalty obligations for the Paris Hilton cosmetics license, which expired on January 15, 2011, and was not renewed. The assignment of the worldwide exclusive licensing rights for the production and distribution of Paris Hilton sunglasses and the sublicensed international rights for the handbags continue to absorb a portion of the minimum royalty. We generated sublicense revenue of $0.2 million, during fiscal year 2011, as compared to $0.6 million for the prior year, which has been recorded as a reduction in royalty expense.  The Paris Hilton handbag license expired on January 15, 2011, and was not renewed.
 
Royalties increased by 3% to $13.4 million for the year ended March 31, 2010, as compared to $13.0 million for the prior year, remaining constant as a percentage of net sales at 9%. The increase in royalties reflects contractual royalty rates on actual sales coupled with minimum royalty requirements, most notably for Paris Hilton cosmetics, sunglasses, and handbags, as well as XOXO, babyGUND, and Andy Roddick fragrances, for which minimum sales levels were not achieved. The license for Paris Hilton cosmetics is due to expire on January 15, 2011, and all remaining royalty obligations have been accrued and expensed in fiscal year 2010.  In fiscal year 2009, we assigned the worldwide exclusive licensing rights for the production and distribution of Paris Hilton sunglasses, which began generating sublicensing revenues in August 2009. In fiscal year 2008, we sublicensed the international rights for the handbags, which continued to absorb a portion of the minimum royalty. We generated sublicense revenue for these two licenses of $0.6 million in fiscal year 2010, as compared to $0.4 million, for the prior year, which has been recorded as a reduction in royalty expense.
 
 
34

 
 
General and Administrative Expenses
 
General and administrative expenses decreased 21% to $8.1 million for the year ended March 31, 2011, as compared to $10.3 million for the prior year, remaining constant as a percentage of net sales at 7%. The decrease in general and administrative expenses was primarily due to a decrease in personnel and the related benefits and insurance expenses (as noted above) and lower professional fees. During the year ended March 31, 2011, we were able to resolve certain past due accounts receivables, which allowed us to reduce our reserves for uncollectible accounts receivables, resulting in a decrease in bad debt expense of $0.5 million, as compared to the prior year.
 
General and administrative expenses decreased 2% to $10.3 million for the year ended March 31, 2010, as compared to $10.6 million for the prior year, remaining constant as a percentage of net sales at 7%. The decrease in general and administrative expenses was primarily due to a decrease in personnel and the related benefits and insurance expenses, partially offset by an increase in professional fees and severance costs, as compared to the prior year.
 
Depreciation and Amortization
 
Depreciation and amortization decreased 20% to $2.3 million for the year ended March 31, 2011, as compared to $2.9 million for the prior year, remaining constant as a percentage of net sales at 2%. The decrease relates to lower amortization expense of molds and tooling and a decrease in intangible assets amortization, as compared to the prior year. On June 30, 2010, our XOXO license expired and was not renewed, and the fully amortized intangible asset was written-off.
 
Depreciation and amortization increased 15% to $2.9 million for the year ended March 31, 2010, as compared to $2.5 million for the prior year, remaining constant as a percentage of net sales at 2%. The increase includes additional amortization of molds and tooling associated with our new brand products launched during fiscal year 2010.
 
Operating Income (Loss)
 
   
For the Years Ended March 31,
 
   
2011
   
%
Change *
   
2010
   
%
Change *
   
2009
 
               
(in millions)
             
Operating income (loss)
  $ 2.5       111 %   $ (23.5 )     (246 )%   $ (6.8 )
As a % of net sales
    2 %             (16 )%             (5 )%
Net interest (expense and bank charges) income
    (0.6 )     (153 )%     (0.2 )     (202 )%     0.2  
As a % of net sales
    0 %             0 %             0 %
Foreign exchange loss
          N/A             N/A        
As a % of net sales
    0 %             0 %             0 %
Income (loss) before income taxes
  $ 1.9       108 %   $ (23.7 )     (261 )%   $ (6.6 )
As a % of net sales
    2 %             (16 )%             (4 )%
———————
*
% change is based on unrounded numbers
 
 
35

 
 
As a result of the factors discussed above, we earned operating  income of $2.5 million in fiscal year 2011, as compared to incurring an operating loss of $(23.5) million and $(6.8) million in fiscal years 2010 and 2009, respectively.
 
Net Interest Income/Expense
 
Net interest expense was $0.6 million for the year ended March 31, 2011, as compared to $0.2 million for the prior year.  During the year ended March 31, 2011, we incurred loan fees relating to our new credit facility with GE Capital, which are being amortized to expense over the life of the credit facility.  In the prior year, we incurred interest expense as we utilized a portion of our prior line of credit with Regions.
 
Net interest expense was $0.2 million for the year ended March 31, 2010, as compared to net interest income of $0.2 million for the prior year, as we utilized a portion of our line of credit with Regions Bank during fiscal year 2010.
 
Income (Loss) Before Income Taxes, Income Taxes and Net Income (Loss)
 
   
For the Years Ended March 31,
 
   
2011
   
%
Change *
   
2010
   
%
Change *
   
2009
 
               
(in millions)
             
Income (loss) before income taxes
  $ 1.9       108 %   $ (23.7 )     (261 )%   $ (6.6 )
As a % of net sales
    2 %             (16 )%             (4 )%
Income tax provision (benefit)
    0.7       N/A       (8.9 )     N/A       (2.3 )
As a % of net sales
    (1 )%             6 %             2 %
Net income (loss)
  $ 1.2       108 %   $ (14.8 )     (245 )%   $ (4.3 )
As a % of net sales
    1 %             (10 )%             (3 )%
———————
*
% change is based on unrounded numbers
 
Income before income taxes for the year ended March 31, 2011, was $1.9 million, as compared to a loss before income taxes of $(23.7) million in fiscal year 2010. Our tax provision for fiscal year 2011 reflects an estimated effective tax rate of 33.8% and includes a carry forward of approximately $4.4 million in U.S. federal and state tax net operating losses generated during the current year, which can be carried forward for federal tax purposes twenty years and for the various states tax purposes a period of seven to twenty years.
 
Loss before income taxes for the year ended March 31, 2010, was $(23.7) million, as compared to a loss before taxes of $(6.6) million in fiscal year 2009.  Our tax benefit for fiscal year 2010 reflected an estimated effective tax rate of 37.8% and includes a carry back of approximately $19.4 million in tax operating losses generated during fiscal year 2010 to offset U.S. federal income taxes paid during fiscal year 2006, in the amount of approximately $6.8 million.
 
As a result, we earned net income of $1.2 million in fiscal year 2011, as compared to incurring a net loss of $(14.8) million in fiscal year 2010 and $(4.3) million in fiscal year 2009.
 
We are under an Internal Revenue Service (“IRS”) audit of our fiscal years 2007 through 2010, Federal income tax returns as a result of the carry back of our net operating losses incurred in fiscal years ended March 31, 2009 and 2010.
 
 
36

 
 
Liquidity and Capital Resources
 
Working capital was $93.0 million as of March 31, 2011, as compared to $88.8 million as of March 31, 2010, and $102.5 million as of March 31, 2009.  The increase in fiscal year 2011, as compared to fiscal year 2010, was primarily due to net income earned for the year ended March 31, 2011.  The decrease in fiscal year 2010, as compared to fiscal year 2009, was primarily the result of the net loss for the year ended March 31, 2010.
 
Cash Flows
 
Cash and cash equivalents increased by $2.9 million during fiscal year 2011, increased by $11.5 million during fiscal year 2010, and decreased by $15.3 million during fiscal year 2009.
 
