**UNITEDSTATES**

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the Quarterly Period Ended April 29, 2006**

** **

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commission file no. 1-9659**

 

**TheNeiman Marcus Group, Inc.**

(Exact name of registrant as specified in itscharter)

 
| **Delaware**                    | ** ** | **95-4119509**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**One Marcus Square**

**1618 Main Street**

**Dallas, Texas 7520**1

(Address of principal executive offices)

 

**(214) 741-6911**

(Registrant’s telephone number, includingarea code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.(1)

 

YES o                                                                          NOý

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

 
| Large accelerated filer  ý |   | Accelerated filer  o |   | Non-accelerated filer  o |
|--------------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

 

YES o                                                                          NOý

 

There were 900 shares of the registrant’s common stock, par value $.01per share, outstanding at April 29, 2006.

 

----

(1) After October 6, 2005, theregistrant was not subject to reporting requirements under the Exchange Act of1934, but complied with those requirements pursuant to contractual obligations.

 

 

----

 

**THE NEIMAN MARCUS GROUP, INC.**

 

**INDEX**

 
| Part I.    | Financial Information                                                                                                                                                                                            |   |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                                                                                                                             |   |
| Item 1.    | Condensed Consolidated Balance Sheets as of April 29, 2006  (Successor), July 30, 2005 (Predecessor) and April 30, 2005 (Predecessor)                                                                            |   |
|       |                                                                                                                                                                                                             |   |
|       | Condensed Consolidated Statements of Earnings for the Thirteen Weeks  Ended April 29, 2006 (Successor) and Thirteen Weeks Ended April 30, 2005  (Predecessor)                                                    |   |
|       |                                                                                                                                                                                                             |   |
|       | Condensed  Consolidated Statements of Earnings for the Thirty Weeks Ended April 29, 2006  (Successor), Nine Weeks Ended October 1, 2005 (Predecessor) and Thirty-Nine  Weeks Ended April 30, 2005 (Predecessor)  |   |
|       |                                                                                                                                                                                                             |   |
|       | Condensed Consolidated Statements of Cash Flows for the Thirty Weeks  Ended April 29, 2006 (Successor), Nine Weeks Ended October 1, 2005  (Predecessor) and Thirty-Nine Weeks Ended April 30, 2005 (Predecessor) |   |
|       |                                                                                                                                                                                                             |   |
|       | Notes to Condensed Consolidated Financial Statements                                                                                                                                                             |   |
|       |                                                                                                                                                                                                             |   |
| Item 2.    | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                                                                                                      |   |
|       |                                                                                                                                                                                                             |   |
| Item 3.    | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                                                                      |   |
|       |                                                                                                                                                                                                             |   |
| Item 4.    | Controls and Procedures                                                                                                                                                                                          |   |
|       |                                                                                                                                                                                                             |   |
| Part  II.  | Other  Information                                                                                                                                                                                               |   |
|       |                                                                                                                                                                                                             |   |
| Item 1.    | Legal Proceedings                                                                                                                                                                                                |   |
|       |                                                                                                                                                                                                             |   |
| Item 2.    | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                                                                                     |   |
|       |                                                                                                                                                                                                             |   |
| Item 4.    | Submission of Matters to a Vote of Security  Holders                                                                                                                                                             |   |
|       |                                                                                                                                                                                                             |   |
| Item 6.    | Exhibits                                                                                                                                                                                                         |   |
|       |                                                                                                                                                                                                             |   |
| Signatures |                                                                                                                                                                                                             |

 

----

 

**THE NEIMANMARCUS GROUP, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

 
| **(in thousands)**                                                                                                             | ** **   | **April 29,  2006** | ** **   | ** **   | **July 30,  2005** | ** **   | **April 30,  2005** | ** **   |
|--------------------------------------------------------------------------------------------------------------------------------|--------------|---------------------|--------------|--------------|--------------------|--------------|---------------------|--------------|
| ** **                                                                                                                     | ** **   | **(Successor)**     | ** **   | ** **   | **(Predecessor)**  | ** **   | **(Predecessor)**   | ** **   |
| **ASSETS**                                                                                                                     | ** **   | ** **          | ** **   | ** **   | ** **         | ** **   | ** **          | ** **   |
| Current  assets:                                                                                                               |         |                |         |         |               |         |                |         |
| Cash and cash equivalents                                                                                                      |         | $                   | 108,982      |         |               | $            | 853,482             |         | $ | 337,589 |   |
| Restricted cash                                                                                                                |         | —              |         |         | —             |         | 37,500              |         |
| Accounts receivable, net of allowance                                                                                          |         | 56,744              |         |         | 29,886             |         | 666,455             |         |
| Merchandise inventories                                                                                                        |         | 854,979             |         |         | 748,366            |         | 788,915             |         |
| Other current assets                                                                                                           |         | 64,700              |         |         | 76,747             |         | 49,715              |         |
| Total current assets                                                                                                           |         | 1,085,405           |         |         | 1,708,481          |         | 1,880,174           |         |
|                                                                                                                           |         |                |         |         |               |         |                |         |
| Property and  equipment, net                                                                                                   |         | 1,045,184           |         |         | 855,009            |         | 821,810             |         |
| Customer  lists, net                                                                                                           |         | 554,650             |         |         | —             |         | —              |         |
| Favorable  lease commitments, net                                                                                              |         | 469,591             |         |         | —             |         | —              |         |
| Trademarks                                                                                                                     |         | 1,691,155           |         |         | 56,645             |         | 56,645              |         |
| Goodwill                                                                                                                       |         | 1,681,021           |         |         | 14,872             |         | 14,872              |         |
| Debt  issuance costs                                                                                                           |         | 101,034             |         |         | 3,526              |         | 3,656               |         |
| Other assets                                                                                                                   |         | 31,974              |         |         | 22,127             |         | 62,649              |         |
| Total assets                                                                                                                   |         | $                   | 6,660,014    |         |               | $            | 2,660,660           |         | $ | 2,839,806 |   |
|                                                                                                                           |         |                |         |         |               |         |                |         |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                 | ** **   | ** **          | ** **   | ** **   | ** **         | ** **   | ** **          | ** **   |
| Current  liabilities:                                                                                                          |         |                |         |         |               |         |                |         |
| Accounts payable                                                                                                               |         | $                   | 251,444      |         |               | $            | 282,887             |         | $ | 246,971 |   |
| Accrued liabilities                                                                                                            |         | 389,756             |         |         | 332,937            |         | 352,526             |         |
| Notes payable and current maturities of  long-term liabilities                                                                 |         | 15,129              |         |         | 1,450              |         | 200                 |         |
| Current portion of borrowings under Credit  Card Facility                                                                      |         | —              |         |         | —             |         | 187,500             |         |
| Total current liabilities                                                                                                      |         | 656,329             |         |         | 617,274            |         | 787,197             |         |
|                                                                                                                           |         |                |         |         |               |         |                |         |
| Long-term  liabilities:                                                                                                        |         |                |         |         |               |         |                |         |
| Senior secured term loan facility                                                                                              |         | 1,875,000           |         |         | —             |         | —              |         |
| Senior debentures due 2028                                                                                                     |         | 120,663             |         |         | 124,823            |         | 124,820             |         |
| Senior notes                                                                                                                   |         | 700,000             |         |         | —             |         | —              |         |
| Senior subordinated notes                                                                                                      |         | 500,000             |         |         | —             |         | —              |         |
| Senior notes due 2008                                                                                                          |         | —              |         |         | 124,957            |         | 124,953             |         |
| Deferred real estate credits                                                                                                   |         | 11,099              |         |         | 86,575             |         | 74,429              |         |
| Deferred income taxes                                                                                                          |         | 1,129,899           |         |         | —             |         | 33,614              |         |
| Other long-term liabilities                                                                                                    |         | 186,169             |         |         | 120,973            |         | 99,500              |         |
| Total long-term liabilities                                                                                                    |         | 4,522,830           |         |         | 457,328            |         | 457,316             |         |
|                                                                                                                           |         |                |         |         |               |         |                |         |
| Minority  interest                                                                                                             |         | 12,810              |         |         | 12,112             |         | 13,498              |         |
|                                                                                                                           |         |                |         |         |               |         |                |         |
| ***Predecessor:***                                                                                                             | *** *** | *** ***        | *** *** | *** *** | *** ***       | *** *** | *** ***        | *** *** |
| Common stocks (par value $0.01 per share,  issued 49,716,309 shares at July 30, 2005 and 48,947,578 shares at April 30,  2005) |         |                |         |         | 497                |         | 497                 |         |
| ***Successor:***                                                                                                               | *** *** | *** ***        | *** *** | *** *** | *** ***       | *** *** | *** ***        | *** *** |
| Common stock  (par value $0.01 per share, issued 900 shares)                                                                   |         | —              |         |         |               |         |                |         |
|                                                                                                                           |         |                |         |         |               |         |                |         |
| Additional  paid-in capital                                                                                                    |         | 1,473,139           |         |         | 520,414            |         | 511,338             |         |
| Carryover  basis adjustment for management shareholders                                                                        |         | (69,200             | )            |         | —             |         | —              |         |
| Accumulated  other comprehensive income (loss)                                                                                 |         | 9,666               |         |         | (47,030            | )            | (3,432              | )            |
| Retained earnings                                                                                                              |         | 54,440              |         |         | 1,125,726          |         | 1,099,053           |         |
| Treasury stock, at cost (768,731 shares at  July 30, 2005 and 768,731 shares at April 30, 2005)                                |         |                |         |         | (25,661            | )            | (25,661             | )            |
| Total  shareholders’ equity                                                                                               |         | 1,468,045           |         |         | 1,573,946          |         | 1,581,795           |         |
| Total  liabilities and shareholders’ equity                                                                               |         | $                   | 6,660,014    |         |               | $            | 2,660,660           |         | $ | 2,839,806 |   |

 

*See Notesto Condensed Consolidated Financial Statements.*

 

1

----

 

**THE NEIMANMARCUS GROUP, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF EARNINGS**

**(UNAUDITED)**

 
| **(in thousands)**                                                                | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **(Successor)**                            | ** ** | ** ** | **(Predecessor)**                          | ** ** |
|                                                                              |       |                                       |       |       |                                       |       |
| Revenues                                                                          |       | $                                          | 1,027,009  |       |                                       | $          | 933,372 |   |
| Cost of goods sold including buying and  occupancy costs (excluding depreciation) |       | 602,957                                    |       |       | 549,740                                    |       |
| Selling, general and administrative  expenses (excluding depreciation)            |       | 255,380                                    |       |       | 240,396                                    |       |
| Income from credit card operations, net                                           |       | (15,136                                    | )          |       | (19,030                                    | )          |
| Depreciation expense                                                              |       | 32,913                                     |       |       | 27,614                                     |       |
| Amortization of customer lists                                                    |       | 13,715                                     |       |       | —                                     |       |
| Amortization of favorable lease commitments                                       |       | 4,502                                      |       |       | —                                     |       |
|                                                                              |       |                                       |       |       |                                       |       |
| Operating earnings                                                                |       | 132,678                                    |       |       | 134,652                                    |       |
|                                                                              |       |                                       |       |       |                                       |       |
| Interest expense, net                                                             |       | 67,216                                     |       |       | 2,933                                      |       |
|                                                                              |       |                                       |       |       |                                       |       |
| Earnings before income taxes and minority  interest                               |       | 65,462                                     |       |       | 131,719                                    |       |
|                                                                              |       |                                       |       |       |                                       |       |
| Income taxes                                                                      |       | 24,953                                     |       |       | 50,713                                     |       |
|                                                                              |       |                                       |       |       |                                       |       |
| Earnings before minority interest                                                 |       | 40,509                                     |       |       | 81,006                                     |       |
|                                                                              |       |                                       |       |       |                                       |       |
| Minority interest in net loss (earnings) of  subsidiaries                         |       | 38                                         |       |       | (1,231                                     | )          |
|                                                                              |       |                                       |       |       |                                       |       |
| Net earnings                                                                      |       | $                                          | 40,547     |       |                                       | $          | 79,775 |   |

 

*See Notes to CondensedConsolidated Financial Statements.*

 

2

----

 
| **(in thousands)**                                                                | ** ** | **Thirty weeks  ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** **        | **Thirty-nine  weeks ended  April 30,  2005** | ** **        |
|-----------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|-------------------|-----------------------------------------------|-------------------|
| ** **                                                                        | ** ** | **(Successor)**                          | ** ** | ** **                              | **(Predecessor)** | ** **                                    | **(Predecessor)** | ** ** |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Revenues                                                                          |       | $                                        | 2,583,215  |                                    |              | $                                             | 651,648           |   | $ | 2,970,533 |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Cost of goods sold including buying and occupancy  costs (excluding depreciation) |       | 1,634,187                                |       |                                    | 378,767           |                                          | 1,816,602         |   |
| Selling, general and administrative expenses  (excluding depreciation)            |       | 623,972                                  |       |                                    | 168,853           |                                          | 747,432           |   |
| Income from credit card operations, net                                           |       | (35,894                                  | )          |                                    | (7,818            | )                                             | (52,414           | ) |
| Depreciation expense                                                              |       | 77,977                                   |       |                                    | 19,960            |                                          | 79,338            |   |
| Amortization of customer lists                                                    |       | 31,652                                   |       |                                    | —            |                                          | —            |   |
| Amortization of favorable lease commitments                                       |       | 10,389                                   |       |                                    | —            |                                          | —            |   |
| Transaction and other costs                                                       |       | —                                   |       |                                    | 23,544            |                                          | —            |   |
| Loss on disposition of Chef’s Catalog                                        |       | —                                   |       |                                    | —            |                                          | 15,348            |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Operating earnings                                                                |       | 240,932                                  |       |                                    | 68,342            |                                          | 364,227           |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Interest expense (income), net                                                    |       | 150,626                                  |       |                                    | (866              | )                                             | 10,948            |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Earnings before income taxes and minority  interest                               |       | 90,306                                   |       |                                    | 69,208            |                                          | 353,279           |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Income taxes                                                                      |       | 34,791                                   |       |                                    | 25,607            |                                          | 136,014           |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Earnings before minority interest                                                 |       | 55,515                                   |       |                                    | 43,601            |                                          | 217,265           |   |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Minority interest in net (earnings) loss of  subsidiaries                         |       | (1,075                                   | )          |                                    | 553               |                                          | (2,787            | ) |
|                                                                              |       |                                     |       |                                    |              |                                          |              |   |
| Net earnings                                                                      |       | $                                        | 54,440     |                                    |              | $                                             | 44,154            |   | $ | 214,478 |   |

 

*See Notes to CondensedConsolidated Financial Statements.*

 

3

----

 

**THE NEIMANMARCUS GROUP, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| **(in thousands)**                                                                   | ** ** | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** **        | **Thirty-nine  weeks ended  April 30,  2005** | ** **        |
|--------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|-------------------|-----------------------------------------------|-------------------|
| ** **                                                                           | ** ** | **(Successor)**                          | ** ** | ** **                              | **(Predecessor)** | ** **                                    | **(Predecessor)** | ** ** |
| **CASH  FLOWS - OPERATING ACTIVITIES**                                               | ** ** | ** **                               | ** ** | ** **                              | ** **        | ** **                                    | ** **        | ** ** |
| Net earnings                                                                         |       | $                                        | 54,440     |                                    |              | $                                             | 44,154            |   | $ | 214,478 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities: |       |                                     |       |                                    |              |                                          |              |   |
| Depreciation                                                                         |       | 77,977                                   |       |                                    | 19,960            |                                          | 79,338            |   |
| Amortization of debt issue costs                                                     |       | 8,183                                    |       |                                    | —            |                                          | 465               |   |
| Amortization of customer lists and  favorable lease commitments                      |       | 42,041                                   |       |                                    | —            |                                          | —            |   |
| Non-cash charges related to step-up in  carrying value of inventory                  |       | 38,067                                   |       |                                    | —            |                                          | —            |   |
| Stock-based compensation charges                                                     |       | 2,509                                    |       |                                    | 19,968            |                                          | 3,646             |   |
| Deferred income taxes                                                                |       | (27,110                                  | )          |                                    | (7,327            | )                                             | —            |   |
| Loss on disposition of Chef’s Catalog                                           |       | —                                   |       |                                    | —            |                                          | 15,348            |   |
| Minority interest                                                                    |       | 1,075                                    |       |                                    | (553              | )                                             | 2,787             |   |
| Other, primarily costs related to defined  benefit pension plans                     |       | 8,876                                    |       |                                    | 1,656             |                                          | 23,111            |   |
|                                                                                 |       | 206,058                                  |       |                                    | 77,858            |                                          | 339,173           |   |
| Changes in operating assets and  liabilities:                                        |       |                                     |       |                                    |              |                                          |              |   |
| Increase in accounts receivable                                                      |       | (19,481                                  | )          |                                    | (7,377            | )                                             | (114,270          | ) |
| Decrease (increase) in merchandise  inventories                                      |       | 67,217                                   |       |                                    | (173,829          | )                                             | (78,955           | ) |
| Decrease in other current assets                                                     |       | 39,185                                   |       |                                    | 6,164             |                                          | 10,530            |   |
| Decrease (increase) in other assets                                                  |       | 735                                      |       |                                    | (2,274            | )                                             | 12,276            |   |
| (Decrease) increase in accounts payable and  accrued liabilities                     |       | (27,629                                  | )          |                                    | 114,604           |                                          | 38,763            |   |
| Payment of deferred compensation and  stock-based awards                             |       | (12,901                                  | )          |                                    | —            |                                          | —            |   |
| Increase in deferred real estate credits                                             |       | 11,270                                   |       |                                    | 4,289             |                                          | 2,531             |   |
| Funding of defined benefit pension plan                                              |       | —                                   |       |                                    | —            |                                          | (20,000           | ) |
| **Net cash provided by operating activities**                                        |       | 264,454                                  |       |                                    | 19,435            |                                          | 190,048           |   |
| **CASH FLOWS - INVESTING ACTIVITIES**                                                | ** ** | ** **                               | ** ** | ** **                              | ** **        | ** **                                    | ** **        | ** ** |
| Capital expenditures                                                                 |       | (112,214                                 | )          |                                    | (26,311           | )                                             | (150,830          | ) |
| Acquisition of The Neiman Marcus Group,  Inc.                                        |       | (5,156,423                               | )          |                                    | —            |                                          | —            |   |
| Increase in cash restricted for repayment  of borrowings under Credit Card Facility  |       | —                                   |       |                                    | —            |                                          | (37,500           | ) |
| Proceeds from the sale of Chef’s Catalog                                        |       | —                                   |       |                                    | —            |                                          | 14,419            |   |
| **Net cash used for investing activities**                                           |       | (5,268,637                               | )          |                                    | (26,311           | )                                             | (173,911          | ) |
| **CASH FLOWS - FINANCING ACTIVITIES**                                                | ** ** | ** **                               | ** ** | ** **                              | ** **        | ** **                                    | ** **        | ** ** |
| Proceeds from borrowings on lines of credit                                          |       | 21,000                                   |       |                                    | 5,750             |                                          | 7,750             |   |
| Repayment of borrowings on lines of credit                                           |       | (16,000                                  | )          |                                    | (750              | )                                             | (9,113            | ) |
| Borrowings under asset-based revolving  credit facility                              |       | 150,000                                  |       |                                    | —            |                                          | —            |   |
| Repayment of borrowings under asset-based  revolving credit facility                 |       | (150,000                                 | )          |                                    | —            |                                          | —            |   |
| Borrowings under senior term loan facility                                           |       | 1,975,000                                |       |                                    | —            |                                          | —            |   |
| Repayment of borrowings under senior term  loan facility                             |       | (100,000                                 | )          |                                    | —            |                                          | —            |   |
| Borrowings of senior notes and subordinated  debt                                    |       | 1,200,000                                |       |                                    | —            |                                          | —            |   |
| Repayment of senior notes due 2008                                                   |       | (134,734                                 | )          |                                    | —            |                                          | —            |   |
| Repayment of borrowings under Credit Card  Facility                                  |       | —                                   |       |                                    | —            |                                          | (37,500           | ) |
| Capital lease obligation payments                                                    |       | (1,078                                   | )          |                                    | —            |                                          | —            |   |
| Debt issuance costs paid                                                             |       | (102,854                                 | )          |                                    | —            |                                          | —            |   |
| Cash equity contributions                                                            |       | 1,427,739                                |       |                                    | —            |                                          | —            |   |
| Acquisitions of treasury stock                                                       |       | —                                   |       |                                    | —            |                                          | (3,088            | ) |
| Proceeds from stock-based compensation  awards                                       |       | —                                   |       |                                    | —            |                                          | 16,432            |   |
| Cash dividends paid                                                                  |       | —                                   |       |                                    | (7,346            | )                                             | (20,042           | ) |
| Distribution paid                                                                    |       | (168                                     | )          |                                    | —            |                                          | (1,354            | ) |
| **Net cash provided by (used for) financing  activities**                            |       | 4,268,905                                |       |                                    | (2,346            | )                                             | (46,915           | ) |
| **CASH AND CASH EQUIVALENTS**                                                        | ** ** | ** **                               | ** ** | ** **                              | ** **        | ** **                                    | ** **        | ** ** |
| Decrease during the period                                                           |       | (735,278                                 | )          |                                    | (9,222            | )                                             | (30,778           | ) |
| Beginning balance                                                                    |       | 844,260                                  |       |                                    | 853,482           |                                          | 368,367           |   |
| Ending balance                                                                       |       | $                                        | 108,982    |                                    |              | $                                             | 844,260           |   | $ | 337,589 |   |
| **Supplemental Schedule of Cash Flow  Information**                                  | ** ** | ** **                               | ** ** | ** **                              | ** **        | ** **                                    | ** **        | ** ** |
| Cash paid (received) during the period for:                                          |       |                                     |       |                                    |              |                                          |              |   |
| Interest                                                                             |       | $                                        | 122,253    |                                    |              | $                                             | 207               |   | $ | 12,992 |   |
| Income taxes                                                                         |       | $                                        | (13,332    | )                                       |              | $                                             | 10,693            |   | $ | 98,942 |   |
| Noncash activities:                                                                  |       |                                     |       |                                    |              |                                          |              |   |
| Equity contribution from Parent                                                      |       | $                                        | 25,000     |                                    |              | $                                             | —            |   | $ | — |   |
| Equity contribution from management  shareholders                                    |       | $                                        | 17,891     |                                    |              | $                                             | —            |   | $ | — |   |
| Capital lease additions                                                              |       | $                                        | 11,909     |                                    |              | $                                             | —            |   | $ | — |   |

* *

*SeeNotes to Condensed Consolidated Financial Statements.*

 

4

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** **

**THE NEIMANMARCUS GROUP, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

1.              Basisof Presentation

 

The Neiman Marcus Group,Inc. (Company) was acquired on October 6, 2005 through a merger transactionwith Newton Acquisition Merger Sub, Inc., a wholly-owned subsidiary of NeimanMarcus, Inc. (formerly Newton Acquisition, Inc.) (Parent). The acquisition wasaccomplished through the merger of Newton Acquisition Merger Sub, Inc. with andinto the Company, with the Company being the surviving entity (the Acquisition).Subsequent to the Acquisition, we are a subsidiary of the Parent, which iscontrolled by Newton Holding, LLC (Holding). Both the Parent and Holding wereformed by investment funds affiliated with Texas Pacific Group and WarburgPincus LLC (the Sponsors). Although we continued as the same legal entity afterthe Acquisition, the accompanying condensed consolidated statements of earningsand cash flows present our results of operations and cash flows for the periodspreceding the Acquisition (Predecessor) and the periods succeeding theAcquisition (Successor), respectively.

 

Our fiscal year ends on the Saturday closest to July 31. All referencesto the third quarter of fiscal year 2006 relate to the thirteen weeks endedApril 29, 2006 of the Successor. All references to the third quarter of fiscalyear 2005 relate to the thirteen weeks ended April 30, 2005 of the Predecessor.All references to the year-to-date fiscal year 2006 period relate to thecombined thirty-nine weeks ended April 29, 2006 and all references to theyear-to-date fiscal year 2005 period relate to the thirty-nine weeks endedApril 30, 2005.

 

We have prepared theaccompanying unaudited condensed consolidated financial statements inaccordance with generally accepted accounting principles for interim financialinformation and the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, these financial statements do not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements. Therefore, these financial statements should be read inconjunction with our Annual Report on Form 10-K for the fiscal year ended July30, 2005.

 

In our opinion, theaccompanying unaudited condensed consolidated financial statements contain alladjustments, consisting of normal recurring adjustments, necessary to presentfairly our financial position, results of operations and cash flows for theapplicable interim periods. The results of operations for these periods are notnecessarily comparable to, or indicative of, results of any other interimperiod or for the fiscal year as a whole.

 

**We are required to make estimates and assumptions aboutfuture events in preparing financial statements in conformity with generallyaccepted accounting principles. These estimates and assumptions affect theamounts of assets, liabilities, revenues and expenses and the disclosure ofgain and loss contingencies at the date of the unaudited condensed consolidatedfinancial statements. While we believe that our past estimates and assumptionshave been materially accurate, our current estimates are subject to change ifdifferent assumptions as to the outcome of future events were made. We evaluateour estimates and judgments on an ongoing basis and predicate those estimatesand judgments on historical experience and on various other factors that webelieve to be reasonable under the circumstances. We make adjustments to ourassumptions and judgments when facts and circumstances dictate. Since futureevents and their effects cannot be determined with absolute certainty, actualresults may differ from the estimates used in preparing the accompanyingunaudited condensed consolidated financial statements.**

** **

We believe the followingcritical accounting policies, among others, encompass the more significantjudgments and estimates used in the preparation of our financial statements:

 

•                  Preliminaryallocation of the price paid to acquire the Company to our assets andliabilities as of the date of the Acquisition (as more fully described in Note3);

 

•                  Recognitionof revenues;

 

•                  Valuationof merchandise inventories, including determination of original retail values,recognition of markdowns and vendor allowances, estimation of inventoryshrinkage, and determination of cost of goods sold;

 

•                  Determinationof impairment of long-lived assets;

 

•                  Recognitionof advertising and catalog costs;

 

•                  Measurementof liabilities related to our loyalty programs;

 

•                  Recognitionof income taxes; and

 

5

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•                  Measurementof accruals for litigation, general liability, workers’ compensation and healthinsurance, short-term disability, pension and postretirement health carebenefits.

 

A description of our critical accounting policies is included in ourAnnual Report on Form 10-K for the fiscal year ended July 30, 2005.

 

Certain prior period balances have been reclassifiedto conform to the current period presentation. Depreciation expense and incomefrom credit card operations, net are now shown as separate line items on ourstatements of earnings. Prior to the second quarter of fiscal year 2006,depreciation expense was included in buying and occupancy costs and the incomefrom our credit card operations was included as a reduction to selling, generaland administrative expenses.

