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INDEX

FORM 10-Q

 

				Page No.
Part I.		Financial Information		3
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets - March 31, 2008 (unaudited) and December 31, 2007		3
		Unaudited Condensed Consolidated Income Statements - Three Months Ended March 31, 2008 and 2007		4
		Unaudited Condensed Consolidated Statement of Stockholders' Equity - Three Months Ended March 31, 2008		5
		Unaudited Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2008 and 2007		6
		Notes to Unaudited Condensed Consolidated Financial Statements		7
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		21
Item 4.		Controls and Procedures		22
Part II.		Other Information		22
Item 1.		Legal Proceedings		22
Item 1A.		Risk Factors		22
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		25
Item 5		Other Information		25
Item 6.		Exhibits		25
Signatures				26

 

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Part I.  Financial Information

Item 1. Financial Statements 

Iconix Brand Group, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

			March 31, 2008			December 31, 2007
			(Unaudited)
Assets
Current Assets:
Cash (including restricted cash of $3,839 in 2008 and $5,205 in 2007)		$	56,336		$	53,272
Accounts receivable, net of reserve of $3,519 in 2008 and 2007			36,636			29,757
Deferred income tax assets			7,442			7,442
Prepaid advertising and other			6,114			5,397
Total Current Assets			106,528			95,868
Property and equipment:
Furniture, fixtures and equipment			3,341			2,903
Less: Accumulated depreciation			(1,681	)		(1,610	)
			1,660			1,293
Other Assets:
Restricted cash			15,865			15,186
Marketable securities			10,660			10,920
Goodwill			128,898			128,898
Trademarks and other intangibles, net			1,036,390			1,038,201
Deferred financing costs, net			7,836			8,270
Non-current deferred income tax assets			12,867			21,158
Other			15,930			16,336
			1,228,446			1,238,969
Total Assets		$	1,336,634		$	1,336,130
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses		$	18,016		$	15,804
Accounts payable, subject to litigation			1,878			1,878
Deferred revenue			1,885			6,162
Current portion of long-term debt			33,035			52,566
Total current liabilities			54,814			76,410
Deferred income taxes			70,836			73,418
Long-term debt, less current maturities			648,898			649,590
Long term deferred revenue			8,912			8,792
Total Liabilities			783,460			808,210
Commitments and contingencies
Stockholders' Equity
Common stock, $.001 par value - shares authorized 150,000; shares issued 57,671 and 57,330 respectively			58			58
Additional paid-in capital			477,254			469,941
Retained earnings			79,185			60,941
Accumulated other comprehensive loss			(2,656	)		(2,353	)
Less: Treasury stock - 212 shares at cost			(667	)		(667	)
Total Stockholders’ Equity			553,174			527,920
Total Liabilities and Stockholders' Equity		$	1,336,634		$	1,336,130

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Iconix Brand Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Income Statements

(in thousands, except earnings per share data)

 

			Three Months Ended March 31,
			2008			2007
Licensing revenue		$	55,667		$	30,841
Selling, general and administrative expenses			18,711			7,719
Special charges			191			763
Operating income			36,765			22,359
Other expenses:
Interest expense			10,121			3,535
Interest income			(1,565	)		(913	)
Interest expense- net			8,556			2,622
Income before income taxes			28,209			19,737
Provision for income taxes			9,965			6,990
Net income		$	18,244		$	12,747
Earnings per share:
Basic		$	0.32		$	0.23
Diluted		$	0.30		$	0.21
Weighted average number of common shares outstanding:
Basic			57,422			56,402
Diluted			61,350			61,243

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Iconix Brand Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statement of Stockholders' Equity

Three Months Ended March 31, 2008

(in thousands)

 

			Common Stock
			Shares			Amount			Additional  Paid-in Capital			Retained Earnings			Accumulated  Other Comprehensive Loss			Treasury Stock			Total
Balance at January 1, 2008			57,330		$	58		$	469,941		$	60,941		$	(2,353	)	$	(667	)	$	527,920
Exercise of stock options			341			-			1,206			-			-			-			1,206
Tax benefit of stock option exercises			-			-			4,001			-			-			-			4,001
Amortization expense in connection with restricted stock			-			-			2,106			-			-			-			2,106
Comprehensive income:
Net Income			-			-			-			18,244			-			-			18,244
Change in fair value of cash flow hedge			-			-			-			-			(43	)		-			(43	)
Change in fair value of securities			-			-			-			-			(260	)		-			(260	)
Total comprehensive income			-			-			-			-			-			-			17,941
Balance at March 31, 2008			57,671		$	58		$	477,254		$	79,185		$	(2,656	)	$	(667	)	$	553,174

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Iconix Brand Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

			Three Months Ended March 31,
			2008			2007
Cash flows from operating activities:
Net income		$	18,244		$	12,747
Depreciation of property and equipment			71			39
Amortization of trademarks and other intangibles			1,917			903
Amortization of deferred financing costs			440			165
Amortization of convertible note discount			323			-
Stock-based compensation expense			2,106			359
Bad debt expense			173			469
Accrued interest on long-term debt			1,344			60
Deferred income tax provision (benefit)			5,709			6,990
Changes in operating assets and liabilities, net of business acquisitions:
Accounts receivable			(7,052	)		(10,208	)
Prepaid advertising and other			(1,217	)		(776	)
Other assets			363			570
Deferred revenue			(4,157	)		3,808
Accounts payable and accrued expenses			862			(11	)
Net cash provided by operating activities			19,126			15,115
Cash flows used in investing activities:
Purchases of property and equipment			(438	)		(40	)
Addition to trademarks			(106	)		-
Collection on promissory note			500			-
Acquisition of Danskin			-			(70,799	)
Acquisition of Rocawear			-			(204,233	)
Net cash used in investing activities			(44	)		(275,072	)
Cash flows provided by financing activities:
Proceeds from long-term debt			-			212,500
Proceeds from exercise of stock options and warrants			1,206			643
Payment of long-term debt			(20,546	)		(4,151	)
Payment of expenses related to common stock issuance				-		(184	)
Deferred financing costs			-			(3,915	)
Excess tax benefit from share-based payment arrangements			4,001			-
Restricted cash - current			1,366			2,338
Restricted cash - non-current			(679	)		(1,085	)
Net cash provided by (used in) financing activities			(14,652	)		206,146
Net increase (decrease) in cash and cash equivalents			4,430			(53,811	)
Cash and cash equivalents, beginning of period			48,067			73,572
Cash and cash equivalents, end of period		$	52,497		$	19,761
Balance of restricted cash - current			3,839			1,930
Total cash and cash equivalents including current restricted cash, end of period		$	56,336		$	21,691

 

Supplemental disclosure of cash flow information:

 

			Three Months Ended March 31,
			2008			2007
Cash paid during the period:
Income taxes		$	343		$	291
Interest		$	7,823		$	3,375

Supplemental disclosures of non-cash investing and financing activities:

 

			Three Months Ended March 31,
			2008			2007
Acquisitions:
Common stock issued		$	-		$	496
Warrants issued - acquisition cost		$	-		$	4,931

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Iconix Brand Group, Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements (Unaudited)

March 31, 2008

1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management of Iconix Brand Group, Inc. ("Company", "we", "us", or "our"), all adjustments (consisting primarily of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2008 (“Current Quarter”) are not necessarily indicative of the results that may be expected for a full fiscal year.

 

Certain prior year amounts have been reclassified to conform to the current year's presentation.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007 (“Fiscal 2007”).

