PARL Parlux Fragrances, Inc. (MM)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A.

Basis of Presentation

Parlux Fragrances, Inc. is a manufacturer and international distributor of prestige products. It holds licenses for Paris Hilton fragrances, watches, cosmetics, sunglasses, handbags and other small leather accessories in addition to licenses to manufacture and distribute the designer fragrance brands of GUESS?, Jessica Simpson, Nicole Miller, XOXO, Ocean Pacific (OP), Maria Sharapova, Andy Roddick, babyGund, and Fred Hayman Beverly Hills.

The accompanying condensed consolidated financial statements include the accounts of Parlux Fragrances, Inc., and its wholly-owned subsidiaries, Parlux, S.A., a French company (“S.A.”), and Parlux Ltd. (jointly referred to as the “Company”). All material intercompany balances and transactions have been eliminated in consolidation.

On May 17, 2006, the Company announced a two-for-one stock split of common stock in the form of a dividend, for stockholders of record on May 31, 2006 (the “Stock Split”). The Stock Split was effected on June 16, 2006 and did not include shares held in treasury. The par value of the common stock remains at $0.01 per share.

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“United States” or “US”) have been omitted pursuant to those rules and regulations, although the Company believes that the disclosures made herein are adequate to make the information presented not misleading. The financial information presented herein, which is not necessarily indicative of results to be expected for the entire current fiscal year, reflects all adjustments (consisting only of normal recurring accruals), which, in the opinion of management, are necessary for a fair presentation of the interim unaudited condensed consolidated financial statements. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2007.

B.

Share-Based Compensation

On October 11, 2007, the Company’s stockholders approved the Parlux Fragrances, Inc. 2007 Stock Incentive Plan (the “2007 Plan”), which reserved an additional 1,500,000 shares of common stock for equity-based awards to employees, officers, directors, consultants and/or independent contractors of the Company.  The 2007 Plan was adopted by the Board of Directors on June 20, 2007, subject to stockholder approval.

On October 11, 2007, the Company granted 240,000 options under the 2007 Plan to certain executives in connection with their July 2007 employment agreements, and 75,000 options (15,000 each) to its five non-employee directors, to acquire common stock during a five-year period at $4.60 per share, the closing price of stock on October 11, 2007. The directors’ options vested on the grant date, while the executives’ options vest over a three-year period at the annual rate of 40,000, 80,000 and 120,000, respectively.  The fair value of the combined October 11, 2007 options was determined to be $728,784.  The directors’ options were expensed as share-based compensation during the current quarter, while the executives’ options will be expensed as share-based compensation over a three year period in accordance with the applicable vesting periods.

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

The expected life of all of the various options and warrants represented the estimated period of time until exercise based on historical experience of similar awards, giving consideration to the remaining contractual terms and expectations of future employee behavior. The expected volatility was estimated using the historical volatility of the Company's stock which management believes is the best indicator at this time. The risk-free interest rate was

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based on the implied yield available on U.S. Treasury zero coupon issues with an equivalent term. The Company has not paid dividends in the past and does not intend to in the foreseeable future.

The Company had two stock option plans which provide for equity-based awards to its employees other than its directors and officers (collectively, the "Employee Plans"). Under the Employee Plans, the Company reserved 1,000,000 shares of common stock; 470,774 options (including 102,500 granted during August 2007 discussed below) were granted of which 368,274 were exercised. All stock options had an exercise price that was equal to the fair market value of the Company's stock on the date the options were granted. The term of the stock option awards is five years from the date of grant. In addition, the Company had previously issued 3,440,000 warrants to certain officers, employees, consultants and directors (919,000 of which are outstanding at December 31, 2007), all of which were granted at or in excess of the market value of the underlying shares at the date of grant, and are exercisable for a ten-year period.

Effective April 1, 2006, the beginning of the Company's first quarter of fiscal 2007, the Company became subject to the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123R "Share Based Payment" (“SFAS No. 123R”), using the modified-prospective transition method. Under this transition method, share based compensation expense is required to be recognized in the consolidated financial statements for stock options and warrants which are granted, modified or vested subsequent to April 1, 2006. As of March 31, 2006, all options and warrants were fully vested, and as such, adopting SFAS No. 123R on April 1, 2006, did not have an effect on the Company’s results of operations or financial position. The compensation expense recognized will include the estimated expense for stock options granted, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R.