Cash Flows from Operating Activities
 
During the year ended March 31, 2011, net cash provided by operating activities was $3.6 million, as compared to $13.9 million during the prior year. The activity for fiscal year 2011 reflects an increase in trade receivables from both related and unrelated parities, partially offset by a decrease in inventories and income taxes receivable resulting from tax refunds of $7.4 million received relating to prior year federal and state income taxes.  The activity for fiscal year 2010 reflected a decrease in trade receivables and inventories (primarily resulting from net sales and the write-down of the GUESS? inventory), partially offset by a decrease in accounts payable.
 
During the year ended March 31, 2010, net cash provided by operating activities was $13.9 million, as compared to net cash used in operating activities of $13.1 million during the prior year. The activity for fiscal year 2009 reflected an increase in inventories, prepaid expenses and other current assets, accounts payable due to the launch of three brand products in fiscal year 2009 and the anticipated launches planned for fiscal year 2010. Cash flows from operating activities were negatively affected by the downturn in global economic conditions.
 
Cash Flows from Investing Activities
 
Net cash used in investing activities was $1.0 million in fiscal year 2011, as compared to $2.0 million in fiscal year 2010, and $0.2 million in fiscal year 2009.  The activity for fiscal year 2011 reflects the purchase of certain molds and tooling relating to the launches of our new brand fragrances.  The activity for fiscal year 2010 reflected the purchase of certain molds and tooling relating to the launches of our new brand products, as well as leasehold improvements, while fiscal year 2009 investing activities reflected a lower purchase of equipment and trademarks.
 
Cash Flows from Financing Activities
 
Net cash provided by financing activities was $0.4 million in fiscal year 2011, as compared to net cash used in financing activities of $0.4 million in fiscal year 2010, and $2.0 million in fiscal year 2009.  The activity for fiscal year 2011 reflects proceeds of $0.3 million from the issuance of common stock resulting from the exercise of stock options and warrants, and proceeds from the sale of common stock, by a former major stockholder, remitted to the Company as a recovery of short-swing profits.  The activity for fiscal year 2010 reflected the final payments on our capital leases, while fiscal year 2009 financing activity was mainly attributable to $1.2 million of cash payments for the repurchase of shares of our common stock  under our stock buy-back program and continued repayments of capital leases.
 
As of the date of this filing, no amounts have been borrowed under the New Loan Agreement and availability under the New Loan Agreement was $10.4 million. The material terms of the New Loan Agreement are described below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Debt."
 
Future Liquidity and Capital Resource Requirements
 
Our principal future uses of funds are for our working capital requirements, including new product launches, brand development, and advertising and promotional expenses, as well as expanding operations through acquisitions of and/or new licensing arrangements. In addition, we plan to use our funds for capital expenditures, within the specifications of our New Loan Agreement with GE Capital, and to promote financial and operational success by attracting motivated talent and retaining key personnel. We have historically financed our working capital requirements primarily through internally generated operational funds, and, when necessary, through our credit facility.  Our cash collections are primarily from our customers, based on customer sales and respective payment terms, which may be seasonal in nature.
 
 
37

 
 
Our Ratios and Other Matters
 
As of March 31, 2011 and 2010, our ratios of the number of days sales in trade receivables and number of days cost of sales in inventory, on an annualized basis, were as follows:
 
   
March 31,
 
   
2011
   
2010
 
             
Trade receivables - Unrelated (1) (3)
    83       26  
Trade receivables - Related parties (2)
    94       93  
                 
Inventories(3)
    255       202  
———————
(1)
Calculated on gross trade receivables based on the number of days sales in trade receivables excluding allowances for doubtful accounts, sales returns and advertising allowances of $3.9 million and $4.1 million in 2011 and 2010, respectively.
 
(2)
Based upon the seasonal nature of our sales to Perfumania, the calculation of number of days sales in trade receivables is based on the actual agings as of March 31, 2011 and 2010, respectively.
 
(3)
The calculation excludes the transition of the remaining GUESS? brand inventory and the trade receivables of its new fragrance licensee as of March 31, 2011 and 2010.
 
The increase in the number of days sales in trade receivables in 2011 from 2010 for unrelated customers was mainly attributable to shipments to domestic customers of new brand fragrances, from the launch of Reb’l Fleur, our new Rihanna brand fragrance, and other new brand fragrances from existing licenses occurring in the fourth quarter of fiscal year 2011. Management closely monitors the Company’s activities with all customers, however, if one or more of our major customers were to default on their payables to the Company, it would have a material adverse affect on our overall sales and liquidity.
 
We had net sales of $47.5 million and $0 million during the year ended March 31, 2011, respectively, to Perfumania and to Quality King. During the year ended March 31, 2010, we had net sales of $37.6 million to Perfumania and $9.1 million to Quality King. The majority shareholders of Perfumania Holdings, Inc. are also the owners of Quality King, a privately-held, wholesale distributor of pharmaceuticals and beauty care products. Transactions with Quality King are also presented as related party transactions. Any significant reduction in business with Perfumania as a customer of the Company would have a material adverse effect on our overall net sales. Perfumania’s inability to pay its account balance due to us at a time when it has a substantial unpaid balance could have an adverse effect on our financial condition and results of operations. Management closely monitors the Company’s activity with Perfumania and holds periodic discussions with Perfumania’s management in order to review their anticipated payments for each quarter. No allowance for credit loss has been recorded as of March 31, 2011.  Between April 1, 2011, and May 25, 2011, we received $1.5 million from Perfumania in payment of its outstanding balance. Management continues to closely monitor all developments with respect to its extension of credit to Perfumania.
 
In addition to its sales to Perfumania and Quality King, we had net sales of $3.7 million and $3.0 million for the years ended March 31, 2011 and 2010, respectively, to Jacavi, a fragrance distributor. Jacavi’s managing member is Rene Garcia.  Rene Garcia owns approximately 8.4% of the outstanding stock of Perfumania Holdings, Inc. as of March 31, 2011, and is one of the principals of Artistic Brands.  Also, on June 14, 2010, certain persons related to Mr. Garcia, the Garcia Group, acquired 2,718,728 shares of our common stock and filed a Schedule 13G with the SEC on June 23, 2010.  In that filing, the Garcia Group reported having beneficial ownership of a total of 2,995,527 shares, or approximately 14.7% of our outstanding shares as of June 14, 2010 (equivalent to14.5% as of March 31, 2011), excluding warrants owned by the Garcia Group. See Notes 6 and 10 to the accompanying Consolidated Financial Statements for further discussion. On March 4, 2011, the Garcia Group replaced their original joint filing by jointly filing a Schedule 13D.  Other than the addition of certain warrants to purchase shares, which vested between the initial and subsequent filing dates, there were no changes in beneficial share ownership included in the updated joint filing. Sales to Jacavi are also included as related party sales in the accompanying Consolidated Statements of Operations.
 
See Note 2 to the accompanying Consolidated Financial Statements for further discussion of our relationship with Perfumania, Quality King, and Jacavi and the trade receivables and sales amounts during the respective periods for each related party.
 
The lead time for certain of our raw materials and components inventory (up to 180 days) requires us to maintain at least a three to six-month supply of some items in order to ensure production schedules. In addition, when we launch a new brand or SKU, we frequently produce a six to nine-month supply to ensure adequate inventories if the new products exceed our forecasted expectations. Generally gross margins on our products outweigh the additional carrying costs. However, if future sales do not reach forecasted levels, it could result in excess inventories and may cause us to decrease prices to reduce inventory levels.
 