2.  Fair Value Measurements

Statement of Financial Accounting Standards (“SFAS”) No. 157 “Fair Value Measurements” (“SFAS No. 157”), which the Company adopted on January 1, 2008, establishes a framework for measuring fair value and requires expanded disclosures about fair value measurement. While SFAS No.157 does not require any new fair value measurements in its application to other accounting pronouncements, it does emphasize that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS No. 157 established the following fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs):

Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets

Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs

Level 3: Unobservable inputs for which there is little or no market data and which requires the owner of the assets or liabilities to develop its own assumptions about how market participants would price these assets or liabilities

The valuation techniques that may be used to measure fair value are as follows:

(A) Market approach - Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities

(B) Income approach - Uses valuation techniques to convert future amounts to a single present amount based on current market expectations about those future amounts, including present value techniques, option-pricing models and excess earnings method

(C) Cost approach - Based on the amount that would currently be required to replace the service capacity of an asset (replacement cost)

The Company relies on a combination of Level 1 inputs generated by market transactions of identical instruments, Level 2 inputs using a market approach based on third party estimates of similarly priced instruments, and Level 3 inputs using an income approach, to determine the fair value of certain financial instruments. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of financial assets and financial liabilities and their placement within the fair value hierarchy. The following table summarizes the instruments measured at fair value during the Current Quarter:

 

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Carrying Amount as of March 31, 2008		Level 1		Level 2		Level 3		Valuation Technique
Marketable Securities				ü		ü		(B) and (C)
Cash Flow Hedge		ü						(A)

Marketable Securities

Marketable securities, which are accounted for as available-for-sale, are stated at fair value in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS No. 115”) and consist of auction rate securities. Temporary changes in fair market value are recorded as other comprehensive income or loss, whereas other than temporary markdowns will be realized through the Company’s statement of operations.

As of March 31, 2008, the Company held $10.7 million in marketable securities. Although these auction rate securities continue to pay interest according to their stated terms, based on a third-party valuation as of March 31, 2008 of these specific auction rate securities using Level 2 inputs and an internally developed discounted cash flow model using Level 3 inputs, during the Current Quarter the Company recorded an unrealized pre-tax loss of $0.3 million in other comprehensive loss as a reduction to stockholders’ equity to reflect a temporary decline in value of the marketable securities reflecting a failed auction due to sell orders exceeding buy orders. The Company believes the decrease in fair value is temporary due to general macroeconomic market conditions, as the underlying securities have maintained their investment grade rating. These funds will not be available to us until a successful auction occurs or a buyer is found outside the auction process. As these instruments have failed to auction and may not auction successfully in the near future, the Company has classified its marketable securities as non-current. The following table summarizes the activity for the period:

 

(000's omitted)

 

Description			Auction Rate Securities
Balance at January 1, 2008		$	10,920
Additions			-
Gains (losses) reported in earnings			-
Gains (losses) reported in other comprehensive income			(260	)
Balance at March 31, 2008		$	10,660

 

Cash Flow Hedge

On July 26, 2007, the Company purchased a hedge instrument to mitigate the cash flow risk of rising interest rates on the Term Loan Facility (see Note 4). This hedge instrument caps the Company’s exposure to rising interest rates at 6.00% for LIBOR for 50% of the forecasted outstanding balance of the Term Loan Facility (“Interest Rate Cap”). Based on management’s assessment, the Interest Rate Cap qualifies for hedge accounting under SFAS 133 “Accounting for Derivative Instruments and Hedging Transactions”. On a quarterly basis, the value of the hedge is adjusted to reflect its current fair value, with any adjustment flowing through other comprehensive income. The fair value of this instrument is calculated based on Level 1 inputs. At March 31, 2008, the fair value of the Interest Rate Cap was $12,000, resulting in an other comprehensive loss of $43,000 for the Current Quarter, which is reflected in the Unaudited Condensed Consolidated Balance Sheet and Statement of Stockholders’ Equity, respectively.

 

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3.  Trademarks and Other Intangibles, net

 

Trademarks and other intangibles, net consist of the following:

 

						March 31, 2008						December 31, 2007
(000's omitted)			Estimated Lives in Years			Gross Carrying Amount			Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
Trademarks:
Indefinite life trademarks			indefinite		$	1,007,731		$	9,498		$	1,007,625		$	9,498
Definite life trademarks			10-15			18,897			1,205			18,897			856
Non-compete agreements:			2-15			10,075			4,963			10,075			4,585
Licensing agreements:			1.5-6			21,093			6,059			21,093			4,897
Domain names			5			570			251			570			223
					$	1,058,366		$	21,976		$	1,058,260		$	20,059

 

Amortization expense for intangible assets for the Current Quarter and the three months ended March 31, 2007 (“Prior Year Quarter”) was $1.9 million and $0.9 million, respectively. The trademarks of Candies®, Bongo®, Joe Boxer®, Rampage®, Mudd®, London Fog®, Mossimo®, Ocean Pacific®, Danskin®, Rocawear®, Cannon®, Royal Velvet®, Fieldcrest®, Charisma®, and Starter® have been determined to have an indefinite useful life and accordingly, consistent with SFAS No. 142, no amortization will be recorded in the Company's consolidated income statements. Instead, the related intangible asset will be tested for impairment at least annually, with any related impairment charge recorded to the statement of operations at the time of determining such impairment.

 

4.  Debt Arrangements

 

The Company's debt is comprised of the following:

 

			March 31,			December 31,
(000’s omitted)			2008			2007
Convertible Notes		$	282,038		$	281,714
Term Loan Facility			255,144			270,751
Asset-Backed Notes			132,565			137,505
Sweet Note (Note 7)			12,186			12,186
Total Debt		$	681,933		$	702,156

 

Convertible Senior Subordinated Notes

On June 20, 2007, the Company completed the issuance of $287.5 million principal amount of the Company's 1.875% convertible senior subordinated notes due 2012 (the “Convertible Notes”) in a private offering to certain institutional investors. The net proceeds received by the Company from the offering were approximately $281.1 million.

 

The Convertible Notes bear interest at an annual rate of 1.875%, payable semi-annually in arrears on June 30 and December 31 of each year, beginning December 31, 2007. The Convertible Notes will be convertible into cash and, if applicable, shares of the Company's common stock based on a conversion rate of 36.2845 shares of the Company's common stock, subject to customary adjustments, per $1,000 principal amount of the Convertible Notes (which is equal to an initial conversion price of approximately $27.56 per share) only under the following circumstances: (1) during any fiscal quarter beginning after September 30, 2007 (and only during such fiscal quarter), if the closing price of the Company's common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is more than 130% of the conversion price per share, which is $1,000 divided by the then applicable conversion rate; (2) during the five business day period immediately following any five consecutive trading day period in which the trading price per $1,000 principal amount of the Convertible Notes for each day of that period was less than 98% of the product of (a) the closing price of the Company's common stock for each day in that period and (b) the conversion rate per $1,000 principal amount of the Convertible Notes; (3) if specified distributions to holders of the Company's common stock are made, as set forth in the indenture governing the Convertible Notes (“Indenture”); (4) if a “change of control” or other “fundamental change,” each as defined in the Indenture, occurs; (5) if the Company chooses to redeem the Convertible Notes upon the occurrence of a “specified accounting change,” as defined in the Indenture; and (6) during the last month prior to maturity of the Convertible Notes. If the holders of the Convertible Notes exercise the conversion provisions under the circumstances set forth, the Company will need to remit the lower of the principal balance of the Convertible Notes or their conversion value to the holders in cash. As such, the Company would be required to classify the entire amount outstanding of the Convertible Notes as a current liability in the following quarter. The evaluation of the classification of amounts outstanding associated with the Convertible Notes will occur every quarter.

 

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Upon conversion, a holder will receive an amount in cash equal to the lesser of (a) the principal amount of the Convertible Note or (b) the conversion value, determined in the manner set forth in the Indenture. If the conversion value exceeds the principal amount of the Convertible Note on the conversion date, the Company will also deliver, at its election, cash or the Company's common stock or a combination of cash and the Company's common stock for the conversion value in excess of the principal amount. In the event of a change of control or other fundamental change, the holders of the Convertible Notes may require the Company to purchase all or a portion of their Convertible Notes at a purchase price equal to 100% of the principal amount of the Convertible Notes, plus accrued and unpaid interest, if any. If a specified accounting change occurs, the Company may, at its option, redeem the Convertible Notes in whole for cash, at a price equal to 102% of the principal amount of the Convertible Notes, plus accrued and unpaid interest, if any. Holders of the Convertible Notes who convert their Convertible Notes in connection with a fundamental change or in connection with a redemption upon the occurrence of a specified accounting change may be entitled to a make-whole premium in the form of an increase in the conversion rate.

