True Religion Apparel (TRLG)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly report period ended September 30, 2007

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

For the transition period from                                    to                                    

Commission File Number: 000-51483

TRUE RELIGION APPAREL, INC.

(Exact name of registrant specified in its charter)

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

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

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

Common stock outstanding as of April 29, 2008: 23,918,831 shares

TABLE OF CONTENTS

EXPLANATORY NOTE

We are amending the prior year financial information contained in this Quarterly Report on From 10-Q. to amend and restate our condensed consolidated financial statements, and the related notes thereto, as discussed in Note 14 in our Notes to Condensed Consolidated Financial Statements contained under Item 1: Financial Statements in this Quarterly Report on Form 10-Q.

On November 6, 2007, the Audit Committee of the Company’s Board of Directors determined that we needed to restate our previously issued consolidated financial statements for the fiscal years ended December 31, 2005 and 2006 and the condensed consolidated financial statements for the quarters ended March 31, 2007 and June 30, 2007.  On that date, the Audit Committee also concluded that, as a result of the pending restatement, the annual consolidated financial statements for fiscal years 2005 and 2006, each of the quarters during those fiscal years, and the quarterly condensed consolidated financial statements for fiscal 2007 appearing in our Quarterly Report on Form 10-Qs for the quarters ended March 31, 2007 and June 30, 2007, should no longer be relied upon.

On April 28, 2008, the Audit Committee of the Company’s Board of Directors determined that we needed to restate our previously issued consolidated financial statements for the fiscal period 2004. On that date, the Audit Committee also concluded that, as a result of the pending restatement, the annual consolidated financial statement for fiscal year 2004, should no longer be relied upon.

On April 30, 2008, the Company filed an Annual Report on Form 10-K/A for the year ended December 31, 2006, to amend and restate our consolidated financial statements at December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004 with respect to errors in the accounting for stock-based compensation to employees and errors in the tax treatment for certain stock-based and cash-based compensation.  The impact of that amendment is reflected in the accompanying condensed consolidated balance sheet as of December 31, 2006.

The effects of these restatements are reflected in the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Therefore, we have not amended and do not intend to amend any of our previously filed Quarterly Reports on Form 10-Q for any period prior to December 31, 2006.

The Company was unable to timely file its Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, primarily due to the unavailability of reliable financial information.  The Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 is being filed concurrently with the Company’s Quarterly Reports on Form 10-Q/A for the quarters ended March 31, 2007 and June 30, 2007.

As a result of our failure to file quarterly reports on a timely basis, we are no longer eligible to use Form S-3 to register our securities with the Securities and Exchange Commission until all required reports under the Securities Exchange Act of 1934 have been timely filed for the 12 months prior to the filing of the registration statement for those securities.

The following items have been amended from the Company’s prior Quarterly Report for the quarter ending September 30, 2006 as a result of the matters described above:

Part I – Item 1 –Financial Statements (unaudited)

Part I – Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

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PART I – FINANCIAL INFORMATION

Item 1. – Financial Statements (unaudited)

TRUE RELIGION APPAREL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

The accompanying notes are an integral part of these statements.

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TRUE RELIGION APPAREL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, expect per share amounts)

(Unaudited)

The accompanying notes are an integral part of these statements.

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TRUE RELIGION APPAREL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

The accompanying notes are an integral part of these statements.

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TRUE RELIGION APPAREL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share amounts)

(unaudited)

NOTE 1 — DESCRIPTION OF THE COMPANY

True Religion Apparel, Inc. (the “Company”) designs, markets, distributes and retails high-fashion denim jeans and denim related apparel that are sold throughout the world.  The Company’s products are sold through three primary distribution channels: U.S. Wholesale, International Wholesale and Consumer Direct, which includes the Company’s retail stores and e-commerce business. The Company also earns licensing revenue from third parties who it authorizes to use portions of its intellectual property.  The Company’s core customer is a fashion-conscious consumer primarily between the ages of 15 and 45.

The Company was founded in 2003. In order to reincorporate in Delaware in 2005, the Company merged with and into True Religion Apparel (Delaware), Inc., which was the Company’s wholly-owned subsidiary formed pursuant to the Delaware General Corporation Law.