 

***Recent Accounting Pronouncements.***InDecember 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (R), “Share-BasedPayment” (SFAS No. 123(R)). This standard is a revision of SFAS No. 123,“Accounting for Stock-Based Compensation,” and supersedes Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25)and its related implementation guidance. SFAS No. 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the financial statements based on their fair values and waseffective for the first interim period or annual reporting period beginningafter June 15, 2005. We adopted SFAS No. 123(R) as of the beginning of ourfirst quarter of fiscal year 2006 using the modified prospective method, whichrequires companies to record stock compensation for all unvested and new awardsas of the adoption date. Accordingly, we have not restated the prior period amountspresented herein. See Note 5 for further description of our stock-basedcompensation.

 

In March 2005, the FASB issued FASB Interpretation No. 47, “Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143” (FIN 47). FIN 47 clarifies that conditional asset retirementobligations meet the definition of liabilities and should be recognized whenincurred if their fair values can be reasonably estimated. FIN 47 is effectiveno later than the end of fiscal years ending after December 15, 2005 with thecumulative effect of initially applying FIN 47 being recognized as a change inaccounting principle. We are in the process of evaluating the expected effectof FIN 47, if any, on our consolidated financial statements.

 

2.              TheTransactions

 

As discussed in Note 1, the Acquisition was completed on October 6,2005 and was financed by:

 

•                  Borrowingsunder our senior secured asset-based revolving credit facility (Asset-BasedRevolving Credit Facility) and our secured term loan credit facility (SeniorSecured Term Loan Facility) (collectively, the Secured Credit Facilities);

 

•                  theissuance of 9.0%/9.75% senior notes due 2015 (Senior Notes);

 

•                  theissuance of 10.375% senior subordinated notes due 2015 (Senior Subordinated Notes);and

 

•                  equityinvestments from Parent funded by direct and indirect equity investments fromthe Sponsors, co-investors and management.

 

The Acquisitionoccurred simultaneously with:

 

•                  theclosing of the financing transactions and equity investments described above;

 

•                  thecall for redemption of, the deposit into a segregated account of the estimatedamount of the redemption payment related to, and the ratable provision ofsecurity pursuant to the terms thereof, for our 6.65% senior notes due 2008 (2008Notes);

 

•                  theratable provision of security to our 7.125% senior debentures due 2028 (2028Debentures) pursuant to the terms thereof; and

 

•                  thetermination of our previous $350 million unsecured revolving credit agreement(Credit Agreement).

 

Werefer to the above transactions, the Acquisition and our payment of any costsrelated to these transactions collectively herein as the “Transactions.”   We refer to the Senior Notes and SeniorSubordinated Notes collectively herein as the “Notes.”

 

6

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***Transaction and Other Costs.***During the periodfrom July 30, 2005 to October 1, 2005, the Predecessor expensed $23.5 millionin connection with the Transactions. These costs consisted primarily of $4.5million of accounting, investment banking, legal and other costs associatedwith the Transactions and a $19.0 million non-cash charge for stockcompensation resulting from the accelerated vesting of Predecessor stockoptions and restricted stock in connection with the Acquisition.

 

***Carryover Basis Adjustment for Management Shareholders.***Executive management participants held certain equity interests, includingstock options, in the Predecessor prior to the Transactions and continue tohold equity interests in the Parent, representing indirect equity interests inthe Successor after the Transactions. In accordance with the provisions ofEmerging Issues Task Force No. 88-16, “Basis in Leveraged Buyout Transactions,”the basis of executive management’s indirect interests in the Successor afterthe Transactions is carried over at the basis of their interests in thePredecessor prior to the Transactions. The carryover basis of such interestsless the net cash received by the management participants represents a deemeddividend of $69.2 million to the management participants and has beenrecognized as a reduction to shareholders’ equity of the Successor.

 

**3.**              Purchase Accounting

** **

We have accounted for the Acquisition in accordancewith the provisions of Statement of Financial Accounting Standards (SFAS) No.141, “Business Combinations,” whereby the purchase price paid to effect theAcquisition is allocated to state the acquired assets and liabilities at fairvalue. The Acquisition and the preliminary allocation of the purchase pricehave been recorded as of October 1, 2005, the beginning of our Octoberaccounting period. The purchase price was approximately $5,461.7 million. Thesources and uses of funds in connection with the Transactions and theredemption of our 2008 Notes are summarized below (in millions):

 
| **Sources**                                                                                   | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|
| Asset-Based Revolving Credit Facility                                                         |       | $          | 150.0      |   |
| Secured Term Loan Facility                                                                    |       | 1,975.0    |       |
| Senior Notes                                                                                  |       | 700.0      |       |
| Senior Subordinated Notes                                                                     |       | 500.0      |       |
| Cash on hand                                                                                  |       | 666.1      |       |
| Equity contribution – cash                                                               |       | 1,427.7    |       |
| Equity contribution – non-cash                                                           |       | 42.9       |       |
| Total sources                                                                                 |       | $          | 5,461.7    |   |
|                                                                                          |       |       |       |
| **Uses**                                                                                      | ** ** | ** ** | ** ** |
| Consideration paid to stockholders  (including non-cash management rollover of $17.9 million) |       | $          | 5,110.8    |   |
| Transaction costs (including non-cash items  of $18.8 million)                                |       | 82.3       |       |
| Redemption of existing 2008 Notes                                                             |       | 134.7      |       |
| Debt issuance costs (including non-cash  items of $6.3 million)                               |       | 109.2      |       |
| Payment of deferred compensation  obligations and other accrued liabilities                   |       | 24.7       |       |
| Total uses                                                                                    |       | $          | 5,461.7    |   |

 

In connection with the preliminary purchase priceallocation, we have made estimates of the fair values of our long-lived andintangible assets based upon assumptions related to future cash flows, discountrates and asset lives utilizing currently available information. As of April29, 2006, we have recorded preliminary purchase accounting adjustments toincrease the carrying value of our property and equipment and inventory, toestablish intangible assets for our tradenames, customer lists and favorablelease commitments and to revalue our long-term benefit plan obligations, amongother things. This allocation of the purchase price is preliminary and subjectto our review and finalization of asset valuations.

 

7

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The purchase price has been preliminarily allocated asfollows (in millions): 

 
| Cash consideration:                                                          |   |     |   |    |    |
|------------------------------------------------------------------------------|--------|----------|--------|---------|---------|
| Paid to shareholders                                                         |   |     |   | $       | 5,092.9 |   |
| Transaction costs                                                            |   |     |   | 63.5    |    |
|                                                                         |   |     |   | 5,156.4 |    |
| Non-cash consideration                                                       |   |     |   | 36.7    |    |
| Total consideration                                                          |   |     |   | 5,193.1 |    |
|                                                                         |   |     |   |    |    |
| Net assets acquired at historical cost                                       |   |     |   | 1,638.1 |    |
|                                                                         |   |     |   |    |    |
| Adjustments to state acquired assets at  fair value:                         |   |     |   |    |    |
| 1) Increase carrying value of property and  equipment                        |   | $        | 135.9  |    |    |   |
| 2) Increase carrying value of inventory                                      |   | 38.1     |   |    |    |
| 3) Write-off historical goodwill and  tradenames                             |   | (71.5    | )      |    |    |
| 4) Record intangible assets acquired                                         |   |     |   |    |    |
| Customer lists                                                               |   | 586.3    |   |    |    |
| Favorable lease commitments                                                  |   | 480.0    |   |    |    |
| Tradenames                                                                   |   | 1,691.1  |   |    |    |
| 5) Write-off other assets, primarily debt  issue costs                       |   | (3.7     | )      |    |    |
| 6) Adjustment to state 2008 Notes at  redemption value                       |   | (6.2     | )      |    |    |
| 7) Adjustment to state 2028 Debentures at  fair value                        |   | 4.5      |   |    |    |
| 8) Write-off deferred real estate credits                                    |   | 90.2     |   |    |    |
| 9) Increase in long-term benefit  obligations, primarily pension obligations |   | (57.6    | )      |    |    |
| 10) Tax  impact of valuation adjustments                                     |   | (1,082.3 | )      |    |    |
| Deemed dividend to management shareholders                                   |   | 69.2     |   | 1,874.0 |    |
| Net assets acquired at fair value                                            |   |     |   | 3,512.1 |    |
|                                                                         |   |     |   |    |    |
| Excess purchase price recorded as goodwill                                   |   |     |   | $       | 1,681.0 |   |
|                                                                              |        |          |        |         |         |  |  |

** **

Our tradenames have indefinite lives and are notsubject to amortization. Our tradenames and goodwill will be reviewed at leastannually for impairment.

 

Total estimated amortization of allacquisition-related intangible assets during the period from October 6, 2005 throughJuly 29, 2006 and for each of our fiscal years ending in July 2006 to 2010 iscurrently estimated as follows (in thousands):

 
| October 6, 2005 through July 29, 2006 |   | $      | 60,261 |   |
|---------------------------------------|--------|--------|--------|--------|
| 2007                                  |   | 72,874 |   |
| 2008                                  |   | 72,874 |   |
| 2009                                  |   | 72,874 |   |
| 2010                                  |   | 72,874 |   |

 

8

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***Pro Forma Financial Information.***Thefollowing unaudited pro forma results of operations assume that theTransactions occurred on August 1, 2004. The following unaudited pro formaresults do not give effect to the sale of our credit card receivables, whichwas completed on July 7, 2005, or the disposition of Chef’s Catalog, which wascompleted on November 8, 2004. This unaudited pro forma information should notbe relied upon as necessarily being indicative of the historical results thatwould have been obtained if the Transactions had actually occurred on thatdate, nor the results that may be obtained in the future. 

 
| ** **         | ** ** | **Thirteen weeks ended** | ** ** | **Thirty-nine weeks ended** | ** ** |
|--------------------|------------|--------------------------|------------|-----------------------------|------------|
| **(in thousands)** | ** ** | **April 29,  2006**      | ** ** | **April 30,  2005**         | ** ** | **April 29,  2006** | ** ** | **April 30,  2005** | ** ** |
|               |       |                     |       |                        |       |   |   |   |   |
| Revenues           |       | $                        | 1,027,009  |                        | $          | 933,372 |   | $ | 3,234,863 |   | $ | 2,970,533 |   |
| Net income         |       | $                        | 42,730     |                        | $          | 27,390 |   | $ | 100,152 |   | $ | 34,123 |   |

 

Included in thedetermination of pro forma net income for the thirty-nine weeks ended April 30,2005 are pro forma adjustments for non-cash charges to increase cost of goodssold for the step-up in the carrying value of inventories acquired of $39.6million. These pro forma adjustments resulted in pro forma decreases to cost ofgoods sold in the thirteen and thirty-nine weeks ended April 29, 2006 by theamount of the actual non-cash charges recorded during these periods.

 

**4.**              Transactions with Sponsors

** **

In connection with the Transactions, we entered into a managementservices agreement with affiliates of the Sponsors pursuant to which affiliatesof one of the Sponsors received on the closing date a transaction fee of $25million in cash in connection with the Transactions. Affiliates of the otherSponsor waived any cash transaction fee in connection with the Transactions.

 

In addition, pursuant to such agreement, and in exchange for on-goingconsulting and management advisory services that will be provided to us by theSponsors and their affiliates, affiliates of the Sponsors will receive anaggregate annual management fee equal to the lesser of (i) 0.25% of ourconsolidated annual revenues or (ii) $10 million. Affiliates of the Sponsorswill also receive reimbursement for out-of-pocket expenses incurred by them ortheir affiliates in connection with services provided pursuant to theagreement. These management fees are payable quarterly in arrears. During thethird quarter of fiscal year 2006 and the thirty weeks ended April 29, 2006, werecorded management fees of $2.6 million and $6.4 million, respectively, whichare included in selling, general and administrative expenses in the condensedconsolidated statements of earnings.

 

The management services agreement also provides thataffiliates of the Sponsors may receive future fees in connection with certainsubsequent financing and acquisition or disposition transactions. Themanagement services agreement includes customary exculpation andindemnification provisions in favor of the Sponsors and their affiliates.

 

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**5.**              Stock-Based Compensation

** **

We previously accounted for stock-based compensation awards toemployees in accordance with APB No. 25 and its related interpretations.Accordingly, we recognized compensation expense on our restricted stock awardsbut did not recognize compensation expense for stock options since all optionsgranted had an exercise price equal to the market value of our common stock onthe grant date. We did not adopt the previous voluntary expense recognitionprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No.123), whereby the fair value of stock-based compensation awards would have beenexpensed over the terms of awards. However, consistent with the disclosurerequirements of SFAS No. 123, we made pro forma disclosures of the effect thatapplication of the fair value expense recognition provisions of SFAS No. 123would have had on our net earnings.

 

In December 2004, the FASB issued SFAS No. 123(R). This standard is arevision of SFAS No. 123 and supersedes APB No. 25 and its relatedimplementation guidance. SFAS No. 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values and is effective for the firstinterim period or annual reporting period beginning after June 15, 2005. Weadopted SFAS No. 123(R) as of the beginning of our first quarter of fiscal year2006 using the modified prospective method, which required us to record stock compensationfor all unvested and new awards as of the adoption date. Accordingly, we havenot restated prior period amounts presented herein.

 

***Predecessor Stock-Based CompensationAccounting.***In connection with the adoption of theprovisions of SFAS No. 123(R), we recorded non-cash charges for stockcompensation of approximately $20.0 million in the period from July 31, 2005 toOctober 1, 2005 primarily as a result of the accelerated vesting of allPredecessor options and restricted stock in connection with the Transactions(see Note 2).

 

The following table illustrates the pro forma effect on net earningsfor periods prior to the adoption of SFAS No. 123(R) as if we had applied thefair value recognition provisions of SFAS No. 123 during such periods:

 
| **(in thousands)**                                                                                                                   | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **(Predecessor)**                          | ** ** | **(Predecessor)**                             | ** ** |
| Net  earnings:                                                                                                                       |       |                                       |       |                                          |       |
| As reported                                                                                                                          |       | $                                          | 79,775     |                                          | $          | 214,478 |   |
| Add: stock-based employee compensation  recorded under the intrinsic value method of APB No. 25, net of related taxes                |       | 826                                        |       | 2,236                                         |       |
| Less: stock-based employee compensation  expense determined under the fair value based method of SFAS No. 123, net of  related taxes |       | (2,917                                     | )          | (8,436                                        | )          |
| Pro forma net earnings                                                                                                               |       | $                                          | 77,684     |                                          | $          | 208,278 |   |

** **

***Successor Stock-Based CompensationAccounting.***On November 29, 2005, the Parentadopted a new equity-based management compensation plan, which authorizesequity awards to be granted for up to 80,708.8 shares of the common stock ofthe Parent, of which options for 75,207.5 shares were issued to certainmanagement employees. All options are outstanding at April 29, 2006. Optionsgranted vest over five years and have an exercise price of $1,445 per share,with the exercise price with respect to approximately 50% of such optionsescalating at a 10% compound rate per year until the earlier to occur of (i)exercise, (ii) the fifth anniversary of the date of grant or (iii) theoccurrence of a change in control; provided that in the event the Sponsorscause the sale of shares of the Parent to an unaffiliated entity, the exerciseprice will cease to accrete at the time of the sale with respect to a pro rataportion of the accreting options. Using the Black-Scholes option-pricing model,the per share fair value of these options was approximately $494 for the fixedprice options and $247 for the options with escalating exercise prices. Inestimating the fair value of our options, we made the following assumptions:expected term to exercise of five years; expected volatility of 30%; risk-freeinterest rate of 4.23%; and no dividend yield. Expected volatility is based ona combination of the Predecessor’s historical volatility adjusted for our newleverage and estimates of implied volatility of our peer group.

 

For the thirty-weeks ended April 29, 2006, we recognized non-cash stockcompensation expense of $2.5 million, which is included in selling, general andadministrative expenses. The adoption of SFAS No. 123(R) had no impact on ourcash flows from operations or financing activities. At April 29, 2006, unearnednon-cash stock-based compensation that we expect to recognize as expense overthe next 5 years aggregates approximately $25.6 million.

 

10

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**6.**              The Credit Card Sale

** **

***Credit Card Sale.***OnJuly 7, 2005, HSBC Bank Nevada, National Association (HSBC) purchased ourapproximately three million private label Neiman Marcus and Bergdorf Goodmancredit card accounts and related assets, as well as the outstanding balancesassociated with such accounts (Credit Card Sale). The total purchase price wasapproximately $647 million, consisting of $534 million in net cash proceeds andthe assumption of approximately $113 million of our outstanding debt under ourprevious revolving credit card securitization facility (Credit Card Facility).We recognized a gain of $6.2 million in connection with the sale of ourcredit card portfolio to HSBC in the fourth quarter of fiscal year 2005.

 

As a part of the Credit CardSale, we entered into a long-term marketing and servicing alliance with HSBC.Under the terms of this alliance, HSBC offers credit card and non-card paymentplans bearing our brands and we receive ongoing payments from HSBC related tocredit card sales and compensation for marketing and servicing activities (HSBCProgram Income). In addition, we continue to handle certain key customerservice functions. In tandem with HSBC, we have initiated various changes inour credit card program to alter the credit terms available to our cardholdersand to enhance the earnings of the portfolio. These changes have increased thelevel of HSBC Program Income earned by the Company. In the future, the HSBCProgram Income may be either decreased based upon the level of future serviceswe provide to HSBC or increased based upon other changes to our historicalcredit card program related to, among other things, the interest rates appliedto unpaid balances and the assessment of late fees.

 

A summary of the income earned in connection with our proprietarycredit card program is as follows:

 
| ** **             | ** ** | **Quarter-to-Date**                        | ** ** | **Year-to-Date**                           | ** **        |
|------------------------|------------|--------------------------------------------|------------|--------------------------------------------|-------------------|
| **(in thousands)**     | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** **        | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
| ** **             | ** ** | **(Successor)**                            | ** ** | ** **                                 | **(Predecessor)** | ** ** | **(Successor)** | ** ** | ** ** | **(Predecessor)** | ** ** | **(Predecessor)** | ** ** |
| ** **             | ** ** | ** **                                 | ** ** | ** **                                 | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| HSBC Program  Income   |       | $                                          | 15,136     |                                       |              | $ | — |   | $ | 35,894 |   |   | $ | 7,818 |   | $ | — |   |
| Finance  charge income |       | —                                     |       |                                       | 23,640            |   | — |   |   | — |   | 64,645 |   |
| Bad debt,  net         |       | —                                     |       |                                       | (4,610            | ) | — |   |   | — |   | (12,231 | ) |
|                   |       | $                                          | 15,136     |                                       |              | $ | 19,030 |   | $ | 35,894 |   |   | $ | 7,818 |   | $ | 52,414 |   |

 

**7.**              Loss on Disposition of Chef’s Catalog

** **

In November 2004, we sold our Chef’s Catalog direct marketing businessto a private equity firm. Chef’s Catalog is a multi-channel retailer ofprofessional-quality kitchenware with revenues in fiscal year 2004 ofapproximately $73 million. At October 30, 2004, Chef’s Catalog had net tangibleassets, primarily inventory, of $12.5 million and net intangible assets of$17.2 million. We received proceeds, net of selling costs, of $14.4 millionfrom the sale. As the carrying value of the Chef’s Catalog assets exceeded thefair value of such assets as determined by the sale, we incurred a pre-tax lossof $15.3 million in the first quarter of fiscal year 2005 related to thedisposition of Chef’s Catalog.

 

11

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8.              Long-termDebt

 

The significant components of our long-term debt are as follows:

 
| **(in thousands)**                                              | ** ** | **Interest  Rate** | ** ** | **April 29,  2006** | ** ** | **July 30,  2005** | ** **        | **April 30,  2005** | ** **        |
|-----------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|-------------------|---------------------|-------------------|
| ** **                                                      | ** ** | ** **         | ** ** | **(Successor)**     | ** ** | ** **         | **(Predecessor)** | ** **          | **(Predecessor)** | ** ** |
|                                                            |       |               |       |                |       |               |              |                |              |   |
| Asset-Based Revolving Credit Facility                           |       | variable           |       | $                   | —     |               |              | $                   | —            |   | $ | — |   |
| Senior Secured Term Loan Facility                               |       | variable           |       | 1,875,000           |       |               | —            |                | —            |   |
| 2028 Debentures                                                 |       | 7.125%             |       | 120,663             |       |               | 124,823           |                | 124,820           |   |
| Senior Notes                                                    |       | 9.0%/9.75%         |       | 700,000             |       |               | —            |                | —            |   |
| Senior Subordinated Notes                                       |       | 10.375%            |       | 500,000             |       |               | —            |                | —            |   |
| 2008 Notes                                                      |       | 6.65%              |       | —              |       |               | 124,957           |                | 124,953           |   |
| Credit Card Facility                                            |       | variable           |       | —              |       |               | —            |                | 187,500           |   |
|                                                            |       |               |       | 3,195,663           |       |               | 249,780           |                | 437,273           |   |
| Less: current portion of borrowings under  Credit Card Facility |       |               |       | —              |       |               | —            |                | 187,500           |   |
| Long-term debt                                                  |       |               |       | $                   | 3,195,663  |               |              | $                   | 249,780           |   | $ | 249,773 |   |

 

***Senior Secured Asset-Based RevolvingCredit Facility.***OnOctober 6, 2005, in connection with the Transactions, the Company entered intoa credit agreement and related security and other agreements for a seniorsecured Asset-Based Revolving Credit Facility with Deutsche Bank Trust CompanyAmericas as administrative agent and collateral agent. The Asset-BasedRevolving Credit Facility provides financing of up to $600.0 million,subject to a borrowing base equal to at any time the lesser of 80% of eligibleinventory (valued at the lower of cost or market value) and 85% of net orderlyliquidation value of the eligible inventory, less certain reserves. TheAsset-Based Revolving Credit Facility includes borrowing capacity available forletters of credit and for borrowings on same-day notice.  At the closingof the Transactions, the Company utilized $150.0 million of theAsset-Based Revolving Credit Facility for loans and approximately $16.5 million for letters of credit. Inthe second quarter of fiscal year 2006, the Company repaid all loans under theAsset-Based Revolving Credit Facility. As of April 29, 2006, the Company had$573.2 million of unusedborrowing availability under the Asset-Based Revolving Credit Facility based ona borrowing base of over $600.0 million and after giving effect to $26.8million used for letters of credit.

 

TheAsset-Based Revolving Credit Facility provides that the Company has the rightat any time to request up to $200.0 million of additional commitments, butthe lenders are under no obligation to provide any such additional commitments,and any increase in commitments will be subject to customary conditionsprecedent. If the Company were to request any such additional commitments andthe existing lenders or new lenders were to agree to provide such commitments,the Asset-Based Revolving Credit Facility size could be increased to up to$800.0 million, but the Company’s ability to borrow would still be limitedby the amount of the borrowing base.

 

Borrowingsunder the Asset-Based Revolving Credit Facility bear interest at a rate perannum equal to, at the Company’s option, either (a) a base rate determinedby reference to the higher of (1) the prime rate of Deutsche Bank TrustCompany Americas and (2) the federal funds effective rate plus 1/2 of 1%or (b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin.  The initial applicable margin is 0% with respect tobase rate borrowings and 1.75% with respect to LIBOR borrowings.  Theapplicable margin is subject to adjustment based on the historical availabilityunder the Asset-Based Revolving Credit Facility. In addition, the Company isrequired to pay a commitment fee of 0.375% per annum in respect of theunutilized commitments. If the average revolving loan utilization is 50% ormore for any applicable period, the commitment fee will be reduced to 0.250%for such period. The Company must also pay customary letter of credit fees andagency fees.

 

Ifat any time the aggregate amount of outstanding loans, unreimbursed letter ofcredit drawings and undrawn letters of credit under the Asset-Based Revolving CreditFacility exceeds the lesser of (i) the commitment amount and (ii) theborrowing base, the Company will be required to repay outstanding loans or cashcollateralize letters of credit in an aggregate amount equal to such excess,with no reduction of the commitment amount. If the amount available under theAsset-Based Revolving Credit Facility is less than $60 million or an eventof default has occurred, the Company will be required to repay outstandingloans and cash collateralize letters of credit with the cash the Company isrequired to deposit daily in a collection account maintained with the agentunder the Asset-Based Revolving Credit Facility. The Company may voluntarilyreduce the unutilized portion of the commitment amount and repay outstanding loansat any time without premium or penalty other than customary “breakage” costswith respect to LIBOR loans. There is no scheduled amortization under theAsset-Based Revolving Credit Facility; the principal amount of the loansoutstanding is due and payable in full on October 6, 2010.

 

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All obligations under the Asset-Based Revolving Credit Facility areguaranteed by Parent and certain of the Company’s existing and future domesticsubsidiaries (excluding, among others, Gurwitch Products, L.L.C., and KateSpade LLC (Brand Development Companies)). As of April 29, 2006, the liabilitiesof the Company’s non-guarantor subsidiaries totaled approximately $38.1million, or 0.7% of consolidated liabilities, and the assets of the Company’snon-guarantor subsidiaries aggregated approximately $194.0 million, or 2.9% ofconsolidated total assets. All obligations under the Company’s Asset-BasedRevolving Credit Facility, and the guarantees of those obligations, are secured,subject to certain significant exceptions, by substantially all of theCompany’s assets and the assets of Parent and the Company’s subsidiaries thathave guaranteed the Asset-Based Revolving Credit Facility (subsidiaryguarantors), including:

 

•                  a first-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by the Company or the subsidiary guarantorsfrom credit card clearinghouses and processors or otherwise in respect of allcredit card charges for sales of inventory by the Company and the subsidiaryguarantors, certain related assets and proceeds of the foregoing; and

 

•                  a second-priority pledge of 100% of theCompany’s capital stock and certain of the capital stock held by the Company,Parent or any subsidiary guarantor (which pledge, in the case of any foreignsubsidiary is limited to 100% of the non-voting stock (if any) and 65% of thevoting stock of such foreign subsidiary); and

 

•                  a second-priority security interest in, andmortgages on, substantially all other tangible and intangible assets of theCompany, Parent and each subsidiary guarantor, including a significant portionof the Company’s material owned and leased real property (which currentlyconsists of a majority of the Company’s full-line retail stores) and equipment.

 

Capital stock and other securities of a subsidiary of the Company thatare owned by the Company or any subsidiary guarantor will not constitutecollateral under the Company’s Asset-Based Revolving Credit Facility to theextent that such securities cannot secure the Company’s 2028 Debentures orother secured public debt obligations without requiring the preparation andfiling of separate financial statements of such subsidiary in accordance withapplicable SEC rules. As a result, the collateral under the Company’sAsset-Based Revolving Credit Facility will include shares of capital stock orother securities of subsidiaries of the Company or any subsidiary guarantoronly to the extent that the applicable value of such securities (on asubsidiary-by-subsidiary basis) is less than 20% of the aggregate principalamount of the 2028 Debentures or other secured public debt obligations. Stockof the Company’s Brand Development Companies and their assets also will notconstitute collateral under the Company’s Asset-Based Revolving CreditFacility.

