Conduct and Ethics available through our website under “Corporate Governance”. The reference to our website does not constitute incorporation by reference of the information contained on our website, and the information contained on the website is not part of this Form 10-K.

Recent Developments

On May 17, 2006, we announced a two-for-one stock split of common stock in the form of a dividend, for shareholders 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. All discussions concerning common stock, earnings per share, and outstanding shares throughout this Annual Report as well as comparable share information, have been adjusted to reflect the Stock Split.

On June 30, 2006, we received a Nasdaq Staff Determination notice from the Nasdaq Stock Market Listing Qualifications Department that the Company’s failure to timely file its Annual Report on Form 10-K for the year ended March 31, 2006 violated Nasdaq Marketplace Rule 4310(c)(14). As a result, the Company’s common stock was subject to delisting from Nasdaq National Market at the opening of business on July 11, 2006, unless we requested a hearing in accordance with Nasdaq Marketplace Rules. We requested a hearing before the Nasdaq Listing Qualifications Panel to review the Staff Determination, which automatically deferred the delisting of our common stock pending the Panel’s review and determination. Parlux’s common stock will continue to be traded on The Nasdaq National Market until the Panel issues a determination and any exception granted by the Panel has expired.

On June 14, 2006, our Board of Directors received an unsolicited letter from our Chairman and CEO, Mr. Ilia Lekach, representing PF Acquisition of Florida LLC (“PFA”), pertaining to the possible acquisition of all of the outstanding common stock of the Company at a proposed price of $29.00 ($14.50 after the Stock Split) per share in cash (the “Proposal”), representing a premium of 55% over the closing price of our common stock on June 13, 2006. The Proposal was subject to financial and other contingencies, and was referred to the Special Committee of Independent Directors of the Parlux Board of Directors (the “Committee”). On June 20, 2006, the Committee, through their counsel, sent a response to the Proposal, which indicated that the Committee did not believe it was prudent for the Company to move forward to consider the Proposal due to the contingencies therein, and requested removal of such as well as a deposit to cover the Company’s expenses that may be required to evaluate the Proposal.

On July 12, 2006, the Committee received a letter from PFA stating that, due to corporate developments occurring with respect to the potential acquisition of certain of the Company’s brands, Mr. Lekach was withdrawing the Proposal.

On June 21, 2006, we were served with a shareholder’s class action complaint (the “Class Action”) filed in the Circuit Court of the Seventeenth Judicial Circuit in and for Broward County, Florida by Glen Hutton, purporting to act on behalf of himself and other public stockholders of the Company, and 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 Class Action names 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 is a director of the Company. The Class Action relates to the Proposal. The Class Action seeks equitable relief for inadequate and unfair consideration, without full disclosure of all material information, to the detriment of the public shareholders, all in breach of defendants’ fiduciary duties. The Class Action alleges that the Proposal is solely designed to ensure that the Company’s management completes the Proposal despite the fact that the consideration called for in the Proposal is unfair to the public shareholders and the Company’s public shareholders have not been provided with all material information concerning the Proposal necessary for them to make an informed decision.

The Derivative Action names the identical defendants as the Class Action and also relates to 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.

The Company and the other named defendants engaged experienced Florida securities counsel and intend to respond to the Class Action and the Derivative Action in due course, but based on the allegations in the complaints and the information presently known to the Company, we believe they are without merit.

On July 22, 2005, we finalized an agreement with SGII, Ltd. (an unrelated Florida limited partnership), to purchase for approximately $14 million certain real property in Sunrise, Florida (the “Sunrise Facility”),  approximately ten miles from our current office and distribution center location in Fort Lauderdale. The property, which we intended to use as our 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. The purchase price included certain office furniture and warehouse packing and conveyor systems. At signing, we paid a deposit of $1 million. On December 29, 2005, we closed on the property acquisition, financing $12.75 million under a fifteen year conventional mortgage with GE Commercial Finance Business Property Corporation at a fixed interest rate of 5.87%.

As a result of various factors including our 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 significant part of our 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, we entered into a five-year lease, commencing approximately August 1, 2006, for 198,500 square feet of warehouse space in Keasbey, New Jersey, to also serve as a backup information technology site if the current Fort Lauderdale, Florida location were to encounter unplanned disruptions. See “ Properties ” for further discussion.

On May 15, 2006, we 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.

During the fiscal year ended March 31, 2006, we entered into exclusive worldwide license agreements to develop, manufacture, and distribute cosmetics and handbags, purses, wallets and other small leather goods for Ms. Paris Hilton. We also recently entered into another exclusive license agreement with Ms. Hilton for sunglasses. See “ Licensing Agreements ” for further discussion. During December 2005, we commenced sales of watches, and during March 2006, we commenced sales of handbags, both under the Paris Hilton brand.