The Company’s business is impacted by the general seasonal trends characteristic of the apparel and retail industries. The Company’s U.S. consumer direct operations are generally stronger in the third and fourth quarters, and the U.S. wholesale operations generally experience their highest sales volume in the third quarter. Spring/Summer season merchandise shipments are normally highest in the first quarter of the year, and Fall/Winter season merchandise shipments are typically highest in the third quarter. As the timing of the shipment of products may vary from year to year, the results for any particular quarter may not be indicative of results for the full year.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information issued by the Securities and Exchange Commission (“SEC”). The accompanying condensed consolidated financial statements should be read in conjunction with the Notes to Consolidated Financial Statements contained in the Company’s Amended Annual Report on Form 10-K/A for the year ended December 31, 2006.  The same accounting policies are followed for preparing quarterly and annual financial information.  All adjustments necessary for the fair presentation of the results of operations, financial position and cash flows have been included and are of a normal, recurring nature.

Inventory for the Company’s wholesale and consumer direct business is valued at the lower of cost of market.  Cost is determined by the average cost method.

The Company’s denim manufacturing process includes two phases: i) cut and sew; and ii) washing and finishing.  At times the Company will instruct its contract manufacturers to send it goods that have been completed through the cut and sew phase only.  By delaying the second phase of the manufacturing process, the Company can use updated market information about which washes and finishes are most popular before it sends these unwashed goods to the laundries and finishing houses to complete the manufacturing process.  The denim products that the Company holds between the cut and sew phase and the wash and finish phase are considered work-in-progress.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“SFAS No. 123(R)”), which requires the Company to measure the cost of employee and director services received in exchange for an award of equity instruments based on the grant-date fair value of the award.  The costs are recognized over the period during which an employee or director is required to provide services in exchange for the award.

Prior to the adoption of SFAS No. 123(R), the Company applied Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), to measure compensation costs for its stock-based compensation programs.  Under APB 25, the Company recorded no compensation expense for stock options granted to employees and directors when the options’ strike price was

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equal to the closing market price of the Company’s common stock on the grant date.  For stock options granted to employees and directors where the options’ strike price was below the closing market price of the Company’s common stock on the grant date, compensation expense was recognized for the difference between the strike price and the closing market price of the Company’s common stock on the grant date.  Through 2005, the Company presented the effect on net earnings and earnings per share of the fair value provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”) in the Notes to the Condensed Consolidated Financial Statements.

The Company adopted SFAS No. 123(R) using the modified prospective method.  Under this transition method, 2006 stock-based compensation expense considered the unvested portion of all outstanding options, calculated using the provisions of SFAS No. 123.  As provided for under the modified prospective method, the Company did not restate its results for the periods prior to 2006.

The Company recognizes its restricted stock compensation expense using the straight-line method over the requisite service period of the entire award.  The requisite service period is the period during which an employee is required to provide service in exchange for an award, which often is the vesting period.  If a portion of the restricted stock vests immediately or in another pattern such that the cumulative expected vested amount exceeds the cumulative straight line expense amount, the Company records compensation expense equal to at least the cumulative compensation expense of the expected vested amount of the restricted stock.

As of September 30, 2007, accounts receivable, net included $2.9 million due from an authorized Japanese distributor. The Company has a security interest in the distributor’s assets as collateral for the receivable.

During the nine months ended September 30, 2007 sales to one customer accounted for 12% of the Company’s net sales.  During the nine months ended September 30, 2006, sales to two customers accounted for 12% and 11% of the Company’s net sales.  During the nine months ended September 30, 2007 and 2006, combined purchases from two suppliers totaled approximately $46,530 and $46,650, respectively.

Revenue is recognized across all segments of the business when there is persuasive evidence of an arrangement, delivery has occurred, price has been fixed or is determinable, and collectibility can be reasonably assured.

Revenue within the Company’s U.S. and International Wholesale segments are recognized at the time title passes and risk of loss is transferred to customers.  Wholesale revenue is recorded net of estimates of returns, discounts and operational chargebacks.  Returns and allowances require pre-approval from management and discounts are based on trade terms.  The Company reviews and refines these estimates on a quarterly basis.  The Company’s historical estimates of these costs have not differed materially from actual results.

Retail store revenue is recognized net of estimated returns at the time of sale to consumers.  E-commerce revenue from sales of products ordered through the Company’s retail internet site known as www.truereligionbrandjeans.com is recognized upon delivery and receipt of the shipment by its customers.  Such revenue also is reduced by an estimate of returns.

