**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 PeriodEnded January 28, 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 ofregistrant as specified in its charter)

 

| **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  75201**

(Address ofprincipal executive offices)

 

**(214)741-6911**

(Registrant’stelephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

| YES  o |   | NO  ý |
|------------------|--------|----------------------|

 

 

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

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

| YES  o |   | NO  ý |
|------------------|--------|----------------------|

 

There were 900 shares ofthe registrant’s common stock, par value $.01 per share, outstanding at January28, 2006.

 

 

----

 

**THENEIMAN MARCUS GROUP, INC.**

 

**INDEX**

 
| Part I.    | Financial Information                                                                                                                                                                                                   |   |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                                                                                                                                    |   |
| Item 1.    | Condensed Consolidated  Balance Sheets as of January 28, 2006 (Successor), July 30, 2005  (Predecessor) and January 29, 2005 (Predecessor)                                                                              |   |
|       |                                                                                                                                                                                                                    |   |
|       | Condensed Consolidated  Statements of Earnings for the Thirteen Weeks Ended January 28, 2006  (Successor) and Thirteen Weeks Ended January 29, 2005 (Predecessor)                                                       |   |
|       |                                                                                                                                                                                                                    |   |
|       | Condensed Consolidated  Statements of Earnings for the Seventeen Weeks Ended January 28, 2006  (Successor), Nine Weeks Ended October 1, 2005 (Predecessor) and Twenty-Six  Weeks Ended January 29, 2005 (Predecessor)   |   |
|       |                                                                                                                                                                                                                    |   |
|       | Condensed Consolidated  Statements of Cash Flows for the Seventeen Weeks Ended January 28, 2006  (Successor), Nine Weeks Ended October 1, 2005 (Predecessor) and Twenty-Six  Weeks Ended January 29, 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 NEIMAN MARCUS GROUP, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