 

Pursuant to Emerging Issues Task Force (“EITF”) 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion” (“EITF 90-19”), EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock” (“EITF 00-19”), and EITF 01-6, “The Meaning of Indexed to a Company's Own Stock” (“EITF 01-6”), the Convertible Notes are accounted for as convertible debt in the accompanying Condensed Consolidated Balance Sheet and the embedded conversion option in the Notes has not been accounted for as a separate derivative. For a discussion of the effects of the Convertible Notes and the convertible note hedge and warrants discussed below on earnings per share, see Note 6.

  

At March 31, 2008, the balance of the Convertible Notes was $282.0 million.

 

In connection with the sale of the Convertible Notes, the Company entered into hedges for the Convertible Notes (“Convertible Note Hedges”) with respect to its common stock with two entities (the “Counterparties”). Pursuant to the agreements governing these Convertible Note Hedges, the Company has purchased call options (the “Purchased Call Options”) from the Counterparties covering up to approximately 10.4 million shares of the Company's common stock. These Convertible Note Hedges are designed to offset the Company's exposure to potential dilution upon conversion of the Convertible Notes in the event that the market value per share of the Company's common stock at the time of exercise is greater than the strike price of the Purchased Call Options (which strike price corresponds to the initial conversion price of the Convertible Notes and is simultaneously subject to certain customary adjustments). On June 20, 2007, the Company paid an aggregate amount of approximately $76.3 million of the proceeds from the sale of the Convertible Notes for the Purchased Call Options, of which $26.7 million was included in the balance of deferred income tax assets at June 30, 2008 and will be recognized over the term of the Convertible Notes. As of March 31, 2008, the balance of deferred income tax assets related to this transaction was $22.7 million.

 

The Company also entered into separate warrant transactions with the Counterparties whereby the Company, pursuant to the agreements governing these warrant transactions, sold to the Counterparties warrants (the “Sold Warrants”) to acquire up to 3.6 million shares of the Company's common stock, at a strike price of $42.40 per share of the Company's common stock. The Sold Warrants will become exercisable on September 28, 2012 and will expire by the end of 2012. The Company received aggregate proceeds of approximately $37.5 million from the sale of the Sold Warrants on June 20, 2007.

 

The Convertible Note Hedge transactions and the warrant transactions were separate transactions, entered into by the Company with the Counterparties, and as such are not part of the terms of the Convertible Notes and will not affect the holders' rights under the Convertible Notes. In addition, holders of the Convertible Notes will not have any rights with respect to the Purchased Call Options or the Sold Warrants. As a result of these transactions, the Company recorded a reduction to additional paid-in-capital of $12.1 million in June 2007.

 

If the market value per share of the Company's common stock at the time of conversion of the Convertible Notes is above the strike price of the Purchased Call Options, the Purchased Call Options entitle the Company to receive from the Counterparties net shares of the Company's common stock, cash or a combination of shares of the Company's common stock and cash, depending on the consideration paid on the underlying Convertible Notes, based on the excess of the then current market price of the Company's common stock over the strike price of the Purchased Call Options. Additionally, if the market price of the Company's common stock at the time of exercise of the Sold Warrants exceeds the strike price of the Sold Warrants, the Company will owe the Counterparties net shares of the Company's common stock or cash, not offset by the Purchased Call Options, in an amount based on the excess of the then current market price of the Company's common stock over the strike price of the Sold Warrants.

 

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These transactions will generally have the effect of increasing the conversion price of the Convertible Notes to $42.40 per share of the Company's common stock, representing a 100% percent premium based on the last reported sale price of the Company’s common stock of $21.20 per share on June 14, 2007.

Term Loan Facility

In connection with the acquisition of the Rocawear brand, in March 2007, the Company entered into a $212.5 million credit agreement (the “Credit Agreement” or “Term Loan Facility”) with Lehman Brothers Inc. and Lehman Commercial Paper Inc. (“LCPI”). At the time, the Company pledged to LCPI 100% of the capital stock owned by the Company in its subsidiaries, OP Holdings and Management Corporation, a Delaware corporation (“OPHM”), and Studio Holdings and Management Corporation, a Delaware corporation (“SHM”). The Company's obligations under the Credit Agreement are guaranteed by each of OPHM and SHM, as well as by two of its other subsidiaries, OP Holdings LLC, a Delaware limited liability company (“OP Holdings”), and Studio IP Holdings LLC, a Delaware limited liability company ("Studio IP Holdings").

 

On October 3, 2007, in connection with the acquisition of Official-Pillowtex LLC, a Delaware limited liability company (“Official-Pillowtex”), with the proceeds of the Convertible Notes, the Company pledged to LCPI 100% of the capital stock owned by the Company in Mossimo, Inc., a Delaware corporation (“MI”), and Pillowtex Holdings and Management Corporation, a Delaware corporation (“PHM”), each of which guaranteed the Company’s obligations under the Credit Agreement. Simultaneously with the acquisition of Official-Pillowtex, each of Mossimo Holdings LLC (“Mossimo Holdings”), a Delaware limited liability company, and Official-Pillowtex guaranteed the Company’s obligations under the Credit Agreement.  

On December 17, 2007, in connection with the acquisition of the Starter brand, the Company borrowed $63.2 million pursuant to the Term Loan Facility (“Additional Borrowing”). The net proceeds received by the Company from the Additional Borrowing were $60 million. At the time of such Additional Borrowing, there was already outstanding under the Term Loan Facility a term loan in the principal amount equal to $211.4 million.

The guarantees are secured by a pledge to LCPI of, among other things, the Ocean Pacific, Danskin, Rocawear, Mossimo, Cannon, Royal Velvet, Fieldcrest, Charisma, and Starter trademarks and related intellectual property assets, license agreements and proceeds therefrom. Amounts outstanding under the term loan facility bear interest, at the Company’s option, at the Eurodollar rate or the prime rate, plus an applicable margin of 2.25% or 1.25%, as the case may be, per annum. The Credit Agreement provides that the Company is required to repay the outstanding term loan in equal quarterly installments in annual aggregate amounts equal to 1.00% of the aggregate principal amount of the loans outstanding, subject to adjustment for prepayments, in addition to an annual payment equal to 50% of the excess cash flow from the Term Loan Facility group, with any remaining unpaid principal balance to be due on April 30, 2013. The Term Loan Facility can be prepaid, without penalty, at any time. On March 11, 2008, the Company paid to LCPI, for the benefit of the lenders under the Term Loan Facility, $15.6 million, representing 50% of the excess cash flow from the Term Loan Facility group for Fiscal 2007. As a result of such payment, the Company is no longer required to pay the quarterly installments described above. The interest rate as of March 31, 2008 was 4.96%. At March 31, 2008, the balance of the Term Loan Facility was $255.1 million. The $272.5 million in proceeds from the Term Loan Facility were used by the Company as follows: $204.0 million was used to pay the cash portion of the initial consideration for the acquisition of the Rocawear brand; $2.1 million was used to pay the costs associated with the Rocawear acquisition; $60 million was used to pay the consideration for the acquisition of the Starter brand; and $3.9 million was used to pay costs associated with the Term Loan Facility. The costs of $3.9 million relating to the Term Loan Facility have been deferred and are being amortized over the life of the loan, using the effective interest method.

 

On July 26, 2007, the Company purchased a hedge instrument to mitigate the cash flow risk of rising interest rates on the Term Loan Facility. See Note 2 for further information.