At September 30, 2005, the end of the second quarter of our current fiscal year, our market capitalization exceeded $75 million, and as such, we became an accelerated filer under Rule 12b-2 of the Exchange Act of 1934, as amended. Under Section 404 of the Sarbanes-Oxley Act of 2002, as an accelerated filer, we are required to perform an assessment of, and complete testing on, our internal controls over financial reporting and report our conclusions on the effectiveness of such controls for the first time at the end of our current fiscal year which ended March 31, 2006. In addition, our independent registered public accounting firm must assess management’s process for evaluating and testing its internal controls, as well as perform their own testing and report on their conclusions.  See Item 9A for further discussion.

The Products

At present, our principal products are fragrances, which are distributed in a variety of sizes and packaging. In addition, beauty-related products such as body lotions, creams, shower gels, deodorants, soaps, and dusting powders complement the fragrance line. Our basic fragrance products generally retail at prices ranging from $20 to $65 per item.

We design and create fragrances using our own staff and independent contractors. We supervise the design of our packaging by independent contractors to create products appealing to the intended customer base. The creation and marketing of each product line is closely linked with the applicable brand name, its positioning and market trends for the prestige fragrance industry. This development process usually takes twelve to eighteen months to complete. During fiscal 2006, we completed the design process for 360 BLACK, for both women and men (new products under the PERRY ELLIS brand), which launched in winter 2005, PARIS HILTON “Just Me” for both women and men, which launched in winter 2005, GUESS? for both women and men, which launched in summer 2005 and spring 2006, respectively, and Maria Sharapova for women, which launched in summer 2005.

During the last three fiscal years, the following brands have accounted for 10% or more of our gross sales in a given year:
   

Fiscal 2006
 

Fiscal 2005
 

Fiscal 2004

PERRY ELLIS

41%

75%

81%

PARIS HILTON 
 

41%
 

11%
 

—

GUESS?
 

12%
 

—
 

—

OCEAN PACIFIC
 

  4%
 

11%
 

13%

Under a separate license agreement, we developed a line of “limited edition” watches under the Paris Hilton brand which were introduced during the 2005 holiday season. We are working closely with several watch manufacturers to establish products at different price levels. The initial “limited edition” products retail at prices ranging from $100,000 to $150,000. A “fashion watch” is now available for sale, and retails at prices ranging from $85 to $200 per item. We anticipate selling the “fashion watch” directly to U.S. department store customers through our own sales force and will continue to enter into distribution agreements for international markets.

In addition, we entered into various distribution agreements in connection with our license with Ms. Hilton for handbags, purses, wallets, and other small leather goods, which recently commenced shipments in the U.S. Launches are anticipated internationally over the next few months. We are currently analyzing different options for cosmetics and sunglasses under agreements with Ms. Hilton, to determine the most efficient and profitable method to produce and distribute such products.

Marketing and Sales

In the United States, we have our own fragrance sales and marketing staff, and utilize independent commissioned sales representatives for sales to domestic U.S. military bases and mail order distribution. We sell directly to retailers, primarily national and regional department stores, whom we believe will maintain the image of our products as prestige fragrances. Our products are sold in over 2,000 retail outlets in the United States. Additionally, we sell a number  of our products to Perfumania, which is a specialty retailer of fragrances with approximately 240retail outlets principally located in manufacturers’ outlet malls and regional malls in the U.S. and in Puerto Rico (see “ Customers ” section for further discussion).

We have a distribution agreement with an unrelated third party to market and distribute handbags in the United States, and we anticipate utilizing a combination of our own sales force and independent commissioned sales representatives to reach the market for watches and sunglasses.

Outside the United States, marketing and sales activities for all of our products are conducted through distribution agreements with independent distributors, whose activities are monitored by our international sales staff. We presently market our fragrances through distributors in Canada, Europe, the Middle East, Asia, Australia, Latin America, the Caribbean and Russia, covering over 80countries. Sales to unrelated international customers amounted to approximately 69%, 67%, and 75% of our total net sales to unrelated customers during the fiscal years ended March 31, 2006, 2005 and 2004, respectively.

We advertise directly, and through cooperative advertising programs in association with major retailers, in fashion media on a national basis and through retailers’ statement enclosures and catalogues. We are required to spend certain minimum amounts for advertising under certain licensing agreements. See “ Licensing Agreements ” and Note 8(B) to the Consolidated Financial Statements.

Raw Materials

Raw materials and components (“raw materials”) for our fragrance products are available from sources in the United States, Europe, and the Far East. We source the raw materials, based on our estimates of anticipated needs for finished goods, from independent suppliers, which are delivered directly to third party contract manufacturers who produce and package the finished products. As is customary in our industry, we do not have long-term agreements with our contract manufacturers. We anticipate purchasing almost all of our watch and handbag finished products from the Far East. We believe we have good relationships with all of our manufacturers and that there are alternative sources available should one or more of these manufacturers be unable to produce at competitive prices.

To date, we have had little difficulty obtaining raw materials at competitive prices. There is no reason to believe that this situation will change in the near future, but there can be no assurance this will continue.