Revenue from licensing arrangement is recognized when earned in accordance with the terms of the underlying agreements, generally based upon the higher of (a) contractually guaranteed minimum royalty levels and (b) estimates of sales and royalty data received from the Company’s licensees.

The preparation of the Company’s condensed consolidated financial statements requires that management make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience and other assumptions that management believes to be reasonable under the circumstances.  Actual results may differ from these estimates.

Effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 requires

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that a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely to be realized upon ultimate settlement. The cumulative effect, if any, of applying FIN 48 is to be reported as an adjustment to the opening balance of retained earnings in the year of adoption. FIN 48 also requires that, subsequent to initial adoption, a change in judgment that results in subsequent recognition, de-recognition or change in a measurement of a tax position taken in a prior annual period (including any related interest and penalties) be recognized as a discrete item in the period in which the change occurs. FIN 48 also requires expanded disclosures, including identification of tax positions for which it is reasonably possible that total amounts of unrecognized tax benefits will significantly change in the next twelve months, a description of tax years that remain subject to examination by major tax jurisdictions, a tabular reconciliation of the total amount of unrecognized tax benefits at the beginning and end of each annual reporting period, the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate and the total amounts of interest and penalties recognized in the statements of operations and financial position.

The adoption of FIN 48 had no effect on the Company’s condensed consolidated financial statements. At September 30, 2007, the Company had no unrecognized tax benefits that, if recognized would affect the Company’s effective income tax rate in future periods. Management is currently unaware of any issues under review that could result in significant payments, accruals or material deviations from its recognized tax positions.

Effective upon adoption of FIN 48, the Company recognizes interest and penalties accrued related to unrecognized tax benefits and penalties within its provision for income taxes. The Company had no such interest and penalties accrued at September 30, 2007. Prior to its adoption of FIN 48, the Company recognized such interest and penalties, which were immaterial in prior periods, within general and administrative expenses.

The major jurisdictions in which the Company files income tax returns include the United States federal jurisdiction as well as various state jurisdictions within the United States. The Company’s federal income tax filings for fiscal year 2004 and thereafter are subject to examination by the United States and, generally, its state income tax filings for fiscal year 2003 and thereafter are subject to examination by various state tax authorities.

In May 2007, the FASB issued FASB Staff Position No. FIN 48-1 (“FSP 48-1”), “Definition of Settlement in FASB Interpretation No. 48.”  FSP 48-1 amended FIN 48 to provide guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits.  FSP 48-1 required application upon the initial adoption of FIN 48.  The adoption of FSP 48-1 did not affect the Company’s condensed consolidated financial statements.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. FAS 157-1 ("FSP 157-1") and FASB Staff Position No. FAS 157-2 ("FSP FAS 157-2"), affecting implementation of SFAS 157. FSP FAS 157-1 excludes FASB Statement No. 13, Accounting for Leases ("SFAS 13"), and other accounting pronouncements that address fair value measurements under SFAS 13, from the scope of SFAS 157. FSP FAS 157-2 delays the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized at fair value on a recurring basis, to fiscal years beginning after November 15, 2008. For all other items, SFAS 157 was effective for the Company as of January 1, 2008. The adoption will not have a material affect on the Company’s 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 Statement No. 115” (“SFAS No. 159”). SFAS No. 159 provides companies with an option to report many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The FASB believes that SFAS No. 159 helps to mitigate accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities, and would require entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, “Fair Value Measurements.” This statement is effective for fiscal years beginning after November 15, 2007. The Company does not expect to change the measurement of our assets and liabilities as a result of SFAS 159, therefore, SFAS No. 159 will have no effect on the Company's condensed consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) establishes principles and requirements for how an acquiring entity in a business combination would recognize and measure in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures any goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) retains certain fundamental requirements of SFAS No. 141, but also clarifies the definition of an acquirer in a business combination, and expands its scope to apply to all transactions and events in which one entity obtains control over one or more other businesses. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Generally, the effect of SFAS 141(R) will depend on future acquisitions, if any.