 

TheCompany’s Asset-Based Revolving Credit Facility contains a number of covenantsthat, among other things and subject to certain significant exceptions, restrictits ability and the ability of its subsidiaries to:

 

•                  incur additional indebtedness;

 

•                  pay dividends on the Company’s capital stockor redeem, repurchase or retire the Company’s capital stock or indebtedness;

 

•                  make investments, loans, advances andacquisitions;

 

•                  create restrictions on the payment ofdividends or other amounts to the Company from its subsidiaries that are notguarantors;

 

•                  engage in transactions with the Company’saffiliates;

 

•                  sell assets, including capital stock of theCompany’s subsidiaries;

 

•                  consolidate or merge;

 

•                  create liens; and

 

•                  enter into sale and lease back transactions.

 

Thecovenants limiting dividends and other restricted payments; investments, loans,advances and acquisitions; and prepayments or redemptions of otherindebtedness, each permit the restricted actions in an unlimited amount,subject to the satisfaction of certain payment conditions, principally that theCompany must have at least $75.0 million of pro forma excess availabilityunder the Asset-Based Revolving Credit Facility and that the Company must be inpro forma compliance with the fixed charge coverage ratio described below.

 

Althoughthe credit agreement governing the Asset-Based Revolving Credit Facility doesnot require the Company to comply with any financial ratio maintenancecovenants, if less than $60.0 million were available to be borrowed underthe Asset-Based Revolving Credit Facility at any time, the Company would not bepermitted to borrow any additional amounts unless its pro forma ratio of

 

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consolidatedEBITDA to consolidated Fixed Charges (as such terms are defined in the creditagreement) were at least 1.1 to 1.0. The credit agreement also containscustomary affirmative covenants and events of default.

 

***Senior Secured Term Loan Facility.***On October 6, 2005, in connection with theTransactions, the Company entered into a credit agreement and related securityand other agreements for a $1,975.0 million Senior Secured Term LoanFacility with Credit Suisse as administrative agent and collateral agent. The full amount of the Senior Secured Term Loan Facility was borrowed onOctober 6, 2005. In the second quarter of fiscal year 2006, the Company repaid$100.0 million principal amount of the loans under the Senior Secured Term LoanFacility.

 

Borrowingsunder the Senior Secured Term Loan Facility bear interest at a rate per annumequal to, at the Company’s option, either (a) a base rate determined byreference to the higher of (1) the prime rate of Credit Suisse and(2) the federal funds effective rate plus 1/2 of 1% or (b) a LIBORrate, subject to certain adjustments, in each case plus an applicable margin.The applicable margin is 1.5% with respect to base rate borrowings and 2.5%with respect to LIBOR borrowings. The interest rate on the outstandingborrowings pursuant to the Senior Secured Term Loan Facility was 7.24% at April29, 2006.

 

Thecredit agreement governing the Senior Secured Term Loan Facility requires theCompany to prepay outstanding term loans with 50% (which percentage will bereduced to 25% if the Company’s total leverage ratio is less than a specifiedratio and will be reduced to 0% if the Company’s total leverage ratio is lessthan a specified ratio) of its annual excess cash flow (as defined in thecredit agreement). If a change of control (as defined in the credit agreement)occurs, the Company will be required to offer to prepay all outstanding termloans, at a prepayment price equal to 101% of the principal amount to beprepaid, plus accrued and unpaid interest to the date of prepayment. TheCompany also must offer to prepay outstanding term loans at 100% of theprincipal amount to be prepaid, plus accrued and unpaid interest, with theproceeds of certain asset sales under certain circumstances.

 

TheCompany may voluntarily prepay outstanding loans under the Senior Secured TermLoan Facility at any time without premium or penalty other than customary“breakage” costs with respect to LIBOR loans. If the Company repays all or anyportion of the Senior Secured Term Loan Facility prior to October 6, 2006(other than a prepayment that is made with certain designated asset saleproceeds), the Company must pay 101% of the principal amount to be repaid.There is no scheduled amortization under the Senior Secured Term Loan Facility.The principal amount of the loans outstanding is due and payable in full onApril 6, 2013.

 

Allobligations under the Senior Secured Term Loan Facility are unconditionallyguaranteed by Parent and each direct and indirect domestic subsidiary of theCompany that guarantees the obligations of the Company under its Asset-BasedRevolving Credit Facility. All obligations under the Senior Secured Term LoanFacility, and the guarantees of those obligations, are secured, subject tocertain significant exceptions, by substantially all of the Company’s assetsand the assets of its Parent and the subsidiary guarantors, including:

 

•                  a first-priority pledge of 100% of theCompany’s capital stock and certain of the capital stock held by the Company,Parent or any subsidiary guarantor (which pledge, in the case of any foreignsubsidiary is limited to 100% of the non-voting stock (if any) and 65% of thevoting stock of such foreign subsidiary); and

 

•                  a first-priority security interest in, andmortgages on, substantially all other tangible and intangible assets of theCompany, Parent and each subsidiary guarantor, including a significant portionof the Company’s material owned and leased real property (which currently consistsof a majority of the Company’s full-line retail stores) and equipment, butexcluding, among other things, the collateral described in the following bulletpoint; and

 

•                  a second-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by the Company or the subsidiary guarantorsfrom credit card clearinghouses and processors or otherwise in respect of allcredit card charges for sales of inventory by the Company and the subsidiaryguarantors, certain related assets and proceeds of the foregoing.

 

Capital stock and other securities of a subsidiary of the Company thatare owned by the Company or any subsidiary guarantor will not constitutecollateral under the Company’s Senior Secured Term Loan Facility to the extentthat such securities cannot secure the 2028 Debentures or other secured publicdebt obligations without requiring the preparation and filing of separatefinancial statements of such subsidiary in accordance with applicable SECrules. As a result, the collateral under the Company’s Senior Secured Term LoanFacility will include shares of capital stock or other securities ofsubsidiaries of the Company or any subsidiary guarantor only to the extent thatthe applicable value of such securities (on a subsidiary-by-subsidiary basis)is less than 20% of the aggregate principal amount of the 2028 Debentures orother secured public debt obligations. Stock of the Company’s Brand DevelopmentCompanies and their assets also will not constitute collateral under theCompany’s Senior Secured Term Loan Facility.

 

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Thecredit agreement governing the Senior Secured Term Loan Facility contains anumber of negative covenants that are substantially similar to those governingthe Senior Notes and additional covenants related to the security arrangementsfor the Senior Secured Term Loan Facility. The credit agreement also containscustomary affirmative covenants and events of default.

 

***2028 Debentures.***InMay 1998, the Company issued $125.0 million aggregate principal amount of its2028 Debentures. In connection with the Transactions, the Company equally andratably secured the 2028 Debentures by a first lien security interest oncertain collateral subject to liens granted under the Company’s Senior SecuredCredit Facilities constituting (a) (i) 100% of the capital stock of certain ofthe Company’s existing and future domestic subsidiaries, and (ii) 100% of thenon-voting stock and 65% of the voting stock of certain of the Company’sexisting and future foreign subsidiaries and (b) certain of the Company’sprincipal properties that include a majority of the Company’s full-line stores,in each case, to the extent required by the terms of the indenture governingthe 2028 Debentures. The 2028 Debentures contain covenants that restrict theCompany’s ability to create liens and enter into sale and lease backtransactions. The collateral securing the 2028 Debentures will be released uponthe release of liens on such collateral under the Company’s Senior SecuredCredit Facilities and any other debt (other than the 2028 Debentures) securedby such collateral. Capital stock and other securities of a subsidiary of theCompany that are owned by the Company or any subsidiary will not constitutecollateral under the 2028 Debentures to the extent such property does notconstitute collateral under the Company’s Senior Secured Credit Facilities asdescribed above. Parent is currently considering providing a guarantee of the2028 Debentures.

 

***Senior Notes.***On October 6, 2005, Newton Acquisition MergerSub, Inc. issued $700.0 million aggregate original principal amount of 9.0% /9.75% Senior Notes under a senior indenture (Senior Indenture) with Wells FargoBank, National Association, as trustee. At the closing of the Transactions, asthe surviving corporation in the Acquisition, the Company assumed all theobligations of Newton Acquisition Merger Sub, Inc. under the SeniorIndenture.  The Senior Notes mature on October 15, 2015.

 

For any interest payment period through October 15, 2010, theCompany may, at its option, elect to pay interest on the Senior Notes entirelyin cash (Cash Interest) or entirely by increasing the principal amount of theoutstanding Senior Notes or by issuing additional Senior Notes (PIK Interest).Cash Interest on the Senior Notes accrues at the rate of 9% per annum. PIK Interest on the Senior Notes accrues at the rate of 9.75% per annum. After October 15, 2010, the Company will make all interest payments on theSenior Notes entirely in cash.  All Senior Notes mature onOctober 15, 2015 and have the same rights and benefits as the Senior Notesissued on October 6, 2005. Interest on the Senior Notes is payable quarterly inarrears on each January 15, April 15, July 15 andOctober 15, commencing on January 15, 2006.

 

TheSenior Notes are guaranteed, jointly and severally, on an unsecured, seniorbasis, by each of the Company’s wholly-owned domestic subsidiaries thatguarantee the Company’s obligations under its Senior Secured Credit Facilitiesand by Parent. The Senior Notes and the guarantees thereof are the Company’sand the guarantors’ unsecured, senior obligations and rank (i) equal in theright of payment with all of the Company’s and the guarantors’ existing andfuture senior indebtedness, including any borrowings under the Company’s SeniorSecured Credit Facilities and the guarantees thereof and the Company’s 2028Debentures; and (ii) senior to all of the Company’s and its guarantors’ existingand future subordinated indebtedness, including the Senior Subordinated Notesdue 2015 and the guarantees thereof. The Senior Notes also are effectivelyjunior in priority to the Company’s and its guarantors’ obligations under allsecured indebtedness, including the Company’s Senior Secured Credit Facilities,the 2028 Debentures, and any other secured obligations of the Company, in eachcase, to the extent of the value of the assets securing such obligations. Inaddition, the Senior Notes are structurally subordinated to all existing andfuture liabilities, including trade payables, of the Company’s subsidiariesthat are not providing guarantees.

 

TheCompany is not required to make any mandatory redemption or sinking fundpayments with respect to the Senior Notes, but under certain circumstances, theCompany may be required to offer to purchase Senior Notes as described below.The Company may from time to time acquire Senior Notes by means other than aredemption, whether by tender offer, in open market purchases, throughnegotiated transactions or otherwise, in accordance with applicable securitieslaws.

 

Exceptas described below, the Senior Notes are not redeemable at the Company’s optionprior to October 15, 2010. From and after October 15, 2010, theCompany may redeem the Senior Notes, in whole or in part, at a redemption priceequal to 104.5% of principal amount, declining annually to 100% of theprincipal amount on October 15, 2013, plus accrued and unpaid interest, andAdditional Interest (as defined in the Senior Indenture), if any, thereon tothe applicable redemption date.

 

Prior to October 15, 2008, the Company may, at its option, subjectto certain conditions, redeem up to 35% of the original aggregate principalamount of Senior Notes at a redemption price equal to 109% of the aggregateprincipal amount thereof, *plus*accrued and unpaid interest, and Additional Interest, if any, thereon to theredemption date, with the net cash proceeds of one or more equity offerings ofthe Company or any direct or indirect parent of the Company to the extent suchnet proceeds are contributed to the Company. At any time prior toOctober 15, 2010, the Company also may redeem all or a part of the SeniorNotes at a redemption

 

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priceequal to 100% of the principal amount of Senior Notes redeemed plus anapplicable premium, as provided in the Senior Indenture, as of, and accrued andunpaid interest and Additional Interest, if any, to the redemption date.

 

Uponthe occurrence of a change of control (as defined in the Senior Indenture),each holder of the Senior Notes has the right to require the Company torepurchase some or all of such holder’s Senior Notes at a price in cash equalto 101% of the aggregate principal amount thereof plus accrued and unpaidinterest, and Additional Interest, if any, to the date of purchase.

 

Theindenture governing the Senior Notes contains covenants that limit theCompany’s ability and certain of its subsidiaries’ ability to:

 

•                  incur additional indebtedness;

 

•                  pay dividends on the Company’s capital stockor redeem, repurchase or retire the Company’s capital stock or subordinatedindebtedness;

 

•                  make investments;

 

•                  create restrictions on the payment ofdividends or other amounts to the Company from its restricted subsidiaries thatare not guarantors of the notes;

 

•                  engage in transactions with the Company’saffiliates;

 

•                  sell assets, including capital stock of theCompany’s subsidiaries;

 

•                  consolidate or merge;

 

•                  create liens; and

 

•                  enter into sale and lease back transactions.

 

TheCompany’s Brand Development Companies are not subject to the covenantscontained in the Senior Indenture. The Senior Indenture also provides forevents of default, which, if any of them occurs, would permit or require theprincipal, premium, if any, interest and any other monetary obligations on alloutstanding Senior Notes to be due and payable immediately.

 

***Senior Subordinated Notes.***On October 6, 2005, Newton Acquisition MergerSub, Inc. issued $500.0 million aggregate principal amount of 10.375% SeniorSubordinated Notes under a senior subordinated indenture (Senior SubordinatedIndenture) with Wells Fargo Bank, National Association, as trustee. At theclosing of the Transactions, as the surviving corporation in the Acquisition,the Company assumed all the obligations of Newton Acquisition Merger Sub, Inc.under the Senior Subordinated Indenture.  The Senior Subordinated Notesmature on October 15, 2015. Interest on the Senior Subordinated Notes is payablein cash semi-annually in arrears on each April 15 and October 15,commencing April 15, 2006.

 

TheSenior Subordinated Notes are guaranteed, jointly and severally, on anunsecured, senior subordinated basis, by each of the Company’s wholly-owneddomestic subsidiaries that guarantee the Company’s obligations under its SeniorSecured Credit Facilities and by Parent. The Senior Subordinated Notes and theguarantees thereof are the Company’s and the guarantors’ unsecured, seniorsubordinated obligations and rank (i)   junior to all ofthe Company’s and the guarantors’ existing and future senior indebtedness,including the Senior Notes and any borrowings under the Company’s SeniorSecured Credit Facilities, and the guarantees thereof and the Company’s 2028 Debentures;(ii) equally with any of the Company’s and the guarantors’ future seniorsubordinated indebtedness; and (iii) senior to any of the Company’s and theguarantors’ future subordinated indebtedness. In addition, the SeniorSubordinated Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of the Company’s subsidiaries that arenot providing guarantees.

 

TheCompany is not required to make any mandatory redemption or sinking fundpayments with respect to the Senior Subordinated Notes, but, under certaincircumstances, the Company may be required to offer to purchase SeniorSubordinated Notes as described below.  The Company may from time to timeacquire Senior Subordinated Notes by means other than a redemption, whether bytender offer, in open market purchases, through negotiated transactions orotherwise, in accordance with applicable securities laws.

 

Exceptas described below, the Senior Subordinated Notes are not redeemable at theCompany’s option prior to October 15, 2010. From and afterOctober 15, 2010, the Company may redeem the Senior Subordinated Notes, inwhole or in part, at a redemption price equal to 105.188% of principal amount,declining annually to 100% of principal amount on October 15, 2013, plusaccrued and unpaid interest, and Additional Interest (as defined in the SeniorSubordinated Indenture), if any, thereon to the applicable redemption date.

 

Priorto October 15, 2008, the Company may, at its option, subject to certainconditions, redeem up to 35% of the original aggregate principal amount ofSenior Subordinated Notes at a redemption price equal to 110.375% of theaggregate principal amount thereof,

 

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*plus* accrued and unpaid interest, and Additional Interest, if any, thereonto the redemption date, with the net cash proceeds of one or more equityofferings of the Company or any direct or indirect parent of the Company to theextent such net proceeds are contributed to the Company.

 

Atany time prior to October 15, 2010, the Company also may redeem all or apart of the Senior Subordinated Notes at a redemption price equal to 100% ofthe principal amount of Senior Subordinated Notes redeemed plus an applicablepremium, as provided in the Senior Subordinated Indenture, as of, and accruedand unpaid interest and Additional Interest, if any, to the redemption date.

 

Uponthe occurrence of a change of control (as defined in the Senior SubordinatedIndenture), the Company will make an offer to purchase all of the SeniorSubordinated Notes at a price in cash equal to 101% of the aggregate principalamount thereof plus accrued and unpaid interest, and Additional Interest, ifany, to the date of purchase.

 

Theindenture governing the Senior Subordinated Notes contains covenantssubstantially similar to those applicable to the Company’s Senior Notesdescribed above. The Senior Subordinated Indenture also provides for events ofdefault, which, if any of them occurs, would permit or require the principal,premium, if any, interest and any other monetary obligations on all outstandingSenior Notes to be due and payable immediately, subject to certain exceptions.

 

***Redemptionof 2008 Notes.***In May 1998, the Company issued $125.0 million aggregateprincipal amount of its 2008 Notes. Upon closing of the Transactions, theCompany called its 2008 Notes for redemption pursuant to their terms. OnNovember 7, 2005, the Company used $134.7 million of reserved cash to redeemits 2008 Notes, which included a call premium of $6.2 million plus accruedinterest of $3.5 million through the redemption date.

*** ***

***Maturities of Long-Term Debt.***AtApril 29, 2006, annual maturities of long-term debt during the next five yearsand thereafter are as follows (in millions):

 
| 2006       |   | $       | — |   |
|------------|--------|---------|--------|--------|
| 2007       |   | —  |   |
| 2008       |   | —  |   |
| 2009       |   | —  |   |
| 2010       |   | —  |   |
| Thereafter |   | 3,195.7 |   |

 

***Interest Rate Swaps.***TheCompany uses derivative financial instruments to help manage its interest raterisk. Effective December 6, 2005, the Company entered into floating to fixed interestrate swap agreements for an aggregate notional amount of $1,000.0 million tolimit its exposure to interest rate increases related to a portion of itsfloating rate indebtedness. The interest rate swap agreements terminate afterfive years. As of the effective date, the Company designated the interest rateswaps as cash flow hedges. As a result, changes in the fair value of theCompany’s swaps are recorded subsequent to the effective date as a component ofother comprehensive income.

 

At April 29, 2006, the fair value of the Company’s interest rate swapagreements was a gain of approximately $19.4 million, which amount is includedin other assets. As a result of the swap agreements, the Company’s effectivefixed interest rates as to the $1,000.0 million in floating rate indebtednesswill range from 6.931% to 7.499% per quarter and result in an average fixedrate of 7.285%.

 

9.              AccumulatedOther Comprehensive Income (Loss)

 

The following table shows thecomponents of accumulated other comprehensive income (loss):

 
| **(in thousands)**                                   | ** ** | **April 29,  2006** | ** ** | ** ** | **July 30,  2005** | ** ** | **April 30,  2005** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|------------|--------------------|------------|---------------------|------------|
| ** **                                           | ** ** | **(Successor)**     | ** ** | ** ** | **(Predecessor)**  | ** ** | **(Predecessor)**   | ** ** |
|                                                 |       |                |       |       |               |       |                |       |
| Unrealized  gain (loss) on financial instruments     |       | $                   | 9,350      |       |               | $          | (1,114              | )          | $ | 57 |   |
| Minimum  pension liability adjustments               |       | —              |       |       | (46,921            | )          | (4,673              | )          |
| Other                                                |       | 316                 |       |       | 1,005              |       | 1,184               |       |
| Total  accumulated other comprehensive income (loss) |       | $                   | 9,666      |       |               | $          | (47,030             | )          | $ | (3,432 | ) |

 

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10.       EmployeeBenefit Plans

 

***Description of Benefit Plans.***Wesponsor a defined benefit pension plan (Pension Plan) covering substantiallyall full-time employees. We also sponsor an unfunded supplemental executiveretirement plan (SERP Plan) that provides additional pension benefits tocertain employees. Benefits under both plans are based on the employees’ yearsof service and compensation over defined periods of employment. Pension Planassets consist primarily of equity and fixed income securities.

 

Retirees and active employees hired prior to March 1, 1989 are eligibleto participate in a plan providing certain limited postretirement health carebenefits (Postretirement Plan) if they have met certain service and minimum agerequirements.

 

***Costs of Benefits.***Thecomponents of the expenses incurred under our Pension Plan, SERP Plan andPostretirement Plan are as follows:

 
| ** **                                          | ** ** | **Quarter-to-Date**                        | ** ** | **Year-to-Date**                           | ** **        |
|-----------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|-------------------|
| **(in thousands)**                                  | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** **        | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
|                                                |       | **(Successor)**                            |       |                                       | **(Predecessor)** |   | **(Successor)** |   |   | **(Predecessor)** |   | **(Predecessor)** |   |
| Pension Plan:                                       |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| Service cost                                        |       | $                                          | 4,027      |                                       |              | $ | 3,196 |   | $ | 9,293 |   |   | $ | 2,823 |   | $ | 9,588 |   |
| Interest cost                                       |       | 5,250                                      |       |                                       | 4,636             |   | 12,115 |   |   | 3,468 |   | 13,907 |   |
| Expected return on plan assets                      |       | (5,684                                     | )          |                                       | (4,712            | ) | (13,118 | ) |   | (3,636 | ) | (14,137 | ) |
| Net amortization of losses and prior  service costs |       | —                                     |       |                                       | 1,208             |   | — |   |   | 1,205 |   | 3,626 |   |
| Pension Plan expense                                |       | $                                          | 3,593      |                                       |              | $ | 4,328 |   | $ | 8,290 |   |   | $ | 3,860 |   | $ | 12,984 |   |
|                                                |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| SERP Plan:                                          |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| Service cost                                        |       | $                                          | 474        |                                       |              | $ | 361 |   | $ | 1,094 |   |   | $ | 330 |   | $ | 1,084 |   |
| Interest cost                                       |       | 1,114                                      |       |                                       | 1,014             |   | 2,571 |   |   | 730 |   | 3,042 |   |
| Net amortization of losses and prior  service costs |       | —                                     |       |                                       | 384               |   | — |   |   | 394 |   | 1,151 |   |
| SERP Plan expense                                   |       | $                                          | 1,588      |                                       |              | $ | 1,759 |   | $ | 3,665 |   |   | $ | 1,454 |   | $ | 5,277 |   |
|                                                |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| Postretirement Plan:                                |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| Service cost                                        |       | $                                          | 12         |                                       |              | $ | 15 |   | $ | 27 |   |   | $ | 8 |   | $ | 44 |   |
| Interest cost                                       |       | 214                                        |       |                                       | 318               |   | 494 |   |   | 139 |   | 954 |   |
| Net amortization of losses (gains)                  |       | —                                     |       |                                       | 26                |   | — |   |   | (5 | ) | 79 |   |
| Postretirement expense                              |       | $                                          | 226        |                                       |              | $ | 359 |   | $ | 521 |   |   | $ | 142 |   | $ | 1,077 |   |

 

***Purchase Accounting Adjustments.***Theobligations and assets related to our benefit plans were valued at fair valueas of the date of the Acquisition, using a discount rate of 5.75%, as follows:

 
| **(in thousands)**                                                          | ** ** | **Pension  Plan** | ** ** | **SERP  Plan** | ** ** | **Postretirement  Plan** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|--------------------------|------------|
|                                                                        |       |              |       |           |       |                     |       |
| Benefit obligations at fair value                                           |       | $                 | 354,807    |           | $          | 76,806                   |       | $ | 15,281 |   |
| Assets held by defined benefit pension  plan, at fair value                 |       | 287,871           |       | —         |       | —                   |       |
| Excess of benefit obligations over assets                                   |       | 66,936            |       | 76,806         |       | 15,281                   |       |
| Less: previously recorded benefit plan  obligations recorded by Predecessor |       | (19,655           | )          | (66,161        | )          | (18,205                  | )          |
| Adjustment to increase benefit plan  obligations                            |       | $                 | 47,281     |           | $          | 10,645                   |       | $ | (2,924 | ) |

 

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***Funding Policy and Plan Assets.***Ourpolicy is to fund the Pension Plan at or above the minimum required by law. In2005, we made voluntary contributions of $20.0 million for the plan year endedJuly 31, 2004. Based upon currently available information, we will not berequired to make contributions to the Pension Plan for either the 2006 or 2005plan years; however, we could decide to make a voluntary contribution based onour evaluation of the Pension Plan.

 

***Effect of Medicare Subsidy on PostretirementPlan.***In December 2003, the U.S. Congressenacted the Medicare Prescription Drug, Improvement and Modernization Act of2003 (Act) that provides a prescription drug subsidy, beginning in January2006, to companies that sponsor postretirement health care plans that providedrug benefits. Based upon the provisions of the legislation enacted inJanuary 2005, we reviewed the provisions of our Postretirement Plan withour actuaries to determine whether the benefits offered by our plan met thestatutory definition of “actuarially equivalent” prescription drug benefitsthat qualify for the federal subsidy. Based upon this review, we believe thatour benefits qualify for the subsidy. We estimate the annual federal subsidy tobe received in the next ten years under the Act to be approximately$0.2 million, which subsidy was considered in the determination of thefair value of the Postretirement Plan as of the date of the Acquisition.

 

11.       Segments

 

We have identifiedtwo reportable segments: Specialty Retail Stores and Direct Marketing. TheSpecialty Retail Stores segment includes all of our Neiman Marcus and BergdorfGoodman retail stores, including Neiman Marcus clearance stores. The DirectMarketing segment conducts both online operations and print catalog under theNeiman Marcus, Horchow and Bergdorf Goodman brand names. Other includes our 51%interest in Gurwitch Products, L.L.C., which designs and markets the LauraMercier cosmetic line, and our 56% interest in Kate Spade LLC, which designsand retails high-end designer handbags and accessories.

 

Both the SpecialtyRetail Stores and Direct Marketing segments, as well as Kate Spade LLC andGurwitch Products, L.L.C., derive their revenues from the sale of high-endfashion apparel, accessories, cosmetics and fragrances from leading designers,precious and fashion jewelry and decorative home accessories.