Concurrent with the Stock Split, effected on June 16, 2006, the Company 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, during the six months ended September 30, 2006, the Company was required to record share-based compensation in the amount of $16,201,950, reflecting the change in the warrants’ fair value before and after the Stock Split. This non-cash charge was previously included as a separate component in operating expenses for the six months ended September 30, 2006 and has been included in general and administrative expenses for the current period presentation. The Company also recorded a deferred tax benefit of $1,058,034 as a result of the charge, which reduced income tax expense for the period. See Note I for further discussion of this tax benefit.

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

On August 22, 2007, the Company granted, to various employees, options under the Employee Plans to acquire 102,850 shares of common stock at $3.30 per share, the closing price of the stock on August 21, 2007.  These options have a life of five years from the date of grant (or thirty days after termination for any reason), and vest 25% after each of the first two years, and 50% after the third year. The fair value of the options was determined to be $170,536, which will be expensed as share-based compensation over a three year period in accordance with the vesting period of the options.

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

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A summary of stock option and warrant activity during the nine months ended December 31, 2007 follows:

Except for the 102,850 and 240,000 options granted during the nine months ended December 31, 2007, all options and warrants outstanding as of December 31, 2007 were fully vested. Prior to July 24, 2007, upon exercise of options and warrants, the Company issued previously authorized but unissued common stock to the holders. Commencing July 24, 2007, upon exercise the Company issued shares from treasury shares to the holders.  Of the 2,075,000 warrants exercised during the nine months ended December 31, 2007, 1,515,000 shares were issued from treasury shares. The difference between the original cost of the treasury shares ($4,126,067) and the proceeds received from the warrant holders ($1,744,102) was recorded as a reduction in retained earnings.

The intrinsic value of the warrants exercised during the nine months ended December 31, 2007 was approximately $6,188,000 and the tax benefit from the exercise of such warrants is expected to approximate $1,772,000 for income tax purposes. As of March 31, 2007, a deferred tax benefit of approximately $3,060,000 was provided on these warrants in connection with the share-based compensation charge discussed above. During the nine-month period ended December 31, 2007, the Company adjusted the deferred tax asset and reduced additional paid-in capital by $1,268,307 as a result of the exercise.

The following table summarizes information about the options and warrants outstanding at December 31, 2007, of which 994,000 are exercisable:

Included in general and administrative expenses for the three and nine-month periods ended December 31, 2007, is $210,867 of share-based compensation relating to the options issued in August and November 2007.

C.

Inventories

The components of inventories are as follows:

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The cost of inventories includes product costs and handling charges, including an allocation of the Company’s applicable overhead in the approximate amount of $4,694,000 and $4,333,000 at December 31, 2007 and March 31, 2007, respectively.

As is more fully described in Note J, one of the Company’s licensors, GUESS? Inc., filed a complaint against the Company alleging that GUESS? fragrance products were being sold in unauthorized retail channels. The Company subsequently entered into a settlement agreement with GUESS? that, among other things, requires pre-approval of each international customer to whom the Company sells GUESS? fragrances. The complaint was subsequently withdrawn.  If the Company were to be found in breach of its agreement with GUESS?, Inc. at any point in the future, termination or modification of the license agreement could occur.

As of December 31, 2007, our inventories of GUESS? products totaled approximately $18.8 million, of which approximately $6.3 million has been classified as non-current (approximately $30.8 million and $16.5 million, respectively, at March 31, 2007). If the licensing agreement were to be terminated or modified at any time in the future, the Company may be required to record charges to operations to reduce the recorded value of such inventories to the amounts which would be realized upon their sale or liquidation.

D.

Trademarks and Licenses

Trademarks and licenses are attributable to the following brands:

During the year ended March 31, 2007, the Company recorded an impairment charge of $1,129,273 in connection with the XOXO license as the estimated future net cash flows for the remaining period of the license were determined to be less than the license’s carrying value.  During the nine-months ended December 31, 2007, the Company recorded an additional impairment charge of $385,232 in connection with this license.

E.