Seasonality

Typical of the fragrance industry, we have our highest sales as our customers purchase our products in advance of the Mother’s and Father’s Day periods and the calendar year end holiday season.  Lower than projected sales during these periods could have a material adverse effect on our operating results.

Industry Practices

It is an industry practice in the United States for businesses that market fragrances to department stores to provide the department stores with rights to return merchandise. Our fragrance products are subject to such return rights. It is our practice to establish reserves and provide allowances for product returns at the time of sale based on historical return patterns. We believe that such reserves and allowances are adequate based on past experience; however, no assurance can be made that reserves and allowances will continue to be adequate or that returns will not increase. Consequently, if product returns are in excess of the reserves and allowances provided, net sales will be reduced when such fact becomes known.

Customers

We concentrate our fragrance sales efforts in the United States in a number of regional department store retailers including, among others, Belk, Bon Ton, Boscovs, Carson’s, Famous Barr, Filene’s, Foley’s, Hecht’s, J.C. Penney, Lord & Taylor, Macy’s, Parisians, Marshall Fields, Robinsons, and Stage Door. We also sell directly to perfumery and cosmetic retailers, including Perfumania, Sephora and Ulta, as well as the GUESS? And Perry Ellis retail stores. Retail distribution has been targeted by brand to maximize potential revenue and minimize overlap between each of these distribution channels.

Our international sales efforts are carried out through distributors in over 80 countries, the main focus of which has been in Latin America, Canada, Europe, Asia, Australia, the Middle East, the Caribbean and Russia, including a related party for the Mexican market. These distributors sell our products to the local department stores as well as to numerous perfumeries in the local markets. Some of these distributors will also sell our watches, handbags and sunglass products, and we continue to negotiate agreements with new distributors who specialize in such products.

During the fiscal years ended March 31, 2006, 2005 and 2004, we had net sales of $23,517,313, $35,330,772 and $31,964,407, respectively, to Perfumania, which represented 13%, 35% and 40%, respectively, of our net sales for the periods. Perfumania is one of our largest customers and transactions with them are closely monitored by our Audit Committee and Board of Directors. Perfumania offers us the opportunity to sell our products in approximately 240 retail outlets and our terms with Perfumania take into consideration the companies’ over 15 year relationship. Pricing and terms with Perfumania reflect (a) the volume of Perfumania’s purchases, (b) a policy of no returns from Perfumania, (c) minimal spending for advertising and promotion, (d) exposure of our products provided in Perfumania’s store windows, and (e) minimal distribution costs to fulfill Perfumania orders shipped directly to their distribution center.

While our invoice terms to Perfumania are net ninety days, for over ten years, the Board of Directors has granted longer payment terms taking into consideration the factors discussed above. Our Board of Directors evaluates the credit risk involved and imposes a specific dollar limit, which is determined based on Perfumania’s reported results and comparable store sales performance. Management monitors the account activity to ensure compliance with the Board limit.

Net trade accounts receivable owed by Perfumania to us amounted to $8,506,303, $8,566,939 and $10,890,338 at March 31, 2006, 2005 and 2004, respectively. Trade accounts receivable from Perfumania are non-interest bearing, and are paid in accordance with the terms established by our Board of Directors. See “ Liquidity and Capital Resources ” for further discussion of this receivable.

ECMV’s financial statements included in its Annual Report on Form 10-K for the year ended January 28, 2006, reflect pre-tax income of approximately $6.6 million compared to $3.3 million in the prior year. We continue to evaluate our credit risk and assess the collectibility of the Perfumania receivable. Perfumania’s reported financial information, as well as our payment history with Perfumania, indicates that, historically, their first quarter ending

approximately April 30, is Perfumania’s most difficult operating quarter as is the case with most U.S. based retailers. We have, in the past, received significant payments from Perfumania during the last three months of the calendar year, and have no reason to believe that this will not continue. Based on our evaluation, no allowances have been recorded as of March 31, 2006 and 2005. We will continue to evaluate Perfumania’s financial condition on an ongoing basis and consider the possible alternatives and effects, if any, on the Company.

We own 378,101 shares of ECMV common stock, which is an available-for-sale security and is reflected as an “investment in affiliate” in the accompanying consolidated balance sheets. As of March 31, 2006, the fair market value of the investment was $6,900,343 or $18.25 per share ($4,764,073 or $12.60 per share as of March 31, 2005), based on the quoted market price of the shares. Our adjusted cost basis (after a non-cash charge to earnings during fiscal 2002 of $2,858,447, which was reported as another-than-temporary decline in the value of the investment) for the shares is $1,648,523 or $4.36 per share.

As of July 21, 2006, the fair market value of the investment in ECMV was $5,104,364 ($13.50 per share).