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NOTE 3 — MARKETABLE SECURITIES

Investments in marketable securities may consist of United States Government and Government Agency Bonds, auction rate securities and commercial paper. Auction rate securities are variable rate bonds whose interest rate is periodically reset, typically every 7, 28, or 35 days. The underlying securities have contractual maturities from 2025 through 2041. The auction rate securities are classified as “available-for-sale” in accordance with the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and are recorded at fair value. Any unrealized gains, which amounted to $0 and $77 for the nine months ended September 30, 2007 and 2006, respectively, or temporary unrealized losses, if any, are reported as a component of accumulated other comprehensive income in the condensed consolidated balance sheets.

The Company assesses whether an other-than-temporary impairment loss on an investment has occurred due to declines in fair value or other market conditions. At September 30, 2007, the Company does not believe any unrealized losses represent other-than-temporary impairments based on its evaluation of available evidence as of these dates. The Company has the ability to hold such securities until the maturity dates.

As of September 30, 2007, the Company held $15.2 million of municipal notes with an auction reset feature (“auction rate securities”). The Dutch auction process that resets the applicable interest rate at predetermined calendar intervals is intended to provide liquidity to the holder of the auction rate securities by matching buyers and sellers within a market context enabling the holder to gain immediate liquidity by selling such interests at par or rolling over their investment. If there is an imbalance between buyers and sellers the risk of a failed auction exists. The Company had not experienced a failed auction for any of its securities as of September 30, 2007. However, the Company had eight issues fail at auction in February, March, and April 2008 with a total par value of $10.2 million. Given the deteriorating credit markets and the increased incidence of failure within the auction market, there can be no assurances as to when, or if, the Company will be able to liquidate a particular issue. In such case of a failure the Company would not be able to access those funds until a future auction of these investments is successful, the security is called by the issuer or a buyer is found outside of the auction process. Furthermore, if this situation were to persist despite the Company’s ability to hold such investments for the long-term, the Company may be required to record an impairment charge at a future date.

The Company will continue to monitor and evaluate these investments as there is no assurance as to when the market for this investment class will return to orderly operations.

NOTE 4 — DUE FROM FACTOR, NET OF CHARGEBACKS AND OTHER ALLOWANCES

The Company uses a factor for credit administration purposes. Under the factoring agreement, the factor purchases a portion of the Company’s domestic wholesale sales invoices and assumes most of the credit risks with respect to such accounts for a charge of 0.60% of the gross invoice amount. The Company can draw cash advances from the factor based on a pre-determined percentage of eligible outstanding accounts receivable. The factor holds as security substantially all assets of the Company and charges interest at a rate of prime plus 0.5% on the outstanding advances.  The Company is liable to the factor for merchandise disputes and customer claims on receivables sold to the factor. In December 2007, the Company entered into a new factoring agreement with a minimum term of seven months.

At times, customers place orders that exceed the credit that they have available from the factor.  The Company evaluates those orders to consider if the customer is worthy of additional credit based on our past experience with the customer.  In the event the Company elects to sell merchandise to the customer on credit, we take the credit risk for the amounts that are above the credit limit established with the factor.  As of September 30, 2007, the amount of Due from Factor for which the Company bears the credit risk is $757.

For the nine months ended September 30, 2007 and 2006, the Company paid a total of approximately $13 and $53, respectively, of interest to the factor which is reported as a component of interest income, net in the condensed consolidated statements of income.

Due from factor, net of charge-backs and other deductions as presented in the balance sheet at September 30, 2007 and December 31, 2006 is summarized as follows:

NOTE 5 — INVENTORY

Inventory consists of the following:

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NOTE 6 — PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

NOTE 7 – LICENSING REVENUE

The Company has entered into five License Agreements whereby it has granted to the licensee the right to use the TRUE RELIGION trademark and related intellectual property.  Each licensee will pay to the Company a royalty fee equal to the greater of a percentage of the licensee’s actual net sales or minimum net sales (as defined in the underlying agreement).  Additionally, each licensee will pay to the Company a minimum advertising contribution fee equal to a percentage of the minimum net sales (as defined in the underlying agreement).

Each licensee is also required to make non-refundable advance royalty payments which are to be credited against the first dollars of royalties that become due under the agreement and the minimum royalty guarantee.  These payments are recognized ratably as revenue over the contract year (as defined) of the license agreement as a component of net sales in the accompanying condensed consolidated statement of income.  During the nine months ended September 30, 2007 and 2006, the Company recognized $642 and $9, respectively, as royalty and advertising revenue which is included in net sales in the condensed consolidated statements of income.  The unearned minimum payments are included in other liabilities in the condensed consolidated balance sheet.