 
38

 
 
During the fiscal year 2011, the number of days sales in inventory increased to 255 days from 202 days.  This calculation compares the ending inventory value to an estimated average daily cost of sales.  In fiscal year 2011, lower sales due to the expiration of the GUESS? brand products license agreement resulted in a decrease in cost of goods sold and an increase in the number of days in inventory.  In fiscal year 2010, total sales and costs of sales were higher, which resulted in a decrease in the number of days in inventory.  Inventory balances, as well as the number of days sales in inventory, are generally higher during our first and second quarters due to increased production in anticipation of the upcoming holiday gift-giving season. We anticipate that, as new licenses are signed, and new products are launched, our inventory levels will increase in relation to anticipated sales for our existing products, as well as any new products. We believe that the carrying value of our inventory at March 31, 2011, based on current conditions, is stated at the lower of cost or market and, based upon projected sales, we also believe that all inventory will be utilized within the next twelve months.
 
Share Repurchases
 
On January 4, 2007, our Board approved the repurchase of 10,000,000 shares, subject to certain limitations, including approval from our lender if we had amounts outstanding under our line of credit. Our lender’s approval was never requested. At that time, the August 6, 2004, repurchase plan for 1,000,000 shares was effectively terminated with approximately 200,000 shares remaining. During the year ended March 31, 2007, we had repurchased, in the open market, 360,420 shares at a cost of $2.1 million, all of which was purchased during January 2007.
 
On October 16, 2008, our Board approved the reinstatement of our buy-back program, approving the repurchase of 1,000,000 shares, subject to certain limitations, including approval from our former lender. There is no expiration date specified for this program. Our former lender’s approval was received on October 24, 2008. During the fiscal year ended March 31, 2009, we repurchased, in the open market, 371,600 shares at a cost of $1.2 million. During the quarter ended March 31, 2009, our lender notified us to cease further buy-backs of our shares. As of March 31, 2011 and 2010, we had repurchased, under all phases of our common stock buy-back program (including those phases before 2007), a total of 11,718,977 shares at a cost of $40.4 million. We did not repurchase any shares of our common stock during the years ended March 31, 2011 and 2010.  Our New Loan Agreement restricts the ability of our subsidiaries to make distributions to us for the purpose of repurchasing our common stock, subject to certain exceptions.
 
Our Debt
 
On July 22, 2008, we signed a Loan and Security Agreement (the “Loan Agreement”) with Regions Bank (“Regions”). The Loan Agreement provided a credit line of up to $20.0 million, depending upon the availability of a borrowing base, at an interest rate of LIBOR plus 2.00% or Regions’ prime rate, at our option.
 
During the period of July 22, 2008, through February 15, 2010, substantially all of our assets were collateralized under our Loan Agreement. The Loan Agreement contained customary events of default and covenants which prohibited, among other things, incurring additional indebtedness in excess of a specified amount, paying dividends, creating liens, and engaging in mergers and acquisitions without the prior consent of Regions. The Loan Agreement also contained certain financial covenants relating to fixed charge coverage, and the ratio of funded debt to EBITDA.
 
On March 9, 2009, we entered into the First Amendment and Ratification of Loan and Security Agreement and Other Loan Documents (the “Amendment”) to the Loan Agreement, dated as of July 22, 2008, with Regions. The Amendment changed certain terms of the Loan Agreement. Under the Amendment, the interest rate for any borrowings was LIBOR rate plus the applicable margin. The applicable margin for any borrowings was calculated on a sliding scale basis and was tied to our fixed charge coverage ratio, with rates calculated between 3% and 4%, with an initial starting rate of 4.25%. Prior to December 31, 2009, the borrowing base amount was the lesser of the sum of an amount equal to 75% of the net amount (after deduction of such reserves and allowances as Regions deemed reasonably proper and necessary) of all eligible accounts plus an amount equal to the lesser of $10 million or 25% of the lower of cost or market value (after deduction of such reserves and allowances as Regions deemed reasonably proper and necessary) of all eligible inventory or the product of two times the sum of EBITDA measured from January 1, 2009, to the date of measurement, minus non-cash expenses related to the issuance of options and warrants, minus other non-cash expenses. After December 31, 2009, the borrowing base amount was the sum of an amount equal to 75% of the net amount (after deduction of such reserves and allowances as Regions deemed reasonably proper and necessary) of all eligible accounts plus an amount equal to the lesser of $10 million or 25% of the lower of cost or market value (after deduction of such reserves and allowances as Regions deemed reasonably proper and necessary) of all eligible inventory. In addition, receivables due from Perfumania, Inc., a related party, were not considered an eligible account. A tangible net worth covenant was added, which required us to maintain a tangible net worth of not less than $85 million at all times. We were required to obtain written consent from Regions prior to repurchasing shares of our common stock, including repurchases which had been previously authorized under our existing stock buy-back program. We were no longer required to pay a non-utilization fee.
 
 
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Our Loan Agreement required us to maintain compliance with various financial covenants. The calculation of our fixed charge coverage ratio was measured on a trailing twelve months basis, at the end of each fiscal quarter. We calculated the ratio as follows: (“A”) the sum of EBITDA, less any non-cash gains, less cash taxes paid, less any dividends and distributions (if any), to (“B”) the sum of the current portion of long-term debt (“CPLTD”) paid during the period plus lease and interest expense. If the ratio of our rolling twelve months EBITDA (A) to the sum of the debt (B) was less than the minimum coverage ratio we failed the ratio requirements. We were required to maintain a minimum ratio of 1.50 to 1. The calculation of our funded debt to EBITDA ratio was measured at the end of each fiscal quarter, based on our indebtedness to EBITDA. We were required to maintain a ratio of no greater than 2.50 to 1.00 for each fiscal quarter. The Amendment deferred the fixed charge coverage ratio and the funded debt to EBITDA requirements until December 31, 2009, and added the tangible net worth covenant, which required us to maintain a tangible net worth of not less than $85 million at all times.
 
 Our Loan Agreement defined EBITDA, a non-GAAP financial measure, as net income before interest, taxes, depreciation, amortization and non-cash expenses related to the issuance of options and warrants. Tangible net worth is the sum of our total assets, less intangible assets, minus our total liabilities. The following tables are the reconciliation of EBITDA to our net income and the calculation of our tangible net worth for the periods indicated. We do not show EBITDA nor tangible net worth for the quarter ended March 31, 2010, since all outstanding borrowings were repaid on February 16, 2010, and the Loan Agreement, as amended by the Second Amendment was terminated.
 
   
For the Quarters Ended
       
   
March 31,
2009
   
June 30,
2009
   
September 30, 2009
   
December 31, 2009
   
Rolling
Twelve Months
Ended December 31, 2009
 
(Unaudited)               (in thousands)              
EBITDA:
                             
Net income (loss)
  $ 1,491     $ (2,467 )   $ 2,969     $ (5,426 )   $ (3,433 )
Interest
    16       56       97       131       300  
Taxes
    1,253       (1,512 )     1,820       (3,326 )     (1,765 )
Depreciation and amortization
    622       687       812       755       2,876  
Non-cash expenses (issuance of options and warrants)
    70       82       82       192       426  
EBITDA
  $ 3,452     $ (3,154 )   $ 5,780     $ (7,674 )   $ (1,596 )
 
   
December 31,
2009
 
(Unaudited)
 
(in thousands)
 
Tangible Net Worth:
       
Total assets
 
$
127,061
 
Less intangible assets
   
4,847
 
     
122,214
 
Less total liabilities
   
17,591
 
Tangible Net Worth
 
$
104,623
 
 
On August 31, 2009, we entered into a Forbearance Agreement (“Forbearance Agreement”) regarding our Loan Agreement with Regions. The Forbearance Agreement was entered into to address that our outstanding borrowings as of June 30, 2009, were in excess of the limitation in our Loan Agreement, as amended. As of June 30, 2009, our outstanding principal balance under the Loan Agreement was $6.7 million. Pursuant to the Loan Agreement, our outstanding principal balance at no time should exceed the revolving loan availability, as defined in the Loan Agreement. The revolving loan availability as of June 30, 2009, was $0.2 million, resulting in an excess of the revolving loan availability in the amount of $6.5 million. Under the Forbearance Agreement, Regions agreed to forbear from any legal action to accelerate our obligations to the bank until October 28, 2009, subject to no further events of default under the terms of our Loan Agreement, as amended.
 