Borrowings

The composition of borrowings is as follows:

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On July 20, 2001, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with GMAC Commercial Credit LLC (“GMACCC”). On January 4, 2005, the Loan Agreement was extended through July 20, 2006. Under the Loan Agreement, the Company was able to borrow, depending on the availability of a borrowing base, on a revolving basis, up to $20,000,000 at an interest rate of LIBOR plus 2.75% or the Bank of New York’s prime rate, at the Company’s option.

On January 10, 2006, the Loan Agreement was amended, increasing the loan amount to $30,000,000 with an additional $5,000,000 available at the Company’s option. In addition, the maturity was extended through July 20, 2008, and the interest rate was reduced to 0.25% below the prime rate. During May 2006, the Company exercised its option and increased the line of credit to $35,000,000.

On September 13, 2006, the Loan Agreement was further amended, temporarily increasing the loan amount to $40,000,000 until December 13, 2006, at which time the maximum loan amount reverted back to $35,000,000.

At December 31, 2007, based on the borrowing base at that date, available borrowing under the credit line amounted to $29,319,000, of which there was no balance outstanding .  As of March 31, 2007, $16,775,318 was utilized. Restricted cash represents collections of trade accounts receivable deposited with our bank and pending transfer to GMACCC. As of December 31, 2007, the restricted cash balance was zero.  As of March 31, 2007, $1,273,896 was on deposit with our bank pending transfer.

Substantially all of the assets of the Company, excluding the New Jersey warehouse equipment discussed below, collateralize the credit line borrowing. The 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 GMACCC. The Loan Agreement also contains certain financial covenants relating to net worth, interest coverage and other financial ratios.

Although the Company substantially exceeded the net worth covenant, it was not in compliance with the fixed charge covenant as of March 31, 2007. An amendment to the agreement was requested from the lender, which was granted on June 27, 2007, and which revised such covenant through March 31, 2008.

As of December 31, 2007 and September 30, 2007, we were not in compliance with our minimum EBITDA requirements.  We requested amendments of our agreement from our lender, which were granted on February 6, 2008 and November 9, 2007, respectively, and which revised such covenant at those dates. The Loan Agreement, as amended, also contains certain financial covenants relating to net worth, interest coverage and other financial ratios, which we were in compliance with as of December 31, 2007 and September 30, 2007.

On August 16, 2004, GMACCC approved a continuation of the Company’s common stock buyback program not to exceed $8,000,000. During December 2006, the Company effectively completed this program with approximately $198,000 remaining.

During May 2006, the Company entered into an agreement with Provident Equipment Leasing (“Provident”) covering approximately $2,761,000 of certain warehouse equipment and leasehold improvements to be purchased for the Company’s new leased distribution center in New Jersey. Provident advanced, on behalf of the Company, progress payments to various suppliers based on the work completed. In accordance with the terms of the agreement, the advances bore interest at a rate of 1% per month until all payments were made, at which time the arrangement converted to a thirty-six month lease, which has been classified as a capital lease. The Company has an option to purchase the equipment and leasehold improvements at the end of the lease term for $1.

On December 15, 2006, the Company entered into a lease agreement with International Business Machines (“IBM”) covering approximately $124,000 of computer equipment which has been classified as a capital lease. The Company has an option to purchase the computer equipment at the end of the lease term for $1.

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F.

Related Party Transactions

Related party transactions include the following balances:

The Company had net sales from continuing operations of $39,778,788 and $7,279,013 during the nine-month periods ended December 31, 2007 and 2006 ($9,488,470 and $1,996,771 during the three months ended December 31, 2007 and 2006, respectively), respectively, to Perfumania, Inc. (“Perfumania”), a wholly-owned subsidiary of E Com Ventures, Inc. (“ECMV”). These amounts exclude sales of Perry Ellis brand products during the nine and three month periods ended December 31, 2006 in the amount of $5,512,469 and $958,370, respectively.