Foreign and Export Sales

During the years ended March 31, 2006, 2005, and 2004, gross sales to unrelated international customers were approximately $77,681,000, $31,619,000, and $28,356,000, respectively. During the fiscal year ended March 31, 2004, we increased our attention to the Mexican marketplace and engaged a distributor for Mexico in lieu of a commissioned representative. The Mexican distributor is owned and operated by individuals related to our Chairman and Chief Executive Officer. Sales to this distributor during the fiscal years ended March 31, 2006, 2005 and 2004, which are included in related party sales, amounted to approximately $12,734,000, $9,000,000 and $3,966,000, respectively, and are in addition to the sales to unrelated international customers noted above.

Licensing Agreements

See “ The Products ” on page 3 for further discussion of the relative importance of our license agreements.

PERRY ELLIS : We acquired the Perry Ellis license in December 1994. The license renews automatically every two years if average annual net sales in the preceding two-year license period exceed 75% of the average net sales of the previous four years. All minimum sales levels have been met; based on our current sales projections, management believes that this will continue. The license requires the payment of royalties, which decline as a percentage of net sales as net sales volume increases, and the spending of certain minimum amounts for advertising based upon net sales levels achieved in the prior year.

PARIS HILTON : On May 4, 2004, we entered into a letter of intent with Ms. Paris Hilton (“PH”), to develop, manufacture and distribute prestige fragrances and related products, on an exclusive basis, under her name. Effective June 1, 2004, we entered into a definitive license agreement with Paris Hilton Entertainment, Inc. (“PHEI”), which expires on June 30, 2009. The agreement is renewable for an additional five-year period. The first PH women’s fragrance was launched during November 2004, and was followed by a launch of a men’s fragrance in April 2005.

On January 26, 2005, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute watches and other time pieces under the Paris Hilton name. The initial term of the agreement expires on June 30, 2010 and is renewable for an additional five-year period. The first “limited edition” watches under this agreement were launched during December 2005 and a line of “fashion watches” launched during spring 2006.

On May 11, 2005, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute cosmetics under the Paris Hilton name. The initial term of the agreement expires on January 15, 2011 and is renewable for an additional five-year period. We anticipate the first cosmetics under this agreement will be launched during fall 2006.

On May 13, 2005, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute handbags, purses, wallets and other small leather goods, under the Paris Hilton name. The initial term of the agreement expires on January 15, 2011 and is renewable for an additional five-year period. We anticipate the first products under this agreement will be launched during summer 2006.

On April 5, 2006, we entered into an exclusive worldwide license agreement with PHEI, to develop, manufacture and distribute sunglasses under the Paris Hilton name. The initial term of the agreement expires on January 15, 2012 and is renewable for an additional five-year period. We anticipate the first sunglasses under this agreement will be launched during spring 2007.

Under all of the PHEI Agreements, we must pay a royalty and spend minimum amounts for advertising based on sales volume.

GUESS : Effective November 1, 2003, we entered into an exclusive license agreement with GUESS? And GUESS? IP HOLDER L.P., to develop, manufacture and distribute prestige fragrances and related products on a worldwide basis. The term of the agreement continues through December 2009, and is renewable for an additional five years if certain sales levels are met.

Under the GUESS? Agreement, we must pay a royalty and spend minimum amounts for advertising based on sales volume. The first GUESS? Women’s fragrance was launched during July 2005, which was followed by a launch of a men’s fragrance in March 2006.

OCEAN PACIFIC : In August 1999, we entered into an exclusive worldwide licensing agreement with Ocean Pacific Apparel Corp. (“OP”), to manufacture and distribute men’s and women’s fragrances and other related products under the OP label. The initial term of the agreement extended through December 31, 2003, and was automatically renewed for an additional three-year period. We have six additional three-year renewal options, of which the first two contain automatic renewals at our option, and the last four require the achievement of certain minimum net sales. The license requires the payment of royalties, which decline as a percentage of net sales as net sales volume increases, and the spending of certain minimum amounts for advertising based upon annual net sales of the products.

XOXO : Effective January 6, 2005, we entered into a purchase and sale agreement (the “Purchase Agreement”) with Victory International (USA), LLC (“Victory”), whereby we acquired the exclusive worldwide licensing rights, along with inventories, molds, designs and other assets, relating to the XOXO fragrance brand. As consideration, we paid Victory approximately $7.46 million, of which $2.55 million was in the form of a 60-day promissory note payable in two equal installments on February 6 and March 6, 2005. The payments were made as scheduled. The value allocated to the licensing rights was $5,800,000.

Victory had previously entered into a license agreement with Global Brand Holdings, LLC (the “Fragrance License”) to manufacture and distribute XOXO branded fragrances. The first XOXO fragrances were introduced by Victory during December 2004. The term of the Fragrance License continues through June 30, 2007, and is renewable for an additional three-year period. Under the Purchase Agreement, Victory assigned its rights, and we assumed the obligations, under the Fragrance License, which requires the payment of a royalty and minimum spending for advertising.

During June 2006, we extended the contract through June 30, 2010 and negotiated renewal terms which, among other items, reduced minimum royalty requirements.