On October 29, 2009, we entered into a Second Amendment to Loan Agreement and Amendment to Forbearance Agreement (the “Second Amendment”) with Regions extending the forbearance period through February 15, 2010, and calling for us to repay the remaining loan balance over the course of the extension period, as noted in the table below. The Second Amendment called for us to continue to comply with certain covenants with Regions under the Loan Agreement, as amended by the Second Amendment. See Note 7 to the accompanying Consolidated Financial Statements for further discussion.
 
 
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We were required and repaid the remaining outstanding principal balance over the course of the extension period as follows:
 
Payment Date
 
Payment Amount
     
November 30, 2009
 
$1.0 million
December 31, 2009
 
$1.6 million
February 1, 2010
 
$1.0 million
February 16, 2010
 
Fully paid
 
 On February 16, 2010, we repaid the remaining outstanding principal balance plus interest and fees in the amount of $1.1 million and the Loan Agreement, as amended by the Second Amendment, was terminated.
 
On June 25, 2010, we entered into a New Loan Agreement with GE Capital, as amended April 15, 2011. The New Loan Agreement is a revolving credit facility that provides a credit line of up to $20.0 million, depending upon the availability of a borrowing base and certain reserves established by GE Capital from time to time, at an interest rate equal to the highest of (a) the prime rate, (b) the federal funds rate plus 3.0%, or (c) the LIBOR rate over one minus any Euro dollar reserve requirement (the “Eurodollar Rate”),  in each case plus 3.50%; or the Eurodollar Rate plus 4.50%, at our option except in certain circumstances including defaults in the payment of any amounts under the revolving credit facility or the unavailability of the LIBOR rate. The term of the revolving credit facility under the New Loan Agreement is two years. In connection with obtaining the revolving credit facility, we incurred approximately $0.7 million in deferred loan fees, which are being amortized over the life of the credit facility on a straight-line basis to interest expense, in the accompanying Consolidated Statements of Operations.  In addition, under the terms of the New Loan Agreement we incur monthly loan monitoring and unused commitment fees, which are recorded to interest expense, in the accompanying Consolidated Statements of Operations.  During the year ended March 31, 2011, we amortized $0.3 million in deferred loan fees and incurred $0.3 million in loan monitoring and unused commitment fees.
 
The New Loan Agreement contains customary events of default and covenants which prohibit, among other things, incurring additional indebtedness in excess of a specified amount, paying dividends, creating liens, and engaging in mergers and acquisitions without the prior consent of GE Capital. The New Loan Agreement requires us to maintain a minimum net liquidity balance of $12.5 million through October 31, 2010, and $15.0 million thereafter through the end of the term. Under the New Loan Agreement, net liquidity is the sum of our unrestricted cash assets plus the excess availability under the revolving credit facility.  At any point if we fall below the net liquidity requirements, the New Loan Agreement contains certain additional financial covenants relating to minimum consolidated EBITDA (as defined below), minimum consolidated interest coverage ratios and maximum capital expenditure limits. In addition, Parlux Ltd. and its affiliates must have a minimum net liquidity balance of $12.5 million to borrow under the New Loan Agreement. As of March 31, 2011, we met the minimum liquidity requirements under the New Loan Agreement.
 
The New Loan Agreement defines consolidated EBITDA, a non-GAAP financial measure, as (a) our consolidated net income plus (b) the sum of, any provision for federal income taxes or other taxes measured by net income, consolidated interest expense, amortization of debt discount and commissions and other fees and charges associated with indebtedness, losses from extraordinary items, depreciation, depletion and amortization expense, aggregate net loss on the sale of property outside the ordinary course of business and other non-cash expenditures, charge or loss for such period (other than any non-cash expenditures, charge or loss relating to write-offs, write-downs or reserves with respect to accounts receivable, inventory and sales returns), including the amount of compensation deduction as the result of any grant of stock or stock equivalents to employees, officers, directors or consultants and minus (c) the sum of, credit for federal income taxes or other taxes measured by net income, interest income, gain from extraordinary items and other non-recurring gain, but without giving effect to any gain resulting from any reappraisal or write-up of assets, aggregate net gain from the sale of property out of the ordinary course of business, other non-cash gain, including any reversal of a decrease in the value of stock or stock equivalent, and other cash payment in respect of expenditures, charges and losses that have been added to consolidated EBITDA. The consolidated interest coverage ratio is the ratio of consolidated EBITDA to consolidated interest expense.
 
Borrowings under the New Loan Agreement are secured by all of our assets and the assets of our subsidiary, Parlux Ltd., pursuant to a Guaranty and Security Agreement. In addition, GE Capital, as administrative and collateral agent, has a security interest in and to certain of our patents and trademarks, as well as those of our subsidiary, Parlux Ltd., pursuant to a Patent Security Agreement and Trademark Security Agreement, respectively. We have provided to GE Capital, as administrative and collateral agent, a full guaranty of payment of the obligations under the New Loan Agreement. As of March 31, 2011, no amounts have been borrowed under the New Loan Agreement and our availability under the New Loan Agreement was $10.4 million.
 
 
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We believe that funds from operations will be sufficient to meet our current operating and seasonal needs through fiscal year 2012.  In addition, the revolving credit facility will provide us an opportunity to improve liquidity and profitability.  However, if we were to expand operations through acquisitions, new licensing arrangements or both, we may need to obtain additional financing. There can be no assurances that we could obtain additional financing or what the terms of such financing, if available, would be. In addition, the current business environment may increase the difficulty of obtaining, and the cost of, additional financing, if necessary.
 
Contractual Obligations
 
The following table sets forth information regarding our contractual obligations as of March 31, 2011:
 
   
Payment Due by Period
 
Type of Obligation
 
Total
   
Less Than
1 Year
   
1-3 Years
   
3-5 Years
   
More Than
5 Years
 
               
(In thousands)
             
Operating Lease Obligations (1)
  $ 9,227     $ 2,166     $ 3,922     $ 3,139     $  
Revolving Credit Facility(2)
    563       450       113              
Purchase Obligations (3)
    26,184       26,184                    
Advertising Obligations (4)
    121,552       28,403       60,278       28,981       3,890  
Employment and Consulting Agreements (5)
    803       803                    
Other Long-term Obligations (6)
    34,266       7,724       16,289       9,086       1,167  
    $ 192,595     $ 65,730     $ 80,602     $ 41,206     $ 5,057  
———————
(1)
Represents the future minimum annual rental commitments net of future minimum annual rental income of $186 in fiscal year 2012. See Notes 5 and 8A to the accompanying Consolidated Financial Statements for further discussion.
 
(2)
Represents GE Capital loan monitoring and unused commitment fees.
 
(3)
Represents purchase orders issued in the normal course of business for components, raw materials and promotional supplies.
 