The Company’s former Chairman and Chief Executive Officer had an ownership interest and held identical management positions in ECMV until February 2004. Transactions with Perfumania have historically been presented as related party transactions.  ECMV’s current majority shareholders acquired an approximate 12.2% ownership interest in the Company during August and September 2006, and accordingly, transactions with Perfumania continue to be presented as related party transactions. Perfumania is one of the Company’s largest customers, and transactions with Perfumania are closely monitored by management, and any unusual trends or issues are brought to the attention of the Company’s Audit Committee and Board of Directors. Perfumania offers the Company the opportunity to sell its products in approximately 275 retail outlets and the Company’s pricing and terms with Perfumania take into consideration the relationship existing between the companies for over 15 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 the Company’s products provided in Perfumania’s store windows and (e) minimal distribution costs to fulfill Perfumania orders shipped directly to their distribution center.

The Company owned 378,101 shares of ECMV common stock, which was previously classified as an available-for-sale security. The Company’s adjusted cost basis for the shares was $1,648,523 or $4.36 per share. During August and September 2006, the Company sold all of the shares in the open market for $3,423,147. Accordingly, the Company recorded a gain on sale of $1,774,624 in the accompanying condensed consolidated statements of operations for the nine-month period ended December 31, 2006 (See Note I for discussion of the income tax effect of the sale).

While the Company’s invoice terms to Perfumania are stated as net ninety days, for over ten years, management has granted longer payment terms, taking into consideration the factors discussed above. Management evaluates the credit risk involved, considering Perfumania’s reported results and comparable store sales performance. Management monitors the account activity to ensure compliance with its limits. Net trade accounts receivable owed by Perfumania to the Company totaled $12,088,389 and $6,101,456 at December 31, 2007 and March 31, 2007, respectively.

Prior to July 1, 2007, sales to parties related to the Company’s former Chairman and CEO were treated as related party sales. As of June 30, 2007, the former Chairman and CEO’s beneficial ownership interest in the Company had declined to approximately 7.6%, further declining during the quarter ended September 30, 2007, to less than 5% (less than 2% at December 31, 2007).

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Accordingly, effective July 1, 2007, transactions with parties related to the former Chairman and CEO are no longer included as related party activity. Net sales to these parties and reported as related party sales during the three months ended December 31, 2007 and 2006 were $0 and $11,680,807, respectively. Net sales to these parties during the nine months ended December 31, 2007 and 2006 were $8,004,914 and $26,128,763 respectively. The above amounts exclude sales of the discontinued Perry Ellis product during the three and nine months ended December 31, 2006 of $5,936,742 and $15,027,792, respectively.

As of March 31, 2007 trade receivables from related parties included $7,931,006 from these customers, which were current in accordance with their sixty or ninety day terms. The Company also reimbursed these related party distributors for advertising and promotional expenses totaling approximately $77,000 and $1,801,000 for the nine months ended December 31, 2007 and 2006, ($0 and $734,000 during the three months ended December 31, 2007 and 2006) respectively.

During the nine months ended December 31, 2006, the Company purchased $1,160,420 ($386,807 during the three months ended December 31, 2006) in television advertising on the “Adrenalina” show, which is broadcast in various U.S. markets and Latin American countries. The Company’s former Chairman and CEO has a controlling ownership interest in a company, which has the production rights to the show and publishes certain magazines. During the nine months ended December 31, 2006, the Company also purchased $21,875 ($4,075 during the three months ended December 31, 2006) of advertising space in these magazines. There were no such transactions during the three or nine months ended December 31, 2007.

G.

Basic and Diluted Earnings Per Common Share

The following is the reconciliation of the numerators and denominators of the basic and diluted net income per common share calculations, retroactively restated for the Stock Split:

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(1)

In accordance with paragraph 15 of Statement of Financial Accounting Standards (“SFAS”) No. 128, “ Earnings Per Share” , the number of shares utilized in the calculation of diluted (loss) earnings 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 three and nine months ended December 31, 2006, as we incurred a loss from continuing operations for those periods.

H.

Cash Flow Information

The Company considers temporary investments with an original maturity of three months or less to be cash equivalents. Supplemental disclosures of cash flow information are as follows:

Supplemental disclosures of non-cash investing and financing activities are as follows:

Nine months ended December 31, 2006:

·

The consideration received from the sale of the Perry Ellis fragrance brand and assets related thereto, included an accounts receivable of $5,035,694, pending final inventory valuations.

·

Change in unrealized holding gain of $4,342,338 on the investment in affiliate, net of deferred taxes.

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I.