 

Thefollowing table sets forth the information for our reportable segments:

 
| ** **                                                                                       | ** ** | **Quarter-to-Date**                        | ** ** | **Year-to-Date**                           | ** **        |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|-------------------|
| **(in thousands)**                                                                               | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** **        | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
| ** **                                                                                       | ** ** | **(Successor)**                            | ** ** | ** **                                 | **(Predecessor)** | ** ** | **(Successor)** | ** ** | ** ** | **(Predecessor)** | ** ** | **(Predecessor)** | ** ** |
| REVENUES:                                                                                        |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | $                                          | 840,220    |                                       |              | $ | 766,877 |   | $ | 2,084,129 |   |   | $ | 544,857 |   | $ | 2,415,749 |   |
| Direct Marketing                                                                                 |       | 152,097                                    |       |                                       | 130,532           |   | 416,479 |   |   | 87,515 |   | 458,514 |   |
| Other                                                                                            |       | 34,692                                     |       |                                       | 35,963            |   | 82,607 |   |   | 19,276 |   | 96,270 |   |
| Total                                                                                            |       | $                                          | 1,027,009  |                                       |              | $ | 933,372 |   | $ | 2,583,215 |   |   | $ | 651,648 |   | $ | 2,970,533 |   |
|                                                                                             |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| OPERATING  EARNINGS:                                                                             |       |                                       |       |                                       |              |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | $                                          | 142,603    |                                       |              | $ | 125,832 |   | $ | 280,984 |   |   | $ | 91,372 |   | $ | 343,781 |   |
| Direct Marketing                                                                                 |       | 22,950                                     |       |                                       | 16,780            |   | 67,280 |   |   | 8,246 |   | 55,943 |   |
| Other                                                                                            |       | (155                                       | )          |                                       | 4,572             |   | 4,006 |   |   | (1,923 | ) | 10,241 |   |
| Subtotal                                                                                         |       | 165,398                                    |       |                                       | 147,184           |   | 352,270 |   |   | 97,695 |   | 409,965 |   |
| Corporate expenses                                                                               |       | (14,375                                    | )          |                                       | (12,532           | ) | (30,691 | ) |   | (5,809 | ) | (30,390 | ) |
| Amortization of customer lists and  favorable lease commitments                                  |       | (18,217                                    | )          |                                       | —            |   | (42,041 | ) |   | — |   | — |   |
| Non-cash charges related to other valuation  adjustments made in connection with the Acquisition |       | (128                                       | )          |                                       | —            |   | (38,606 | ) |   | — |   | — |   |
| Transaction and other costs                                                                      |       | —                                     |       |                                       | —            |   | — |   |   | (23,544 | ) |   |   |
| Loss on disposition of Chef’s Catalog                                                       |       | —                                     |       |                                       | —            |   | — |   |   | — |   | (15,348 | ) |
| Total                                                                                            |       | $                                          | 132,678    |                                       |              | $ | 134,652 |   | $ | 240,932 |   |   | $ | 68,342 |   | $ | 364,227 |   |

** **

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** **

**12.**       Commitments and Contingencies

** **

***Investments in Brand DevelopmentCompanies. ***Ourbrand development companies consist of our 56% interest in Kate Spade LLC,which designs and markets high-end designer handbags and accessories, and our51% interest in Gurwitch Products, L.L.C., which designs and markets the LauraMercier cosmetics line. Our investments in and relationships with our branddevelopment companies are governed by operating agreements that provide for anorderly transition process in the event any investor wishes to sell itsinterest, or purchase another investor’s interest. Among other things, theseoperating agreements contain currently exercisable put option provisionsentitling each minority investor to put their interest to us, and currentlyexercisable call option provisions entitling us to purchase each minorityinvestor’s interest, at a purchase price mutually agreed to by the parties. Thepurchase price will be determined, in the case of the Gurwitch interests, byone or more nationally recognized investment banking firms and, in the case ofthe Kate Spade interests, by the parties or, in the event the parties areunable to agree on a mutually acceptable price, by a mutually acceptablenationally recognized investment banking firm, subject to certain conditions.We may elect to defer the consummation of a put option for a period of sixmonths by cooperating with the other investors in seeking either a sale of therelevant brand development company to a third party or a public offering of therelevant brand development company’s securities. If a sale to a third party orpublic offering of the relevant brand development company’s securities is notconsummated within six months after the exercise of the put option (whichperiod may be automatically extended for an additional two months if a registrationstatement for the relevant brand development company is filed with the SEC), weare obligated to consummate the put option. Under the terms of the Kate Spadeoperating agreement, consummation of the put option shall occur within thirtydays after the determination of the valuation with respect to the exercise ofthe put option, unless we have elected to defer the consummation of the putoption for the six-month period referred to above, and should a third partysale or public offering of Kate Spade occur within such six-month period, weare required to pay the Kate Spade investors the difference, if any, betweenthe put option valuation price for their interest and the amount they realizethrough the third party sale of public offering.

 

In April 2005, the minority investors in Kate Spade LLC exercised theput option described above with respect to the full amount of their stake insuch company. We subsequently entered into a standstill agreement to postponethe put process while we engaged in discussions with the minority investors ofKate Spade LLC regarding certain strategic alternatives, including the possiblesale of such company. The standstill agreement, as extended, expired on March21, 2006, but the parties are continuing to pursue discussions regarding apossible sale of such company while the put valuation process proceeds.Although such discussions are ongoing, no assurance can be given that they willultimately lead to any transaction. It is possible that we may be required topurchase the shares of the minority investors in Kate Spade LLC pursuant to theoption as early as the fourth quarter of fiscal 2006.

 

We have also been in discussions with the minority investors ofGurwitch Products, L.L.C. regarding certain strategic alternatives, includingthe possible sale of such company. No assurance can be given that thesediscussions will ultimately lead to any transaction. In addition, theindentures governing the notes and the terms of our senior secured creditfacilities permit us to distribute all of our equity interests in GurwitchProducts, L.L.C. to the holders of our equity without restriction (except incertain limited circumstances when we are paying PIK interest on the seniornotes).

 

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***Litigation.***Weare currently involved in various legal actions and proceedings that arose inthe ordinary course of our business. We believe that any liability arising as aresult of these actions and proceedings will not have a material adverse effecton our financial position, results of operations or cash flows.

 

On May 4, 2005, apurported class action complaint, NECA-IBEW Pension Fund (The Decatur Plan) v.The Neiman Marcus Group, Inc. et al. (CA No. 3-05 CV-0898B), wasfiled by a putative stockholder in federal court in the Northern District ofTexas against our Company and its directors challenging the proposed merger. Anamended complaint was filed on July 25, 2005. The amended complaintalleged a cause of action for breach of fiduciary duty against us and ourdirectors, claiming, among other things, that the defendants had endeavored tocomplete the sale of our Company and its assets at a grossly inadequate andunfair price and pursuant to an unfair process that failed to maximizeshareholder value. In addition, the amended complaint alleged that ourdirectors were not independent and breached their fiduciary duties inconnection with the approval of the merger by, among other things, (i)tailoring the transaction to serve the interests of the defendants and thefamily of Richard A. Smith, the then chairman of our board of directors and ourlargest stockholder, rather than structuring the merger to obtain the highestprice for stockholders, (ii) depriving public stockholders of the value ofcertain assets (including the credit card business and our third quarter 2005profits), (iii) failing to realize the financial benefits from the sale of thecredit card business, (iv) not engaging in a fair process of negotiating atarm’s length, including provisions precluding superior competing bids(including a termination fee and no solicitation provision), and (v)structuring a preferential deal for insiders. The amended complaint furtherclaimed that our financial advisor had a conflict of interest by also acting asa financing source for the merger, and that our proxy statement in respect ofthe merger omitted material information purportedly necessary to ensure a fullyinformed shareholder vote. The amended complaint sought, among other things,injunctive relief to enjoin the consummation of the merger, to rescind anyactions taken to effect the merger, to direct the defendants to sell or auctionour Company for the highest possible price, and to impose a constructive trustin favor of plaintiffs upon any benefits improperly received by defendants.Following the closing of the merger, plaintiff voluntarily dismissed thelawsuit with prejudice as moot on December 1, 2005, and provided a release ofall of the defendants for claims arising out of the merger. The Company paidplaintiff’s attorneys’ fees in connection with certain disclosures requested byplaintiff and included in the proxy statement sent to the shareholdersregarding the merger.

 

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**ITEM 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

**EXECUTIVE OVERVIEW**

 

The following discussion and analysis of ourfinancial condition and results of operations should be read in conjunctionwith our Annual Report on Form 10-K for the fiscal year ended July 30, 2005.Unless otherwise specified, the meanings of all defined terms in Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A) are consistent with the meanings of such terms as defined in theNotes to the Condensed Consolidated Financial Statements. This discussioncontains forward-looking statements. Please see “Forward-Looking Statements”for a discussion of the risks, uncertainties and assumptions relating to ourforward-looking statements.

 

**Overview**

 

The Neiman MarcusGroup, Inc., together with our operating segments and subsidiaries, is ahigh-end specialty retailer. Our operations include the Specialty Retail Storessegment and the Direct Marketing segment. The Specialty Retail Stores segmentconsists primarily of Neiman Marcus and Bergdorf Goodman stores. The DirectMarketing segment conducts both online operations and print catalog under thebrand names of Neiman Marcus, Bergdorf Goodman, Horchow and Chef’s Catalog(prior to its disposition in November 2004). We own a 51% interest inGurwitch Products, L.L.C., which designs and markets the Laura Mercier cosmeticline, and a 56% interest in Kate Spade LLC, which designs and markets high-enddesigner handbags and accessories (the Brand Development Companies).

 

The Neiman Marcus Group,Inc. (Company) was acquired on October 6, 2005 through a merger transactionwith Newton Acquisition Merger Sub, Inc., a wholly-owned subsidiary of NeimanMarcus, Inc. (formerly Newton Acquisition, Inc.) (Parent). The acquisition wasaccomplished through the merger of the Newton Acquisition Merger Sub, Inc. withand into the Company, with the Company being the surviving entity (theAcquisition). Subsequent to the Acquisition, we are a subsidiary of the Parent,which is controlled by Newton Holding, LLC (Holding). Both the Parent andHolding were formed by investment funds affiliated with Texas Pacific Group andWarburg Pincus LLC (the Sponsors). Although we continued as the same legalentity after the Acquisition, the accompanying condensed consolidatedstatements of earnings and cash flows present our results of operations andcash flows for the periods preceding the Acquisition (Predecessor) and theperiods succeeding the Acquisition (Successor), respectively.

 

In connection with theTransactions, the Company incurred significant indebtedness and became highlyleveraged. See “Liquidity and Capital Resources.”  In addition, the purchase price paid inconnection with the Acquisition has been preliminarily allocated to state theacquired assets and liabilities at fair value. The preliminary purchaseaccounting adjustments increased the carrying value of our property andequipment and inventory, established intangible assets for our tradenames,customer lists and favorable lease commitments and revalued our long-termbenefit plan obligations, among other things. Subsequent to the Transactions,interest expense and non-cash depreciation and amortization charges havesignificantly increased. As a result, our Successor financial statementssubsequent to the Transactions are not comparable to our Predecessor financialstatements.

 

We have prepared our discussion of the results of operations for thenine months (thirty-nine weeks) ended April 29, 2006 by comparing the resultsof operations of the Predecessor for the thirty-nine weeks ended April 30, 2005to the combined amounts obtained by adding the earnings and cash flows for thePredecessor nine-week period ended October 1, 2005 and the Successorthirty-week period ended April 29, 2006. Although this combined presentationdoes not comply with generally accepted accounting principles (GAAP), webelieve that it provides a meaningful method of comparison. The combinedoperating results have not been prepared on a pro forma basis under applicableregulations and may not reflect the actual results we would have achievedabsent the Transactions and may not be predictive of future results ofoperations.

 

Our fiscal year ends on the Saturday closest to July 31. All referencesto the third quarter of fiscal year 2006 relate to the thirteen weeks endedApril 29, 2006 of the Successor. All references to the third quarter of fiscalyear 2005 relate to the thirteen weeks ended April 30, 2005 of the Predecessor.All references to the year-to-date fiscal year 2006 period relate to thecombined thirty-nine weeks ended April 29, 2006 (calculated as described above)and all references to the year-to-date fiscal year 2005 period relate to thethirty-nine weeks ended April 30, 2005.

 

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**Factors Affecting Our Results**

 

***Revenues.***Wegenerate our revenues primarily from the sale of high-end merchandise throughour Specialty Retail Stores and Direct Marketing operation. Components of ourrevenues include:

 

•                  Sales of merchandise—Revenues from our Specialty RetailStores are recognized at the later of the point of sale or the delivery ofgoods to the customer. Revenues from our Direct Marketing operation arerecognized when the merchandise is delivered to the customer. We maintainreserves for anticipated sales returns primarily based on our historical trendsrelated to returns by both our retail and direct marketing customers.

 

•                  Commissions from leased departments—A small portion of thesales of our Specialty Retail Stores consist of commissions from certaindepartments in our stores that we lease to independent companies.

 

•                  Delivery and processing—We generate revenues from deliveryand processing charges related to merchandise delivered to our customers fromour retail and direct marketing operations.

 

Our revenues can be affected bythe following factors:

 

•                  changes in the level of consumer spending generally and,specifically, on luxury goods;

 

•                  changes in the level of full-price sales;

 

•                  changes in the level of promotional events conducted by ourSpecialty Retail Stores;

 

•                  our ability to successfully implement our store expansionand remodeling strategies;

 

•                  the rate of growth in internet sales by our DirectMarketing operation; and

 

•                  general economic conditions.

 

In addition, our revenues areseasonal. For a description of the seasonality of our business, see“—Seasonality.”

 

***Cost of goods sold including buying andoccupancy costs (excluding depreciation) (COGS).***COGSconsists of the following components:

 

•                  Inventory costs—We utilize the retail method of accounting,which is widely used in the retail industry due to its practicality, forsubstantially all of our merchandise inventories. Merchandise inventories arestated at the lower of cost or market. Under the retail inventory method, thevaluation of inventories at cost and the resulting gross margins are determinedby applying a calculated cost-to-retail ratio, for various groupings of similaritems, to the retail value of inventories. The cost of the inventory reflectedon the consolidated balance sheet is decreased by charges to cost of goods soldat the time the retail value of the inventory is lowered through the use ofmarkdowns. Hence, earnings are negatively impacted when merchandise is markeddown.

 

•                  Buying costs—Buying costs consist primarily of salaries andexpenses incurred by our merchandising and buying operations.

 

•                  Occupancy costs—Occupancy costs consist primarily of rent,property taxes and operating costs of our retail, distribution and supportfacilities. A significant portion of our buying and occupancy costs are fixed.

 

•                  Delivery and processing costs—Delivery and processing costsconsist primarily of delivery charges we pay to third-party carriers and othercosts related to the fulfillment of customer orders not delivered at thepoint-of-sale.

 

With the introduction of newfashions in the first and third quarters and our emphasis on full-price sellingin these quarters, a lower level of markdowns and higher margins are characteristicof these quarters.

 

Consistent with industrybusiness practice, we receive allowances from certain of our vendors in supportof the merchandise we purchase for resale. Certain allowances are received toreimburse us for markdowns taken or to support the gross margins that we earnin connection with the sales of the vendor’s merchandise. These allowancesresult in an increase to gross margin when we earn the

 

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allowances and they areapproved by the vendor. Other allowances we receive represent reductions to theamounts we pay to acquire the merchandise. These allowances reduce the cost ofthe acquired merchandise and are recognized at the time the goods are sold.

 

Changes in our COGS as apercentage of revenues are affected primarily by the following factors:

 

•                  customer acceptance of and demand for the merchandise weoffer in a given season and the related impact of such factors on the level offull-price sales;

 

•                  our ability to order an appropriate amount of merchandiseto match customer demand and the related impact on the level of net markdownsincurred;

 

•                  factors affecting revenues generally;

 

•                  changes in occupancy costs primarily associated with theopening of new stores or distribution facilities; and

 

•                  the amount of vendor reimbursements we receive during thefiscal year.

 

***Selling, general and administrative expenses(excluding depreciation) (SG&A).***SG&Aprincipally consists of costs related to employee compensation and benefits inthe selling and administrative support areas, advertising and catalog costs andinsurance expense. A significant portion of our selling, general andadministrative expenses are variable in nature and are dependent on the saleswe generate.

 

Advertising costs incurred byour Specialty Retail segment consist primarily of print media costs related topromotional materials mailed to our customers, while advertising costs incurredby our Direct Marketing operation relate to the production, printing anddistribution of our print catalogs and the production of the photographiccontent on our websites, as well as online marketing costs. We receiveadvertising allowances from certain of our merchandise vendors. Substantiallyall the advertising allowances we receive represent reimbursements of direct,specific and incremental costs that we incur to promote the vendor’smerchandise in connection with our various advertising programs, primarilycatalogs and other print media. As a result, these allowances are recorded as areduction of our advertising costs when earned.

 

We also receive allowances fromcertain merchandise vendors in conjunction with compensation programs foremployees who sell the vendor’s merchandise. These allowances are nettedagainst the related compensation expense that we incur.

 

Changes in our selling, generaland administrative expenses are affected primarily by the following factors:

 

•                  changes in the number of sales associates primarily due toexpansion of existing stores and new store openings, including increased healthcare and related benefits expenses;

 

•                  changes in expenses incurred in connection with ouradvertising and marketing programs; and

 

•                  changes in expenses related to insurance and long-termbenefits due to general economic conditions such as rising health care costs.

 

***Income from credit card operations, net.***Priorto the Credit Card Sale on July 7, 2005, our credit card operationsgenerated finance charge income, net of credit losses, which we recognized asincome when earned. As a part of the Credit Card Sale, we entered into along-term marketing and servicing alliance with HSBC. Under the terms of thisalliance, HSBC offers credit card and non-card payment plans bearing our brandsand we receive ongoing payments from HSBC based on net credit card sales andcompensation for marketing and servicing activities (HSBC Program Income). Werecognize HSBC Program Income when earned. Prior to the second quarter offiscal year 2006, we presented income from credit card operations as areduction of selling, general and administrative expenses. We now present thisincome as a separate line item on our statements of earnings and havereclassified prior periods to conform to this presentation.

 

As a percentage of revenues, the HSBC Program Income is lower than thenet finance charge income we earned prior to the Credit Card Sale. However, theresulting decrease in income from credit card operations is mitigated, in part,by 1) decreases in SG&A expenses we incur due to the transfer of certainservicing functions to HSBC after the sale, 2) decreases in our capitalinvestments related to the servicing of the credit card portfolio and 3)decreases in carrying costs related to our previous funding of the seasonalworking capital requirements of the credit card portfolio. In tandem with HSBC,we have initiated various changes in our credit card

 

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program to alter the credit terms available to our cardholders and toenhance the earnings of the portfolio. These changes have increased the levelof HSBC Program Income earned by the Company.

 

In the future, the HSBC ProgramIncome may be:

 

•                  decreased based upon the level of future services weprovide to HSBC; and

 

•                  increased based upon other changes to our historical creditcard program related to, among other things, the interest rates applied tounpaid balances and the assessment of late fees.

 

**Seasonality**

 

We conduct our sellingactivities in two primary selling seasons—Fall and Spring. The Fall season iscomprised of our first and second fiscal quarters and the Spring season iscomprised of our third and fourth fiscal quarters.

 

Our first fiscal quarter isgenerally characterized by a higher level of full-price selling with a focus onthe initial introduction of Fall season fashions. Aggressive in-store marketingactivities designed to stimulate customer buying, a lower level of markdownsand higher margins are characteristic of this quarter. The second fiscalquarter is more focused on promotional activities related to the Decemberholiday season, the early introduction of resort season collections fromcertain designers and the sale of Fall season goods on a marked down basis. Asa result, margins are typically lower in the second fiscal quarter. However,due to the seasonal increase in sales that occurs during the holiday season,the second fiscal quarter is typically the quarter in which our revenues arethe highest and in which expenses as a percentage of revenues are the lowest.Our working capital requirements are also the greatest in the first and secondfiscal quarters as a result of higher seasonal requirements.

 

Similarly, the third fiscalquarter is generally characterized by a higher level of full-price selling witha focus on the initial introduction of Spring season fashions. Aggressivein-store marketing activities designed to stimulate customer buying, a lowerlevel of markdowns and higher margins are again characteristic of this quarter.Revenues are generally the lowest in the fourth fiscal quarter with a focus onpromotional activities offering Spring season goods to the customer on a markeddown basis, resulting in lower margins during the quarter. Our working capitalrequirements are typically lower in the third and fourth fiscal quarters than inthe other quarters.

 

A large percentage of ourmerchandise assortment, particularly in the apparel, fashion accessories andshoe categories, is ordered months in advance of the introduction of suchgoods. For example, women’s apparel, men’s apparel and shoes are typicallyordered six to nine months in advance of the products being offered for salewhile handbags, jewelry and other categories are typically ordered three to sixmonths in advance. As a result, inherent in the successful execution of ourbusiness plans is our ability both to predict the fashion trends that will beof interest to our customers and to anticipate future spending patterns of ourcustomer base.

 

We monitor the salesperformance of our inventories throughout each season. We seek to orderadditional goods to supplement our original purchasing decisions when the levelof customer demand is higher than originally anticipated. However, in certainmerchandise categories, particularly fashion apparel, our ability to purchaseadditional goods can be limited. This can result in lost sales in the event ofhigher than anticipated demand of the fashion goods we offer or a higher thananticipated level of consumer spending. Conversely, in the event we buy fashiongoods that are not accepted by the customer or the level of consumer spendingis less than we anticipated, we typically incur a higher than anticipated levelof markdowns, net of vendor allowances, to sell the goods that remain at theend of the season, resulting in lower operating profits. We believe that theexperience of our merchandising and selling organizations helps to minimize theinherent risk in predicting fashion trends.

 

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**OPERATING RESULTS**

 

**Performance Summary**

 

Thefollowing table sets forth certain items expressed as percentages of netrevenues for the periods indicated.

 
| ** **                                                                        | ** ** | **Quarter-to-Date**                        | ** ** | **Year-to-Date**                           | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** ** | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirty-nine  weeks ended  April 29,  2006** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
| ** **                                                                        | ** ** | **(Successor)**                            | ** ** | **(Predecessor)**                          | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** | **(Combined)** | ** ** | **(Predecessor)** | ** ** |
|                                                                              |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                                                          |       | 100.0                                      | %          | 100.0                                      | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of goods sold including buying and  occupancy costs (excluding depreciation) |       | 58.7                                       |       | 58.9                                       |       | 63.3 |   | 58.1 |   | 62.2 |   | 61.2 |   |
| Selling, general and administrative  expenses (excluding depreciation)            |       | 24.9                                       |       | 25.8                                       |       | 24.2 |   | 25.9 |   | 24.5 |   | 25.2 |   |
| Income from credit card operations, net                                           |       | (1.5                                       | )          | (2.0                                       | )          | (1.4 | ) | (1.2 | ) | (1.4 | ) | (1.8 | ) |
| Depreciation expense                                                              |       | 3.2                                        |       | 3.0                                        |       | 3.0 |   | 3.1 |   | 3.0 |   | 2.7 |   |
| Amortization of customer lists                                                    |       | 1.4                                        |       | —                                     |       | 1.2 |   | — |   | 1.0 |   | — |   |
| Amortization of favorable lease commitments                                       |       | 0.4                                        |       | —                                     |       | 0.4 |   | — |   | 0.3 |   | — |   |
| Transaction and other costs                                                       |       | —                                     |       | —                                     |       | — |   | 3.6 |   | 0.7 |   | — |   |
| Loss on disposition of Chef’s Catalog                                        |       | —                                     |       | —                                     |       | — |   | — |   | — |   | 0.5 |   |
| Operating earnings                                                                |       | 12.9                                       |       | 14.4                                       |       | 9.3 |   | 10.5 |   | 9.6 |   | 12.3 |   |
| Interest expense (income), net                                                    |       | 6.5                                        |       | 0.3                                        |       | 5.8 |   | (0.1 | ) | 4.6 |   | 0.4 |   |
| Earnings before income taxes and minority  interest                               |       | 6.4                                        |       | 14.1                                       |       | 3.5 |   | 10.6 |   | 5.0 |   | 11.9 |   |
| Income taxes                                                                      |       | 2.4                                        |       | 5.4                                        |       | 1.3 |   | 3.9 |   | 1.9 |   | 4.6 |   |
| Earnings before minority interest                                                 |       | 3.9                                        |       | 8.7                                        |       | 2.2 |   | 6.7 |   | 3.1 |   | 7.3 |   |
| Minority interest in net (earnings) loss of  subsidiaries                         |       | 0.0                                        |       | (0.1                                       | )          | (0.1 | ) | 0.1 |   | (0.1 | ) | (0.1 | ) |
| Net earnings                                                                      |       | 3.9                                        | %          | 8.6                                        | %          | 2.1 | % | 6.8 | % | 3.0 | % | 7.2 | % |

 

In connection with theTransactions, the Company incurred significant indebtedness and became highlyleveraged. See “Liquidity and Capital Resources.”  In addition, the purchase price paid inconnection with the Acquisition has been preliminarily allocated to state theacquired assets and liabilities at fair value. The preliminary purchase accountingadjustments increased the carrying value of our property and equipment andinventory, established intangible assets for our tradenames, customer lists andfavorable lease commitments and revalued our long-term benefit planobligations, among other things. Subsequent to the Transactions, interestexpense and non-cash depreciation and amortization charges have significantlyincreased. As a result, our Successor financial statements subsequent to theTransactions are not comparable to our Predecessor financial statements.