(4)
Consists of advertising commitments under our licensing agreements. These amounts were calculated based on the guaranteed minimum sales goals, as set forth in the agreements. Unlike guaranteed minimum royalties, advertising and promotional spending are based on a percentage of actual net sales, and are not contractually required if there are no sales. See Note 8B to the accompanying Consolidated Financial Statements for further discussion of these amounts.
 
(5)
Consists of amounts remaining under employment and consulting agreements. See Note 8D to the accompanying Consolidated Financial Statements for further discussion.
 
(6)
Consists of guaranteed minimum royalty requirements under our licensing agreements.
 
 
42

 
 
Off-Balance Sheet Arrangements
 
As of March 31, 2011, we did not have any “off-balance sheet arrangements” as that term is defined in Regulation S-K Item 303(a)(4).
 
Forward-Looking Statements

Our business, financial condition, results of operations, and cash flows, and the prevailing market price and performance of our common stock, may be adversely affected by a number of factors, including the matters discussed below. Certain statements and information set forth in this Annual Report on Form 10-K, as well as other written or oral statements made from time to time by us or by our authorized officers on our behalf, constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. We intend our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions, strategies, future events or performance are not statements of historical facts and may be forward-looking.  Forward-looking statements involve estimates, assumptions and uncertainties.  Accordingly, any such statements are qualified in their entirety by reference to, and are accompanied by, the following important factors (in addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements.) You should note that forward-looking statements in this document speak only as of the date of this Annual Report on Form 10-K and we undertake no duty or obligation to update or revise our forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that the expectations, plans, intentions and projections reflected in our forward-looking statements are reasonable, such statements are subject to known and unknown risks, uncertainties and other factors, or combination of factors, that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The risks, uncertainties and other factors that our stockholders and prospective investors should consider include the following:

 
·
The Paris Hilton line is our primary source of revenue following the expiration of our GUESS? license.
 
 
·
If we are unable to acquire or license additional brands, secure additional distribution arrangements, or obtain the required financing for these agreements and arrangements, the growth of our business could be impaired.
 
 
·
The development of new products by us involves considerable costs and any new product may not generate sufficient consumer interest and sales to become a profitable brand or to cover the costs of its development and subsequent promotions.
 
 
·
We depend on a relatively small number of customers for most of our revenue, therefore if any of our significant customers reduced their demand for our products or became financially unstable it may have a material adverse effect on our business.
 
 
·
The loss of or interruption in our arrangements with our manufacturers, suppliers and customers could have a material adverse affect on our sales, financial condition, and operating cash flow.
 
 
·
The fragrance and cosmetic industry is highly competitive, and if we are unable to compete effectively it could have a material adverse effect on our sales, financial condition, operating cash flow, and many other aspects of our business, prospects, results of operations and financial condition.
 
 
·
Our net sales, operating income and inventory levels fluctuate on a seasonal basis and a decrease in sales or profit margins during our peak seasons could have a disproportionate effect on our overall financial condition and results of operations.
 
 
·
The continued consolidation of the U.S. department store segment could have a material adverse effect on our sales, financial condition, and operating cash flow.
 
 
·
Our customers’ inability  or other failure to pay their accounts payable balance due to us could have a material adverse effect on our financial condition and results of operations.
 
 
·
Consumers have reduced discretionary purchases of our products as a result of the general economic downturn, and may further reduce discretionary purchases of our products in the event of further economic decline, terrorism threats or other external factors.
 
 
·
Our New Loan Agreement contains restrictive and financial covenants that could adversely affect our ability to borrow funds under the New Loan Agreement or adversely affect our business by limiting our flexibility.
 
 
43

 
 
 
·
Failure to manage inventory effectively could negatively impact our operations.
 
 
·
The value of our long-lived assets, including brand licenses and trademarks, may be adversely affected if we experience declines in operating results or experience significant negative industry or economic trends.
 
 
·
If we are unable to protect our intellectual property rights, specifically trademarks and trade names, our ability to compete could be negatively impacted.
 
 
·
If we experience privacy breaches and liability for online content, it could negatively affect our reputation, credibility and business.
 
 
·
The loss of, or disruption in our distribution facility, could have a material adverse effect on our sales and our relationships with our customers.
 
 
·
Our success depends, in part, on the quality and safety of our fragrance and related products.
 
 
·
We are subject to risks related to our international operations.
 
 
·
Reductions in worldwide travel could hurt sales volumes in our duty-free related business.
 
 
·
If we lose the services of our executive officers and senior management, it could have a negative impact on our business.
 
 
·
If we lose our key personnel, or fail to attract and retain additional qualified experienced personnel, we will be unable to continue to develop our prestige fragrance products and attract and obtain new licensing partners.
 
 
·
We may unknowingly infringe on others’ intellectual property rights which could result in litigation.
 
 
·
We are involved in litigation from time to time in the ordinary course of business, which, if the outcome of such litigation is adverse to us, could materially adversely affect our business, results of operations, financial condition, and cash flows.
 
 
·
Our quarterly results of operations could fluctuate significantly due to retailing peaks related to gift giving seasons and delays in new product launches, which could adversely affect our stock price.
 
 
·
Our information systems and websites may be susceptible to outages and other risks.
 
 
·
Our business is subject to regulation in the United States and internationally.
 
 
·
Our stock price has been volatile.
 
 
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
We sell our products worldwide with all such sales being denominated in United States dollars. As a result, we were not at risk to foreign exchange translation exposure.
 
We could, however, be subject to changes in political and economic conditions in the countries in which we are represented internationally. We closely monitor such conditions and are able, for the most part, to adjust our sales strategies accordingly.
 
During the year ended March 31, 2011, our exposure to market risk for changes in interest rates related to our former bank line of credit. The bank line of credit bore interest at a variable rate, as discussed above under “Liquidity and Capital Resources.” On February 16, 2010, we repaid the remaining outstanding principal balance plus interest and fees of $1.1 million and the line of credit with Regions was terminated.
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
The financial statements and supplemental data are included herein commencing on page F-1. The financial statement schedule is listed in the Index to Financial Statements on page F-1 and is incorporated herein by reference.
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
 
None.
 
ITEM 9A. CONTROLS AND PROCEDURES.
 
Evaluation of Disclosure Controls and Procedures
 
We carried out an evaluation under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2011.
 
Changes in Internal Control

Based on an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, there has been no change in our internal control over financial reporting (as defined in Rules 13a-15 and 15d-15 under the Exchange Act) during our last fiscal quarter, identified in connection with that evaluation, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
Management of Parlux Fragrances, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
 
 
·
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
 
 
·
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
 
 
·
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
 
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
 
Management assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2011. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
 
Based on our assessment, management concluded that the Company’s internal control over financial reporting was effective as of March 31, 2011.

 
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ITEM 9B. OTHER INFORMATION.
 
None.

 
47

 
 
PART III
 
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
Certain information concerning our executive officers and directors as of March 31, 2011, is set forth below.  There are no family relationships between any of our executive officers or directors.

Name
 
Age
 
Position
Frederick E. Purches
  73  
Chairman of the Board of Directors and Chief Executive Officer
Frank A. Buttacavoli
  56  
Executive Vice President and Chief Operating Officer
Raymond J. Balsys
  54  
Senior Vice President and Chief Financial Officer
Anthony D’Agostino
  53  
Independent Director
Esther Egozi Choukroun
  49  
Independent Director
Glenn Gopman
  55  
Independent Director
Robert Mitzman
  56  
Independent Director

Frederick E. Purches was appointed Chairman of the Board of Directors and Chief Executive Officer in January 2010. Mr. Purches founded the Company in 1984, and served from 1984 until 2005 in a variety of capacities for the Company, including as the Chairman of the Board of Directors and Vice Chairman of the Board of Directors. Mr. Purches has been engaged in the cosmetic and fragrance business for over 40 years, including in various executive capacities with Helena Rubinstein/Armani, Inc. and Revlon, Inc. During the past fifteen years, Mr. Purches has served as a consultant to the Company through Cosmix, Inc., a private company controlled by Mr. Purches.
 