 
| **(in thousands)**                                                                                                          | ** ** | **January 28,  2006** | ** ** | **July 30,  2005** | ** **        | **January 29,  2005** | ** **        |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------|-------------------|----------------------------|-------------------|
| ** **                                                                                                                       | ** ** | **(Successor)**            | ** ** | ** **              | **(Predecessor)** | ** **                 | **(Predecessor)** | ** ** |
| **ASSETS**                                                                                                                       |       |                       |       |                    |              |                       |              |   |
| Current assets:                                                                                                                  |       |                       |       |                    |              |                       |              |   |
| Cash and cash  equivalents                                                                                                       |       | $                          | 91,523     |                    |              | $                          | 853,482           |   | $ | 377,857 |   |
| Accounts  receivable, net of allowance                                                                                           |       | 34,446                     |       |                    | 29,886            |                       | 659,015           |   |
| Merchandise  inventories                                                                                                         |       | 789,998                    |       |                    | 748,366           |                       | 726,169           |   |
| Other current  assets                                                                                                            |       | 116,324                    |       |                    | 76,747            |                       | 79,679            |   |
| Total current  assets                                                                                                            |       | 1,032,291                  |       |                    | 1,708,481         |                       | 1,842,720         |   |
|                                                                                                                             |       |                       |       |                    |              |                       |              |   |
| Property and  equipment, net                                                                                                     |       | 1,042,989                  |       |                    | 855,009           |                       | 793,715           |   |
| Customer lists,  net                                                                                                             |       | 568,365                    |       |                    | —            |                       | —            |   |
| Favorable lease  commitments, net                                                                                                |       | 474,093                    |       |                    | —            |                       | —            |   |
| Trademarks                                                                                                                       |       | 1,691,155                  |       |                    | 56,642            |                       | 56,642            |   |
| Goodwill                                                                                                                         |       | 1,680,503                  |       |                    | 14,872            |                       | 14,872            |   |
| Debt issuance  costs                                                                                                             |       | 104,532                    |       |                    | 3,526             |                       | 3,787             |   |
| Other assets                                                                                                                     |       | 16,721                     |       |                    | 22,130            |                       | 44,026            |   |
| Total assets                                                                                                                     |       | $                          | 6,610,649  |                    |              | $                          | 2,660,660         |   | $ | 2,755,762 |   |
|                                                                                                                             |       |                       |       |                    |              |                       |              |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                   |       |                       |       |                    |              |                       |              |   |
| Current  liabilities:                                                                                                            |       |                       |       |                    |              |                       |              |   |
| Accounts payable                                                                                                                 |       | $                          | 283,251    |                    |              | $                          | 282,887           |   | $ | 241,946 |   |
| Accrued  liabilities                                                                                                             |       | 374,745                    |       |                    | 332,937           |                       | 327,435           |   |
| Notes payable  and current maturities of long-term liabilities                                                                   |       | 8,207                      |       |                    | 1,450             |                       | 2,200             |   |
| Current portion  of borrowings under Credit Card Facility                                                                        |       | —                     |       |                    | —            |                       | 225,000           |   |
| Total current  liabilities                                                                                                       |       | 666,203                    |       |                    | 617,274           |                       | 796,581           |   |
|                                                                                                                             |       |                       |       |                    |              |                       |              |   |
| Long-term  liabilities:                                                                                                          |       |                       |       |                    |              |                       |              |   |
| Asset-based  revolving credit facility                                                                                           |       | —                     |       |                    | —            |                       | —            |   |
| Senior secured  term loan facility                                                                                               |       | 1,875,000                  |       |                    | —            |                       | —            |   |
| Senior  debentures due 2028                                                                                                      |       | 120,614                    |       |                    | 124,823           |                       | 124,819           |   |
| Senior notes                                                                                                                     |       | 700,000                    |       |                    | —            |                       | —            |   |
| Senior  subordinated notes                                                                                                       |       | 500,000                    |       |                    | —            |                       | —            |   |
| Senior notes due  2008                                                                                                           |       | —                     |       |                    | 124,957           |                       | 124,949           |   |
| Deferred real  estate credits                                                                                                    |       | 8,825                      |       |                    | 86,575            |                       | 69,276            |   |
| Deferred income  taxes                                                                                                           |       | 1,130,379                  |       |                    | —            |                       | 21,487            |   |
| Other long-term  liabilities                                                                                                     |       | 180,377                    |       |                    | 120,973           |                       | 97,375            |   |
| Total long-term  liabilities                                                                                                     |       | 4,515,195                  |       |                    | 457,328           |                       | 437,906           |   |
|                                                                                                                             |       |                       |       |                    |              |                       |              |   |
| Minority  interest                                                                                                               |       | 13,024                     |       |                    | 12,112            |                       | 11,664            |   |
|                                                                                                                             |       |                       |       |                    |              |                       |              |   |
| ***Predecessor:***                                                                                                               |       |                       |       |                    |              |                       |              |   |
| Common stocks  (par value $0.01 per share, issued 49,716,309 shares at July 30, 2005 and  49,576,284 shares at January 29, 2005) |       |                       |       |                    | 497               |                       | 497               |   |
| *** ***                                                                                                                     |       |                       |       |                    |              |                       |              |   |
| ***Successor:***                                                                                                                 |       |                       |       |                    |              |                       |              |   |
| Common stock  (par value $0.01 per share, issued 900 shares)                                                                     |       | —                     |       |                    |              |                       |              |   |
|                                                                                                                             |       |                       |       |                    |              |                       |              |   |
| Additional  paid-in capital                                                                                                      |       | 1,472,118                  |       |                    | 520,414           |                       | 510,119           |   |
| Carryover basis  adjustment for management shareholders                                                                          |       | (69,200                    | )          |                    | —            |                       | —            |   |
| Accumulated  other comprehensive loss                                                                                            |       | (583                       | )          |                    | (47,030           | )                          | (1,996            | ) |
| Retained  earnings                                                                                                               |       | 13,892                     |       |                    | 1,125,726         |                       | 1,026,652         |   |
| Treasury stock,  at cost (768,731 shares at July 30, 2005 and 768,731 shares at January 29,  2005)                               |       | —                     |       |                    | (25,661           | )                          | (25,661           | ) |
| Total  shareholders’ equity                                                                                                 |       | 1,416,227                  |       |                    | 1,573,946         |                       | 1,509,611         |   |
| Total  liabilities and shareholders’ equity                                                                                 |       | $                          | 6,610,649  |                    |              | $                          | 2,660,660         |   | $ | 2,755,762 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