MARIA SHARAPOVA : On September 15, 2004, we entered into an exclusive worldwide license agreement with Ms. Maria Sharapova, to develop, manufacture and distribute prestige fragrances and related products under her name. The initial term of the agreement expires on June 30, 2008 and is renewable for an additional three-year period. The first fragrance under this agreement was launched in September 2005. Under the Sharapova agreement, we must pay a royalty and spend minimum amounts for advertising based on sales volume.

ANDY RODDICK : On December 8, 2004, we entered into an exclusive worldwide license agreement with Mr. Andy Roddick, to develop, manufacture and distribute prestige fragrances and related products under his name. The initial term of the agreement, as amended, expires on September 30, 2009 and is renewable for an additional three-year period. We anticipate that the first fragrance under this agreement will be launched during fall 2006. Under the Roddick agreement, we must pay a royalty and spend minimum amounts for advertising based on sales volume.

babyGUND : Effective April 6, 2005, we entered into an exclusive license agreement with GUND, Inc., to develop, manufacture and distribute children’s fragrances and related products on a worldwide basis under the babyGund trademark. The agreement continues through June 2010, and is renewable for an additional two years if certain sales levels are met. We anticipate that the first products under this agreement will be launched during fall

2006. Under the babyGund agreement, we must pay a royalty and spend minimum amounts for advertising based on sales volume.

FRED HAYMAN : In June 1994, we entered into an Asset Purchase Agreement with Fred Hayman Beverly Hills, Inc. (FHBH), purchasing substantially all of the assets and liabilities of the FHBH fragrance division. In addition, FHBH granted us an exclusive royalty free 55-year license to use FHBH’s United States Class 3 trademarks Fred Hayman â , 273 â , Touch â , With Love â and Fred Hayman Personal Selections â and the corresponding international registrations. There are no minimum sales or advertising requirements.

On March 28, 2003, we entered into an exclusive agreement to sublicense the FHBH rights to Victory for a royalty of 2% of net sales, with a guaranteed minimum annual royalty of $50,000 (the “Sublicense”). The initial term of the Sublicense is for five years, renewable every five years at the sublicensee’s option.

The Sublicense excluded the right to “273 Indigo” for men and women, the latest fragrance introduction for the FHBH brand, as well as all new FHBH product development rights.

On October 17, 2003, the parties amended the Sublicense, granting new FHBH product development rights to the sublicensee. In addition, the guaranteed minimum annual royalty increased to $75,000 and the royalty percentage on sales of new FHBH products was increased to 3% of net sales.

JOCKEY INTERNATIONAL : On March 23, 2001, we entered into an exclusive worldwide licensing agreement with Jockey International, Inc. (“Jockey”), to manufacture and distribute men’s and women’s fragrances and other related products under the Jockey â label. The initial term of the agreement extended through December 31, 2004, with three (3) three-year renewal options. The license required the payment of royalties, which declined as a percentage of net sales as net sales volume increases, and the spending of certain minimum amounts for advertising based upon annual net sales of the products. We launched Jockey fragrances for women and men during the first calendar quarter of 2002. We did not exercise the renewal option as market penetration of the brand did not meet our expectations. We have no further liability under the Jockey agreement.

ROYAL COPENHAGEN : On September 1, 2003, the Company entered into an agreement with Five Star Fragrances Company, Inc. (“Five Star”), to market and distribute Royal Copenhagen fragrance products to the U.S. department store market. The original term of the agreement is for three years, with an option to renew for one additional year. Five Star has elected to terminate the agreement as of July 31, 2006. There are no royalties, sales minimums or advertising commitments under this agreement. In accordance with the terms of the agreement, Five Star is required to repurchase all of our unsold Royal Copenhagen inventory at our cost.

We believe we are in compliance with all material obligations under the above agreements. There can be no assurance that we will be able to continue to comply with the terms of these agreements in the future.

Trademarks

We have exclusive licenses, as discussed above, to use trademark and tradename rights in connection with the packaging, marketing and distribution of our products, both in the United States and internationally where such products are sold. See “ The Products ” on page 3 for further discussion of the relative importance of these licenses.

In addition, we own the worldwide trademark and distribution rights to LIMOUSINE fragrances. There are no licensing agreements requiring the payment of royalties to us for this trademark. We have not distributed fragrance products under the LIMOUSINE brand since fiscal 1998, nor do we anticipate distribution in the near future.

On January 16, 2003, we entered into an agreement with the Animale Group, S.A., to sell the inventory, promotional materials, molds, and trademarks relating to the Animale brand (we owned the worldwide trademarks and distribution rights prior to the sale) for $4,000,000, which closely approximated the brand’s net book value at the date of sale. At closing, the purchaser paid $2,000,000 in cash and provided a $2,000,000 note payable in twelve equal monthly installments of $166,667, plus interest at prime plus 1%, through January 31, 2004. The note was repaid in full in accordance with its terms.