Mr. Purches possesses extensive executive and operational experience in the cosmetic and fragrance industry, including as founder of the Company and in executive roles with other major cosmetic companies, which provides the Board of Directors and the Company with key leadership and guidance in the areas of Company history and knowledge, strategic planning, branding and marketing, business development, retail sales and distribution.
 
Frank A. Buttacavoli, a Certified Public Accountant, served as Vice President and Chief Financial Officer of the Company from April 1993 until May 2007, and was a director of the Company from March 1993 until February 2007. From July 1979 through June 1992, Mr. Buttacavoli was employed by Price Waterhouse, and was a Senior Manager from July 1987 to June 1992. In June 1996, Mr. Buttacavoli was promoted to Executive Vice President of the Company, and in October 1999, he assumed the additional responsibilities of Chief Operating Officer. On May 15, 2007, in an effort to segregate duties, he gave up the title of Chief Financial Officer to work more closely with the Chief Executive Officer on overall planning, management, logistical activities, building our core businesses and in the signing of new fragrance licenses.
 
Raymond J. Balsys, a Certified Public Accountant, was promoted to Chief Financial Officer effective as of May 15, 2007. He had served as Vice President Finance since July 2006, when he rejoined the Company. From 2001 to 2005, Mr. Balsys served as the Director of SEC Reporting and Assistant Controller of AOL Latin America. He also served as the Client Services Manager at The Premier Group, an international provider of enterprise resource planning (ERP) solutions focusing on J.D. Edwards’ software, from 1998 to 2001. Mr. Balsys served as Vice President Controller of the Company from 1994 to 1997. Prior to 1994, Mr. Balsys worked as an Audit Manager at Price Waterhouse.
 
 
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Anthony D’Agostino, a Certified Public Accountant, has served as an independent director of the Company since February 2007 and, as of April 2007, was appointed Chairman of the Audit Committee and a member of the Compensation, Independent, and Nominating Committees. Currently, Mr. D’Agostino is an audit manager with Sauvigne & Company, LLP, a Manhattan based CPA firm that he joined in December of 2007. He has been a consultant, assisting the chief financial officers and boards of directors of private and public companies, including Quality King, with compliance issues under the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and various transactions since 2004. From 2003 to 2004, Mr. D’Agostino served as the Vice President of Finance and Chief Financial Officer of CPI Aerostructures, Inc., a defense contractor. From 2002 to 2003, Mr. D’Agostino served as the Vice President of Finance and Chief Financial Officer of American Patriot Apparel Corporation, a start-up not-for-profit organization. From 2000 to 2002, he served as Senior Vice President of Finance and Chief Financial Officer of Softheon, Inc., a software start-up company.
 
Mr. D'Agostino possesses extensive accounting and finance experience as an audit manager, Chief Financial Officer and Sarbanes-Oxley consultant, which provides the Board of Directors and the Company with his expertise as an audit committee financial expert, accounting and financial guidance generally, and corporate governance and compliance insights relating to Sarbanes-Oxley.
 
Esther Egozi Choukroun, has served as an independent director of the Company since October 2000, and has served as Chairman and/or as a member of various committees during that time. As of April 2007, she became Chairman of the Nominating Committee, and a member of the Audit and Independent Committees. Since January 2007, Ms. Egozi Choukroun has been the Chief Financial Officer of Flagler Investment, LLC, a real estate investment firm specializing in the acquisition and management of underperforming office buildings in the Southeast United States and Texas. In addition, she is the Managing Member of PIX Holdings, LLC, a real estate advisory and consulting firm created in January 2007 and operating in South Florida and the Caribbean. From 2002 through 2006, Ms. Egozi Choukroun was the Executive Vice President and Chief Financial Officer of PIX Latin America Investments Corporation, a full service real estate company operating in Florida and Latin America. Ms. Egozi Choukroun was employed by Banque Nationale de Paris, Miami, from 1984 through 1996, and was Senior Vice President and Deputy General Manager from 1988 through 1996. From 1997 through 1999, she was Director of International Philanthropy at the Mount Sinai Medical Center Foundation, and through 2002 was Executive Director of the Women’s International Zionist Organization for Florida. Ms. Egozi Choukroun currently serves as a member of the Advisory Board of the Scott Rakow Youth Center which is run by the Parks and Recreation Department of the City of Miami Beach.
 
Ms. Egozi Choukroun possesses extensive executive and financial experience as a Chief Financial Officer, a Managing Member and Senior Vice President, which provides the Board of Directors and the Company with her valuable experience in the areas of senior management and financial experience, including managing companies with underperforming assets and international operations, as well as experience in the banking sector.
 
Glenn H. Gopman, a Certified Public Accountant, has served as an independent director of the Company since October 1995, and has served as Chairman and/or as a member of various committees during that time. As of April 2007, he became Chairman of the Compensation and Independent Committees, and a member of the Audit Committee. Since 2003, Mr. Gopman has owned and operated an independent certified public accounting practice. He is presently a principal shareholder in the public accounting firm of Levi & Gopman, P.A. Until 2002, he was a partner in the public accounting firm of Rachlin Cohen & Holtz LLP. Prior to that, Mr. Gopman was a principal stockholder in the public accounting firm of Thaw, Gopman and Associates, P.A. He is a member of the American and Florida Institutes of Certified Public Accountants. Mr. Gopman has been appointed to Chair the F.I.C.P.A. Management of Accounting Practice 2010/2011 Section Steering Committee. Mr. Gopman presently serves as Chairman of the Citizen’s Oversight Committee under the Inter-Local Agreement on School Facilities Planning in Miami-Dade County.  He is also an officer and director of The Hebrew Free Loan Association of South Florida, Inc. and the Miami Beach Senior High School Alumni Association, both of which are a non-profit organizations.
 
 
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Mr. Gopman possesses extensive accounting experience as a Certified Public Accountant practicing in the area of public accounting, which provides the Board of Directors and the Company with his valuable experience counseling companies with respect to the implementation and impact of accounting policies, and the use of management judgment and estimates regarding such accounting policies.
 
Robert Mitzman, has served as an independent director of the Company since February 2007, and, as of April 2007, became a member of the Audit, Compensation, Independent and Nominating Committees. Since 1981, he has served as President and Chief Executive Officer of Quick International Courier, a privately held courier company, with over 600 employees and over 4,000 agents and worldwide offices. Mr. Mitzman currently serves on the board of directors of Esquire Bank Corp. He was previously a member of Young Presidents Organization and served on the board of directors of Orbit International Corp. until December 2008.

Mr. Mitzman possesses extensive executive experience as a Chief Executive Officer, which provides the Board of Directors and the Company with important business and leadership experience, including leading an organization with global operations, experience in the human resources area managing a numerous and diverse pool of employees, and growing a business while managing the proper allocation of resources and cost structure.
 
CORPORATE GOVERNANCE
 
Board of Director Meetings
 
In fiscal year 2011, there were twelve meetings of the Board of Directors, and each director attended at least 75% of the meetings of the Board of Directors and the meetings of all committees on which he or she served (during the period of such Board and committee service). It is our policy for all members of the Board of Directors to attend our annual meeting of stockholders.  All of our then current directors attended the annual meeting of stockholders for the fiscal year ended March 31, 2010.
 