1

----

 

**THENEIMAN MARCUS GROUP, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF EARNINGS**

**(UNAUDITED)**

 
| **(in thousands)**                                  | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------|------------|------------|--------------------------------------------------------|------------|
| ** **                                               | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                      | ** ** |
|                                                     |       |                                                   |       |       |                                                   |       |
| Revenues                                                 |       | $                                                      | 1,231,416  |       |                                                   | $          | 1,129,225 |   |
| Cost of goods  sold including buying and occupancy costs |       | 835,938                                                |       |       | 735,677                                                |       |
| Selling, general  and administrative expenses            |       | 285,610                                                |       |       | 264,591                                                |       |
| Income from  credit card operations, net                 |       | (16,972                                                | )          |       | (18,041                                                | )          |
| Depreciation  expense                                    |       | 35,435                                                 |       |       | 27,338                                                 |       |
| Amortization of  customer lists                          |       | 14,559                                                 |       |       | —                                                 |       |
| Amortization of  favorable lease commitments             |       | 4,328                                                  |       |       | —                                                 |       |
|                                                     |       |                                                   |       |       |                                                   |       |
| Operating  earnings                                      |       | 72,518                                                 |       |       | 119,660                                                |       |
|                                                     |       |                                                   |       |       |                                                   |       |
| Interest  expense, net                                   |       | 66,125                                                 |       |       | 3,978                                                  |       |
|                                                     |       |                                                   |       |       |                                                   |       |
| Earnings before  income taxes and minority interest      |       | 6,393                                                  |       |       | 115,682                                                |       |
|                                                     |       |                                                   |       |       |                                                   |       |
| Income taxes                                             |       | 2,568                                                  |       |       | 44,326                                                 |       |
|                                                     |       |                                                   |       |       |                                                   |       |
| Earnings before  minority interest                       |       | 3,825                                                  |       |       | 71,356                                                 |       |
|                                                     |       |                                                   |       |       |                                                   |       |
| Minority  interest in net earnings of subsidiaries       |       | (781                                                   | )          |       | (769                                                   | )          |
|                                                     |       |                                                   |       |       |                                                   |       |
| Net earnings                                             |       | $                                                      | 3,044      |       |                                                   | $          | 70,587 |   |

 

*SeeNotes to Condensed Consolidated Financial Statements.*

 

2

----

 

**THENEIMAN MARCUS GROUP, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF EARNINGS**

**(UNAUDITED)**

 
| **(in thousands)**                                   | ** ** | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** **        | **Twenty-six  weeks ended  January 29,  2005** | ** **        |
|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------|-------------------|----------------------------------------------------------|-------------------|
| ** **                                                | ** ** | **(Successor)**                                         | ** ** | ** **                                        | **(Predecessor)** | ** **                                               | **(Predecessor)** | ** ** |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Revenues                                                  |       | $                                                       | 1,556,206  |                                              |              | $                                                        | 651,648           |   | $ | 2,037,161 |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Cost of goods  sold including buying and occupancy costs  |       | 1,031,229                                               |       |                                              | 378,767           |                                                     | 1,266,861         |   |
| Selling, general  and administrative expenses             |       | 368,593                                                 |       |                                              | 168,853           |                                                     | 507,037           |   |
| Income from  credit card operations, net                  |       | (20,757                                                 | )          |                                              | (7,818            | )                                                        | (33,384           | ) |
| Depreciation  expense                                     |       | 45,064                                                  |       |                                              | 19,960            |                                                     | 51,724            |   |
| Amortization of  customer lists                           |       | 17,937                                                  |       |                                              | —            |                                                     | —            |   |
| Amortization of  favorable lease commitments              |       | 5,887                                                   |       |                                              | —            |                                                     | —            |   |
| Transaction and  other costs                              |       | —                                                  |       |                                              | 23,544            |                                                     | —            |   |
| Loss on  disposition of Chef’s Catalog               |       | —                                                  |       |                                              | —            |                                                     | 15,348            |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Operating  earnings                                       |       | 108,253                                                 |       |                                              | 68,342            |                                                     | 229,575           |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Interest expense  (income), net                           |       | 83,410                                                  |       |                                              | (866              | )                                                        | 8,015             |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Earnings before  income taxes and minority interest       |       | 24,843                                                  |       |                                              | 69,208            |                                                     | 221,560           |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Income taxes                                              |       | 9,838                                                   |       |                                              | 25,607            |                                                     | 85,301            |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Earnings before  minority interest                        |       | 15,005                                                  |       |                                              | 43,601            |                                                     | 136,259           |   |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Minority  interest in net (earnings) loss of subsidiaries |       | (1,113                                                  | )          |                                              | 553               |                                                     | (1,556            | ) |
|                                                      |       |                                                    |       |                                              |              |                                                     |              |   |
| Net earnings                                              |       | $                                                       | 13,892     |                                              |              | $                                                        | 44,154            |   | $ | 134,703 |   |