Future minimum royalty and advertising fees as of September 30, 2007 are summarized as follows:

NOTE 8 — SHARE-BASED COMPENSATION

On June 16, 2005, the Company’s Board of Directors approved the True Religion Apparel, Inc. 2005 Stock Incentive Plan (the “2005 Incentive Plan”) which amends and restates the 2004 Option Plan and the 2004 Equity Plan (the “prior plans”).  The Company has granted restricted stock awards and stock options under the 2005 Incentive Plan.

The Company recognizes share-based compensation expense on a straight-line basis over the requisite service period.  The following table summarizes the Company’s share-based compensation expense, which is included in general and administrative expenses in the condensed consolidated statements of income:

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Shares awarded under the 2005 Incentive Plan entitle the shareholder to all the rights of common stock ownership except that the shares may not be sold, transferred, pledged, exchanged or otherwise disposed of during the restriction period.  The restriction period is determined by the Compensation Committee of the Board of Directors and may not exceed 10 years.  Restricted stock awards have generally been granted with vesting periods of up to three years.  Upon termination of an employee or officer, any unvested restricted shares are forfeited.

During the nine months ended September 30, 2007 and 2006, the Company granted 305,583 and 450,000 shares, respectively, of restricted stock to employees, officers and directors which vest over a period of two to three years.  The fair value of the restricted shares granted during the nine months ended September 30, 2007 and 2006, based on the price of the Company’s common stock at the date of grant, was $4,964 and $7,865, respectively.  The Company’s policy for attributing the value of graded vesting share-based payments is the straight-line single option approach.

During 2007, the Company implemented a practice of repurchasing common shares, upon an employee’s request, to satisfy employee minimum statutory income tax withholdings for restricted shares as they vest.  During the nine months ended September 30, 2007, the Company withheld 113,952 shares for a total cost of $1,777 which is included in tax withholding payment for stock-based compensation in the financing activities section of the condensed consolidated statements of cash flows.

The following table summarizes the Company’s restricted stock activities for the nine months ended September 30, 2007:

As of September 30, 2007, the total unamortized share-based compensation expense related to the restricted shares was $5,579, which is expected to be recognized over a weighted average period of 1.5 years.  The total fair value of restricted stock vested during the nine months ended September 30, 2007 and 2006 was $5,543 and $1,365, respectively.

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Stock options outstanding as of September 30, 2007 were granted under the Company’s 2005 Stock Incentive Plan.  Option grants were for a term of five years and vested over a period of up to three years.  Options were issued at the current market price at the date of grant.  The grant date fair value was calculated using the Black-Scholes option valuation model.  The Company did not grant any new stock options during the nine months ended September 30, 2007 and 2006, and all outstanding options are fully exercisable.

The following table summarizes the Company’s stock option activities for the nine months ended September 30, 2007:

During the nine months ended September 30, 2007, options to acquire 271,667 shares of the Company’s common stock were exercised, of which 67,848 of these shares were withheld by the Company to meet the related employee minimum statutory income tax withholding requirement of $1,282.  The minimum statutory income tax withholding amount is included in tax withholding payment for stock-based compensation in the financing activities section of the condensed consolidated statements of cash flows.

The fair value of each option grant was estimated as of the date of grant using a modified Black-Scholes option pricing model.  The significant assumptions used to estimate the fair value of options granted in 2004 are described in the Company’s annual report on Form 10-K/A for the year ended December 31, 2006.  During the nine months ended September 30, 2007 and 2006, the Company amortized $319 and $891, respectively, to general and administrative expenses in the condensed consolidated statements of income as stock-based compensation expense.

The total intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $4,570 and $3,890, respectively.

The following table summarizes information about stock options outstanding and exercisable as of September 30, 2007:

The Company receives a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the fair value of stock at the date of exercise over the exercise price of the options.  SFAS No. 123(R) requires cash flows resulting from tax benefits in excess of the related stock-based compensation to be classified as part of cash flows from financing activities.  In accordance with SFAS No. 123(R), the Company reported $1,270 and $1,089, respectively, of excess tax benefits as financing cash flows for the nine months ended September 30, 2007 and 2006.  The total tax benefit realized from stock option exercises for the nine months ended September 30, 2007 and 2006 was $1,303 and $1,130, respectively.  Cash received from stock option exercises was $198 and $207 for the nine months ended September 30, 2007 and 2006, respectively.