Board of Director Independence
 
The Board of Directors has determined that four directors, Ms. Egozi Choukroun and Messrs. D’Agostino, Gopman and Mitzman are independent, as defined in the rules of the Nasdaq Stock Market (“Nasdaq”).
 
Board Leadership Structure
 
The Board of Directors has no policy regarding the need to separate or combine the offices of Chairman of the Board and Chief Executive Officer and instead the Board of Directors remains free to make this determination from time to time in a manner that seems most appropriate for the Company. Currently, the Company combines the positions of Chief Executive Officer and Chairman of the Board of Directors as it believes that the Chief Executive Officer is in the best position to fulfill the Chair’s responsibilities, including those related to identifying emerging issues facing the Company, communicating essential information to the Board of Directors about the Company’s performance and strategies, and preparing agendas for the Board of Directors.
 
Currently, the Company has not designated a lead independent director and executive sessions of the Board of Directors are led by the Chairperson of the Board Committee having authority over the subject matter discussed at the executive session, as appropriate. We believe this leadership structure is appropriate based on the Company's size and characteristics and its commitment to a strong, independent Board of Directors, exemplified by four out of five of its directors qualifying as an independent director.
 
 
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Committees of the Board of Directors
 
The Board of Directors established four standing committees: the Audit Committee, the Compensation Committee, the Nominating Committee, and the Independent Committee, all of which are composed of independent directors. The Audit Committee and Nominating Committee each operate under a written charter adopted by the Board of Directors which sets forth the scope of responsibilities of such committees. Copies of those charters are available for review on our website at www.parlux.com under “Corporate Website - Corporate Governance.”
 
Audit Committee
 
In July 2007, the Board of Directors approved an Audit Committee charter. Pursuant to its written charter, the Audit Committee appoints our independent registered public accountants to audit our financial statements, as well as reviews the scope, purpose and type of audit services to be performed by the independent registered public accountants, and the findings and recommendations of the accountants. During fiscal 2011, the Audit Committee was composed of Messrs. D’Agostino, Gopman and Mitzman, and Ms. Egozi Choukroun, each of whom is independent, as defined in the rules of Nasdaq.

The Audit Committee held five meetings in fiscal 2011. Mr. D’Agostino, a Certified Public Accountant and an independent director as defined in the rules of Nasdaq, served as Chairman of the Audit Committee during fiscal 2011. The Board of Directors has determined that Mr. D’Agostino is an audit committee financial expert as defined in the applicable regulations of the SEC.

For fiscal 2012, the Audit Committee will continue to be composed of Messrs. D'Agostino (Chairman), Mitzman, and Gopman, and Ms. Egozi Choukroun as members, each of whom is independent, as defined in the rules of Nasdaq. The Committee reviewed and discussed the audited financial statements of the Company for the 2011 fiscal year with management and the independent registered public accounting firm. Management has the responsibility for the preparation of the Company's financial statements, and the independent registered public accounting firm has the responsibility for the examination of those statements. Based on the above-mentioned review and discussions with management and the independent registered public accounting firm, the Committee recommended to the Board that the Company's audited financial statements be  included in this Annual Report on Form 10-K for the fiscal year ended March 31, 2011.
 
Compensation Committee
 
The duties of the Compensation Committee are to make recommendations to the Board of Directors concerning the salaries, bonuses and other compensation of Company executive officers, and to advise and act for the Board of Directors on other compensation matters. For further information on the Compensation Committee’s processes and procedures for consideration and determination of executive compensation, see Compensation Discussion and Analysis below. During fiscal 2011, the Compensation Committee was composed of Messrs. D’Agostino, Mitzman and Gopman, all of whom are independent directors as defined in the rules of Nasdaq. During fiscal 2011, Mr. Gopman served as the Chairman of the Compensation Committee. The Compensation Committee held one meeting in fiscal 2011. For fiscal 2012, the Compensation Committee will continue to be composed of Messrs. Gopman (Chairman), D’Agostino and Mitzman. The Compensation Committee does not have a formal written charter.
 
Nominating Committee
 
Pursuant to its written charter, the duties of the Nominating Committee are to identify, evaluate, and submit to the Board of Directors qualified individuals, including any individual recommended by stockholders through the process described below, to be recommended by the Board of Directors for election at each annual meeting of stockholders and to be appointed by the Board of Directors at any other time due to any expansion of the Board of Directors, director resignations or retirements or otherwise and candidates for membership on each committee of the Board of Directors. The Nominating Committee determines the criteria for membership of the Board of Directors including desired skills and attributes which include industry experience, fashion/artistic talents and/or financial capabilities. While the Company does not have a formal policy regarding the consideration of diversity in identifying and evaluating potential director candidates, the Nominating Committee will consider diversity as one factor in identifying and evaluating potential director candidates. Qualified individuals recommended by the Board of Directors are then presented in our proxy statement to be voted upon by our stockholders at each annual meeting.
 
 
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During fiscal 2011, the Nominating Committee was composed of Ms. Egozi Choukroun, and Messrs D’Agostino and Mitzman, all of whom are independent directors as defined in the rules of Nasdaq. During fiscal 2011, Ms. Egozi Choukroun served as the Chairperson of the Nominating Committee. The Nominating Committee held one meeting in fiscal 2011. For fiscal 2012, the Nominating Committee will continue to be composed of Ms. Egozi Choukroun (Chairperson), and Messrs. D’Agostino and Mitzman. It is the policy of the Nominating Committee to receive and evaluate any stockholder nominations to the Board of Directors.
 
Independent Committee
 
The Independent Committee was originally formed during April 2003 to address a possible tender offer; such offer was subsequently withdrawn in June 2003. The Independent Committee reconvened during June 2006, to address a second possible tender offer, which was also subsequently withdrawn in July 2006. The Independent Committee does not have a formal written charter. To date, the Independent Committee's responsibilities have been to evaluate, negotiate, and ultimately recommend approval or disapproval to the Board of Directors and the stockholders, of offers made to acquire all of our Common Stock or to act on consent actions seeking control of the Company.
 
The Independent Committee did not meet in fiscal 2011. During fiscal 2011, the Independent Committee was composed of Messrs. Gopman, D’Agostino and Mitzman and Ms. Egozi Choukroun. During fiscal 2011, Mr. Gopman served as the Chairman of the Independent Committee. For fiscal 2012, the Independent Committee will continue to be composed of Messrs. Gopman (Chairman), D’Agostino and Mitzman and Ms. Egozi Choukroun.
 
Risk Management
 
The Board of Directors is actively involved in the oversight and management of risks that could affect the Company. This oversight and management is conducted primarily through committees of the Board of Directors, as disclosed in the descriptions of each of the committees above and in the charters of the Audit Committee and Nominating Committee, but the full Board of Directors has retained responsibility for general oversight of risks. The Audit Committee is primarily responsible for overseeing the risk management function, specifically with respect to management’s assessment of risk exposures (including risks related to liquidity, credit, operations and regulatory compliance, among others), and the processes in place to monitor and control such exposures. The other committees of the Board of Directors consider the risks within their areas of responsibility. The Board of Directors satisfies their oversight responsibility through full reports by each committee chair regarding the committee’s considerations and actions, as well as through regular reports directly from officers responsible for oversight of particular risks within the Company.  The Board believes that the combination of the Chairman and Chief Executive Officer roles facilitates the exercise by the Board of Directors of their key risk oversight responsibility by focusing on clear lines of communication between management and the Board of Directors and its committees. See the discussion of "Board Leadership Structure" above.
 