 

Asset-Backed Notes

The financing for certain of the Company's acquisitions has been accomplished through private placements by its subsidiary, IP Holdings LLC ("IP Holdings") of asset-backed notes ("Asset-Backed Notes") secured by intellectual property assets (trade names, trademarks, license agreements and payments and proceeds with respect thereto relating to the Candie’s, Bongo, Joe Boxer, Rampage, Mudd and London Fog brands) of IP Holdings. At March 31, 2008, the balance of the Asset-Backed Notes was $132.6 million. 

 

Cash on hand in the bank account of IP Holdings is restricted at any point in time up to the amount of the next debt principal and interest payment required under the Asset-Backed Notes. Accordingly, $3.8 million and $5.2 million as of March 31, 2008 and December 31, 2007, respectively, have been disclosed as restricted cash within the Company's current assets. Further, in connection with IP Holdings' issuance of Asset-Backed Notes, a reserve account has been established and the funds on deposit in such account will be applied to the last principal payment with respect to the Asset-Backed Notes. Accordingly, $15.9 million and $15.2 million as of March 31, 2008 and December 31, 2007, respectively, have been disclosed as restricted cash within other assets on the Company's balance sheets.

Interest rates and terms on the outstanding principal amount of the Asset-Backed Notes as of March 31, 2008 are as follows: $46.4 million principal amount bears interest at a fixed interest rate of 8.45% with a six year term, $20.5 million principal amount bears interest at a fixed rate of 8.12% with a six year term, and $65.7 million principal amount bears interest at a fixed rate of 8.99% with a six and a half year term. The aggregate principal amount of the Asset-Backed Notes will be fully paid by February 22, 2013.

 

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Neither the Company nor any of its subsidiaries (other than IP Holdings) is obligated to make any payment with respect to the Asset-Backed Notes, and the assets of the Company and its subsidiaries (other than IP Holdings) are not available to IP Holdings' creditors. The assets of IP Holdings are not available to the creditors of the Company or its subsidiaries (other than IP Holdings).

 

The Sweet Note

On April 23, 2002, the Company acquired the remaining 50% interest in Unzipped (see Note 7) from Sweet Sportswear, LLC (“Sweet”) for a purchase price comprised of 3,000,000 shares of its common stock and $11.0 million in debt, which was evidenced by the Company’s issuance of the 8% Senior Subordinated Note due in 2012 (“Sweet Note”). Prior to August 5, 2004, Unzipped was managed by Sweet pursuant to the Management Agreement (as defined in Note 7), which obligated Sweet to manage the operations of Unzipped in return for, commencing in fiscal 2003, an annual management fee based upon certain specified percentages of net income achieved by Unzipped during the three- year term of the agreement. In addition, Sweet guaranteed that the net income, as defined in the agreement, of Unzipped would be no less than $1.7 million for each year during the term, commencing with fiscal 2003. In the event that the guarantee was not met for a particular year, Sweet was obligated under the Management Agreement to pay the Company the difference between the actual net income of Unzipped, as defined, for such year and the guaranteed $1.7 million. That payment, referred to as the shortfall payment, could be offset against the amounts due under the Sweet Note at the option of either the Company or Sweet. As a result of such offsets, the balance of the Sweet Note was reduced by the Company to $3.1 million as of December 31, 2006 and $3.0 million as of December 31, 2005 and was reflected in Long- term debt. This note bears interest, which was accrued for in the Current Quarter, at the rate of 8% per year and matures in April 2012.

 

In November 2007, the Company received a signed judgment related to the Sweet/Guez litigation. See Note 9.

The judgment also stated that the Sweet Note (originally $11.0 million when issued by the Company upon the acquisition of Unzipped from Sweet in 2002) should total approximately $12.2 million as of December 31, 2007. The recorded balance of the Sweet Note, prior to any adjustments related to the judgment was approximately $3.2 million. The Company increased the Sweet Note by approximately $6.2 million and recorded the expense as a special charge. The Company further increased the Sweet Note by approximately $2.8 million to record the related interest and included the charge in interest expense. The Sweet Note as of March 31, 2008 is approximately $12.2 million and included in the Current portion of long-term debt.

In addition, the Company was awarded a judgment of approximately $12.2 million for claims made by it against Hubert Guez and Apparel Distribution Services, Inc. As a result, the Company recorded a receivable of approximately $12.2 million and recorded the benefit in special charges. This receivable is included in Other assets - non-current and bears interest, which was accrued for in the Current Quarter, at the rate of 8% per year.

Debt Maturities

The Company's debt maturities are the following:

 

(000’s omitted)			Total			2008			2009			2010			2011			2012			thereafter
Convertible Notes		$	282,038		$	-		$	-		$	-		$	-		$	282,038		$	-
Term Loan Facility			255,144			-			-			-			-			-			255,144
Asset-Backed Notes			132,565			20,849			22,711			24,740			26,950			37,315			-
Sweet Note (Note 7)			12,186			12,186			-			-			-			-			-
Total Debt		$	681,933		$	33,035		$	22,711		$	24,740		$	26,950		$	319,353		$	255,144

 

5.  Stockholders' Equity

 

Stock Options

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

 

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The fair value for these options and warrants was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:

Expected Volatility			.30 - .50
Expected Dividend Yield			0	%
Expected Life (Term)			3 - 7 years
Risk-Free Interest Rate			3.00 - 4.75	%

 

The options that were granted under the Plans expire between five and ten years from the date of grant.

Summaries of the Company's stock options, warrants and performance related options activity, and related information for the Current Quarter are as follows:

 

			Options			Weighted-Average Exercise Price
Outstanding January 1, 2008			5,106,543		$	4.23
Granted			-			-
Canceled			-			-
Exercised			340,749			4.40
Expired			-			-
Outstanding March 31, 2008			4,765,794			4.22
Exercisable at March 31, 2008			4,681,126			4.17

 

			Warrants			Weighted-Average Exercise Price
Outstanding January 1, 2008			266,900		$	16.76
Granted			-			-
Canceled			-			-
Exercised			-			-
Expired			-			-
Outstanding March 31, 2008			266,900		$	16.76
Exercisable at March 31, 2008			266,900		$	16.76

All warrants issued in connection with acquisitions are recorded at fair market value using the Black Scholes model and are recorded as part of purchase accounting. Certain warrants are exercised using the cashless method.

The Company values other warrants issued to non-employees at the commitment date at the fair market value of the instruments issued, a measure which is more readily available than the fair market value of services rendered, using the Black Scholes model. The fair market value of the instruments issued is expensed over the vesting period.

At March 31, 2008, 1,394,108, 682,250, and 484,221 common shares were reserved for issuance on exercise of stock options under the 2002, 2001, and 2000 Stock Option Plans, respectively.

 

Restricted stock

 

Compensation cost for restricted stock is measured as the excess, if any, of the quoted market price of our stock at the date the common stock is issued over the amount the employee must pay to acquire the stock (which is generally zero). The compensation cost, net of projected forfeitures, is recognized over the period between the issue date and the date any restrictions lapse, with compensation cost for grants with a graded vesting schedule recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. The restrictions do not affect voting and dividend rights.

 

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The Company has granted restricted stock-based awards to certain employees. The awards have restriction periods tied to employment and vest over a period of six months to five years. The cost of the restricted stock-based awards, which is the fair market value on the date of grant net of estimated forfeitures, is expensed ratably over the vesting period. During the Current Quarter, the Company awarded an aggregate of 1,789,430 restricted stock-based awards, a portion of which are performance based. The awarded securities have a vesting period of six months to five years and a fair market value of approximately $27.6 million. There were no restricted securities awarded during the Prior Year Quarter. As of March 31, 2008, 82,835 restricted stock-based grants had vested.

Unearned compensation expense related to restricted securities grants for the Current Quarter and Prior Year Quarter was approximately $2.1 million and $0.3 million, respectively. An additional amount of $27.8 million is expected to be expensed evenly over a period of approximately three months to five years.