As part of the agreement we retained the right to sell Chaleur d’Animale, the Animale brand’s newest product introduction, and maintained the rights to manufacture and distribute this product line, on a royalty-free

basis, until January 2005, at which time we destroyed all remaining inventory (which amount was not significant) and wrote off intangibles relating to this brand, which had been fully amortized.

Product Liability

We have insurance coverage for product liability in the amount of $5 million per incident. We maintain an additional $5 million of coverage under an “umbrella” policy. We believe that the manufacturers of the products sold by us also carry product liability coverage and that we effectively are protected thereunder.

There are no pending and, to the best of our knowledge, no threatened product liability claims of a material nature.  Over the past ten years, we have not been presented with any significant product liability claims. Based on this historical experience, management believes that its insurance coverage is adequate.

In connection with our PH fashion watch business, we will provide a one-year warranty on the watch mechanism and anticipate that repair service would be handled by an outside third party, as necessary. We could also opt to replace the watch if we consider this action to be more cost beneficial.

Government Regulations

A fragrance is defined as a “cosmetic” under the Federal Food, Drug and Cosmetics Act (the “FDC Act”). A fragrance must comply with the labeling requirements of the FDC Act as well as the Fair Packaging and Labeling Act and its regulations. Under U.S. law, a product may be classified as both a cosmetic and a drug. If we produce such products, there would be additional regulatory requirements for products which are “drugs” including additional labeling requirements, registration of the manufacturer and the semi-annual update of a drug list.

Effective March 11, 2005, we were required to comply with the labeling, durability and non-animal testing guidelines from the European Cosmetic Toiletry and Perfumery Association (“COLIPA”) Amendment No. 7, to distribute our products in the European Union (“EU”). We have created “safety assessor approved” dossiers for all our products to be distributed in the EU, and have filed such documentation both domestically and with our agent in France. In addition to the EU specific requirements, we comply with all other significant international requirements.

Competition

The market for fragrance and beauty related products is highly competitive and sensitive to changing consumer preferences and demands. We believe that the quality of our fragrance products, as well as our ability to develop, distribute and market new products, will enable us to continue to compete effectively in the future and to continue to achieve positive product reception, position and inventory levels in retail outlets. We believe we compete primarily on the basis of product recognition and emphasis on providing in-store customer service. However, there are products, which are better known than the products distributed by us. There are also companies, which are substantially larger and more diversified (the September 2005 issue of “WWD Beauty Biz” lists the 70 largest companies in the world ranked by total beauty sales. The top 26 companies in the listing have sales levels exceeding $1 billion, with the 70 th largest at $128 million) and which have substantially greater financial and marketing resources than us, as well as greater name recognition, with the ability to develop and market products similar to, and competitive with, those distributed by us.

Employees

As of March 31, 2006, we had a total of 144 full-time and part-time employees, all of which were located in the United States. Of these, 57 were engaged in worldwide sales activities, 57 in operations, marketing, administrative and finance functions and 30 in warehousing and distribution activities. None of our employees are covered by a collective bargaining agreement and we believe that our relationship with our employees is satisfactory. We also use the services of independent contractors in various capacities, including sales representatives, as well as temporary agency personnel to assist with seasonal distribution requirements.

We have a 401-K Plan covering substantially all of our employees. We match 25% of the first 6% of employee contributions, within annual limitations established by the Internal Revenue Code.

Item 1A.

RISK FACTORS

The following is a discussion of some of the risk factors relating to our business:

If we lose our key personnel, or fail to attract and retain additional qualified experienced personnel, we will be unable to continue to develop our prestige fragrance products and attract and obtain new licensing partners.

We believe that our future success depends upon the continued contributions of our highly qualified sales, creative, marketing, and management personnel and on our ability to attract and retain those personnel. These individuals have developed strong reliable relationships with customers and suppliers. There can be no assurance that our current employees will continue to work for us or that we will be able to hire any additional personnel necessary for our growth. Our future success also depends on our continuing ability to identify, hire, train and retain other highly qualified managerial personnel. Competition for these employees can be intense. We may not be able to attract, assimilate or retain qualified managerial personnel in the future, and our failure to do so would limit the growth potential of our business and potential licensing partners may not be as attracted to our organization.

If the appeal of one of our celebrities would diminish, it could have a material adverse affect on future sales of that specific celebrity-branded fragrance.

During the last two fiscal years, we have entered into various license agreements with celebrities (entertainers or athletes) to develop, manufacture and distribute products under their names (see “ Licensing Agreements ” for further discussion). These agreements require substantial royalty commitments. During the year ended March 31, 2006, licensed Paris Hilton brand products generated approximately $76 million in gross sales. If a celebrities’ appeal would diminish, it could result in a material reduction in our sales of such products, adversely affecting our profitability and operating cash flows.

Consumers may reduce discretionary purchases of our products as a result of a general economic downturn, terrorism threats, or other external factors.