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NOTE 9 – EARNINGS PER SHARE

Basic earnings per share are computed based upon the weighted average number of common shares outstanding, and diluted earnings per share are computed based upon the weighted average number of common shares outstanding and dilutive common share equivalents (consisting of incentive stock options, non-qualified stock options and restricted stock awards) outstanding during the periods using the treasury stock method.

The following is a reconciliation of the shares used to compute basic and diluted earnings per share (in thousands, except per share information):

NOTE 10 – COMPREHENSIVE INCOME

Comprehensive income consists of net income and unrealized gains on marketable securities available for sale.  A reconciliation of comprehensive income for the three and nine months ended September 30, 2007 and 2006 is as follows:

NOTE 11 — COMMITMENTS AND CONTINGENCIES

The Company leases its headquarters and retail store locations under operating lease agreements expiring on various dates through July 2019. Some of these leases require the Company to make periodic payments for property taxes, utilities and common area operating expenses. Certain leases include lease incentives, rent abatements and fixed rent escalations, for which the effects are being recorded and amortized over the initial lease term on a straight-line basis.

Most of the Company’s retail leases also require payment of a percent of sales ranging from 6.0% to 7.0% if the store’s sales exceed a stated amount. Three of the Company’s leases include options that allow the Company to extend the lease term beyond the minimum lease period, subject to terms agreed to at lease inception. The Company has no capitalized lease obligations.  As of September 30, 2007, the Company had entered into a total of twenty three lease agreements for an aggregate of approximately 155,000 square feet of space.

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Future minimum lease payments under these operating leases as of September 30, 2007 are summarized as follows:

Subsequent to September 30, 2007, the Company entered into 22 new retail leases that have expiration dates through January 2019 and cumulative future minimum lease payments of approximately $41,600.

As part of their employment agreements, the Company’s Chief Executive Officer, President and Chief Financial Officer are eligible to earn incentive compensation which is paid annually after the end of the Company’s fiscal year.  For the three and nine months ended September 30, 2007, incentive compensation expense totaled approximately $637 and $1,850, respectively.  For the three and nine months ended September 30, 2006, incentive compensation expense totaled approximately $582 and $1,050, respectively. Bonuses are paid annually after the end of the Company’s fiscal year.

The Company is involved in routine claims, proceedings and litigation arising in the normal course of business.  The Company does not believe any such claims, proceedings or litigation, either alone or in the aggregate, will have a material impact on its results of operations, financial position or liquidity.

NOTE 12 — SEGMENT INFORMATION

The operating segments of the Company are U.S. wholesale, international wholesale, consumer direct and corporate. The consumer direct segment includes the Company’s retail and e-commerce operations. The corporate segment generally includes licensing revenue and, among other things, the following costs: information technology, human resources, accounting and finance, executive compensation, headquarter and distribution facilities and legal. Merchandise inter-segment transfers from the U.S. wholesale segment to the consumer direct segment have been eliminated from the amounts shown below.

The segment information for 2006 has been adjusted from our previous disclosures as the wholesale segment has been split into a U.S. wholesale segment and an international wholesale segment.   Also, a corporate segment has been included which includes licensing revenue and the cost associated with the corporate operations

During the three and nine months ended September 30, 2007, U.S. wholesale sales constituted approximately 62% and 66%, respectively, and international wholesale sales constituted approximately 22% and 19%, respectively, of the Company’s overall sales.  During the three and nine months ended September 30, 2006, U.S. wholesale sales constituted approximately 69% and 71%, respectively, and international sales constituted approximately 29% and 27%, respectively, of the Company’s overall sales.

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The accounting policies of each segment are the same as those described in the summary of significant accounting policies. The Company evaluates the performance of each operating segment based on operating income.  Summarized financial information concerning the Company’s reportable segments is shown in the following table for the three and nine months ended September 30, 2007 and 2006:

**   September 30, 2006 balance sheet has been restated for the impact of the adjustments described in Note 14 below