Code of Ethics
 
We have adopted a Code of Business Conduct and Ethics, which is applicable to all of our employees, officers and directors and a separate Code of Ethics for Executive and Financial Officers. Both the Code of Business Conduct and Ethics and the Code of Ethics for Executive and Financial Officers are available for review on our web site at www.parlux.com under "Corporate Website – Corporate Governance."  We intend to post amendments to, or waivers from, our Code of Business Conduct and Ethics and Code of Ethics for Executive and Financial Officers on our web site.
 
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
Based solely upon a review of (1) Forms 3 and 4 and amendments to each form furnished to us pursuant to Rule 16a-3(e) under the Securities Exchange Act of 1934, as amended, during our fiscal year ended March 31, 2011, (2) any Forms 5 and amendments to such forms furnished to us with respect to our fiscal year ended March 31, 2011, and (3) any written representations referred to us in subparagraph (b)(1) of Item 405 of Regulation S-K under the Securities Exchange Act of 1934, as amended: (i) there was a Form 4 for each of Messrs. D'Agostino, Gopman, Mitzman and Ms. Egozi Choukroun relating to a stock option grant on October 12, 2010, that was inadvertently filed late.  The failure to timely report the above transactions was inadvertent and, as soon as the oversight was discovered, the Form 4s were promptly filed.  Other than as provided above, to the best of our knowledge, all required Section 16 reports by our directors, executive officers and beneficial owners of more than 10% of our common stock, were filed on time.
 
 
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ITEM 11.  EXECUTIVE COMPENSATION
 
Compensation Discussion and Analysis
 
This section describes the material elements of compensation awarded to, earned by or paid to our principal executive officer, our principal financial officer and our principal operating officer during fiscal 2011. These individuals are referred to as the "Named Executive Officers" and are listed in the executive compensation tables provided below.

Our executive compensation programs are determined and proposed by our Compensation Committee and are approved by our Board of Directors. None of the Named Executive Officers are members of the Compensation Committee.
 
Executive Compensation Program Objectives and Overview
 
The Compensation Committee conducts an annual review of our executive compensation programs to ensure that:
 
 
·
the program is designed to achieve our goals of promoting financial and operational success by attracting, motivating and facilitating the retention of key employees with outstanding talent and ability; and
 
 
·
the program adequately rewards performance which is tied to creating stockholder value.
 
Our current executive compensation program consists of three components, which are designed to be consistent with our compensation philosophy: (1) base salary; (2) annual incentive bonuses; and (3) grants of stock options.
 
In structuring executive compensation packages, the Compensation Committee considers how each component promotes retention and/or motivates performance by the executive. Base salaries, perquisites and personal benefits, and severance and other termination benefits are primarily intended to attract and retain highly qualified executives. We believe that in order to attract and retain top executives, we need to provide them with compensation levels that reward their continued productive service. Annual incentive bonuses are primarily intended to motivate our executive officers to achieve specific strategies and operating objectives, although we believe they also help us to attract and retain top executives. Our long-term equity incentives are primarily intended to align executive officers’ long-term interests with stockholders’ long-term interests, although we believe they also play a role in helping us to attract and retain top executives. Annual incentive bonuses and stock option grants are the elements of our executive compensation program designed to reward performance and thus the creation of stockholder value.
 
We view our current executive compensation program as one in which the individual components combine together to create a total compensation package for each executive officer that we believe achieves our compensation objectives. In the past, the Compensation Committee has evaluated current executive compensation data for companies in our industry as part of its process prior to determining our current executive compensation program and the amounts of compensation for each component of our program. The companies reviewed during fiscal 2009 were Elizabeth Arden, Estee Lauder, Revlon and Inter Parfums, Inc. The Compensation Committee used this data to obtain a general understanding of current compensation practices in our industry and to ensure that it was acting in an informed and responsible manner to make sure the Company's compensation program was competitive. The Compensation Committee viewed this data as one factor in assisting its compensation decisions, but did not use this data as a reference point, either wholly or in part, to base, justify or provide a framework for its compensation decisions. Further, the Compensation Committee did not target any element of executive compensation to be at the median or any specific percentile of this industry data. The Compensation Committee used its experience and judgment to make final compensation decisions. For fiscal 2010 and 2011, the Compensation Committee determined it was not necessary to undertake an evaluation of executive compensation data for companies in our industry, particularly in light of global economic conditions, the Company's cost-cutting initiatives and the terms of the employment agreements with the Named Executive Officers.
 
 
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Based upon the Compensation Committee’s review of our compensation design features, and our applied compensation objectives, the Compensation Committee determined that risks arising from our compensation policies and practices for our employees are not reasonably likely to have a material adverse effect on the Company.
 
Role of Executive Officers in Compensation Decisions
 
The Compensation Committee makes recommendations to our Board of Directors for all compensation decisions, including non-cash compensation, for our senior executive officers, including the Named Executive Officers. Our Compensation Committee and Chief Executive Officer annually review the performance of our senior executive officers and the Compensation Committee considers the recommendations of the Chief Executive Officer in setting compensation levels for the other senior executive officers. The conclusions reached and recommendations based on these reviews, including with respect to salary adjustments and annual award amounts, are presented to the Board of Directors by the Compensation Committee. The Compensation Committee can modify any recommended adjustments or awards to our executive officers.
 
Current Executive Compensation Program Elements
 
Base Salaries
 
We provide our Named Executive Officers with a base salary to compensate them for services rendered during the fiscal year. The initial base salaries for certain of our Named Executive Officers were fixed pursuant to their written employment agreements. See “Employment Agreements” beginning on page 59. The initial base salary ranges were determined for each executive officer based upon their position, responsibility and industry experience. Any adjustments in the base salaries of our executive officers who are party to an employment agreement will be determined by the Compensation Committee based upon a combination of data derived from current surveys of compensation levels for similar positions in public companies of comparable size and industry type as determined by the Committee to be appropriate for consideration and a subjective review of the executive officer’s performance by the Compensation Committee, and the attainment of financial and operational objectives, with no specified weight being given to any of these factors. Salary levels are typically considered annually as part of our performance review process, as well as upon a promotion or other change in job responsibility. During fiscal 2011, the cash salaries paid to Messrs. Purches, Buttacavoli, and Balsys were $379,646, $361,231, and $225,769, respectively. As discussed in more detail below, Mr. Purches was appointed Chief Executive Officer on January 25, 2010, and as a result for fiscal 2010 served in this capacity from January 25, 2010 through March 31, 2010, and received the pro-rata portion of an annual base salary of $300,000. Additionally, the Company entered into an employment agreement with Mr. Purches for a term of one year beginning April 1, 2010 and ending March 31, 2011, pursuant to which he received an annual base salary of $300,000, and such annual base salary is equivalent to half of the annual base salary the Company's prior Chief Executive Officer would have been entitled to receive under the terms of his employment agreement. Effective November 8, 2010, the Company and Mr. Purches entered into a new employment agreement (the New Employment Agreement) which superseded the previous agreement then in place.  The New Employment Agreement expires on October 7, 2011, and provides for a base annual salary of $500,000. On May 18, 2011, we entered into an amendment to Mr. Purches’ executive employment agreement, which amends the term of his employment to continue through March 31, 2012, unless terminated at an earlier date in accordance with the agreement. Additional details regarding the New Employment Agreement and amendment follows below.
 
Mr. Buttacavoli's base salary for fiscal 2010 was set in accordance with the terms of his employment agreement. Mr. Balsys' base salary for fiscal 2010 was set in accordance with the terms of his employment agreement and increased from $225,000 in fiscal 2009 to $250,000 in fiscal 2010 upon the use of the Compensation Committee's discretion. For fiscal 2011, in recognition of the challenges and difficulties faced by the Company as a result of