Income Taxes for Continuing Operations

The tax provision for continuing operations for the three-month periods ended December 31, 2007 and 2006 and the nine-month period ended December 31, 2007 reflect an estimated effective rate of 38%.

The tax provision for the nine-month period ended December 31, 2006 was affected by:

(1)

a limitation on the estimated tax benefit that is expected to result from the share-based compensation charge related to the warrant modification. Such benefit will be limited by the maximum allowable annual compensation deduction for corporate officers under Section 162 (m) of the Internal Revenue Code. Consequently, the benefit recorded in the prior year period reflected management’s best estimate at that time based upon assumptions regarding the timing and market value of the Company’s common stock upon exercise of the warrants and the amount and nature of other forms of compensation to be paid to the holders of the warrants using the method in which the cash compensation (salary and bonus) of the related individuals takes priority over the share-based compensation in determining the annual limitation. Actual tax benefits realized may be greater or less than the amounts recorded, and such differences may be material. The Company will adjust this deferred tax asset as additional information becomes available, with adjustments reflected in the Company’s income tax (benefit) provision for the period in which the adjustments are identified. As of March 31, 2007, the Company adjusted the deferred tax asset due to a change in the maximum allowable annual compensation deduction for corporate officers under Section 162 (m), as a result of the resignation of the Company’s former Chairman and CEO, in February 2007.  

(2)

the difference in basis of the ECMV shares sold during the current period as such sale resulted in a capital loss of $1,083,823 for income tax purposes, for which we are able to offset with capital gains, as well as a portion of the gain in connection with the December 2006 Perry Ellis fragrance brand (See Notes M and O, respectively, for further discussion). The Company had previously recorded a non-cash charge of $2,858,447 during fiscal 2002, reducing the basis of the shares for financial reporting purposes.  

On April 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation 48 (“FIN 48”) Accounting for Income Tax Uncertainties , which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS Statement No. 109 Accounting for Income Taxe s. FIN 48 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. As a result of the implementation of FIN 48, the Company did not recognize a liability for unrecognized tax benefits and, accordingly, was not required to record any cumulative effect adjustment to beginning of year retained earnings. As of both the date of adoption and December 31, 2007, there was no material liability for income tax associated with unrecognized tax benefits. The Company does 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.

J.

License and Distribution Agreements

During the year ended March 31, 2007, the Company held exclusive worldwide licenses to manufacture and sell fragrance and other related products for Paris Hilton, GUESS?, Ocean Pacific (“OP”), Maria Sharapova, Andy Roddick, babyGund, Perry Ellis and XOXO. During December 2006, the Company sold its Perry Ellis licensing rights and other related assets to Perry Ellis International, its Licensor. See Note O for further discussion.

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Under all of the existing license 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. Except as discussed below, the Company believes it is presently in compliance with all material obligations under these agreements.

GUESS?, Inc. (“GUESS?”) filed a complaint against the Company alleging that GUESS? fragrance products were being sold in unauthorized retail channels. Although the Company did not sell such products directly to these channels, it represented a violation of the Company’s license agreement with GUESS?. On May 7, 2007, the Company entered into a settlement agreement with GUESS? which, among other items, requires GUESS?’s reapproval of all international distributors selling GUESS? fragrance products, payment of liquidated damages in the amount of $500,000, in nine equal monthly installments of $55,556, (which was expensed in the year ended March 31, 2007), as well as strict monitoring of distribution channels. The complaint was subsequently withdrawn.  Any further violations surrounding unapproved distribution could result in termination of the license agreement. During the quarter ended March 31, 2007, the Company stopped shipments to international distributors. Over the last six months GUESS? has approved certain international distributors and the Company has commenced shipments to these approved distributors. The Company continues to submit approval requests for additional international distributors in accordance with procedures outlined in the license agreement.

On June 21, 2007, the Company 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. The Company must pay a minimum royalty to VCJS, LLC, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. The Company anticipates that the first fragrance under this agreement will be launched during fall 2008.

On August 1, 2007, the Company 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. The Company must pay a minimum royalty, whether or not any product sales are made, and spend minimum amounts for advertising based upon sales volume. The Company anticipates launching a new fragrance under this license in the fall of 2008, and has recently resumed the manufacturing of certain previously developed Nicole Miller fragrances.