 

26

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Set forth in the following table is certain summary information withrespect to our operations for the periods indicated.

 
| ** **                                                                                       | ** ** | **Quarter-to-Date**                        | ** ** | **Year-to-Date**                           | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| **(dollars in millions)**                                                                        | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** ** | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirty-nine  weeks ended  April 29,  2006** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
| ** **                                                                                       | ** ** | **(Successor)**                            | ** ** | **(Predecessor)**                          | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** | **(Combined)** | ** ** | **(Predecessor)** | ** ** |
| REVENUES                                                                                         |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | $                                          | 840.2      |                                       | $          | 766.9 |   | $ | 2,084.1 |   | $ | 544.9 |   | $ | 2,629.0 |   | $ | 2,415.7 |   |
| Direct Marketing                                                                                 |       | 152.1                                      |       | 130.5                                      |       | 416.5 |   | 87.5 |   | 504.0 |   | 458.5 |   |
| Other (1)                                                                                        |       | 34.7                                       |       | 36.0                                       |       | 82.6 |   | 19.2 |   | 101.9 |   | 96.3 |   |
| Total                                                                                            |       | $                                          | 1,027.0    |                                       | $          | 933.4 |   | $ | 2,583.2 |   | $ | 651.6 |   | $ | 3,234.9 |   | $ | 2,970.5 |   |
|                                                                                             |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| OPERATING EARNINGS                                                                               |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | $                                          | 142.6      |                                       | $          | 125.8 |   | $ | 281.0 |   | $ | 91.4 |   | $ | 372.4 |   | $ | 343.8 |   |
| Direct Marketing                                                                                 |       | 23.0                                       |       | 16.8                                       |       | 67.3 |   | 8.2 |   | 75.5 |   | 55.9 |   |
| Other (1)                                                                                        |       | (0.2                                       | )          | 4.6                                        |       | 4.0 |   | (2.0 | ) | 2.0 |   | 10.2 |   |
| Subtotal                                                                                         |       | 165.4                                      |       | 147.2                                      |       | 352.3 |   | 97.6 |   | 449.9 |   | 409.9 |   |
| Corporate expenses                                                                               |       | (14.4                                      | )          | (12.5                                      | )          | (30.8 | ) | (5.8 | ) | (36.5 | ) | (30.4 | ) |
| Amortization of customer lists and  favorable lease commitments                                  |       | (18.2                                      | )          | —                                     |       | (42.0 | ) | — |   | (42.0 | ) | — |   |
| Non-cash charges related to other valuation  adjustments made in connection with the Acquisition |       | (0.1                                       | )          | —                                     |       | (38.6 | ) | — |   | (38.6 | ) | — |   |
| Transaction and other costs                                                                      |       | —                                     |       | —                                     |       | — |   | (23.5 | ) | (23.5 | ) | — |   |
| Loss on disposition of Chef’s Catalog                                                       |       | —                                     |       | —                                     |       | — |   | — |   | — |   | (15.3 | ) |
| Total                                                                                            |       | $                                          | 132.7      |                                       | $          | 134.7 |   | $ | 240.9 |   | $ | 68.3 |   | $ | 309.3 |   | $ | 364.2 |   |
|                                                                                             |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| OPERATING PROFIT MARGIN                                                                          |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | 17.0                                       | %          | 16.4                                       | %          | 13.5 | % | 16.8 | % | 14.2 | % | 14.2 | % |
| Direct Marketing                                                                                 |       | 15.1                                       | %          | 12.9                                       | %          | 16.2 | % | 9.4 | % | 15.0 | % | 12.2 | % |
| Total                                                                                            |       | 12.9                                       | %          | 14.4                                       | %          | 9.3 | % | 10.5 | % | 9.6 | % | 12.3 | % |
|                                                                                             |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| CHANGE IN COMPARABLE REVENUES (2)                                                                |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | 5.7                                        | %          | 6.5                                        | %          | 5.3 | % | 9.8 | % | 6.2 | % | 9.1 | % |
| Direct Marketing                                                                                 |       | 16.5                                       | %          | 16.8                                       | %          | 14.2 | % | 9.6 | % | 13.4 | % | 15.3 | % |
| Total                                                                                            |       | 6.8                                        | %          | 8.0                                        | %          | 6.6 | % | 9.0 | % | 7.1 | % | 9.9 | % |
|                                                                                             |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| SALES PER SQUARE FOOT                                                                            |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Specialty Retail Stores                                                                          |       | $                                          | 149        |                                       | $          | 141 |   | $ | 375 |   | $ | 103 |   | $ | 478 |   | $ | 449 |   |
|                                                                                             |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| STORE COUNT                                                                                      |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Neiman Marcus and Bergdorf Goodman stores:                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Open at beginning of period                                                                      |       | 38                                         |       | 37                                         |       | 37 |   | 36 |   | 36 |   | 37 |   |
| Opened during the period                                                                         |       | —                                     |       | —                                     |       | 1 |   | 1 |   | 2 |   | — |   |
| Open at end of period                                                                            |       | 38                                         |       | 37                                         |       | 38 |   | 37 |   | 38 |   | 37 |   |
| Clearance centers:                                                                               |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Open at beginning of period                                                                      |       | 17                                         |       | 15                                         |       | 17 |   | 16 |   | 16 |   | 14 |   |
| Opened during the period                                                                         |       | 1                                          |       | —                                     |       | 1 |   | 1 |   | 2 |   | 1 |   |
| Open at end of period                                                                            |       | 18                                         |       | 15                                         |       | 18 |   | 17 |   | 18 |   | 15 |   |

 

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(1)         Otherincludes the operations of the Brand Development Companies.

 

(2)         Comparablerevenues include 1) revenues derived from our retail stores open for more than52 weeks, including stores that have been relocated or expanded, 2) revenuesfrom our Direct Marketing operation and 3) revenues from our Brand DevelopmentCompanies. Comparable revenues exclude the revenues of closed stores and therevenues of our Chef’s Catalog operations (sold in November 2004) for allperiods prior to the Chef’s Catalog Disposition.

 

27

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**Third Quarter Fiscal Year 2006 Highlights**

 

We believe that our productassortment of luxury, designer and fashion merchandise, coupled with our salespromotion activities and our commitment to superior customer service, have beencritical to our success in the past. In addition, we believe these factors arecritical to our future growth and success. A summary of the third fiscalquarter and the year-to-date fiscal year 2006 period operating results is asfollows:

 

•                  **Revenues**—We generated revenue growth in the quarterly andthe year-to-date fiscal year periods ended April 29, 2006 of 10.0% and 8.9%,respectively. These increases were attributable to 1) increases in comparablerevenues, 2) revenues derived from two new full-line stores and 3) the growthof internet sales.

 

Comparable revenues increased 6.8%in the third quarter of fiscal year 2006 and 7.1% in the year-to-date fiscalperiod.

 

For Specialty Retail Stores, our sales persquare foot for the last twelve trailing months increased to $605 as of April2006 compared to $567 as of April 2005.

 

•                  **Cost ofgoods sold including buying and occupancy costs (excluding depreciation)**—COGS represented 58.7% of revenues in the thirdquarter of fiscal year 2006 and 58.9% of revenues in the third quarter offiscal year 2005. This decrease was due to a lower level of net markdowns inthe third quarter of fiscal year 2006 than in the corresponding quarter infiscal year 2005.

 

COGSrepresented 62.2% of revenues in the combined year-to-date fiscal period of2006 and 61.2% of revenues in the corresponding fiscal period in 2005. Thisincrease was primarily due to purchase accounting adjustments in fiscal year2006 of $42.5 million, or 1.3% of revenues.

 

•                  **Selling,general and administrative expenses (excluding depreciation)**—SG&A decreased in the third quarter of fiscalyear 2006 to 24.9% of revenues from 25.8% of revenues in the third quarter offiscal year 2005 and decreased in the combined year-to-date fiscal period of2006 to 24.5% of revenues from 25.2% of revenues in the corresponding fiscalperiod of 2005.

 

•                  **Operatingearnings—**For the third quarter offiscal year 2006, our operating earnings were $132.7 million, or 12.9% ofrevenues, compared to $134.7 million, or 14.4% of revenues, in the prior yearfiscal quarter. For the combined year-to-date fiscal year 2006, our operatingearnings were $309.3 million, or 9.6% of revenues, compared to $364.2 million,or 12.3% of revenues for the year-to-date fiscal year 2005 period.

 

Operatingearnings in both the third quarter and year-to-date periods in fiscal year 2006were negatively impacted by 1) higher depreciation and amortization expensesdue to higher asset values resulting from the revaluation of our assets to fairvalue as of the Acquisition date and 2) costs incurred in connection with theTransactions. These expenses aggregated $18.3 million, or 1.8% of revenues, inthe third quarter of fiscal year 2006 and $104.1 million, or 3.2% of revenues,in the year-to-date fiscal year period of 2006. In addition, operating earnings,as a percentage of revenues, were negatively impacted by 1) higher depreciationcharges of $4.7 million, or 0.1% of revenues for the third quarter, and $16.0million, or 0.2% of revenues for the year-to-date fiscal year 2006 period, as aresult of higher levels of capital expenditures for new stores and storeremodels in recent years and 2) a lower level of income from our credit cardoperations of $3.9 million, or 0.5% of revenues for the third quarter, and $8.7million, or 0.4% of revenues for the year-to-date fiscal year 2006 period, dueto the sale of our credit card operations to HSBC in July 2005.

 

**Thirteen Weeks Ended April 29, 2006 Compared toThirteen Weeks Ended April 30, 2005**

** **

***Revenues.***Ourrevenues for the third quarter of fiscal year 2006 of $1,027.0 millionincreased $93.6 million, or 10.0%, from $933.4 million in the third quarter offiscal year 2005. This increase in our revenues is attributable to increases incomparable revenues, revenues from new stores and higher internet sales. Revenuesincreased in the third quarter of fiscal year 2006 compared to the prior yearfiscal period at all our operating companies, except for Kate Spade.

 

Comparable revenues in the third quarter of fiscal year 2006 increased6.8% compared to the prior year fiscal period. Comparable revenues increased5.7% for Specialty Retail Stores and 16.5% for Direct Marketing. Comparablerevenues decreased 6.8% for the Brand Development Companies in the thirdquarter of fiscal year 2006 compared to the prior year fiscal period. Thedecrease in comparable revenues for the Brand Development Companies during thethird quarter of fiscal year 2006 relates primarily to lower wholesale andretail sales by Kate Spade.

 

28

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New stores generated sales of $36.0 million in the third quarter offiscal year 2006. In the third quarter of fiscal year 2006, internet sales byDirect Marketing were $96.7 million, an increase of 30.9% compared to the thirdquarter of fiscal year 2005.

 

***Cost of goods sold including buying andoccupancy costs (excluding depreciation).***COGS forthe third quarter of fiscal year 2006 and fiscal year 2005 were:

 
| ** **                                                                                                                | ** ** | **Thirteen weeks ended  April 29, 2006  (Successor)** | ** ** | **Thirteen weeks ended  April 30, 2005  (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in millions, except  percentages)**                                                                                    | ** ** | **$**                                                 | ** ** | **% of  revenues**                                      | ** ** | **$** | ** ** | **% of  revenues** | ** ** |
| COGS, before purchase accounting  adjustments                                                                             |       | $                                                     | 600.1      |                                                    | 58.4       | % | $ | 549.7 |   | 58.9 | % |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of acquired inventories |       | 2.9                                                   |       | 0.3                                                     |       | — |   | — |   |
| COGS, as reported                                                                                                         |       | $                                                     | 603.0      |                                                    | 58.7       | % | $ | 549.7 |   | 58.9 | % |

 

We present the non-GAAP financial measure COGS, before purchaseaccounting adjustments because we use this measure to monitor and evaluate theperformance of our business and believe the presentation of this measure willenhance investors’ ability to analyze trends in our business and evaluate ourperformance relative to other companies in our industry.

 

The decrease in COGS as reported under GAAP to 58.7% of revenues from58.9% of revenues in the prior year fiscal period includes $2.9 million ofpurchase accounting adjustments recorded in connection with the Transactions. Thedecrease in COGS before purchase accounting adjustments to 58.4% of revenuesfrom 58.9% of revenues in the prior year fiscal period was primarily due:

 

•                  adecrease in product costs by approximately 0.4% of revenues; and

 

•                  adecrease in buying and occupancy costs by approximately 0.1% of revenues,primarily due to leveraging rent expense on a higher level of revenues in thethird quarter of fiscal year 2006.

 

We had lower product costs as a percentage of revenues during the thirdquarter of fiscal year 2006 compared to the third quarter of fiscal year 2005primarily due to:

 

•                  ahigher level of full-price sales generated by our Specialty Retail Stores aswell as higher initial markups;

 

•                  alower level of net markdowns by our Specialty Retail Stores due to both a latermarkdown cadence and a higher level of markdown allowances earned in the thirdquarter of fiscal year 2006 compared to the third quarter of fiscal year 2005;offset, in part, by

 

•                  ahigher level of net markdowns by our Direct Marketing segment.

 

Consistent with industry business practice, we receive allowances fromcertain of our vendors in support of the merchandise we purchase for resale. Wereceive certain allowances to reimburse us for markdowns taken and/or tosupport the gross margins realized in connection with the sales of the vendor’smerchandise. We recognize these allowances as a decrease in COGS when theallowances are earned and approved by the vendor. Other allowances we receiverepresent reductions to the amounts paid to acquire the merchandise. Werecognize these allowances as a reduction in the cost of the acquired merchandiseresulting in a decrease in COGS at the time the goods are sold. We receivedvendor allowances of $7.5 million, or 0.7% of revenues, in the thirdquarter of fiscal year 2006 and $4.5 million, or 0.5% of revenues, in thethird quarter of fiscal year 2005.

 

***Selling, general and administrative expenses(excluding depreciation)*.**SG&A expenses were24.9% of revenues in the third quarter of fiscal year 2006 compared to 25.8% ofrevenues in the prior year fiscal period.

 

The net decrease in SG&A expenses as a percentage of revenues inthe third quarter of fiscal year 2006 was primarily due to:

 

•                  lowerexpected annual incentive compensation costs of approximately 0.4% of revenues;

 

•                  adecrease in our payroll and employee benefit costs, including medical anddental and workers’ compensation expense, by approximately 0.2% of revenuesprimarily due to the leveraging of these expenses on a higher level of revenuesin the third quarter of fiscal year 2006;

 

29

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•                  adecrease in costs incurred to support our credit card operations subsequent tothe Credit Card Sale of approximately 0.1% of revenues;

 

•                  adecrease in pension, SERP and post-retirement expenses of approximately 0.1% ofrevenues primarily driven by both lower discount rates and the revaluation ofour related benefit obligations in connection with purchase accountingadjustments required in connection with the Acquisition; and

 

•                  adecrease in professional fees and legal fees of approximately 0.1%.

 

These decreases in SG&A expenses, as a percentage of revenues, werepartially offset by management services fees of $2.6 million, or 0.2% ofrevenues, payable to the Sponsors as a result of the Acquisition.

 

***Income from credit card operations, net.***Wereceived HSBC Program Income of $15.1 million, or 1.5% of revenues, in thethird quarter of fiscal year 2006 compared to net finance charge income of$19.0 million, or 2.0% of revenues, in the third quarter of fiscal year 2005.

 

***Depreciation expense.***Depreciationexpense was $32.9 million, or 3.2% of revenues, in the third quarter of fiscalyear 2006 compared to $27.6 million, or 3.0% of revenues, in the prior yearfiscal period. The increase in depreciation expense was primarily due to 1) ahigher level of capital spending in recent years and 2) additional depreciationexpense resulting from the revaluation of our property and equipment at fairvalue in connection with the Acquisition.

 

***Amortization expense.***Amortizationof acquisition related intangibles (customer lists and favorable leasecommitments) recorded as a result of the application of purchase accounting inconnection with the Acquisition aggregated $18.2 million, or 1.8% of revenues,for the third quarter of fiscal year 2006. We had no amortization expense inthe third quarter of fiscal year 2005.

 

***Segment operating earnings.***Segmentoperating earnings for our Specialty Retail Stores and Direct Marketingsegments do not reflect the impact of adjustments to revalue our assets andliabilities to estimated fair value at the Acquisition date. See Note 11   to our unaudited condensed consolidatedfinancial statements.

 

Operating earnings for our Specialty Retail Stores segment were $142.6million, or 17.0% of Specialty Retail Stores revenues, for the third quarter offiscal year 2006 compared to $125.8 million, or 16.4% of Specialty RetailStores revenues, for the prior year fiscal period. This increase in operatingearnings and operating margin was primarily due to 1) lower product costsdriven by a lower level of net markdowns and 2) lower SG&A expenses forpayroll and related benefits, as a percentage of revenues, as a result of theleveraging of these expenses on a higher level of revenues in the third quarterof fiscal year 2006 and lower incentive compensation costs. These positiveeffects on Specialty Retail operating earnings margin were offset, in part, by1) a lower level of income from our credit card operations due to the sale ofour credit card operations to HSBC in July 2005 and 2) higher depreciation chargesas a result of higher levels of capital expenditures for new stores and storeremodels in recent years.

 

Operating earnings for Direct Marketing increased to $23.0 million, or15.1% of Direct Marketing revenues, in the third quarter of fiscal year 2006from $16.8 million, or 12.9% of Direct Marketing revenues, for the prior yearperiod. The increase in operating earnings and operating margin for DirectMarketing is primarily the result of 1) higher product margins and 2) thedecrease in advertising and marketing costs, as a percentage of revenues,incurred to support internet sales.

 

30

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***Interest expense, net*.**Net interest expense was $67.2 million in the third quarter of fiscal year2006 and $2.9 million for the prior year fiscal year period. The significantcomponents of interest expense are as follows:

 
| **(in thousands)**                     | ** ** | **Thirteen  weeks ended  April 29,  2006** | ** ** | **Thirteen  weeks ended  April 30,  2005** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **(Successor)**                            | ** ** | **(Predecessor)**                          | ** ** |
| Senior Secured Term Loan Facility      |       | $                                          | 33,170     |                                       | $          | — |   |
| 2028 Debentures                        |       | 2,226                                      |       | 2,226                                      |       |
| Senior Notes                           |       | 15,925                                     |       | —                                     |       |
| Senior Subordinated Notes              |       | 13,113                                     |       | —                                     |       |
| Credit Agreement                       |       | —                                     |       | 1,575                                      |       |
| 2008 Notes                             |       | —                                     |       | 2,078                                      |       |
| Debt issue cost amortization and other |       | 4,439                                      |       | 464                                        |       |
| Total interest expense                 |       | 68,873                                     |       | 6,343                                      |       |
|                                   |       |                                       |       |                                       |       |
| Less:                                  |       |                                       |       |                                       |       |
| Interest income                        |       | 789                                        |       | 1,712                                      |       |
| Capitalized interest                   |       | 868                                        |       | 1,698                                      |       |
| Interest expense, net                  |       | $                                          | 67,216     |                                       | $          | 2,933 |   |

 

The increase in interest expense was due to the $3.3 billion increasein debt incurred in connection with the Transactions.

 

***Income taxes.***Oureffective income tax rate for the thirteen weeks ended April 29, 2006 was 38.1%compared to 38.5% for the thirteen weeks ended April 30, 2005.

 

The Company’s federal tax returns for fiscal years 2004 and 2003 arecurrently under examination by the Internal Revenue Service (IRS). We believeour recorded tax liabilities as of April 29, 2006 are sufficient to cover anypotential assessments to be made by the IRS upon the completion of theirexaminations. We will continue to monitor the progress of the IRS examinationsand review our recorded tax liabilities for potential audit assessments. Adjustmentsto increase or decrease the recorded tax liabilities may be required in thefuture as additional facts become known.

 

**Combined Thirty-nine Weeks Ended April 29, 2006Compared to Thirty-nine Weeks Ended April 30, 2005**

** **

***Revenues.***Ouryear-to-date fiscal year 2006 revenues of $3,234.9 million increased $264.4million, or 8.9%, from $2,970.5 million in the year-to-date fiscal year 2005period, reflecting increases in comparable revenues, revenues from new storesand higher internet sales. Revenues increased in the year-to-date fiscal year2006 period compared to the prior year period at all our operating companies,except for Kate Spade.

 

Comparable revenues in the year-to-date fiscal year 2006 periodincreased 7.1% compared to the prior year-to-date period. Comparable revenuesincreased 6.2% for Specialty Retail Stores, 13.4% for Direct Marketing and 0.9%for the Brand Development Companies in the year-to-date fiscal year 2006period.

 

New stores generated sales of $88.1 million in the year-to-date fiscalyear 2006 period. In the year-to-date fiscal year 2006 period, internet salesby Direct Marketing were $310.0 million, an increase of 33.1% from theyear-to-date fiscal year 2005 period, excluding Chef’s Catalog. Total revenuesof Chef’s Catalog (prior to its sale in November 2004) of $13.9 million areincluded in consolidated revenues for the year-to-date fiscal year 2005 period.

 

31

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***Cost of goods sold including buying andoccupancy costs (excluding depreciation).***COGS forthe year-to-date fiscal year 2006 period and the year-to-date fiscal year 2005period were:

 
| ** **                                                                                                                | ** ** | **Thirty-nine weeks ended  April 29, 2006  (Combined)** | ** ** | **Thirty-nine weeks ended  April 30, 2005  (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(in millions, except  percentages)**                                                                                    | ** ** | **$**                                                   | ** ** | **% of  revenues**                                         | ** ** | **$** | ** ** | **% of  revenues** | ** ** |
| COGS, before  purchase accounting adjustments                                                                             |       | $                                                       | 1,970.5    |                                                       | 60.9       | % | $ | 1,816.6 |   | 61.2 | % |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of acquired inventories |       | 42.5                                                    |       | 1.3                                                        |       | — |   | — |   |
| COGS, as reported                                                                                                         |       | $                                                       | 2,013.0    |                                                       | 62.2       | % | $ | 1,816.6 |   | 61.2 | % |

 

We present the non-GAAP financial measure COGS, before purchaseaccounting adjustments because we use this measure to monitor and evaluate theperformance of our business and believe the presentation of this measure willenhance investors’ ability to analyze trends in our business and evaluate ourperformance relative to other companies in our industry.

 

The increase in COGS as reported under GAAP to 62.2% of revenues from61.2% of revenues in the prior year fiscal period primarily reflects $42.5million of purchase accounting adjustments recorded in connection with theTransactions. COGS before purchase accounting adjustments was 60.9% of revenuescompared to 61.2% of revenues in the prior year reflecting:

 

•                  adecrease in product costs by approximately 0.2% of revenues; and

 

•                  adecrease in buying and occupancy costs by approximately 0.1% of revenues,primarily due to leveraging payroll and rent expense on a higher level ofrevenues in the year-to-date fiscal year 2006 period.

 

We had lower product costs as a percentage of revenues during theyear-to-date fiscal year 2006 period compared to the year-to-date fiscal year2005 period primarily due to:

 

•                  ahigher level of full-price sales generated by our Specialty Retail Stores aswell as higher initial mark-ups at both Specialty Retail Stores and DirectMarketing;

 

•                  alower level of net markdowns by our Specialty Retail Stores due to both a latermarkdown cadence and a higher level of markdown allowances earned in the thirdquarter of fiscal year 2006 compared to the third quarter of fiscal year 2005;offset, in part, by

 

•                  anincrease in the level of net markdowns at Direct Marketing for the year-to-dateperiod and at our Specialty Retail Stores for the first and second quarters offiscal year 2006.

 

Consistent with industry business practice, we receive allowances fromcertain of our vendors in support of the merchandise we purchase for resale. Wereceive certain allowances to reimburse us for markdowns taken and/or tosupport the gross margins realized in connection with the sales of the vendor’smerchandise. We recognize these allowances as a decrease in COGS when theallowances are earned and approved by the vendor. Other allowances we receiverepresent reductions to the amounts paid to acquire the merchandise. Werecognize these allowances as a reduction in the cost of the acquiredmerchandise resulting in a decrease in COGS at the time the goods are sold. Wereceived vendor allowances of $51.5 million or 1.6% of revenues, in theyear-to-date fiscal year 2006 period and $47.4 million, or 1.6% ofrevenues, in the year-to-date fiscal year 2005 period.

 

***Selling, general and administrative expenses(excluding depreciation)*.**SG&A expenses were24.5% of revenues in the year-to-date fiscal year 2006 period compared to 25.2%of revenues in the prior year fiscal year period.

 

The net decrease in SG&A expenses as a percentage of revenues inthe year-to-date fiscal year 2006 period was primarily due to:

 

•                  adecrease in marketing and advertising costs of approximately 0.4% of revenuesprimarily due to higher internet sales by our Direct Marketing segment, whichhave a lower expense to revenue ratio than catalog sales;

 

•                  adecrease in our payroll and employee benefit costs, including medical anddental and workers’ compensation expense, by approximately 0.2% of revenues primarilydue to the leveraging of these expenses on a higher level of revenues in theyear-to-date fiscal year 2006 period;

 

32

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•                  lowerexpected annual incentive compensation costs of approximately 0.2% of revenues;

 

•                  adecrease in costs incurred to support our credit card operations subsequent tothe Credit Card Sale of approximately 0.1% of revenues; and

 

•                  adecrease in pension, SERP and post-retirement expenses of approximately 0.1% ofrevenues primarily driven by both lower discount rates and the revaluation ofour related benefit obligations in connection with purchase accountingadjustments required in connection with the Acquisition.

 

These decreases in SG&A expenses, as a percentage of revenues, werepartially offset by:

 

•                  anincrease in preopening expenses and store remodeling expenses primarilyincurred in connection with the opening of our San Antonio store in September2005 and our Boca Raton store in November 2005 by approximately 0.2% ofrevenues;

 

•                  managementservices fees of $6.4 million, or 0.2% of revenues, payable to the Sponsors asa result of the Acquisition.

 

***Income from credit card operations, net.***Wereceived HSBC Program Income of $43.7 million, or 1.4% of revenues, in theyear-to-date fiscal year 2006 period compared to net finance charge income of$52.4 million, or 1.8% of revenues, in the year-to-date fiscal year 2005period.

 

***Depreciation expense.***Depreciationexpense was $97.9 million, or 3.0% of revenues, in the year-to-date fiscal year2006 period compared to $79.3 million, or 2.7% of revenues, in the prior yearperiod. The increase in depreciation was primarily due to 1) a higher level ofcapital spending in recent years and 2) additional depreciation expenseresulting from the revaluation of our property and equipment at fair value inconnection with the Acquisition.

 

***Amortization expense.***Amortizationof acquisition related intangibles (customer lists and favorable leasecommitments) recorded as a result of the application of purchase accounting inconnection with the Acquisition aggregated $42.0 million, or 1.3% of revenues,for the year-to-date fiscal year 2006 period. We had no amortization expense inthe prior year period.

 

***Transaction and other costs.***Duringthe period July 30, 2005 to October 1, 2005, we expensed $23.5 million inconnection with the Transactions. These costs consisted of $4.5 million ofaccounting, investment banking, legal and other costs associated with theTransactions and a $19.0 million non-cash charge for stock compensationresulting from the accelerated vesting of Predecessor stock options andrestricted stock.

 

***Segment operating earnings.***Segmentoperating earnings for our Specialty Retail Stores and Direct Marketingsegments do not reflect the impact of adjustments to revalue our assets andliabilities to estimated fair value at the Acquisition date. See Note 11 to ourunaudited condensed consolidated financial statements.

 

Operating earnings for our Specialty Retail Stores segment were $372.4million, or 14.2% of Specialty Retail Stores revenues, for the year-to-datefiscal year 2006 period compared to $343.8 million, or 14.2% of SpecialtyRetail Stores revenues, for the prior year period. Operating margin forSpecialty Retail Stores was positively impacted by 1) higher product margins,2) lower SG&A expenses for compensation and related benefits, as apercentage of revenues, as a result of leveraging these expenses on a higherlevel of revenues in the year-to-date fiscal year 2006 period and 3) the leveragingof buying and occupancy costs on a higher level of revenues. These effects wereoffset, in part, by 1) a lower level of income from our credit card operationsdue to the sale of our credit card operations to HSBC in July 2005, 2) higherpreopening costs and 3) higher depreciation charges as a result of higherlevels of capital expenditures for new stores and store remodels in recentyears.

 

Operating earnings for Direct Marketing increased to $75.5 million, or15.0% of Direct Marketing revenues, in the year-to-date fiscal year 2006 periodfrom $55.9 million, or 12.2% of Direct Marketing revenues, for the prior yearperiod. The increase in operating earnings and operating margin for DirectMarketing was primarily the result of 1) higher product margins and 2) thedecrease in advertising and marketing costs, as a percentage of revenues,incurred to support internet sales.