The following tables summarize information about unvested restricted securities transactions:

 

			Securities			Weighted Average Grant Date Fair Value
Non-vested, January 1, 2008			144,127		$	19.41
Granted			1,789,430			18.42
Vested			(82,835	)		18.80
Forfeited			-			-
Non-vested, March 31, 2008			1,850,722		$	18.48

 

Stockholder Rights Plan

In January 2000, the Company's Board of Directors adopted a stockholder rights plan. Under the plan, each stockholder of common stock received a dividend of one right for each share of the Company's outstanding common stock, entitling the holder to purchase one thousandth of a share of Series A Junior Participating Preferred Stock, par value, $0.01 per share of the Company, at an initial exercise price of $6.00. The rights become exercisable and will trade separately from the common stock ten business days after any person or group acquires 15% or more of the common stock, or ten business days after any person or group announces a tender offer for 15% or more of the outstanding common stock.

Stock Repurchase Program

On September 15, 1998, the Company's Board of Directors authorized the repurchase of up to two million shares of the Company's common stock, which was replaced with a new agreement on December 21, 2000, authorizing the repurchase of up to three million shares of the Company's common stock. During the Current Quarter, no shares were repurchased in the open market.

 

6.  Earnings Per Share 

Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of restricted stock-based awards and common shares issuable upon exercise of stock options and warrants. The difference between reported basic and diluted weighted-average common shares results from the assumption that all dilutive stock options outstanding were exercised and all convertible notes have been converted into common stock.

  

As of March 31, 2008, of the total potentially dilutive shares related to restricted stock-based awards, stock options and warrants, 1.5 million were anti-dilutive, compared to none as of March 31, 2007.

As of March 31, 2008, of the performance related restricted stock-based awards issued in connection with the Company’s new employment agreement with its chairman, chief executive officer and president, 1.2 million of such awards (which is included in the total 1.5 million anti-dilutive stock-based awards described above) were anti-dilutive and therefore not included in this calculation.

Warrants issued in connection with the Company’s Convertible Notes financing were anti-dilutive and therefore not included in this calculation. Portions of the convertible note that would be subject to conversion to common stock were anti-dilutive as of March 31, 2008 and therefore not included in this calculation.

 

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A reconciliation of shares used in calculating basic and diluted earnings per share follows:

 

(000's omitted)			For the Three Months Ended March 31,
			2008			2007
Basic			57,422			56,402
Effect of exercise of stock options			3,757			4,832
Effect of contingent common stock issuance			144			-
Effect of assumed vesting of restricted stock			27			9
			61,350			61,243

7. Unzipped Apparel, LLC (“Unzipped”)

Equity Investment

On October 7, 1998, the Company formed Unzipped with its then joint venture partner Sweet Sportswear, LLC (“Sweet”), the purpose of which was to market and distribute apparel under the Bongo label. The Company and Sweet each had a 50% interest in Unzipped. Pursuant to the terms of the joint venture, the Company licensed the Bongo trademark to Unzipped for use in the design, manufacture and sale of certain designated apparel products.

Acquisition

On April 23, 2002, the Company acquired the remaining 50% interest in Unzipped from Sweet for a purchase price of three million shares of the Company's common stock and $11 million in debt evidenced by the Sweet Note. See Note 4. In connection with the acquisition of Unzipped, the Company filed a registration statement with the Securities and Exchange Commission ("SEC") for the three million shares of the Company's common stock issued to Sweet, which was declared effective by the SEC on July 29, 2003.

Related Party Transactions

Prior to August 5, 2004, Unzipped was managed by Sweet pursuant to a management agreement (the “Management Agreement”). Unzipped also had a supply agreement with Azteca Productions International, Inc. ("Azteca") and a distribution agreement with Apparel Distribution Services, LLC ("ADS"). All of these entities are owned or controlled by Hubert Guez.

On August 5, 2004, Unzipped terminated the Management Agreement with Sweet, the supply agreement with Azteca and the distribution agreement with ADS and commenced a lawsuit against Sweet, Azteca, ADS and Hubert Guez. See Note 9.

There were no transactions with these related parties during the Current Quarter and the Prior Year Quarter.

In November 2007, a judgment was entered in the Unzipped litigation, pursuant to which the $3.1 million in accounts payable to ADS/Azteca (previously shown as “accounts payable - subject to litigation”) was eliminated and recorded in the income statement as a benefit in special charges.

As a result of the judgment, the balance of the $11.0 million principal amount Sweet Note, originally issued by the Company upon the acquisition of Unzipped from Sweet in 2002, including interest, was increased from approximately $3.2 million to approximately $12.2 million as of December 31, 2007. Of this increase, approximately $6.2 million was attributed to the principal of the Sweet Note and the expense was recorded as a special charge. The remaining $2.8 million of the increase was attributed to related interest on the Sweet Note and recorded as interest expense. As of March 31, 2008, the full $12.2 million current balance of the Sweet Note and $0.2 million of accrued interest are included in the Current portion of long term debt and Accounts payable and accrued expenses, respectively.

In addition, the Company was awarded a judgment of approximately $12.2 million for claims made by it against Hubert Guez and ADS. As a result, the Company recorded a receivable of approximately $12.2 million and recorded the benefit in special charges for Fiscal 2007. As of March 31, 2008, this receivable and the associated accrued interest of $0.2 million for the Current Quarter are both included in Other assets - non-current.

 

8.  Special Charges

Special charges consist of legal expenses and costs related to the Unzipped litigation. For the Current Quarter and Prior Year Quarter, the Company recorded special charges of $0.2 million and $0.8 million, respectively. See Note 7 for information relating to Unzipped.

 

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9.  Commitments and Contingencies

 

Sweet Sportswear/Unzipped litigation

 On August 5, 2004, the Company, along with its subsidiaries, Unzipped, Michael Caruso & Co., referred to as Caruso, and IP Holdings, collectively referred to as the plaintiffs, commenced a lawsuit in the Superior Court of California, Los Angeles County, against Unzipped's former manager, former supplier and former distributor, Sweet, Azteca and ADS, respectively, and a principal of these entities and former member of the Company's board of directors, Hubert Guez, collectively referred to as the Guez defendants. The Company pursued numerous causes of action against the Guez defendants, including breach of contract, breach of fiduciary duty, trademark infringement and others and sought damages in excess of $20 million. On March 10, 2005, Sweet, Azteca and ADS, collectively referred to as cross-complainants, filed a cross-complaint against the Company claiming damages resulting from a variety of alleged contractual breaches, among other things.

 

In January 2007, a jury trial was commenced, and on April 10, 2007, the jury returned a verdict of approximately $45 million in favor of the Company and its subsidiaries, finding in favor of the Company and its subsidiaries on every claim that they pursued, and against the Guez defendants on every counterclaim asserted. Additionally, the jury found that all of the Guez defendants acted with malice, fraud or oppression with regard to each of the tort claims asserted by the Company and its subsidiaries, and on April 16, 2007, awarded plaintiffs $5 million in punitive damages against Mr. Guez personally. The Guez defendants filed post-trial motions seeking, among other things, a new trial. Through a set of preliminary rulings dated September 27, 2007, the Court granted in part, and denied in part, the Guez defendants’ post trial motions, and denied plaintiffs’ request that the Court enhance the damages awarded against the Guez defendants arising from their infringement of plaintiffs’ trademarks. Through these rulings, the Court, among other things, reduced the amount of punitive damages assessed against Mr. Guez to $4 million, and reduced the total damages awarded against the Guez defendants by approximately 50%.