K.

Segment Information

In accordance with SFAS No. 131, " Disclosures about Segments of an Enterprise and Related Information ", the Company determined its operating segments on the same basis that it uses to evaluate performance internally.

Prior to the quarter ended December 31, 2005, the Company operated in one industry segment as a manufacturer and distributor of prestige fragrances and beauty related products. During December 2005 and March 2006, the Company commenced sales of watches and handbags, respectively, both of which are under license agreements with Paris Hilton Entertainment, Inc. Revenues from the sale of watches and handbags during the nine- month period ended December 31, 2007 totaled $3,074,741 and $307,111, respectively ($736,142 and $1,285,604 for the nine months ended December 31, 2006, respectively). Included in inventories at December 31, 2007, is  $2,058,420 and $379,473 relating to watches and handbags, respectively ($1,189,105 and $31,359 for watches and handbags at March 31, 2007). The Company anticipates preparing full segment disclosure if these operations become more significant.

L.

L egal Proceedings

On June 21, 2006, the Company was 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 was a director of the Company at that date. The Derivative Action related to the proposal (previously disclosed in the Company’s June 14, 2006 Form 8-K) from PF Acquisition of Florida LLC (“PFA”), which was

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owned by Ilia Lekach, to acquire all of the outstanding shares of common stock of the Company for $29.00 ($14.50 after the Stock Split) per share in cash (the “Proposal”).

The Derivative Action seeks to remedy the alleged breaches of fiduciary duties, waste of corporate assets, and other violations of law and seeks 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 the Company and its public shareholders, and to report to the Court and plaintiff’s counsel regarding the same. The Derivative Action alleges that the unlawful plan to attempt to buy out the public shareholders of the Company without having proper financing in place, and for inadequate consideration, violates 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 Company counsel on August 17, 2006.

The Amended Complaint continues to name the then Board of Directors as defendants along with the Company, as a nominal defendant. The Amended Complaint is largely a collection of claims previously asserted in a 2003 derivative action, which the plaintiffs in that action, when provided with additional information, elected not to pursue. It adds to those claims, assertions regarding a 2003 buy-out effort and the abandoned buy-out effort of PF Acquisition of Florida. It also contains allegations regarding the prospect that the Company's stock might be delisted because of a delay in meeting SEC filing requirements. It relies in large measure on a bevy of media articles rather than facts known to the plaintiffs.

The Company and the other defendants engaged Florida securities counsel, including the counsel who successfully represented the Company 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, adding alleged violations of securities laws, which the Company moved to dismiss of 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 days to respond, and a response was filed on March 29, 2007. Since that time there has been extremely limited discovery conducted in the case. Some documents have been produced. Narrow interrogatories were answered. There have been no depositions and none has even been scheduled. A number of the factual allegations upon which the various complaints were based have fallen away, simply by operation of time. Based on the allegations in the Second Amended Complaint, upon the information collected in the earlier litigation and upon the information provided in response to the limited discovery noted above, it is believed that the Second Amended complaint is without merit.

On March 2, 2007, the Company, Ilia Lekach and Frank Buttacavoli were named as defendants, along with Perry Ellis International, Inc. and its Chairman and CEO, George Feldenkreis, Rene Garcia, Quality King Distributors, Inc., E Com Ventures, Perfumania, Model Reorg, Inc., Glenn Nussdorf, DFA Holdings, Inc., Duty Free Americas, Inc. Falic Fashion Group, LLC, Simon Falic and Jerome Falic. This action by Plaintiff Victory International (“Victory”) relates to Perry Ellis International’s failure to consent to the assignment by the Company of its contractual license to the Perry Ellis brand of perfumes. The Plaintiff is alleging that Perry Ellis International unreasonably withheld its consent and, instead, conspired with a variety of people to prevent Victory from obtaining this license. No direct allegations are made against the Company. The allegations against Messrs. Lekach and Buttacavoli relate to the recent attempt by Glenn Nussdorf to replace all of the directors of the Company with his nominees. The First Amended Complaint alleges that Mr. Nussdorf and certain affiliates are among the alleged co-conspirators with Perry Ellis International to prevent Victory from obtaining the license. On May 18, 2007, the Company, along with Messrs Lekach and Buttacavoli, filed a motion to dismiss on the basis that the complaint failed to state a cause of action against any of them. All other defendants moved to dismiss as well, on a host of different theories. At the same time we moved to transfer the case from the District of New Jersey to the Southern District of Florida, a motion in which 14 of the 17 defendants joined. After a hearing in December, the District Court in New Jersey granted the motion to transfer on January 2, 2008, and ordered the case transferred to the Southern District of Florida. The motions to dismiss are traveling with the case as is the customary practice. It is expected that the Florida Court will rule on those pending motions sometime in the last Spring or early Summer. There has been no discovery conducted. Plaintiff’s request for preliminary discovery to address jurisdictional issues was denied by the Court. Based on very preliminary analysis, since there has been no discovery to date, it appears that the Company and the individual defendants have meritorious defenses to all of the claims asserted.