 

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***Interest expense, net*.**Net interest expense was $149.8 million in the year-to-date fiscal year2006 period and $10.9 million for the prior year period. The significantcomponents of interest expense are as follows:

 
| **(in thousands)**                     | ** ** | **Thirty  weeks ended  April 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirty-nine  weeks ended  April 29,  2006** | ** ** | **Thirty-nine  weeks ended  April 30,  2005** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                             | ** ** | **(Successor)**                          | ** ** | **(Predecessor)**                       | ** ** | **(Combined)**                                | ** ** | **(Predecessor)**                             | ** ** |
| Asset-Based Revolving Credit Facility  |       | $                                        | 1,332      |                                    | $          | —                                        |       | $                                             | 1,332      |   | $ | — |   |
| Senior Secured Term Loan Facility      |       | 76,765                                   |       | —                                  |       | 76,765                                        |       | —                                        |       |
| 2028 Debentures                        |       | 5,136                                    |       | 1,542                                   |       | 6,678                                         |       | 6,678                                         |       |
| Senior Notes                           |       | 35,875                                   |       | —                                  |       | 35,875                                        |       | —                                        |       |
| Senior Subordinated Notes              |       | 29,540                                   |       | —                                  |       | 29,540                                        |       | —                                        |       |
| Credit Agreement                       |       | —                                   |       | —                                  |       | —                                        |       | 4,110                                         |       |
| 2008 Notes                             |       | 638                                      |       | 1,439                                   |       | 2,077                                         |       | 6,231                                         |       |
| Debt issue cost amortization and other |       | 7,300                                    |       | 345                                     |       | 7,645                                         |       | 1,385                                         |       |
| Total interest expense                 |       | 156,586                                  |       | 3,326                                   |       | 159,912                                       |       | 18,404                                        |       |
|                                   |       |                                     |       |                                    |       |                                          |       |                                          |       |
| Less:                                  |       |                                     |       |                                    |       |                                          |       |                                          |       |
| Interest income                        |       | 3,603                                    |       | 3,046                                   |       | 6,649                                         |       | 3,781                                         |       |
| Capitalized interest                   |       | 2,357                                    |       | 1,146                                   |       | 3,503                                         |       | 3,675                                         |       |
| Interest expense, net                  |       | $                                        | 150,626    |                                    | $          | (866                                          | )          | $                                             | 149,760    |   | $ | 10,948 |   |

 

The increase in interest expense is due to the $3.3 billion increase indebt incurred in connection with the Transactions. The increase in interestincome was due primarily to interest earned on higher average invested balancesafter the Credit Card Sale in July 2005 and prior to the Transactions.

 

***Income taxes.***Our effective income tax rate was 38.5% for thethirty weeks ended April 29, 2006. Our effective income tax rate for the nineweeks ended October 1, 2005 was 37.0%, resulting in an effective tax rate of37.9% for the combined year-to-date fiscal year 2006 period. Our effective taxrate for the nine-weeks ended October 1, 2005 was favorably impacted by ahigher level of tax-exempt interest income earned during the period on highercash balances maintained subsequent to the Credit Card Sale. Our effectiveincome tax rate was 38.5% for the thirty-nine weeks ended April 30, 2005 andwas also favorably impacted by tax-exempt interest income.

** **

The Company’s federal tax returns for fiscal years 2004 and 2003 arecurrently under examination by the Internal Revenue Service (IRS). We believeour recorded tax liabilities as of April 29, 2006 are sufficient to cover anypotential assessments to be made by the IRS upon the completion of theirexaminations. We will continue to monitor the progress of the IRS examinationsand review our recorded tax liabilities for potential audit assessments. Adjustmentsto increase or decrease the recorded tax liabilities may be required in thefuture as additional facts become known.

 

**Inflation and Deflation**

** **

We believe changes in revenues and net earnings that have resulted frominflation or deflation have not been material during the periods presented. Inrecent years, we have experienced certain inflationary conditions related to 1)increases in product costs due primarily to changes in foreign currencyexchange rates that have reduced the purchasing power of the U.S. dollar and 2)increases in SG&A. We purchase a substantial portion of our inventory fromforeign suppliers whose costs are affected by the fluctuation of their localcurrency against the dollar or who price their merchandise in currencies otherthan the dollar. Accordingly, changes in the value of the dollar relative toforeign currencies may increase our cost of goods sold and if we are unable topass such cost increases to our customers, our gross margins, and ultimatelyour earnings, would decrease. Fluctuations in the euro-U.S. dollar exchangerate affect us most significantly; however, we source goods from numerouscountries and thus are affected by changes in numerous currencies and,generally, by fluctuations in the U.S. dollar relative to such currencies. Althoughwe hedge some exposures to changes in foreign currency exchange rates arisingin the ordinary course of business, foreign currency fluctuations could have amaterial adverse effect on our business, financial condition and results ofoperations in the future. We attempt to offset the effects of inflation throughprice increases and control of expenses, although our ability to increaseprices may be limited by competitive factors. We attempt to offset the effectsof merchandise deflation, which has occurred on a limited basis in recentyears, through control of expenses. There is no assurance, however, thatinflation or deflation will not materially affect our operations in the future.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

Our cash requirements consistprincipally of:

 

•                  thefunding of our merchandise purchases;

 

•                  capitalexpenditures for new store construction, store renovations and upgrades of ourmanagement information systems;

 

•                  debtservice requirements;

 

•                  incometax payments; and

 

•                  obligationsrelated to our Pension Plan.

 

Our primary sources ofshort-term liquidity are comprised of cash on hand and availability under ourAsset-Based Revolving Credit Facility. The amounts of cash on hand andborrowings under the Asset-Based Revolving Credit Facility are influenced by anumber of factors, including revenues, working capital levels, vendor terms,the level of capital expenditures, cash requirements related to financinginstruments and debt service obligations following the Transactions, PensionPlan funding obligations and our tax payment obligations, among others.

 

Our working capitalrequirements fluctuate during the fiscal year, increasing substantially duringthe first and second quarters of each fiscal year as a result of higherseasonal levels of inventories and accounts receivable (prior to the CreditCard Sale in July 2005). We have typically financed the increases in workingcapital needs during the first and second fiscal quarters with cash flows fromoperations and cash provided from borrowings under our credit facilities.During year-to-date fiscal year 2006 period, we financed our seasonal increasesin working capital with cash flows from operations and borrowings under ourAsset-Based Revolving Credit Facility. During the first quarter of fiscal year2006, we borrowed $150 million under our Asset-Based Revolving Credit Facility.We repaid these borrowings in the second quarter of fiscal year 2006.

 

We believe that operating cashflows, available vendor financing and amounts available pursuant to our seniorsecured Asset-Based Revolving Credit Facility will be sufficient to fund ouroperations and debt service requirements, including Pension Plan fundingrequirements, contractual obligations and commitments, anticipated capitalexpenditure requirements and our debt service obligations, through the end of2006.

 

At April 29, 2006, cash andequivalents were $109.0 million compared to $337.6 million at April 30, 2005. Netcash provided by operating activities was $283.9 million in 2006 compared to$190.0 million in 2005. Cash flows related to operating activities were higherin the year-to-date fiscal year 2006 period primarily due to the Credit CardSale in July 2005. In the year-to-date fiscal year 2005 period (prior to theCredit Card Sale), we funded an increase in accounts receivable of $114.3million while in the year-to-date fiscal year 2006 period (subsequent to theCredit Card Sale), we funded an increase in accounts receivable of $26.9million.

 

Net cash used for investingactivities was $5,294.9 million in the year-to-date fiscal year 2006 periodwhich consisted of 1) $5,156.4 million paid in connection with the Acquisitionand 2) $138.5 million for capital expenditures. Net cash used in investingactivities was $173.9 million in the year-to-date fiscal year 2005 periodprimarily for $150.8 million of capital expenditures and $37.5 million cashrestricted for the repayment of the outstanding indebtedness on our Credit CardFacility, offset by $14.4 million in cash proceeds from the sale of Chef’sCatalog. We incurred capital expenditures in the year-to-date fiscal year 2006period related to the construction of new stores in San Antonio and Boca Ratonand the remodels of our San Francisco, Houston, Beverly Hills, Newport Beachand Bergdorf Goodman stores. We opened our San Antonio store inSeptember 2005 and opened our Boca Raton store in November 2005.

 

Net cash provided by financingactivities was $4,266.6 million in the year-to-date fiscal year 2006 period ascompared to net cash used for financing activities of $46.9 million in theyear-to-date fiscal year 2005 period. Proceeds from debt incurred in connectionwith the Transactions, net of issuance costs, aggregated $3,222.1 million andcash equity contributions received in connection with the Transactionsaggregated $1,427.7 million. In the year-to-date fiscal year 2006 period, wealso repaid our $150.0 million of seasonal borrowings under our Asset-BasedRevolving Credit Facility, paid $134.7 million for the redemption of our 2008Notes pursuant to our call of such notes for redemption in connection with theTransactions and repaid $100.0 million principal amount of borrowings on theSenior Term Loan Facility.

 

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**Financing Structure**

 

Our major sources of funds arecomprised of vendor financing, a $600.0 million Asset-Based Revolving CreditFacility,  $1,975.0 million SeniorSecured Term Loan Facility, $700.0 million Senior Notes, $500.0 million SeniorSubordinated Notes, $125.0 million 2028 Debentures and operating leases.

 

***Senior Secured Asset-Based Revolving CreditFacility.***OnOctober 6, 2005, in connection with the Transactions, the Company entered intoa credit agreement and related security and other agreements for a seniorsecured Asset-Based Revolving Credit Facility with Deutsche Bank Trust CompanyAmericas as administrative agent and collateral agent. The Asset-BasedRevolving Credit Facility provides financing of up to $600.0 million,subject to a borrowing base equal to at any time the lesser of 80% of eligibleinventory (valued at the lower of cost or market value) and 85% of net orderlyliquidation value of the eligible inventory, less certain reserves. TheAsset-Based Revolving Credit Facility includes borrowing capacity available forletters of credit and for borrowings on same-day notice.  At the closingof the Transactions, the Company utilized $150.0 million of theAsset-Based Revolving Credit Facility for loans and approximately $16.5 million for letters of credit. Inthe second quarter of fiscal year 2006, the Company repaid all loans under theAsset-Based Revolving Credit Facility. As of April 29, 2006, the Company had$573.2 million of unused borrowing availability under the Asset-Based RevolvingCredit Facility based on a borrowing base of over $600.0 million and aftergiving effect to $26.8 million used for letters of credit.

 

The Asset-Based RevolvingCredit Facility provides that the Company has the right at any time to requestup to $200.0 million of additional commitments, but the lenders are underno obligation to provide any such additional commitments, and any increase incommitments will be subject to customary conditions precedent. If the Companywere to request any such additional commitments and the existing lenders or newlenders were to agree to provide such commitments, the Asset-Based RevolvingCredit Facility size could be increased to up to $800.0 million, but theCompany’s ability to borrow would still be limited by the amount of theborrowing base.

 

Borrowings under the Asset-BasedRevolving Credit Facility bear interest at a rate per annum equal to, at theCompany’s option, either (a) a base rate determined by reference to thehigher of (1) the prime rate of Deutsche Bank Trust Company Americas and(2) the federal funds effective rate plus 1/2 of 1% or(b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin.  The initial applicable margin is 0% with respect tobase rate borrowings and 1.75% with respect to LIBOR borrowings.  Theapplicable margin is subject to adjustment based on the historical availabilityunder the Asset-Based Revolving Credit Facility. In addition, the Company isrequired to pay a commitment fee of 0.375% per annum in respect of theunutilized commitments. If the average revolving loan utilization is 50% ormore for any applicable period, the commitment fee will be reduced to 0.250%for such period. The Company must also pay customary letter of credit fees andagency fees.

 

If at any time the aggregateamount of outstanding loans, unreimbursed letter of credit drawings and undrawnletters of credit under the Asset-Based Revolving Credit Facility exceeds thelesser of (i) the commitment amount and (ii) the borrowing base, theCompany will be required to repay outstanding loans or cash collateralizeletters of credit in an aggregate amount equal to such excess, with noreduction of the commitment amount. If the amount available under theAsset-Based Revolving Credit Facility is less than $60 million or an eventof default has occurred, the Company will be required to repay outstandingloans and cash collateralize letters of credit with the cash the Company isrequired to deposit daily in a collection account maintained with the agentunder the Asset-Based Revolving Credit Facility. The Company may voluntarilyreduce the unutilized portion of the commitment amount and repay outstandingloans at any time without premium or penalty other than customary “breakage”costs with respect to LIBOR loans. There is no scheduled amortization under theAsset-Based Revolving Credit Facility; the principal amount of the loansoutstanding is due and payable in full on October 6, 2010.

 

All obligations under theAsset-Based Revolving Credit Facility are guaranteed by Parent and certain ofthe Company’s existing and future domestic subsidiaries (excluding, amongothers, Gurwitch Products, L.L.C., and Kate Spade LLC (Brand DevelopmentCompanies)). As of April 29, 2006, the liabilities of the Company’snon-guarantor subsidiaries totaled approximately $38.1 million, or 0.7% ofconsolidated liabilities, and the assets of the Company’s non-guarantorsubsidiaries aggregated approximately $194.0 million, or 2.9% of consolidatedtotal assets. All obligations under the Company’s Asset-Based Revolving Credit Facility,and the guarantees of those obligations, are secured, subject to certainsignificant exceptions, by substantially all of the Company’s assets and theassets of Parent and the Company’s subsidiaries that have guaranteed theAsset-Based Revolving Credit Facility (subsidiary guarantors), including:

 

•                  a first-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by the Company or the subsidiary guarantorsfrom credit card clearinghouses and processors or otherwise in respect of allcredit card charges for sales of inventory by the Company and the subsidiaryguarantors, certain related assets and proceeds of the foregoing; and

 

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•                  a second-priority pledge of 100% of theCompany’s capital stock and certain of the capital stock held by the Company,Parent or any subsidiary guarantor (which pledge, in the case of any foreignsubsidiary is limited to 100% of the non-voting stock (if any) and 65% of thevoting stock of such foreign subsidiary); and

 

•                  a second-priority security interest in, andmortgages on, substantially all other tangible and intangible assets of theCompany, Parent and each subsidiary guarantor, including a significant portionof the Company’s material owned and leased real property (which currentlyconsists of a majority of the Company’s full-line retail stores) and equipment.

 

Capital stock and other securities of a subsidiary of the Company thatare owned by the Company or any subsidiary guarantor will not constitutecollateral under the Company’s Asset-Based Revolving Credit Facility to theextent that such securities cannot secure the Company’s 2028 Debentures orother secured public debt obligations without requiring the preparation andfiling of separate financial statements of such subsidiary in accordance withapplicable SEC rules. As a result, the collateral under the Company’sAsset-Based Revolving Credit Facility will include shares of capital stock orother securities of subsidiaries of the Company or any subsidiary guarantoronly to the extent that the applicable value of such securities (on asubsidiary-by-subsidiary basis) is less than 20% of the aggregate principalamount of the 2028 Debentures or other secured public debt obligations. Stockof the Company’s Brand Development Companies and their assets also will notconstitute collateral under the Company’s Asset-Based Revolving CreditFacility.

 

TheCompany’s Asset-Based Revolving Credit Facility contains a number of covenantsthat, among other things and subject to certain significant exceptions,restrict its ability and the ability of its subsidiaries to:

 

•                  incur additional indebtedness;

 

•                  pay dividends on the Company’s capital stockor redeem, repurchase or retire the Company’s capital stock or indebtedness;

 

•                  make investments, loans, advances andacquisitions;

 

•                  create restrictions on the payment ofdividends or other amounts to the Company from its subsidiaries that are notguarantors;

 

•                  engage in transactions with the Company’saffiliates;

 

•                  sell assets, including capital stock of theCompany’s subsidiaries;

 

•                  consolidate or merge;

 

•                  create liens; and

 

•                  enter into sale and lease back transactions.

 

Thecovenants limiting dividends and other restricted payments; investments, loans,advances and acquisitions; and prepayments or redemptions of otherindebtedness, each permit the restricted actions in an unlimited amount,subject to the satisfaction of certain payment conditions, principally that theCompany must have at least $75.0 million of pro forma excess availabilityunder the Asset-Based Revolving Credit Facility and that the Company must be inpro forma compliance with the fixed charge coverage ratio described below.

 

Althoughthe credit agreement governing the Asset-Based Revolving Credit Facility doesnot require the Company to comply with any financial ratio maintenancecovenants, if less than $60.0 million were available to be borrowed underthe Asset-Based Revolving Credit Facility at any time, the Company would not bepermitted to borrow any additional amounts unless its pro forma ratio ofconsolidated EBITDA to consolidated Fixed Charges (as such terms are defined inthe credit agreement) were at least 1.1 to 1.0. The credit agreement alsocontains customary affirmative covenants and events of default.

 

***Senior Secured Term Loan Facility.***On October 6, 2005, in connection with theTransactions, the Company entered into a credit agreement and related securityand other agreements for a $1,975.0 million Senior Secured Term LoanFacility with Credit Suisse as administrative agent and collateral agent. The full amount of the Senior Secured Term Loan Facility was borrowed onOctober 6, 2005. In the second quarter of fiscal year 2006, the Company repaid$100.0 million principal amount of the loans under the Senior Secured Term LoanFacility.

 

Borrowingsunder the Senior Secured Term Loan Facility bear interest at a rate per annumequal to, at the Company’s option, either (a) a base rate determined byreference to the higher of (1) the prime rate of Credit Suisse and(2) the federal funds effective rate plus 1/2 of 1% or (b) a LIBORrate, subject to certain adjustments, in each case plus an applicable margin. Theapplicable margin is 1.5%

 

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withrespect to base rate borrowings and 2.5% with respect to LIBOR borrowings. Theinterest rate on the outstanding borrowings pursuant to the Senior Secured TermLoan Facility was 7.24% at April 29, 2006.

 

Thecredit agreement governing the Senior Secured Term Loan Facility requires theCompany to prepay outstanding term loans with 50% (which percentage will bereduced to 25% if the Company’s total leverage ratio is less than a specifiedratio and will be reduced to 0% if the Company’s total leverage ratio is lessthan a specified ratio) of its annual excess cash flow (as defined in thecredit agreement). If a change of control (as defined in the credit agreement)occurs, the Company will be required to offer to prepay all outstanding termloans, at a prepayment price equal to 101% of the principal amount to beprepaid, plus accrued and unpaid interest to the date of prepayment. TheCompany also must offer to prepay outstanding term loans at 100% of theprincipal amount to be prepaid, plus accrued and unpaid interest, with theproceeds of certain asset sales under certain circumstances.

 

TheCompany may voluntarily prepay outstanding loans under the Senior Secured TermLoan Facility at any time without premium or penalty other than customary “breakage”costs with respect to LIBOR loans. If the Company repays all or any portion ofthe Senior Secured Term Loan Facility prior to October 6, 2006 (other than aprepayment that is made with certain designated asset sale proceeds), theCompany must pay 101% of the principal amount to be repaid. There is noscheduled amortization under the Senior Secured Term Loan Facility. Theprincipal amount of the loans outstanding is due and payable in full onApril 6, 2013.

 

Allobligations under the Senior Secured Term Loan Facility are unconditionallyguaranteed by Parent and each direct and indirect domestic subsidiary of theCompany that guarantees the obligations of the Company under its Asset-BasedRevolving Credit Facility. All obligations under the Senior Secured Term LoanFacility, and the guarantees of those obligations, are secured, subject tocertain significant exceptions, by substantially all of the Company’s assetsand the assets of its Parent and the subsidiary guarantors, including:

 

•                  a first-priority pledge of 100% of theCompany’s capital stock and certain of the capital stock held by the Company,Parent or any subsidiary guarantor (which pledge, in the case of any foreignsubsidiary is limited to 100% of the non-voting stock (if any) and 65% of thevoting stock of such foreign subsidiary); and

 

•                  a first-priority security interest in, andmortgages on, substantially all other tangible and intangible assets of theCompany, Parent and each subsidiary guarantor, including a significant portionof the Company’s material owned and leased real property (which currentlyconsists of a majority of the Company’s full-line retail stores) and equipment,but excluding, among other things, the collateral described in the followingbullet point; and

 

•                  a second-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by the Company or the subsidiary guarantorsfrom credit card clearinghouses and processors or otherwise in respect of allcredit card charges for sales of inventory by the Company and the subsidiaryguarantors, certain related assets and proceeds of the foregoing.

 

Capital stock and other securities of a subsidiary of the Company thatare owned by the Company or any subsidiary guarantor will not constitutecollateral under the Company’s Senior Secured Term Loan Facility to the extentthat such securities cannot secure the 2028 Debentures or other secured publicdebt obligations without requiring the preparation and filing of separatefinancial statements of such subsidiary in accordance with applicable SEC rules.As a result, the collateral under the Company’s Senior Secured Term LoanFacility will include shares of capital stock or other securities ofsubsidiaries of the Company or any subsidiary guarantor only to the extent thatthe applicable value of such securities (on a subsidiary-by-subsidiary basis)is less than 20% of the aggregate principal amount of the 2028 Debentures orother secured public debt obligations. Stock of the Company’s Brand DevelopmentCompanies and their assets also will not constitute collateral under theCompany’s Senior Secured Term Loan Facility.

 

Thecredit agreement governing the Senior Secured Term Loan Facility contains anumber of negative covenants that are substantially similar to those governingthe Senior Notes and additional covenants related to the security arrangementsfor the Senior Secured Term Loan Facility. The credit agreement also containscustomary affirmative covenants and events of default.

 

***2028 Debentures.***InMay 1998, the Company issued $125.0 million aggregate principal amount of its2028 Debentures. In connection with the Transactions, the Company equally andratably secured the 2028 Debentures by a first lien security interest oncertain collateral subject to liens granted under the Company’s Senior SecuredCredit Facilities constituting (a) (i) 100% of the capital stock of certain ofthe Company’s existing and future domestic subsidiaries, and (ii) 100% of thenon-voting stock and 65% of the voting stock of certain of the Company’sexisting and future foreign subsidiaries and (b) certain of the Company’sprincipal properties that include a majority of the Company’s full-line stores,in each case, to the extent required by the terms of the indenture governingthe 2028 Debentures. The 2028 Debentures contain covenants that restrict theCompany’s ability to create liens and enter into sale and lease backtransactions. The collateral securing the 2028 Debentures will be released uponthe release

 

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of liens on such collateral under the Company’s Senior Secured CreditFacilities and any other debt (other than the 2028 Debentures) secured by suchcollateral. Capital stock and other securities of a subsidiary of the Companythat are owned by the Company or any subsidiary will not constitute collateralunder the 2028 Debentures to the extent such property does not constitutecollateral under the Company’s Senior Secured Credit Facilities as describedabove. Parent is currently considering providing a guarantee of the 2028Debentures.

 

***Senior Notes.***On October 6, 2005, Newton Acquisition MergerSub, Inc. issued $700.0 million aggregate original principal amount of 9.0% /9.75% Senior Notes under a senior indenture (Senior Indenture) with Wells FargoBank, National Association, as trustee. At the closing of the Transactions, asthe surviving corporation in the Acquisition, the Company assumed all theobligations of Newton Acquisition Merger Sub, Inc. under the SeniorIndenture.  The Senior Notes mature on October 15, 2015.

 

For any interest payment period through October 15, 2010, theCompany may, at its option, elect to pay interest on the Senior Notes entirelyin cash (Cash Interest) or entirely by increasing the principal amount of theoutstanding Senior Notes or by issuing additional Senior Notes (PIK Interest). CashInterest on the Senior Notes accrues at the rate of 9% per annum.  PIKInterest on the Senior Notes accrues at the rate of 9.75% per annum. After October 15, 2010, the Company will make all interest payments on theSenior Notes entirely in cash.  All Senior Notes mature onOctober 15, 2015 and have the same rights and benefits as the Senior Notesissued on October 6, 2005. Interest on the Senior Notes is payable quarterly inarrears on each January 15, April 15, July 15 andOctober 15, commencing on January 15, 2006.

 

TheSenior Notes are guaranteed, jointly and severally, on an unsecured, seniorbasis, by each of the Company’s wholly-owned domestic subsidiaries thatguarantee the Company’s obligations under its Senior Secured Credit Facilitiesand by Parent. The Senior Notes and the guarantees thereof are the Company’sand the guarantors’ unsecured, senior obligations and rank (i) equal in theright of payment with all of the Company’s and the guarantors’ existing andfuture senior indebtedness, including any borrowings under the Company’s SeniorSecured Credit Facilities and the guarantees thereof and the Company’s 2028Debentures; and (ii) senior to all of the Company’s and its guarantors’existing and future subordinated indebtedness, including the SeniorSubordinated Notes due 2015 and the guarantees thereof. The Senior Notes alsoare effectively junior in priority to the Company’s and its guarantors’obligations under all secured indebtedness, including the Company’s SeniorSecured Credit Facilities, the 2028 Debentures, and any other securedobligations of the Company, in each case, to the extent of the value of theassets securing such obligations. In addition, the Senior Notes arestructurally subordinated to all existing and future liabilities, includingtrade payables, of the Company’s subsidiaries that are not providing guarantees.

 

TheCompany is not required to make any mandatory redemption or sinking fundpayments with respect to the Senior Notes, but under certain circumstances, theCompany may be required to offer to purchase Senior Notes as described below. TheCompany may from time to time acquire Senior Notes by means other than aredemption, whether by tender offer, in open market purchases, throughnegotiated transactions or otherwise, in accordance with applicable securitieslaws.

 

Exceptas described below, the Senior Notes are not redeemable at the Company’s optionprior to October 15, 2010. From and after October 15, 2010, theCompany may redeem the Senior Notes, in whole or in part, at a redemption priceequal to 104.5% of principal amount, declining annually to 100% of theprincipal amount on October 15, 2013, plus accrued and unpaid interest, andAdditional Interest (as defined in the Senior Indenture), if any, thereon tothe applicable redemption date.

 

Prior to October 15, 2008, the Company may, at its option, subjectto certain conditions, redeem up to 35% of the original aggregate principalamount of Senior Notes at a redemption price equal to 109% of the aggregateprincipal amount thereof, *plus*accrued and unpaid interest, and Additional Interest, if any, thereon to theredemption date, with the net cash proceeds of one or more equity offerings ofthe Company or any direct or indirect parent of the Company to the extent suchnet proceeds are contributed to the Company. At any time prior toOctober 15, 2010, the Company also may redeem all or a part of the SeniorNotes at a redemption price equal to 100% of the principal amount of SeniorNotes redeemed plus an applicable premium, as provided in the Senior Indenture,as of, and accrued and unpaid interest and Additional Interest, if any, to theredemption date.

 

Uponthe occurrence of a change of control (as defined in the Senior Indenture),each holder of the Senior Notes has the right to require the Company torepurchase some or all of such holder’s Senior Notes at a price in cash equalto 101% of the aggregate principal amount thereof plus accrued and unpaidinterest, and Additional Interest, if any, to the date of purchase.

 

Theindenture governing the Senior Notes contains covenants that limit the Company’sability and certain of its subsidiaries’ ability to:

 

•                  incur additional indebtedness;

 

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•                  pay dividends on the Company’s capital stockor redeem, repurchase or retire the Company’s capital stock or subordinatedindebtedness;

 

•                  make investments;

 

•                  create restrictions on the payment ofdividends or other amounts to the Company from its restricted subsidiaries thatare not guarantors of the notes;

 

•                  engage in transactions with the Company’saffiliates;

 

•                  sell assets, including capital stock of theCompany’s subsidiaries;

 

•                  consolidate or merge;

 

•                  create liens; and

 

•                  enter into sale and lease back transactions.

 

TheCompany’s Brand Development Companies are not subject to the covenantscontained in the Senior Indenture. The Senior Indenture also provides forevents of default, which, if any of them occurs, would permit or require theprincipal, premium, if any, interest and any other monetary obligations on alloutstanding Senior Notes to be due and payable immediately.