We believe that consumer spending on fragrance and other accessory products is influenced more than average by general economic conditions and the availability of discretionary income. Accordingly, we may experience sustained periods of declines in sales during economic downturns, or in the event of terrorism or diseases affecting customers’ purchasing patterns. In addition, a general economic downturn may result in reduced traffic in our customers’ stores which may, in turn, result in reduced net sales to our customers. Any resulting material reduction in our sales could have a material adverse effect on our business, its profitability or operating cash flows.

The fragrance and cosmetic industry is highly competitive, and if we are unable to compete effectively it could have a material adverse effect on our profitability, operating cash flow, and many other aspects of our business, prospects, results of operations and financial condition.

The fragrance and cosmetic industry is highly competitive and at times changes rapidly due to consumer preferences and industry trends. We compete primarily with global prestige fragrance companies, some of whom have significantly greater resources than we have. Our products compete for consumer recognition and shelf space with products that have achieved significant international, national and regional brand name recognition and consumer loyalty. Our products also compete with new products that often are accompanied by substantial promotional campaigns. In addition, these factors, as well as demographic trends, economic conditions and discount pricing strategies by competitors, could result in increased competition and could have a material adverse effect on ourprofitability, operating cash flow, and many other aspects of ourbusiness, prospects, results of operations and financial condition.

The continued consolidation of the U.S. department store segment, and the transition period after such consolidation, could have a material adverse effect on our sales and profitability.

Over the last few years, the United States department store market has encountered a significant amount of consolidation, the most recent of which was the merger of Federated Department Stores and May Corp. Such mergers and consolidations have resulted in store closings, increased inventory management as well as changes in administrative responsibilities. This transition, if not completed smoothly, could have a material adverse effect on our sales and profitability.

The development of new products by us involves considerable costs and any new product may not generate sufficient consumer interest and sales to become a profitable brand or to cover the costs of its development.

Over the last few years, a significant number of new prestige fragrance products have been introduced on a worldwide basis. The beauty industry in general is highly competitive and consumer preferences change rapidly. The initial appeal of these new fragrances, launched for the most part in U.S. department stores, has fueled the growth of our industry. Department stores continue to lose sales to the mass market as a product matures. To counter the effect of lower department store sales, companies are required to introduce new products more quickly, which requires additional spending for development, advertising and promotional expenses. In addition, a number of the new launches are with celebrities (either entertainers or athletes) which require substantial royalty commitments and whose careers and/or appeal could change dramatically, either positively or negatively, based on a single event. If one or more of our new product introductions were to be unsuccessful, or the appeal of the celebrity were to diminish, it could result in a reduction in profitability and operating cash flows.

The accessories market, specifically, watches, handbags, and sunglasses, is also highly competitive and if we are unable to compete effectively it could have a material adverse effect on our profitability, operating cash flow, and many other aspects of our business, prospects, results of operations and financial condition.

As with fragrances and cosmetics, the accessories market is highly competitive and also changes rapidly due to consumer preferences and industry trends. In addition, we do not have the extent of experience in this market segment as we do in fragrances. We may have difficulty in sourcing these accessory items, all of which will be manufactured by independent third parties, and may not meet the quality standards expected by the licensor and/or the consumer. Additionally, the consumer awareness and positive imagery of the licensor could be impacted by adverse publicity, which could negatively impact retailer and consumer attitudes. Our lack of experience in this highly competitive market could result in a material adverse effect on ourprofitability, operating cash flow, and many other aspects of ourbusiness, prospects, results of operations and financial condition.

If we are unable to protect our intellectual property rights, specifically trademarks and trade names, our ability to compete could be negatively impacted.

The market for our products depends to a significant extent upon the value associated with our trademarks and trade names. We own, or have licenses or other rights to use, the material trademark and trade name rights used in connection with the packaging, marketing and distribution of our major products both in the United States and in other countries where such products are principally sold; therefore, trademark and trade name protection is important to our business. Although most of our brand names are registered in the United States and in certain foreign countries in which we operate, we may not be successful in asserting trademark or trade name protection. In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. The costs required to protect our trademarks and trade names may be substantial.

Other parties may infringe on our intellectual property rights or intellectual property rights which we are licensed to use and may thereby dilute our brands in the marketplace.

Any infringement of our intellectual property rights would likely result in a commitment of our time and resources to protect these rights through litigation or otherwise. Under our license agreement with GUESS?, we are responsible for monitoring for infringement of the GUESS? Intellectual property rights. We must take action, at our cost, to stop minor infringement, and may be liable to share a significant portion of the total cost, with GUESS?, to stop substantial infringement.

We may unknowingly infringe on others’ intellectual property rights which could result in litigation.

We may unknowingly produce and sell products in a country where another party has already obtained intellectual property rights. One or more adverse judgments with respect to these intellectual property rights could negatively impact our ability to compete and continue to sell products in the worldwide marketplace and may require the destruction of inventory produced under the infringed name, both of which would adversely affect profitability, and, ultimately operating cash flow.