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Management believes that the ultimate outcome of these matters will not have a material effect on the Company’s financial position or results of operations.

M.

Facility Acquisition and Sale

On July 22, 2005, the Company finalized an agreement with SGII, Ltd. (an unrelated Florida limited partnership), to purchase certain real property in Sunrise, Florida for approximately $14 million. The property, which was intended to be used as the Company’s corporate headquarters and main distribution center, includes approximately 15 acres of land and a 150,000 square foot distribution center, with existing office space of 15,000 square feet. On December 29, 2005, the Company closed on the Sunrise Facility, financing $12.75 million of the purchase price under a fifteen year conventional mortgage with GE Commercial Finance Business Property Corporation.

As a result of various factors including the Company’s continuing growth, the increase in trucking costs resulting primarily from the increase in fuel prices and South Florida’s susceptibility to major storms, management and the Company’s Board of Directors determined that it would be more cost effective and prudent to relocate a major part of the Company’s warehousing and distribution activities to the New Jersey area, close to where the Company’s products are filled and packaged. Accordingly, on April 17, 2006, the Company entered into a five-year lease for 198,500 square feet of warehouse space in New Jersey, to also serve as a backup information technology site if the current Fort Lauderdale, Florida location encounters unplanned disruptions. The Company commenced activities in the New Jersey facility during the latter part of August 2006.

On May 15, 2006, the Company entered into an agreement to sell the Sunrise Facility for $15 million receiving a non-refundable deposit of $250,000 from the buyer. The sale was completed on June 21, 2006, and the mortgage was repaid. The Company has recorded a gain of $494,465 from the sale, which is included in the accompanying condensed consolidated statement of operations for the nine months ended December 31, 2006.

N.

New Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “ Fair Value Measurements ” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently reviewing the provisions of SFAS No. 157 to determine the impact, if any, on its condensed consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “ The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB No. 115 ” ("SFAS No. 159"). SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value in order to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for the Company's fiscal year ending March 31, 2009. The Company is currently assessing the impact of this statement on its condensed consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“ SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141(R) also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The provisions of SFAS 141(R) are effective for financial statements issued for fiscal years beginning after December 15, 2008. We are currently assessing the financial impact of SFAS 141(R) on our consolidated financial statements.

In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51 (“SFAS 160”). SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” or ARB 51, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends certain of ARB 51’s consolidation procedures for consistency with the requirements of SFAS 141(R). In addition, SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its

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noncontrolling interest. The provisions of SFAS 160 are effective for fiscal years beginning after December 15, 2008. Earlier adoption is prohibited. We are currently assessing the financial impact of SFAS 160 on our consolidated financial statements.

O.

Discontinued Operations

On November 28, 2006, the Company’s Board of Directors approved the sale of the Perry Ellis fragrance brand license back to Perry Ellis International (“PEI”) at a price of approximately $63 million, including approximately $21 million for inventory and promotional products relating to the brand. A definitive agreement was signed on December 6, 2006 and the closing took place shortly thereafter. The sale included all inventory, promotional products, molds and other intangibles. The transaction generated proceeds of approximately $63 million, and resulted in a pre-tax gain of approximately $34.3 million.

Beginning with the quarter ended December 31, 2006, the Perry Ellis brand activity has been presented as discontinued operations. Prior period statements of operations have been retrospectively adjusted. The activity for this discontinued operation is summarized as follows:

* * * *

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