 

***Senior Subordinated Notes.***On October 6, 2005, Newton Acquisition MergerSub, Inc. issued $500.0 million aggregate principal amount of 10.375% SeniorSubordinated Notes under a senior subordinated indenture (Senior SubordinatedIndenture) with Wells Fargo Bank, National Association, as trustee. At theclosing of the Transactions, as the surviving corporation in the Acquisition,the Company assumed all the obligations of Newton Acquisition Merger Sub, Inc.under the Senior Subordinated Indenture.  The Senior Subordinated Notesmature on October 15, 2015. Interest on the Senior Subordinated Notes ispayable in cash semi-annually in arrears on each April 15 andOctober 15, commencing April 15, 2006.

 

TheSenior Subordinated Notes are guaranteed, jointly and severally, on anunsecured, senior subordinated basis, by each of the Company’s wholly-owneddomestic subsidiaries that guarantee the Company’s obligations under its SeniorSecured Credit Facilities and by Parent. The Senior Subordinated Notes and theguarantees thereof are the Company’s and the guarantors’ unsecured, seniorsubordinated obligations and rank (i)   junior to all ofthe Company’s and the guarantors’ existing and future senior indebtedness,including the Senior Notes and any borrowings under the Company’s SeniorSecured Credit Facilities, and the guarantees thereof and the Company’s 2028Debentures; (ii) equally with any of the Company’s and the guarantors’ futuresenior subordinated indebtedness; and (iii) senior to any of the Company’s andthe guarantors’ future subordinated indebtedness. In addition, the SeniorSubordinated Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of the Company’s subsidiaries that arenot providing guarantees.

 

TheCompany is not required to make any mandatory redemption or sinking fundpayments with respect to the Senior Subordinated Notes, but, under certaincircumstances, the Company may be required to offer to purchase SeniorSubordinated Notes as described below.  The Company may from time to timeacquire Senior Subordinated Notes by means other than a redemption, whether bytender offer, in open market purchases, through negotiated transactions orotherwise, in accordance with applicable securities laws.

 

Exceptas described below, the Senior Subordinated Notes are not redeemable at theCompany’s option prior to October 15, 2010. From and afterOctober 15, 2010, the Company may redeem the Senior Subordinated Notes, inwhole or in part, at a redemption price equal to 105.188% of principal amount,declining annually to 100% of principal amount on October 15, 2013, plusaccrued and unpaid interest, and Additional Interest (as defined in the SeniorSubordinated Indenture), if any, thereon to the applicable redemption date.

 

Priorto October 15, 2008, the Company may, at its option, subject to certainconditions, redeem up to 35% of the original aggregate principal amount ofSenior Subordinated Notes at a redemption price equal to 110.375% of theaggregate principal amount thereof, *plus*accrued and unpaid interest, and Additional Interest, if any, thereon to theredemption date, with the net cash proceeds of one or more equity offerings ofthe Company or any direct or indirect parent of the Company to the extent suchnet proceeds are contributed to the Company.

 

Atany time prior to October 15, 2010, the Company also may redeem all or apart of the Senior Subordinated Notes at a redemption price equal to 100% ofthe principal amount of Senior Subordinated Notes redeemed plus an applicablepremium, as provided in the Senior Subordinated Indenture, as of, and accruedand unpaid interest and Additional Interest, if any, to the redemption date.

 

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Uponthe occurrence of a change of control (as defined in the Senior SubordinatedIndenture), the Company will make an offer to purchase all of the SeniorSubordinated Notes at a price in cash equal to 101% of the aggregate principalamount thereof plus accrued and unpaid interest, and Additional Interest, ifany, to the date of purchase.

 

Theindenture governing the Senior Subordinated Notes contains covenantssubstantially similar to those applicable to the Company’s Senior Notesdescribed above. The Senior Subordinated Indenture also provides for events ofdefault, which, if any of them occurs, would permit or require the principal,premium, if any, interest and any other monetary obligations on all outstandingSenior Notes to be due and payable immediately, subject to certain exceptions.

 

***Redemptionof 2008 Notes.***In May 1998, the Company issued $125.0 million aggregateprincipal amount of its 2008 Notes. Upon closing of the Transactions, theCompany called its 2008 Notes for redemption pursuant to their terms. On November7, 2005, the Company used $134.7 million of reserved cash to redeem its 2008Notes, which included a call premium of $6.2 million plus accrued interest of$3.5 million through the redemption date.

*** ***

**OTHERMATTERS**

 

**Factors That May Affect Future Results**

 

Matters discussed in MD&Ainclude forward-looking statements. Forward-looking statements generally can beidentified by the use of forward-looking terminology such as “may,” “plan,” “predict,”“expect,” “estimate,” “intend,” “would,” “could,” “should,” “anticipate,” “believe,”“project” or “continue.” We make these forward-looking statements based on ourexpectations and beliefs concerning future events, as well as currentlyavailable data. These forward-looking statements involve a number of risks anduncertainties and, therefore, are not guarantees of future performance. Avariety of factors could cause our actual results to differ materially from theanticipated or expected results expressed in our forward-looking statements.Factors that could affect future performance include, but are not limited, to:

 

*Political and General Economic Conditions*

 

•                  currentpolitical and general economic conditions or changes in such conditionsincluding relationships between the United States and the countries from whichwe source our merchandise;

 

•                  terroristactivities in the United States and elsewhere;

 

•                  political,social, economic, or other events resulting in the short- or long-termdisruption in business at our stores, distribution centers or offices;

 

*Customer Demographic Issues*

 

•                  changesin the demographic or retail environment;

 

•                  changesin consumer confidence resulting in a reduction of discretionary spending ongoods;

 

•                  changesin consumer preferences or fashion trends;

 

•                  changesin our relationships with key customers;

 

•                  changesin our proprietary credit card arrangement that adversely impact the ability toprovide credit to our customers;

 

*Merchandise Procurement and Supply ChainConsiderations*

 

•                  changesin our relationships with designers, vendors and other sources of merchandise,including adverse changes in their financial viability;

 

•                  delaysin receipt of merchandise ordered due to work stoppages or other causes ofdelay in connection with either the manufacture or shipment of suchmerchandise;

 

•                  changesin foreign currency exchange or inflation rates;

 

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•                  significantincreases in paper, printing and postage costs;

 

*Industry and Competitive Factors*

 

•                  competitiveresponses to our loyalty programs, marketing, merchandising and promotionalefforts or inventory liquidations by vendors or other retailers;

 

•                  seasonalityof the retail business;

 

•                  adverseweather conditions or natural disasters, particularly during peak sellingseasons;

 

•                  delaysin anticipated store openings and renovations;

 

•                  oursuccess in enforcing our intellectual property rights;

 

*Employee Considerations*

 

•                  changesin key management personnel and our ability to retain key management personnel;

 

•                  changesin our relationships with certain of our key sales associates and our abilityto retain our key sales associates;

 

*Legal and Regulatory Issues*

 

•                  changesin government or regulatory requirements increasing our costs of operations;

 

•                  litigationthat may have an adverse effect on our financial results or reputation;

 

*The Transactions*

 

The consummation of the Transactions resultedin the Company becoming highly leveraged. As a result, we are subject toadditional risk factors including:

 

•                  theeffects of incurring a substantial amount of indebtedness under our SeniorSecured Credit Facilities and the Notes;

 

•                  theeffects upon us of complying with the covenants contained in our Senior SecuredCredit Facilities and the indentures governing the Notes;

 

•                  restrictionsthe terms and conditions of the indebtedness under our Senior Secured CreditFacilities and the Notes may place on our ability to respond to changes in ourbusiness or to take certain actions;

 

*Other Factors*

 

•                  impactof funding requirements related to our noncontributory defined benefit pensionplan; and

 

•                  thedesign and implementation of new information systems as well as enhancements ofexisting systems.

 

The foregoing factors are notexhaustive and new factors may emerge or changes to the foregoing factors mayoccur that could impact our business. Except to the extent required by law, weundertake no obligation to update or revise (publicly or otherwise) any forward-lookingstatements to reflect subsequent events, new information or futurecircumstances.

 

**Critical Accounting Policies**

** **

The preparation of condensed consolidated financial statements inconformity with generally accepted accounting principles requires us to makeestimates and assumptions about future events. These estimates and assumptionsaffect amounts of assets, liabilities, revenues and expenses and the disclosureof gain and loss contingencies at the date of the Condensed ConsolidatedFinancial Statements. Our current estimates are subject to change if differentassumptions as to the outcome of future events were made. We evaluate ourestimates and judgments on an ongoing basis and predicate those estimates andjudgments on historical

 

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experience and on various other factors that we believe are reasonableunder the circumstances. We make adjustments to our assumptions and judgmentswhen facts and circumstances dictate. Since future events and their effectscannot be determined with absolute certainty, actual results may differ fromthe estimates we used in preparing the accompanying Condensed ConsolidatedFinancial Statements.

 

**See Note 1 of the Notes to Condensed Consolidated FinancialStatements in Item 1 for a summary of our critical accounting policies. Acomplete description of our critical accounting policies is included in ourAnnual Report to Shareholders on Form 10-K for the fiscal year ended July 30,2005.**

** **

We have changed the basis of presentation of certainprior year amounts and calculations presented in this quarterly report toconform to the current year presentation. Depreciation expense and income fromcredit card operations, net are now shown as separate line items on ourstatements of earnings. Prior to the second quarter of fiscal year 2006,depreciation expense was included in buying and occupancy costs and the incomefrom our credit card operations was included as a reduction to SG&A.

 

***PurchaseAccounting.***We have accounted for the Acquisition inaccordance with the provisions of Statement of Financial Accounting Standards(SFAS) 141, “Business Combinations,” whereby the purchase price paid to effectthe Acquisition is allocated to state the acquired assets and liabilities atfair value. The Acquisition and the allocation of the purchase price have beenrecorded as of October 1, 2005, the beginning of our October 2005 accountingperiod. In connection with the preliminary purchase price allocation, we havemade estimates of the fair values of our long-lived and intangible assets basedupon assumptions related to future cash flows, discount rates and asset livesutilizing currently available information. As of April 29, 2006, we haverecorded preliminary purchase accounting adjustments to increase the carryingvalue of our property and equipment and inventory, to establish intangibleassets for our tradenames, customer lists and favorable lease commitments andto revalue our long-term benefit plan obligations, among other things. Thisallocation of the purchase price is preliminary and subject to our review andfinalization of asset valuations.

 

As of April 29, 2006, we have recorded the followingpreliminary purchase accounting adjustments to increase the carrying values toestimated fair values based upon preliminary valuation results:

 
| **(in millions)**                                                  | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|
|                                                               |       |       |       |
| Property and  equipment                                            |       | $          | 135.9      |   |
| Customer  lists                                                    |       | 586.3      |       |
| Favorable  lease commitments                                       |       | 480.0      |       |
| Tradenames                                                         |       | 1,691.1    |       |
| Goodwill                                                           |       | 1,681.0    |       |
| Long-term  benefit plan obligations, primarily pension obligations |       | 57.6       |       |
|                                                                    |            |            |            |  |

 

Further revisionsto the purchase price allocation will be made as additional information becomesavailable and such revisions could be material.

 

***Recent Accounting Pronouncements.***InDecember 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment” (SFAS No.123(R)). This standard is a revision of SFAS No. 123, “Accounting forStock-Based Compensation,” and supersedes Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) and itsrelated implementation guidance. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the financial statements based on their fair values and waseffective for the first interim period or annual reporting period beginningafter June 15, 2005. We adopted SFAS No. 123(R) as of the beginning of ourfirst quarter of fiscal year 2006 using the modified prospective method, whichrequires companies to record stock compensation for all unvested and new awardsas of the adoption date. Accordingly, we have not restated the prior periodamounts presented herein. See Note 5 for further description of our stock-basedcompensation.

 

In March 2005, the FASB issued FASB Interpretation No. 47, “Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143” (FIN 47). FIN 47 clarifies that conditional asset retirementobligations meet the definition of liabilities and should be recognized whenincurred if their fair values can be reasonably estimated. FIN 47 is effectiveno later than the end of fiscal years ending after December 15, 2005. Thecumulative effect of initially applying FIN 47 will be recognized as a changein accounting principle. We are in the process of evaluating the expectedeffect of FIN 47, if any, on our consolidated financial statements.

 

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**RISKFACTORS**

 

**Risks Related to the Company’s Indebtedness**

 

**The Company has a substantial amount ofindebtedness, which may adversely affect the Company’s cash flow and itsability to operate the Company’s business, to comply with debt covenants andmake payments on its indebtedness.**

 

As a result of theTransactions, the Company is highly leveraged. As of April 29, 2006, theprincipal amount of the Company’s total indebtedness was approximately $3,210.8million and the Company’s unused borrowing availability under the Company’s$600 million Asset-Based Revolving Credit Facility was approximately $573.2million after giving effect to $26.8 million of letters of credit outstandingthereunder. The Company’s substantial indebtedness, combined with its lease andother financial obligations and contractual commitments, could have otherimportant consequences. For example, it could:

 

•                  make it more difficult for the Company to satisfy itsobligations with respect to its indebtedness and any failure to comply with theobligations of any of its debt instruments, including restrictive covenants andborrowing conditions, could result in an event of default under the agreementsgoverning the Company’s indebtedness;

 

•                  make the Company more vulnerable to adverse changes ingeneral economic, industry and competitive conditions and adverse changes ingovernment regulation;

 

•                  require the Company to dedicate a substantial portion ofits cash flow from operations to payments on its indebtedness, thereby reducingthe availability of its cash flows to fund working capital, capitalexpenditures, acquisitions and other general corporate purposes;

 

•                  limit the Company’s flexibility in planning for, orreacting to, changes in its business and the industry in which it operates;

 

•                  place the Company at a competitive disadvantage compared toits competitors that are less highly leveraged and therefore may be able totake advantage of opportunities that the Company’s leverage prevents it fromexploiting; and

 

•                  limit the Company’s ability to borrow additional amountsfor working capital, capital expenditures, acquisitions, debt servicerequirements, execution of the Company’s business strategy or other purposes.

 

Any of the above listed factorscould materially adversely affect the Company’s business, financial conditionand results of operations.

 

In addition, the Company’sinterest expense could increase if interest rates increase because the entireamount of the indebtedness under the senior secured credit facilities bearsinterest at floating rates. As of April 29, 2006, the Company had approximately$1,875.0 million principal amount of floating rate debt, consisting ofoutstanding borrowings under Senior Secured Term Loan Facility. The Company alsohad at that date approximately $573.2 million of unused floating rate debtborrowing capacity available under the Asset-Based Revolving Credit Facilitybased on a borrowing base of over $600.0 million at that date and after givingeffect to $26.8 million used for letters of credit. Effective December 6, 2005,the Company entered into floating to fixed interest rate swap agreements for anaggregate notional amount of $1,000.0 million to limit its exposure to interestrate increases related to a portion of its floating rate indebtedness.

 

**To service the Company’s indebtedness, theCompany will require a significant amount of cash. The Company’s ability togenerate cash depends on many factors beyond its control, and any failure tomeet the Company’s debt service obligations could harm its business, financialcondition and results of operations.**

 

The Company’s ability to payinterest on and principal of the Company’s debt obligations will primarilydepend upon the Company’s future operating performance. As a result, prevailingeconomic conditions and financial, business and other factors, many of whichare beyond the Company’s control, will affect its ability to make thesepayments.

 

If the Company does notgenerate sufficient cash flow from operations to satisfy the Company’s debtservice obligations, the Company may have to undertake alternative financingplans, such as refinancing or restructuring its indebtedness, selling assets,reducing or delaying capital investments or seeking to raise additional capital.The Company’s ability to restructure or refinance its debt will depend on thecondition of the capital markets and the Company’s financial condition at suchtime. Any refinancing of the Company’s debt could be at higher interest ratesand may require it to comply with more onerous covenants, which could furtherrestrict its business operations. The terms of existing or future debtinstruments may restrict the Company from adopting some of these

 

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alternatives. In addition, anyfailure to make payments of interest and principal on the Company’s outstandingindebtedness on a timely basis would likely result in a reduction of theCompany’s credit rating, which could harm its ability to incur additional indebtednesson acceptable terms.

 

Contractual limitations on theCompany’s ability to execute any necessary alternative financing plans couldexacerbate the effects of any failure to generate sufficient cash flow tosatisfy its debt service obligations. The Company’s Asset-Based RevolvingCredit Facility permits it to borrow up to $600.0 million; however, theCompany’s ability to borrow thereunder is limited by a borrowing base, which atany time will equal the lesser of 80% of eligible inventory valued at the lowerof cost or market value and 85% of the net orderly liquidation value of theeligible inventory, less certain reserves. In addition, the Company’s abilityto borrow under this facility is limited by a minimum liquidity condition,providing that, if less than $60.0 million is available at any time, theCompany is not permitted to borrow any additional amounts under the Asset-BasedRevolving Credit Facility unless the Company’s pro forma ratio of consolidatedEBITDA to consolidated Fixed Charges (as such terms are defined in the creditagreement for the Company’s senior secured asset-based revolving creditfacility) is at least 1.1 to 1.0. The Company’s ability to meet this financialratio may be affected by events beyond its control, and the Company cannotassure you that it will meet this ratio.

 

The Company’s inability togenerate sufficient cash flow to satisfy its debt service obligations, or torefinance its obligations at all or on commercially reasonable terms, wouldhave an adverse effect, which could be material, on the Company’s business,financial condition and results of operations.

 

**The terms of the Company’s****Asset-Based Revolving Credit Facility and Senior Secured Term LoanFacility and the indenturesgoverning the Notes and 2028 Debentures may restrict the Company’s current andfuture operations, particularly its ability to respond to changes in itsbusiness or to take certain actions.**

 

The credit agreements governingthe Company’s Asset-Based Revolving Credit Facility and Senior Secured TermLoan Facility credit facilities and the indentures governing the Notes and 2028Debentures contain, and any future indebtedness of the Company’s would likelycontain, a number of restrictive covenants that impose significant operatingand financial restrictions, including restrictions on the Company’s ability toengage in acts that may be in its best long-term interests. The indenturesgoverning the Notes and 2028 Debentures and the credit agreements governing theCompany’s senior secured credit facilities include covenants that, among otherthings, restrict its ability to:

 

•                  incur additional indebtedness;

 

•                  pay dividends on the Company’s capital stock or redeem,repurchase or retire the Company’s capital stock or indebtedness;

 

•                  make investments;

 

•                  create restrictions on the payment of dividends or otheramounts to the Company from the Company’s restricted subsidiaries;

 

•                  engage in transactions with the Company’s affiliates;

 

•                  sell assets, including capital stock of the Company’ssubsidiaries;

 

•                  consolidate or merge;

 

•                  create liens; and

 

•                  enter into sale and lease back transactions.

 

In addition, the Company’sability to borrow under the Asset-Based Revolving Credit Facility is limited bya borrowing base and a minimum liquidity condition, as described above.

 

Moreover, the Company’s Asset-BasedRevolving Credit Facility provides discretion to the agent bank acting onbehalf of the lenders to impose additional availability and other reserves,which could materially impair the amount of borrowings that would otherwise beavailable to the Company. There can be no assurance that the agent bank willnot impose such reserves or, were it to do so, that the resulting impact ofthis action would not materially and adversely impair the Company’s liquidity.

 

A breach of any of therestrictive covenants would result in a default under the Company’s Asset-BasedRevolving Credit Facility and

 

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Senior Secured Term LoanFacility. If any such default occurs, the lenders under the Asset-BasedRevolving Credit Facility and Senior Secured Term Loan Facility may elect todeclare all outstanding borrowings under such facilities, together with accruedinterest and other fees, to be immediately due and payable, or enforce theirsecurity interest, any of which would result in an event of default under theCompany’s Notes and 2028 Debentures. The lenders would also have the right inthese circumstances to terminate any commitments they have to provide furtherborrowings.

 

The operating and financialrestrictions and covenants in these debt agreements and any future financingagreements may adversely affect the Company’s ability to finance futureoperations or capital needs or to engage in other business activities.

 

**Risks Related to Our Business and Industry**

 

**The specialty retail industry is highlycompetitive.**

 

The specialty retail industryis highly competitive and fragmented. Competition is strong both to attract andsell to customers and to establish relationships with, and obtain merchandisefrom, key vendors.

 

We compete for customers withspecialty retailers, traditional and high-end department stores, nationalapparel chains, vendor-owned proprietary boutiques, individual specialtyapparel stores and direct marketing firms. We compete for customers principallyon the basis of quality and fashion, customer service, value, assortment andpresentation of merchandise, marketing and customer loyalty programs and, inthe case of Neiman Marcus and Bergdorf Goodman, store ambiance. In ourSpecialty Retail business, merchandise assortment is a critical competitivefactor, and retail stores compete for exclusive, preferred and limiteddistribution arrangements with key designers. Many of our competitors arelarger than we are and have greater financial resources than we do. Inaddition, certain designers from whom we source merchandise have establishedcompeting free-standing retail stores in the same vicinity as our stores. If wefail to successfully compete for customers or merchandise, our business willsuffer.

 

**We are dependent on our relationships withcertain designers, vendors and other sources of merchandise.**

 

Our relationships withestablished and emerging designers are a key factor in our position as aretailer of high-fashion merchandise, and a substantial portion of our revenuesis attributable to our sales of designer merchandise. Many of our key vendorslimit the number of retail channels they use to sell their merchandise andcompetition among luxury retailers to obtain and sell these goods is intense.Our relationships with our designers have been a significant contributor to ourpast success. We have no guaranteed supply arrangements with our principalmerchandising sources. Accordingly, there can be no assurance that such sourceswill continue to meet our quality, style and volume requirements. Moreover,nearly all of the brands of our top designers are sold by competing retailers,and many of our top designers also have their own dedicated retail stores. Ifone or more of our top designers were to cease providing us with adequatesupplies of merchandise or, conversely, were to increase sales of merchandisethrough its own stores or to the stores of our competitors, our business couldbe adversely affected. In addition, any decline in the popularity or quality ofany of our designer brands could adversely affect our business.

 

**If we significantly overestimate our sales,our profitability may be adversely affected.**

 

We make decisions regarding thepurchase of our merchandise well in advance of the season in which it will besold. For example, women’s apparel, men’s apparel and shoes are typicallyordered six to nine months in advance of the products being offered for salewhile handbags, jewelry and other categories are typically ordered three to sixmonths in advance.. If our sales during any season, particularly a peak season,are significantly lower than we expect for any reason, we may not be able toadjust our expenditures for inventory and other expenses in a timely fashionand may be left with a substantial amount of unsold inventory. If that occurs,we may be forced to rely on markdowns or promotional sales to dispose of excessinventory. This could have an adverse effect on our margins and operatingincome. At the same time, if we fail to purchase a sufficient quantity ofmerchandise, we may not have an adequate supply of products to meet consumerdemand. This may cause us to lose sales or harm our customer relationships.

 

**Our failure to identify changes in consumerpreferences or fashion trends may adversely affect our performance.**

 

Our success depends in largepart on our ability to identify fashion trends as well as to anticipate, gaugeand react to changing consumer demands in a timely manner. If we fail toadequately match our product mix to prevailing customer tastes, we may berequired to sell our merchandise at higher average markdown levels and loweraverage margins. Furthermore, the products we sell often require long leadtimes to order and must appeal to consumers whose preferences cannot bepredicted with certainty and often change rapidly. Consequently, we must stayabreast of emerging lifestyle and consumer trends and anticipate trends andfashions that will appeal to our consumer base. Any failure on our part toanticipate, identify and respond effectively to changing consumer demands andfashion trends could adversely affect our business.

 

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**Our business and performance may be affectedby our ability to implement our store expansion and remodeling strategies.**

 

Based upon our expansionstrategy, we expect that planned new stores will add over 620,000 square feetof new store space over approximately the next four fiscal years, representingan increase of over 11% above the current aggregate square footage of ourfull-line Neiman Marcus and Bergdorf Goodman stores, and that our storeremodeling program will add additional new store space from remodels that arealready underway. New store openings involve certain risks, includingconstructing, furnishing and supplying a store in a timely and cost effectivemanner, accurately assessing the demographic or retail environment at a givenlocation, hiring and training quality staff, obtaining necessary permits andzoning approvals, obtaining commitments from a core group of vendors to supplythe new store, integrating the new store into our distribution network andbuilding customer awareness and loyalty. In undertaking store remodels, we mustcomplete the remodel in a timely, cost effective manner, minimize disruptionsto our existing operations, and succeed in creating an improved shoppingenvironment. If we fail to execute on these or other aspects of our storeexpansion and remodeling strategy, we could suffer harm to our sales, anincrease in costs and expenses and an adverse effect on our business.

 

**Acts of terrorism could adversely affect ourbusiness.**

 

The economic downturn thatfollowed the terrorist attacks of September 11, 2001 had a materialadverse effect on our business. Any further acts of terrorism or other futureconflicts may disrupt commerce and undermine consumer confidence, cause adownturn in the economy generally, cause consumer spending or shopping centertraffic to decline or reduce the desire of our customers to make discretionarypurchases. Any of the foregoing factors could negatively impact our salesrevenue, particularly in the case of any terrorist attack targeting retailspace, such as a shopping center. Furthermore, an act of terrorism or war, orthe threat thereof, could negatively impact our business by interfering withour ability to obtain merchandise from foreign manufacturers. Any futureinability to obtain merchandise from our foreign manufacturers or to substituteother manufacturers, at similar costs and in a timely manner, could adverselyaffect our business.

 

**Deterioration in economic conditions couldadversely affect our business.**

 

The merchandise we sellconsists in large part of luxury retail goods. The purchase of these goods by customersis discretionary, and therefore highly dependent upon the level of consumerspending, particularly among affluent customers. Accordingly, sales of theseproducts may be adversely affected by an economic downturn, increases inconsumer debt levels, uncertainties regarding future economic prospects or adecline in consumer confidence. An economic downturn in the United Statesgenerally or in any of the geographic areas in which we have stores,particularly in Texas, California, Florida and the New York City metropolitanarea, from which we derive a significant portion of our revenues, could have amaterial adverse effect on our business and results of operations.

 

**The loss of any of our senior management teamor attrition among our buyers or key sales associates could adversely affectour business.**

 

Our success in the specialtyretail industry will continue to depend to a significant extent on our seniormanagement team, buyers and key sales associates. We rely on the experience ofour senior management, who have specific knowledge relating to us and ourindustry that would be difficult to replace. If we were to lose a portion ofour buyers or key sales associates, our ability to benefit from long-standingrelationships with key vendors or to provide relationship-based customerservice may suffer. We cannot assure you that we will be able to retain ourcurrent senior management team, buyers or key sales associates. The loss of anyof these individuals could adversely affect our business.