The Court adopted these preliminary rulings as final on November 16, 2007. On the same day, the Court entered judgment against Mr. Guez in the amount of $10,964,730 and ADS in the amount of $1,272,420, and against each of the Guez defendants with regard to each and every claim that they pursued in the litigation including, without limitation, ADS’s and Azteca’s unsuccessful efforts to recover against Unzipped any account balances claimed to be owed, totaling approximately $3.5 million including interest (collectively, the “Judgments”). In entering the Judgments, the Court upheld the jury’s verdict in favor of the Company relating to its writedown of the senior subordinated note due 2012, issued by the Company to Sweet in connection with the Company’s acquisition of Unzipped for Unzipped’s 2004 fiscal year. The monetary portion of the Judgments accrues interest at a rate of 10% per annum from the date of the Judgments’ entry. Also on November 16, 2007, the Court issued a Memorandum Order wherein it upheld an aggregate of approximately $7,000,000 of the jury’s verdicts against Sweet and Azteca, but declined to enter judgment against these entities since it had ordered a new trial with regard to certain other damage awards entered against these entities by the jury. On March 7, 2008, the Court commenced a hearing with regard to the attorneys’ fees and costs petitions filed by the Company and its subsidiaries, and this hearing was concluded on April 18. The Company expects the Court to render a decision with regard to these petitions within the upcoming weeks.

On November 21, 2007, the Guez defendants filed a notice of appeal. They also filed a $49,090,491 undertaking with the Court, consisting primarily of a $43,380,491 personal surety given jointly by Gerard Guez and Jacqueline Rose Guez, bonding the monetary portions of the Judgments. By Order dated December 17, the Court determined that the undertaking was adequate absent changed circumstances. This determination serves to prevent the Company and its subsidiaries from pursuing collection of the monetary portions of the Judgments during the pendency of the appeal. The Company and its subsidiaries filed a notice of appeal on November 26, 2007, appealing, among other things, those parts of the jury’s verdicts vacated by the Court in connection with the Guez defendants’ post-trial motions. The Company and its subsidiaries intend to vigorously pursue their appeal, and vigorously defend against the Guez parties’ appeal.

  

Bader/Unzipped litigation

 

This lawsuit was recently settled and discontinued with prejudice on March 25, 2008. The lawsuit was commenced on November 5, 2004, when Unzipped filed a complaint in the Supreme Court of New York, New York County, against Unzipped's former president of sales, Gary Bader, alleging that Mr. Bader breached certain fiduciary duties owed to Unzipped as its president of sales, unfairly competed with Unzipped and tortiously interfered with Unzipped's contractual relationships with its employees. On October 5, 2005, Unzipped amended its complaint to assert identical claims against Bader's company, Sportswear Mercenaries, Ltd. On October 14, 2005, Bader and Sportswear Mercenaries filed an answer containing counterclaims to Unzipped's amended complaint, and a third-party complaint, which was dismissed in its entirety on June 9, 2006, except with respect to a single claim that it owed Bader and Sportswear Mercenaries $72,000.

 

Redwood Shoe litigation

 

This litigation, which was commenced in January 2002, by Redwood Shoe Corporation (“Redwood”), one of the Company's former buying agents of footwear, was dismissed with prejudice by the court on February 15, 2007, pursuant to an agreement in principle by the Company, Redwood, its affiliate, Mark Tucker, Inc. (“MTI”) and MTI's principal, Mark Tucker, to settle the matter. The proposed settlement agreement provides for the Company to pay a total of $1.9 million to Redwood. The stipulation and order dismissing the action may be reopened should the settlement agreement not be finalized and consummated by all of the parties. The Company is awaiting receipt of the signed Settlement Agreement from the other parties.

 

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Bongo Apparel, Inc. litigation

 

On or about June 12, 2006, Bongo Apparel, Inc. (“BAI”), filed suit in the Supreme Court of the State of New York, County of New York, against the Company and IP Holdings alleging certain breaches of contract and other claims and seeks, among other things, damages of at least $25 million. The Company and IP Holdings believe that, in addition to other defenses and counterclaims that they intend to assert, the claims in the lawsuit are the subject of a release and settlement agreement that was entered into by the parties in August 2005, and based upon this belief, moved to dismiss most of BAI’s claims. In response to the motion to dismiss, BAI made a cross-motion for partial summary judgment on some of its claims. On April 25, 2007, the Court entered an order refusing to consider, and declining to accept BAI's summary judgment motion. On January 2, 2008, the Supreme Court granted the Company’s and IP Holdings’ motion to dismiss BAI’s lawsuit virtually in its entirety, holding that all but one claim against the Company and five claims against IP Holdings were barred by the parties’ August 2005 release and settlement agreement or otherwise failed to state a claim. As to the sole remaining claim against the Company, BAI has since withdrawn it against both the Company and IP Holdings and, as such, the Company is no longer a party to this action. BAI has appealed the Supreme Court’s January 2, 2008 rulings, and the Company and IP Holdings intend to vigorously defend against this appeal.

 

Additionally, on or about October 6, 2006, the Company and IP Holdings filed suit in the United States (“U.S.”) District Court for the Southern District of New York against BAI and its guarantor, TKO Apparel, Inc. (“TKO”). In that complaint, the Company and IP Holdings asserted various contract, tort and trademark claims that arose as a result of the failures of BAI with regard to the Bongo men's jeanswear business and its wrongful conduct with regard to the Bongo women's jeanswear business. The Company and IP Holdings sought monetary damages in an amount in excess of $10 million and a permanent injunction with respect to the use of the Bongo trademark. On January 4, 2007, the District Court denied the motion of BAI and TKO to dismiss the federal court action, and instead stayed the proceeding. On January 14, 2008, the Company and IP Holdings requested that the District Court lift the stay, and on March 1, 2008 the stay was lifted.

On March 7, 2008, the Company and IP Holdings filed an amended complaint, reiterating all of the claims that were asserted in the original complaint and seeking damages identical to those sought by the original complaint. Additionally, the amended complaint contains three fraudulent transfer claims predicated upon BAI’s and TKO’s dissipation of their assets, as well as claims for civil conspiracy and aiding and abetting arising from this conduct. On March 28, 2008, BAI and TKO filed a motion to dismiss the amended complaint in its entirety, and on April 11, 2008 the Company and IP Holdings filed their opposition to that motion. The Company and IP Holdings intend to vigorously pursue this litigation.

Normal Course litigation

 

From time to time, the Company is also made a party to litigation incurred in the normal course of business. While any litigation has an element of uncertainty, the Company believes that the final outcome of any of these routine matters will not have a material effect on the Company’s financial position or future liquidity.

10.  Related Party Transactions

On May 1, 2003, the Company granted Kenneth Cole Productions, Inc. the exclusive worldwide license to design, manufacture, sell, distribute and market footwear under its Bongo brand. The chief executive officer and chairman of Kenneth Cole Productions is Kenneth Cole, who is the brother of Neil Cole, the Company's chairman, chief executive officer and president. During the Current Quarter and Prior Year Quarter, the Company earned $0.3 million and $0.3 million, respectively, in royalties from Kenneth Cole Productions.

  

The Candie's Foundation, a charitable foundation founded by Neil Cole for the purpose of raising national awareness about the consequences of teenage pregnancy, owed the Company $0.5 million and $0.4 million at March 31, 2008 and December 31, 2007, respectively. The Candie's Foundation intends to pay-off the entire borrowing from the Company during 2008, although additional advances will be made as and when necessary. Mr. Cole’s wife, Elizabeth Cole, performs services for the foundation but receives no compensation.

The Company recorded expenses of approximately $131,000 and $0 for the Current Quarter and the Prior Year Quarter, respectively, for the hire and use of aircraft owned by a company in which the Company’s chairman, chief executive officer and president is the sole owner.  Management believes that all transactions were made on terms and conditions similar to or more favorable than those available in the marketplace from unrelated parties.