We depend on third parties for the manufacture and delivery of our products, and any disruption or interruption in this supply chain can affect production levels.

We do not own or operate any significant manufacturing facilities. We use third-party manufacturers and suppliers to manufacture most of our products. We currently obtain these products from a limited number of manufacturers and other suppliers. If we were to experience delays in the delivery of the finished products or the raw materials or components used to make such products, or if these suppliers were unable to supply product, or if there were transportation problems between the suppliers and our distribution center, our sales, profitability, and operating cash flow could be negatively impacted.

Our arrangements with our manufacturers, suppliers and customers are generally informal and if these arrangements were changed, interrupted, or terminated it could limit our supply of inventory and reduce sales, profitability and operating cash flow.

We do not have long-term or exclusive contracts with any of our customers and generally do not maintain long-term or exclusive contracts with our suppliers. Virtually all of our finished products are assembled from multiple components and manufactured by third parties. The loss of key suppliers or customers, Perfumania and other related parties (see Note 2 to the accompanying consolidated financial statements for further discussion), or a change in our relationship with them, could result in supply and inventory interruptions and reduced sales, profitability, and operating cash flows.

The loss of, or disruption in our distribution facility, could have a material adverse effect on our sales and our relationships with our customers.

We currently have one distribution facility, which is located in south Florida. We recently entered into an additional lease to relocate certain of our fragrance distribution functions to New Jersey, which is closer to where our fragrance products are filled and packaged. The loss of, or any damage to our current or future facilities, as well as the inventory stored therein, would require us to find replacement facilities and assets. In addition, weather conditions, such as hurricanes or other natural disasters, could disrupt our distribution operations. Certain of our components require purchasing lead times in excess of ninety days. If we cannot replace our distribution capacity and inventory in a timely, cost-efficient manner, it could reduce the inventory we have available for sale, adversely affecting our profitability and operating cash flows, as well as damaging relationships with our customers who are relying on deliveries of our products.

Our quarterly results of operations could fluctuate significantly due to retailing peaks related to gift giving seasons and delays in new product launches, which could adversely affect our stock price.

We may experience variability in net sales and net income on a quarterly basis as a result of a variety of factors, including timing of customer orders and returns, sell-through of our products by the retailer to the ultimate consumer or gift giver, delays in new product launches, as well as additions or losses of brands or distribution rights. Any resulting material reduction in our sales could have an adverse effect on our business, its profitability and operating cash flows, and correspondingly, the price of our common stock.

If we are unable to acquire or license additional brands, secure additional distribution arrangements, or obtain the required financing for these agreements and arrangements, the growth of our business could be impaired.

Our business strategy contemplates the continued increase of our portfolio of owned or licensed brands and distributed brands. Our future expansion through acquisitions or new product distribution arrangements, if any, will depend upon the capital resources and working capital available to us. We may be unsuccessful in identifying, negotiating, financing and consummating such acquisitions on terms acceptable to us, or at all, which could hinder our ability to increase revenues and build our business.

Reductions in worldwide travel could hurt sales volumes in our duty-free related business.

We depend on consumer travel for sales to our “duty free” customers in airports and other locations throughout the world. Any reductions in travel, including as a result of general economic downturns, or acts of war or terrorism, or epidemics such as Bird Flu or Severe Acute Respiratory Syndrome, could result in a material decline in sales and profitability for this channel of distribution, which could negatively affect our operating cash flow.

Failure to comply with restrictive covenants in our existing credit facility will result in our inability to borrow additional funds under the facility, which would require us to obtain replacement financing, of which there is no assurance.

Our revolving credit facility requires us to maintain compliance with various financial covenants. Our ability to meet those covenants can be affected by events beyond our control, and therefore we may be unable to meet those covenants. If our actual results deviate significantly from our projections, we may not remain in compliance with the covenants and would not be allowed to borrow under the credit facility. If we are not able to borrow under our credit facility, we would be required to develop an alternative source of liquidity, or to sell additional securities which would result in dilution to existing stockholders. We may be unable to obtain replacement credit facilities on favorable terms or at all. Without a source of financing, we could experience cash flow difficulties and disruptions in our supply chain.

Complying with the Sarbanes-Oxley Act of 2002 may result in substantial costs and utilization of Company resources.

At September 30, 2005, the end of the second quarter of our current fiscal year, our market capitalization exceeded $75 million, and as such, the Company became an accelerated filer under Rule 12b-2 of the Exchange Act of 1934, as amended. Under Section 404 of the Sarbanes-Oxley Act of 2002, as an accelerated filer, the Company is required to perform an assessment of, and complete testing on, its internal controls over financial reporting  and report its conclusions on the effectiveness of such controls for the first time at the end of our current fiscal year which ended March 31, 2006. In addition, the Company’s independent registered public accounting firm must assess management’s process for evaluating and testing its internal controls, as well as perform their own testing and report on their conclusions. The cost of such compliance could result in a reduction in profitability as well as distraction to management and employees from performing their day-to-day activities.