 

**Inflation may adversely affect our businessoperations in the future.**

 

In recent years, we haveexperienced certain inflationary conditions in our cost base due primarily to(1) changes in foreign currency exchange rates that have reduced thepurchasing power of the U.S. dollar and (2) increases in selling, generaland administrative expenses, particularly with regard to employee benefits.Inflation can harm our margins and profitability if we are unable to increaseprices or cut costs enough to offset the effects of inflation in our cost base.If inflation in these or other costs worsens, we cannot assure you that ourattempts to offset the effects of inflation and cost increases through controlof expenses, passing cost increases on to customers or any other method will besuccessful. Any future inflation could adversely affect our profitability andour business.

 

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**Failure to maintain competitive terms underour loyalty programs could adversely affect our business.**

 

We maintain loyalty programsthat are designed to cultivate long-term relationships with our customers andenhance the quality of service we provide to our customers. We must constantlymonitor and update the terms of our loyalty programs so that they continue tomeet the demands and needs of our customers and remain competitive with loyaltyprograms offered by other high-end specialty retailers. Given thatapproximately 46% of our revenues at Neiman Marcus stores in calendar year 2005were generated by our InCircle loyalty program members, our failure to continueto provide quality service and competitive loyalty programs to our customersthrough the InCircle loyalty program could adversely affect our business.

 

**Changes in our credit card arrangements,applicable regulations and consumer credit patterns could adversely impact ourability to facilitate the provision of consumer credit to our customers andadversely affect our business.**

 

We maintain a proprietarycredit card program through which credit is extended to customers under the “NeimanMarcus” and “Bergdorf Goodman” names. Because a majority of our revenues weretransacted through our proprietary credit cards, changes in our proprietarycredit card arrangement that adversely impact our ability to facilitate theprovision of consumer credit may adversely affect our performance. In July2005, we sold our approximately three million private label credit cardaccounts and related assets, as well as the outstanding balances associatedwith such accounts. Initially, we will continue to handle key customer servicefunctions, including new account processing, most transaction authorization,billing adjustments, collection services and customer inquiries. As part ofthis transaction, we are changing, and will continue to change, the terms ofcredit offered to our customers following the Credit Card Sale. In addition,the purchaser of our credit card business will have discretion over certainpolicies and arrangements with credit card customers and may change these policiesand arrangements in ways that affect our relationship with these customers. Anysuch changes in our credit card arrangements may adversely affect our creditcard program and ultimately, our business.

 

Credit card operations aresubject to numerous federal and state laws that impose disclosure and otherrequirements upon the origination, servicing and enforcement of credit accountsand limitations on the maximum amount of finance charges that may be charged bya credit provider. The purchaser of our credit card business is subject toregulations to which we were not subject prior to the Credit Card Sale. Anyeffect of these regulations or change in the regulation of credit arrangementsthat would materially limit the availability of credit to our customer basecould adversely affect our business. In addition, changes in credit card use,payment patterns, and default rates may result from a variety of economic,legal, social, and other factors that we cannot control or predict withcertainty.

 

**Our business can be affected by extreme orunseasonable weather conditions.**

 

Extreme weather conditions inthe areas in which our stores are located could adversely affect our business.For example, heavy snowfall, rainfall or other extreme weather conditions overa prolonged period might make it difficult for our customers to travel to ourstores and thereby reduce our sales and profitability. Our business is alsosusceptible to unseasonable weather conditions. For example, extended periodsof unseasonably warm temperatures during the winter season or cool weatherduring the summer season could render a portion of our inventory incompatiblewith those unseasonable conditions. Reduced sales from extreme or prolongedunseasonable weather conditions would adversely affect our business.

 

**We are subject to numerous regulations thatcould affect our operations.**

 

We are subject to customs,truth-in-advertising and other laws, including consumer protection regulationsand zoning and occupancy ordinances that regulate retailers generally and/orgovern the importation, promotion and sale of merchandise and the operation ofretail stores and warehouse facilities. Although we undertake to monitorchanges in these laws, if these laws change without our knowledge, or areviolated by importers, designers, manufacturers or distributors, we couldexperience delays in shipments and receipt of goods or be subject to fines orother penalties under the controlling regulations, any of which could adverselyaffect our business.

 

**Our revenues and cash requirements areaffected by the seasonal nature of our business.**

 

The specialty retail industryis seasonal in nature, with a higher level of sales typically generated in thefall and holiday selling seasons. We have in the past experienced significantfluctuation in our revenues from quarter to quarter with a disproportionateamount of our revenues falling in our second fiscal quarter, which coincideswith the holiday season. In addition, we incur significant additional expensesin the period leading up to the months of November and December in anticipationof higher sales volume in those periods, including for additional inventory,advertising and employees.

 

48

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**Our business is affected by foreign currencyfluctuations.**

 

We purchase a substantialportion of our inventory from foreign suppliers whose cost to us is affected bythe fluctuation of their local currency against the dollar or who price theirmerchandise in currencies other than the dollar. Accordingly, changes in thevalue of the dollar relative to foreign currencies may increase our cost ofgoods sold and, if we are unable to pass such cost increases on to ourcustomers, decrease our gross margins and ultimately our earnings. Fluctuationsin the Euro-dollar exchange rate affect us most significantly; however, wesource goods from numerous countries and thus are affected by changes innumerous currencies and, generally, by fluctuations in the U.S. dollar relativeto such currencies. Although we hedge some exposures to changes in foreigncurrency exchange rates arising in the ordinary course of business, foreigncurrency fluctuations may have a material adverse effect on our business,financial condition and results of operations.

 

**Conditions in, and the United States’relationship with, the countries where we source our merchandise could affectour sales.**

 

A substantial majority of ourmerchandise is manufactured overseas, mostly in Europe. As a result, politicalinstability or other events resulting in the disruption of trade from othercountries or the imposition of additional regulations relating to or dutiesupon imports could cause significant delays or interruptions in the supply ofour merchandise or increase our costs, either of which could have a materialadverse effect on our business. If we are forced to source merchandise fromother countries, those goods may be more expensive or of a different orinferior quality from the ones we now sell. The importance to us of ourexisting designer relationships could present additional difficulties, as itmay not be possible to source merchandise from a given designer fromalternative jurisdictions. If we were unable to adequately replace themerchandise we currently source with merchandise produced elsewhere, ourbusiness could be adversely affected.

 

**Significant increases in costs associatedwith the production of catalogs and other promotional material may adverselyaffect our operating income.**

 

We advertise and promotein-store events, new merchandise and fashion trends through print catalogs andother promotional materials mailed on a targeted basis to our customers.Significant increases in paper, printing and postage costs could affect thecost of producing these materials and as a result, may adversely affect ouroperating income.

 

**Weare indirectly owned and controlled by the Sponsors, and their interests asequity holders may conflict with those of our creditors.**

** **

We are indirectly owned andcontrolled by the Sponsors and certain other equity investors, and the Sponsorshave the ability to control our policies and operations. The interests of theSponsors may not in all cases be aligned with those of our creditors. Forexample, if we encounter financial difficulties or are unable to pay our debtsas they mature, the interests of our equity holders might conflict with ourcreditors’ interests. In addition, our equity holders may have an interest inpursuing acquisitions, divestitures, financings or other transactions that, intheir judgment, could enhance their equity investments, even though suchtransactions might involve risks to holders of our indebtedness. Furthermore,the Sponsors may in the future own businesses that directly or indirectlycompete with us. One or more of the Sponsors also may pursue acquisitionopportunities that may be complementary to our business, and as a result, thoseacquisition opportunities may not be available to us.

 

**If we are unable to enforce our intellectualproperty rights, or if we are accused of infringing on a third party’sintellectual property rights, our net income may decline.**

 

We and our subsidiariescurrently own our trademarks and service marks, including the “Neiman Marcus,” “BergdorfGoodman” and “Kate Spade” marks. Our trademarks and service marks areregistered in the United States and in various foreign countries, primarily inEurope. The laws of some foreign countries do not protect proprietary rights tothe same extent as do the laws of the United States. Moreover, we are unable topredict the effect that any future foreign or domestic intellectual propertylegislation or regulation may have on our existing or future business. The lossor reduction of any of our significant proprietary rights could have an adverseeffect on our business.

 

Additionally, third parties mayassert claims against us alleging infringement, misappropriation or otherviolations of their trademark or other proprietary rights, whether or not theclaims have merit. Claims like these may be time consuming and expensive to defendand could result in our being required to cease using the trademark or otherrights and selling the allegedly infringing products. This might have anadverse affect on our sales and cause us to incur significant litigation costsand expenses.

 

49

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**Failure to successfully maintain and updateinformation technology systems and enhance existing systems may adverselyaffect our business.**

 

To keep pace with changingtechnology, we must continuously provide for the design and implementation ofnew information technology systems as well as enhancements of our existingsystems. Any failure to adequately maintain and update the informationtechnology systems supporting our online operations, sales operations or inventorycontrol could prevent our customers from purchasing merchandise on our websitesor prevent us from processing and delivering merchandise, which could adverselyaffect our business.

 

**Delays in receipt of merchandise inconnection with either the manufacturing or shipment of such merchandise canaffect our performance.**

 

Substantially all of ourmerchandise is delivered to us by our vendors as finished goods and ismanufactured in numerous locations, including Europe and the United States and,to a lesser extent, China, Mexico and South America. Our vendors rely on thirdparty carriers to deliver merchandise to our distribution facilities. Inaddition, our success depends on our ability efficiently to source anddistribute merchandise to our Specialty Retail Stores and Direct Marketingcustomers. Events such as U.S. or foreign labor strikes, natural disasters,work stoppages or boycotts affecting the manufacturing or transportationsectors could increase the cost or reduce the supply of merchandise availableto us and could adversely affect our results of operations.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

The market risk inherent in theCompany’s financial instruments represents the potential loss arising fromadverse changes in interest rates and foreign currency exchange rates. TheCompany does not enter into derivative financial instruments for tradingpurposes. The Company seeks to manage exposure to adverse interest rate changesthrough its normal operating and financing activities. The Company is exposedto interest rate risk through its borrowing activities, which are described inNote 8 to the condensed consolidated financial statements.

 

As of April 29, 2006, theCompany had no borrowings outstanding under its Asset-Based Revolving CreditFacility that bears interest at floating rates. Future borrowings under theCompany’s Asset-Based Revolving Facility, to the extent of outstandingborrowings, would be affected by interest rate changes.

 

At April 29, 2006, the Company had $1,875.0 million of debt under itsSenior Secured Term Loan Facility issued in connection with the Transactionsthat bears interest at floating rates. A 1% increase in these floating rateswould increase annual interest expense by approximately $18.7 million.

 

The Company uses derivative financial instruments to help manage itsinterest rate risk. Effective December 6, 2005, the Company entered intofloating to fixed interest rate swap agreements for an aggregate notionalamount of $1,000.0 million to limit its exposure to interest rate increasesrelated to a portion of its floating rate indebtedness. The interest rate swapagreements terminate after five years. As of the effective date, the Companydesignated the interest rate swaps as cash flow hedges. As a result, changes inthe fair value of the swaps are recorded subsequent to the effective date as acomponent of other comprehensive income.

 

At April 29, 2006, the fair value of the Company’s interest rate swapagreements was a gain of approximately $19.4 million, which amount is includedin other assets. As a result of the swap agreements, the Company’s effectivefixed interest rates as to the $1,000.0 million in floating rate indebtednesswill range from 6.931% to 7.499% per quarter and result in an average fixedrate of 7.285%.

 

The Company uses derivativefinancial instruments to manage foreign currency risk related to theprocurement of merchandise inventories from foreign sources. The Company entersinto foreign currency contracts denominated in the euro and British pound. TheCompany had foreign currency contracts in the form of forward exchangecontracts in the notional amounts of approximately $38.9 million as ofApril 29, 2006 and approximately $35.7 million as of April 30, 2005. Themarket risk inherent in these instruments was not material to the Company’sconsolidated financial position, results of operations or cash flows in theyear-to-date fiscal year 2006 period.

 

The effects of changes in the U.S. equity and bondmarkets serve to increase or decrease the value of Pension Plan assets,resulting in increased or decreased cash funding by the Company. The Companyseeks to manage exposure to adverse equity and bond returns by maintainingdiversified investment portfolios and utilizing professional investmentmanagers.

 

50

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**ITEM 4. CONTROLSAND PROCEDURES**

 

**a.****               DisclosureControls and Procedures**

 

In accordance with Exchange ActRules 13a-15 and 15d-15, we carried out an evaluation as of April 29, 2006,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, as well as other key members of our management, ofthe effectiveness of our disclosure controls and procedures (as defined inRule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). Based onthat evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective to providereasonable assurance that information required to be disclosed in our reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

**b.****               Changesin Internal Control over Financial Reporting**

 

In the ordinary course ofbusiness, we routinely enhance our information systems by either upgrading ourcurrent systems or implementing new systems. No change occurred in our internalcontrols over financial reporting during the quarter ended April 29, 2006 thathas materially affected, or is reasonably likely to materially affect, ourinternal controls over financial reporting.

 

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**THE NEIMAN MARCUS GROUP, INC.**

 

**PART II**

 

**ITEM 1.****                             LEGALPROCEEDINGS**

 

Note 12 of the Notes to Condensed Consolidated Financial Statements inPart I, Item 1 is incorporated herein by reference as if fully restated herein.Note 12 contains forward-looking statements that are subject to the risks anduncertainties discussed in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations – Factors That May Affect Future Results.”

 

###### **ITEM 2.**                             UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

###### ** **

None.

 

**ITEM 4.****                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

**ITEM 6.****                             EXHIBITS**

 
| 3.1    |   | Amended and Restated Certificate of Incorporation of the Company,  incorporated herein by reference to the Company’s Current Report on Form 8-K  dated October 12, 2005.                                                                                                                                                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 3.2    |   | Amended and Restated Bylaws of the Company, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.1    |   | Indenture, dated as of May 27, 1998, between the Company and The Bank  of New York, as trustee, incorporated herein by reference to the Company’s  Annual Report on Form 10-K for the fiscal year ended July 31, 2004.                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.2    |   | Form of 7.125% Senior Notes Due 2028, dated May 27, 1998,  incorporated herein by reference to the Company’s Annual Report on Form 10-K  for the fiscal year ended July 31, 2004.                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.3    |   | Senior Indenture dated as of October 6, 2005, among Newton  Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the Subsidiary  Guarantors, and Wells Fargo Bank, National Association, trustee, incorporated  herein by reference to the Company’s Current Report on Form 8-K dated October  12, 2005.              |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.4    |   | Senior Subordinated Indenture dated as of October 6, 2005, among  Newton Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the Subsidiary  Guarantors, and Wells Fargo Bank, National Association, trustee, incorporated  herein by reference to the Company’s Current Report on Form 8-K dated October  12, 2005. |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.5    |   | Form of 9%/9 3/4% Senior Notes due 2015, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.6    |   | Form of 10 3/8% Senior Subordinated Notes due 2015, incorporated  herein by reference to the Company’s Current Report on Form 8-K dated October  12, 2005.                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 4.7    |   | Registration Rights Agreement dated October 6, 2005, among Newton  Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the Subsidiary  Guarantors, the Company, and the Initial Purchasers, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated October 12, 2005.                    |
|   |   |                                                                                                                                                                                                                                                                                                                          |
| 10.1*  |   | Employment Agreement dated as of October 6, 2005 by and among the  Company, Newton Acquisition Merger Sub, Inc., Newton Acquisition, Inc., and  Burton M. Tansky, incorporated herein by reference to the Company’s Current  Report on Form 8-K dated October 12, 2005.                                                  |

 

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| 10.2*  |   | Rollover Agreement dated as of October 4, 2005 by and among the  Company, Newton Acquisition, Inc., and Burton M. Tansky, incorporated herein  by reference to the Company’s Current Report on Form 8-K dated October 12,  2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.3*  |   | Form of Rollover Agreement by and among the Company, Newton  Acquisition, Inc. and certain members of management, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.4   |   | Credit Agreement dated as of October 6, 2005, among Newton  Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the Company, the  Subsidiary Guarantors, Deutsche Bank Trust Company Americas, as  administrative agent and collateral agent, Credit Suisse and Deutsche Bank  Securities Inc., as joint lead arrangers, Banc of America Securities LLC and  Goldman Sachs Credit Partners L.P., as co-arrangers, Credit Suisse, Deutsche  Bank Securities Inc., Banc of America Securities LLC and Goldman Sachs Credit  Partners L.P., as joint bookrunners, and Credit Suisse, Banc of America  Securities LLC and Goldman Sachs Credit Partners L.P., as co-syndication  agents, General Electric Capital Corporation as documentation agent and the  lenders thereunder, incorporated herein by reference to the Company’s Current  Report on Form 8-K dated October 12, 2005. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5   |   | Credit Agreement dated as of October 6, 2005, among Newton  Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the Company, the  Subsidiary Guarantors, Credit Suisse, as administrative agent and collateral  agent, Credit Suisse and Deutsche Bank Securities Inc. as joint lead  arrangers, Banc of America Securities LLC and Goldman Sachs Credit Partners  L.P. as co-arrangers, Credit Suisse, Deutsche Bank Securities Inc., Banc of  America Securities LLC and Goldman Sachs Credit Partners L.P. as joint  bookrunners, Deutsche Bank Securities Inc., Banc of America Securities LLC  and Goldman Sachs Credit Partners L.P. as co-syndication agents and the  lenders thereunder, incorporated herein by reference to the Company’s Current  Report on Form 8-K dated October 12, 2005.                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6   |   | Pledge and Security Agreement dated as of October 6, 2005 among  Newton Acquisition Merger Sub, Inc., the Company, Newton Acquisition, Inc.,  the Subsidiary Guarantors and Deutsche Bank Trust Company Americas, as  administrative agent and collateral agent, incorporated herein by reference  to the Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.7   |   | Pledge and Security and Intercreditor Agreement dated as of October  6, 2005, among Newton Acquisition Merger Sub, Inc., the Company, Newton  Acquisition, Inc., the Subsidiary Guarantors and Credit Suisse, as  administrative agent and collateral agent, incorporated herein by reference  to the Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.8   |   | Lien Subordination and Intercreditor Agreement dated as of October 6,  2005, among Newton Acquisition, Inc., Newton Acquisition Merger Sub, Inc.,  the Subsidiary Guarantors, Deutsche Bank Trust Company Americas, as revolving  facility agent, and Credit Suisse, as term loan agent, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.9   |   | Form of First Priority Mortgage, Assignment of Leases and Rents, Security  Agreement and Financing Statement from the Company to Credit Suisse,  incorporated herein by reference to the Company’s Current Report on Form 8-K  dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.10  |   | Form of First Priority Leasehold Mortgage, Assignment of Leases and  Rents, Security Agreement and Financing Statement from the Company to Credit  Suisse, incorporated herein by reference to the Company’s Current Report on  Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.11  |   | Form of Second Priority Mortgage, Assignment of Leases and Rents,  Security Agreement and Financing Statement from the Company to Deutsche Bank  Trust Company Americas, incorporated herein by reference to the Company’s  Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.12  |   | Form of Second Priority Leasehold Mortgage, Assignment of Lease and  Rents, Security Agreement and Financing Statement from the Company to  Deutsche Bank Trust Company Americas, incorporated herein by reference to the  Company’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

 

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| 10.13  |   | Amendment No. 1 dated as of October 6, 2005 to the Credit Agreement  dated as of October 6, 2005 among the Company, Newton Acquisition, Inc., each  subsidiary of the Company from time to time party thereto, the Lenders  thereunder, and Credit Suisse, as administrative agent and as collateral  agent for the Lenders, incorporated herein by reference to the Company’s  Current Report on Form 8-K dated October 12, 2005.                                                            |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.14* |   | Newton Acquisition, Inc. Management Equity Incentive Plan,  incorporated herein by reference to the Company’s Current Report on Form 8-K  dated December 5, 2005.                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.15* |   | Stock Option Agreement made as of November 29, 2005 between the  Company and Burton M. Tansky, incorporated herein by reference to the  Company’s Current Report on Form 8-K dated December 5, 2005.                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.16* |   | Form of Stock Option Agreement made as of November 29, 2005 between  the Company and certain eligible key employees, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated December 5, 2005.                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.17  |   | Amendment No. 2 dated as of January 26, 2006 to the Credit Agreement  dated as of October 6, 2005, as amended, among The Neiman Marcus Group, Inc.,  Newton Acquisition, Inc., each subsidiary of The Neiman Marcus Group, Inc.  from time to time party thereto, the Lenders thereunder and Credit Suisse, as  administrative agent and collateral agent for the Lenders, incorporated by  reference to the Company’s Current Report on Form 8-K dated January 30, 2006.                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.18* |   | Employment Agreement between The Neiman Marcus Group, Inc. and Karen  Katz, dated February 1, 2006, effective as of October 6, 2005, incorporated  herein by reference to the Company’s Current Report on Form 8-K dated  February 1, 2006.                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.19  |   | Management Services Agreement, dated as of October 6, 2005 among  Newton Acquisition Merger Sub, Inc., Newton Acquisition, Inc., TPG GenPar IV,  L.P., TPG GenPar III, L.P. and Warburg Pincus LLC, incorporated herein by  reference to the Company’s Quarterly Report on Form 10-Q for the quarter  ended January 28, 2006.                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.20  |   | Registration Rights Agreement, dated as of October 6, 2005, among  Newton Acquisition Merger Sub, Inc., Newton Acquisition, Inc., Newton  Holding, LLC and the “Holders” identified therein as parties thereto,  incorporated herein by reference to the Company’s Quarterly Report on Form  10-Q for the quarter ended January 28, 2006.                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.21  |   | Amendment No. 1 dated as of March 28, 2006 to the Pledge and Security  Intercreditor Agreement dated as of October 6, 2005, among Newton Acquisition  Merger Sub, Inc., The Neiman Marcus Group, Inc., Newton Acquisition, Inc.  (now Neiman Marcus, Inc.), the subsidiary grantors party thereto, Credit  Suisse, as administrative agent and collateral agent for the Secured Parties,  incorporated herein by reference to the Company’s Current Report on Form 8-K  dated March 28, 2006. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.22  |   | Credit Card Program Agreement, dated as of June 8, 2005, by and among  the Company, Bergdorf Goodman, Inc., HSBC Bank Nevada, N.A. and Household  Corporation, incorporated herein by reference to the Company’s Current Report  on Form 8-K dated June 8, 2005.                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.23  |   | Form of Servicing Agreement, by and between the Company and HSBC Bank  Nevada, N.A., incorporated herein by reference to the Company’s Current  Report on Form 8-K dated June 8, 2005.                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.24  |   | Deferred Compensation Plan for Non-Employee Directors, as amended,  incorporated herein by reference to the Company’s Annual Report on Form 10-K  for the fiscal year ended July 31, 2004.                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.25  |   | Confidentiality, Non-Competition and Termination Benefits Agreement  between Bergdorf Goodman, Inc. and James J. Gold dated May 3, 2004,  incorporated herein by reference to the Company’s Annual Report on Form 10-K  for the fiscal year ended July 31, 2004.                                                                                                                                                                                                                              |

 

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| 10.26  |   | Credit Agreement dated as of June 9, 2004, among the Company, the  Lenders parties thereof, Bank of America, N.A., as Syndication Agent,  Wachovia Bank, N.A., as Syndication Agent, Wachovia Bank, N.A., Wells Fargo  Bank National Association, and BNP Paribas, as Documentation Agents, and  JPMorgan Chase Bank, as Administrative Agent, incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the fiscal year  ended July 31, 2004. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.27  |   | Form of Non-Qualified Stock Option Agreement, incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the fiscal year  ended July 31, 2004.                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.28  |   | Form of Regular Restricted Stock Agreement, incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the fiscal year  ended July 31, 2004.                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.29  |   | Form of Retention Restricted Stock Agreement, incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the fiscal year  ended July 31, 2004.                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.30  |   | Form of Purchased Restricted Stock Agreement, incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the fiscal year  ended July 31, 2004.                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.31  |   | Form of Non-Qualified Stock Option Agreement with incremental  vesting, incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the fiscal year ended July 31, 2004.                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.32  |   | Confidentiality, Non-Competition and Termination Benefits Agreement  between the Company and Steven P. Dennis dated September 9, 2004,  incorporated herein by reference to the Company’s Current Report on Form 8-K  dated September 9, 2004.                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.33  |   | Description of annual incentives set by the Compensation Committee of  the Board of Directors for the 2005 fiscal year, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated September 24,  2004.                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.34  |   | The Neiman Marcus Group, Inc. Key Employee Bonus Plan, incorporated  herein by reference to the Company’s Current Report on Form 8-K dated  September 24, 2004.                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.35  |   | Form of Restricted Stock Unit Agreement, incorporated herein by  reference to the Company’s Quarterly Report on Form 10-Q for the quarter  ended October 30, 2004.                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.36  |   | Form of Matching Restricted Stock Unit Agreement, incorporated herein  by reference to the Company’s Quarterly Report on Form 10-Q for the quarter  ended October 30, 2004.                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.37  |   | The Neiman Marcus Group, Inc. 2005 Stock Incentive Plan, incorporated  herein by reference to the Company’s Current Report on Form 8-K dated January  21, 2005.                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.38  |   | Change of Control Termination Protection Agreement between the  Company and Burton M. Tansky dated April 1, 2005, incorporated herein by  reference to the Company’s Quarterly Report on Form 10-Q for the quarter  ended April 30, 2005.                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.39  |   | Form of Change of Control Termination Protection Agreement between  the Company and certain eligible executives, including the Named Executive  Officers, dated April 1, 2005, incorporated herein by reference to the  Company’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2005.                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.40  |   | The Neiman Marcus Group, Inc. Executive Change of Control Severance  Plan dated April 1, 2005, incorporated herein by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended April 30, 2005.                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.41  |   | The Neiman Marcus Group, Inc. General Change of Control Severance  Plan dated April 1, 2005, incorporated herein by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended April 30, 2005.                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.42  |   | Stockholder Agreement, dated as of May 1, 2005, among Newton  Acquisition, Inc., Newton Acquisition Merger Sub, Inc. and other parties  signatory thereto, incorporated herein by reference to the Company’s Current  Report on Form 8-K dated May 4, 2005.                                                                                                                                                                                                            |

 

55

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| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. (1)                              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                  |
| 31.2   |   | Certification of Chief Financial Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. (1)                              |
|   |   |                                                                                                                                  |
| 32     |   | Certifications of Chief Executive Officer and Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1) |

 

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| (1)    |   | Filed herewith                                                   |
|--------|--------|------------------------------------------------------------------|
|   |   |                                                             |
| *      |   | Current management contract or compensatory plan or arrangement. |

 

56

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, asamended, the registrant has duly caused this report to be signed on its behalfby the undersigned hereunto duly authorized.

 

 

THE NEIMAN MARCUS GROUP, INC.

(Registrant)

 
| **Signature**         | ** ** | **Title**                      | ** **                    | **Date** |
|-----------------------|------------|--------------------------------|-------------------------------|----------|
|                  |       |                           |                          |     |
| /s/ T. Dale Stapleton |       |                           | Vice President and Controller |     | June 8, 2006 |
| T. Dale Stapleton     |       | and Duly Authorized Officer    |                          |     |
|                  |       | (principal accounting officer) |                          |     |
|                       |            |                                |                               |          |  |

 

57

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