 

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11.  Subsequent Events

On May 1, 2008, the Company entered into a Contribution Agreement (the "Contribution Agreement") with Novel Fashion Holdings Limited, a corporation organized under the laws of the British Virgin Islands (“Novel”) and controlled by Silas Chou and members of his family. Upon the closing of the transactions contemplated by the Contribution Agreement, the Company and Novel will form a joint venture to develop, exploit and market the Company's brands in the People’s Republic of China, Hong Kong, Macau and Taiwan (the “Territory”). Pursuant to the Contribution Agreement, the Company will commit to contribute $5 million and substantially all rights to its brands in the Territory, and Novel will commit to contribute $20 million, respectively, over the two-year period following the consummation of the transaction. The transactions contemplated by the Contribution Agreement are subject to customary closing conditions.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. The statements that are not historical facts contained in this report are forward looking statements that involve a number of known and unknown risks, uncertainties and other factors, all of which are difficult or impossible to predict and many of which are beyond the control of the Company, which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. These risks are detailed in the Company’s Form 10-K for the fiscal year ended December 31, 2007 and other SEC filings. The words “believe”, “anticipate,” “expect”, “confident”, “project”, provide “guidance” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date the statement was made.

Executive Summary. The Company is a brand management company engaged in licensing, marketing and providing trend direction for a diversified and growing consumer brand portfolio. The Company’s brands are sold across every major segment of retail distribution, from luxury to mass. As of March 31, 2008, the Company owned 16 iconic consumer brands: Candie’s, Bongo, Badgley Mischka, Joe Boxer, Rampage, Mudd, London Fog, Mossimo, Ocean Pacific/OP, Danskin, Rocawear, Cannon, Royal Velvet, Fieldcrest, Charisma, and Starter. The Company licenses its brands worldwide through approximately 215 retail and wholesale licenses for use in connection with a broad variety of product categories, including footwear, fashion accessories, sportswear, home products and décor, and beauty and fragrance. The Company’s business model allows it to focus on its core competencies of marketing and managing brands without many of the risks and investment requirements associated with a more traditional operating company. Its licensing agreements with leading retail and wholesale partners throughout the world provide the Company with a predictable stream of guaranteed minimum royalties.

 

The Company’s growth strategy is focused on increasing licensing revenue from its existing portfolio of brands through the addition of new product categories, expanding its brands’ retail penetration and optimizing the sales of its licensees. The Company will also seek to continue the international expansion of its brands by partnering with leading licensees throughout the world. Finally, the Company believes it will continue to acquire iconic consumer brands with applicability to a wide range of merchandise categories and an ability to further diversify its brand portfolio.

Results of Operations

 

For the three months ended March 31, 2008

 

Revenue. Revenue for the Current Quarter increased to $55.7 million from $30.8 million during the Prior Year Quarter. The driver of this growth of $24.9 million was a full quarter of revenue generated from the acquisitions of Danskin, Rocawear, the Official-Pillowtex brands (i.e. Cannon, Royal Velvet, Fieldcrest, Charisma) and Starter made during Fiscal 2007, which had no comparable revenue in the Prior Year Quarter.

Operating Expenses. Consolidated selling, general and administrative (“SG&A”) expenses totaled $18.7 million in the Current Quarter compared to $7.7 million in the Prior Year Quarter. The increase of $11.0 million was primarily related to (i) an increase of approximately $3.3 million in advertising mainly driven by increased advertising related to brands acquired in Fiscal 2007, with no comparable advertising expense in the Prior Year Quarter; (ii) an increase of approximately $3.8 million in payroll costs, primarily due to an increase of $1.7 million in non-cash stock compensation expense, from $0.4 million in the Prior Year Quarter to $2.1 million in the Current Quarter, of which $1.3 million of the increase related to the new employment contract with our chairman, chief executive officer and president, with the balance of the aggregate increase in payroll costs attributable to the increase in employee headcount mainly related to our 2007 acquisitions; and (iii) non-cash amortization of intangible assets (mainly contracts and non-competes) as a direct result of the Mossimo, Ocean Pacific, Danskin, Rocawear and the Pillowtex brands acquisitions accounted for $1.9 million and $0.9 million, respectively.

 

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For the Current Quarter and Prior Year Quarter, the Company’s special charges included an expense for professional fees of $0.2 million and $0.8 million, respectively, relating to litigation involving Unzipped. See Notes 7 and 8 of Notes to Unaudited Condensed Consolidated Financial Statements.

Operating Income. Operating income for the Current Quarter increased to $36.8 million, or approximately 66% of total revenue, compared to $22.4 million or approximately 72% of total revenue in the Prior Year Quarter. The decrease in our operating margin percentage is primarily the result of the increase in operating expenses for the reasons detailed above.

Interest Expense - Net - Interest expense increased by $6.6 million in the Current Quarter to $10.1 million, compared to interest expense of $3.5 million in the Prior Year Quarter. This increase was due primarily to an increase in the Company’s debt financing arrangements in connection with the acquisitions of Rocawear, Official-Pillowtex and Starter, as well as interest related to the Sweet Note. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements. Specifically, for the Current Quarter, there was a total interest expense relating to the Term Loan Facility, the Convertible Notes and the Sweet Note of approximately $4.8 million, $1.3 million and $0.2 million respectively with no comparable interest expense in the Prior Year Quarter. Deferred financing costs increased by $0.6 million in the Current Quarter to $0.8 million from $0.2 million in the Prior Year Quarter due to additional financing obtained in Fiscal 2007.

 

Provision for Income Taxes. The effective income tax rate for the Current Quarter is approximately 35.3% resulting in the $10.0 million income tax expense, as compared to an effective income tax rate of 35% in the Prior Year Quarter which resulted in the $7.0 million income tax expense. In the Current Quarter, the difference between the effective tax rate and the statutory rate of 35% is mainly driven by the benefit in state income taxes and relates to fluctuations in state rates expected to be realized by the Company due to new or revised tax legislation as well as changes we have recently experienced in the level of business performed within specific tax jurisdictions.

 

Item 1. Legal Proceedings

 

Item 1A. Risk Factors. 

In addition to the risk factors disclosed in Part 1, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2007, set forth below are certain factors that have affected, and in the future could affect, our operations or financial condition. We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could impact our operations. The risks described below and in our Annual Report on Form 10-K for the year ended December 31, 2007 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our financial condition and/or operating results.

 

Our existing and future debt obligations could impair our liquidity and financial condition, and in the event we are unable to meet our debt obligations we could lose title to our trademarks.

 

As of March 31, 2008, we had consolidated debt of approximately $681.9 million, including secured debt of $387.7 million ($255.1 million under our Term Loan Facility and $132.6 million under Asset-Backed Notes issued by our subsidiary, IP Holdings), primarily all of which was incurred in connection with our acquisition activities. We may also assume or incur additional debt, including secured debt, in the future in connection with, or to fund, future acquisitions. Our debt obligations:

 

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·	could impair our liquidity;

 

·	could make it more difficult for us to satisfy our other obligations;

 

·	require us to dedicate a substantial portion of our cash flow to payments on our debt obligations, which reduces the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements;

 

·	could impede us from obtaining additional financing in the future for working capital, capital expenditures, acquisitions and general corporate purposes;

 

·	impose restrictions on us with respect to future acquisitions;

 

·	make us more vulnerable in the event of a downturn in our business prospects and could limit our flexibility to plan for, or react to, changes in our licensing markets; and

 

·	place us at a competitive disadvantage when compared to our competitors who have less debt.

 

While we believe that by virtue of the guaranteed minimum royalty payments due to us under our licenses we will generate sufficient revenues from our licensing operations to satisfy our obligations for the foreseeable future, in the event that we were to fail in the future to make any required payment under agreements governing our indebtedness or fail to comply with the financial and operating covenants contained in those agreements, we would be in default regarding that indebtedness. A debt default could significantly diminish the market value and marketability of our common stock and could result in the acceleration of the payment obligations under all or a portion of our consolidated indebtedness. In the case of our Term Loan Facility, it would enable the lenders to foreclose on the assets securing such debt, including the Ocean Pacific/OP, Danskin, Rocawear, Starter and Mossimo trademarks, as well as the trademarks acquired by us in connection with the Official-Pillowtex acquisition, and, in the case of IP Holdings’ Asset-Backed Notes, it would enable the holders of such notes to foreclose on the assets securing such notes, including the Candie’s, Bongo, Joe Boxer, Rampage, Mudd and London Fog trademarks.

 

  A substantial portion of our licensing revenue is concentrated with a limited number of licensees such that the loss of any of such licensees could decrease our revenue and impair our cash flows.

 

Our licensees Target, Kohl's and Kmart were our three largest direct-to-retail licensees during the Current Quarter, representing approximately 14%, 5% and 5%, respectively, of our total revenue for such period. Our license agreement with Kohl's grants it the exclusive U.S. license with respect to the Candie's trademark for a wide variety of product categories for a term expiring in January 2011; our license agreement with Kmart grants it the exclusive U.S. license with respect to the Joe Boxer trademark for a wide variety of product categories for a term expiring in December 2010; and our license agreement with Target grants it the exclusive U.S. license with respect to the Mossimo trademark for substantially all Mossimo-branded products for an initial term expiring in January 2010; and, our other license agreement with Target grants it the exclusive U.S. license with respect to our Fieldcrest trademark for substantially all Fieldcrest-branded products for an initial term expiring in July 2010. Because we are dependent on these licensees for a significant portion of our licensing revenue, if any of them were to have financial difficulties affecting its ability to make guaranteed payments, or if any of these licensees decides not to renew or extend its existing agreement with us, our revenue and cash flows could be reduced substantially. For example, as of September 2006, Kmart had not approached the sales levels of Joe Boxer products needed to trigger royalty payments in excess of its guaranteed minimums since 2004, and, as a result, when we entered into the current license agreement with Kmart in September 2006 expanding its scope to include Sears stores and extending its term from December 2007 to December 2010, we agreed to reduce the guaranteed annual royalty minimums by approximately half, as a result of which our revenues from this license were substantially reduced.

  

We have a material amount of goodwill and other intangible assets, including our trademarks, recorded on our balance sheet. As a result of changes in market conditions and declines in the estimated fair value of these assets, we may, in the future, be required to write down a portion of this goodwill and other intangible assets and such write-down would, as applicable, either decrease our profitability or increase our net loss.

 

As of March 31, 2008, goodwill represented approximately $128.9 million, or approximately 9.6% of our total assets, and trademarks and other intangible assets represented approximately $1,036.4 million, or approximately 77.5% of our total assets. Under SFAS No. 142, goodwill and indefinite life intangible assets, including some of our trademarks, are no longer amortized, but instead are subject to impairment evaluation based on related estimated fair values, with such testing to be done at least annually. While, to date, no impairment write-downs have been necessary, any write-down of goodwill or intangible assets resulting from future periodic evaluations would, as applicable, either decrease our net income or increase our net loss and those decreases or increases could be material.

 

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Proposed changes in the accounting method for convertible debt securities could, if implemented, have an adverse impact on our reported or future financial results.

 

For the purpose of calculating diluted earnings per share, a convertible debt security providing for net share settlement of the excess of the conversion value over the principal amount, if any, and meeting specified requirements under EITF 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion,” such as our convertible notes, is accounted for similar to non-convertible debt, with the stated coupon constituting interest expense and any shares issuable upon conversion of the security being accounted for under the treasury stock method. The effect of the treasury stock method in relation to our convertible notes is that the shares potentially issuable upon conversion of the notes are not included in the calculation of our diluted earnings per share until the conversion price is “in the money,” at which time we are assumed to have issued the number of shares of common stock necessary to settle.

 

In July 2007, the FASB voted unanimously to reconsider the current accounting treatment for convertible debt securities that require or permit settlement in cash, either in whole or in part, upon conversion, or cash settled debt securities (which would include our outstanding convertible notes). Under a proposed staff position issued by the FASB in August 2007 for a method of accounting that would be applied retroactively, the debt and equity components of such cash settled debt securities would be bifurcated and accounted for separately in a manner that reflects the issuer’s economic interest cost. While the effect on us of this proposal cannot be quantified unless and until the FASB finalizes its guidance, under this proposal, we could recognize higher interest on our convertible notes at effective rates more comparable to what we would have incurred had we issued nonconvertible debt with otherwise similar terms. Therefore, if the proposed method of accounting for cash settled debt securities is adopted by the FASB as described above, it would have an adverse impact on our past and future reported financial results. In addition, any other change that could affect the accounting for convertible securities, including any changes in generally accepted accounting principles in the U.S., could have a material impact on our reported or future financial results.

 

The comment period for the proposed FASB staff position described above expired on October 15, 2007. We cannot determine at this time whether this staff position will ultimately be adopted in its present form or at all. In the event the proposed method of accounting described above is adopted, we will, pursuant to the terms of the indenture governing our outstanding convertible notes, have the right for a period of 90 days thereafter, at our option, to call the convertible notes for redemption. However, although we will have such redemption right, we may not have sufficient cash to pay, or may not be permitted to pay, the required cash portion of the consideration that would be due to holders of the convertible notes in the event we elected to exercise such right or the ability to raise funds through debt or equity financing within the time period required for us to make such an election.

 

Due to the recent downturn in the market, certain of the marketable securities we own may take longer to auction than initially anticipated.

A decline in general economic conditions resulting in a decrease in consumer-spending levels and an inability to access capital may adversely affect our business.

Many economic factors beyond our control may impact our forecasts and actual performance. These factors include consumer confidence, consumer spending levels, employment levels, availability of consumer credit, recession, deflation, inflation, a general slowdown of the U.S. economy or an uncertain economic outlook. Furthermore, changes in the credit and capital markets, including market disruptions, limited liquidity and interest rate fluctuations, may increase the cost of financing or restrict our access to potential sources of capital for future acquisitions.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

The following table represents information with respect to purchases of common stock made by the Company during the three months ended March 31, 2008:

 

Month of purchase			Total number of shares purchased (1)			Average price paid per share			Total number of  shares purchased as part of publicly announced plans or programs			Maximum dollar value of shares that may yet be purchased under the plans or programs
January 1 - January 31, 2008			—		$	—		$	—		$	—
February 1 - February 29, 2008			—		$	—		$	—		$	—
March 1 - March 31, 2008			13,871		$	19.00		$	—		$	—
Total			13,871		$	19.00		$	—		$	—

 

(1)

Represents shares of common stock surrendered to the Company to pay employee withholding taxes due upon the vesting of restricted stock.

 

EXHIBIT NO.	DESCRIPTION OF EXHIBIT
Exhibit 10.1	Employment Agreement between Neil Cole and the Company dated January 28, 2008 (1)*
Exhibit 10.2	Restricted Stock Grant Agreement dated February 19, 2008 between the Company and Neil Cole (2)*
Exhibit 10.3	Restricted Stock Performance Unit Agreement dated February 19, 2008 between the Company and Neil Cole (2)*
Exhibit 31.1	Certification of Chief Executive Officer Pursuant To Rule 13a-14 or 15d-14 of The Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 Of The Sarbanes-Oxley Act of 2002
Exhibit 31.2	Certification of Chief Financial Officer Pursuant To Rule 13a-14 or 15d-14 of The Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 Of The Sarbanes-Oxley Act of 2002
Exhibit 32.1	Certification of Chief Executive Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002
Exhibit 32.2	Certification of Chief Financial Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002

_________

(1) Filed as an exhibit to the Company’s Current Report on Form 8-K for the event dated January 28, 2008 and incorporated by reference herein.

(2) Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 2007 and incorporated by reference herein.

* Denotes management compensation plan or arrangement.

 

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

			Iconix Brand Group, Inc. (Registrant)
Date: May 7, 2008			/s/ Neil Cole
			Neil Cole Chairman of the Board, President and Chief Executive Officer (on Behalf of the Registrant)

 

Date: May 7, 2008			/s/ Warren Clamen
			Warren Clamen Chief Financial Officer

 

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