 

*SeeNotes to Condensed Consolidated Financial Statements.*

 

3

----

 

**THE NEIMAN MARCUS GROUP, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| **(in thousands)**                                                              | ** ** | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** **        | **Twenty-six  weeks ended  January 29,  2005** | ** **        |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------|-------------------|----------------------------------------------------------|-------------------|
| ** **                                                                           | ** ** | **(Successor)**                                         | ** ** | ** **                                        | **(Predecessor)** | ** **                                               | **(Predecessor)** | ** ** |
| **CASH  FLOWS - OPERATING ACTIVITIES**                                               |       |                                                    |       |                                              |              |                                                     |              |   |
| Net earnings                                                                         |       | $                                                       | 13,892     |                                              |              | $                                                        | 44,154            |   | $ | 134,703 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities: |       |                                                    |       |                                              |              |                                                     |              |   |
| Depreciation                                                                         |       | 45,064                                                  |       |                                              | 19,960            |                                                     | 51,724            |   |
| Amortization of  debt issue costs                                                    |       | 4,636                                                   |       |                                              | —            |                                                     | —            |   |
| Amortization of  customer lists and favorable lease commitments                      |       | 23,824                                                  |       |                                              | —            |                                                     | —            |   |
| Non-cash charges  related to step-up in carrying value of inventory                  |       | 36,392                                                  |       |                                              | —            |                                                     | —            |   |
| Stock-based  compensation charges                                                    |       | 1,483                                                   |       |                                              | 19,968            |                                                     | 2,303             |   |
| Deferred income  taxes                                                               |       | (21,194                                                 | )          |                                              | (7,327            | )                                                        | —            |   |
| Loss on  disposition of Chef’s Catalog                                          |       | —                                                  |       |                                              | —            |                                                     | 15,348            |   |
| Minority  interest                                                                   |       | 1,113                                                   |       |                                              | (553              | )                                                        | 1,556             |   |
| Other, primarily  costs related to defined benefit pension plans                     |       | 2,380                                                   |       |                                              | 1,656             |                                                     | 14,816            |   |
|                                                                                 |       | 107,590                                                 |       |                                              | 77,858            |                                                     | 220,450           |   |
| Changes in  operating assets and liabilities:                                        |       |                                                    |       |                                              |              |                                                     |              |   |
| Decrease  (increase) in accounts receivable                                          |       | 2,817                                                   |       |                                              | (7,377            | )                                                        | (106,830          | ) |
| Decrease  (increase) in merchandise inventories                                      |       | 133,873                                                 |       |                                              | (173,829          | )                                                        | (16,209           | ) |
| (Increase)  decrease in other current assets                                         |       | (11,660                                                 | )          |                                              | 6,164             |                                                     | (17,797           | ) |
| (Increase)  decrease in other assets                                                 |       | (110                                                    | )          |                                              | (2,274            | )                                                        | 15,187            |   |
| (Decrease)  increase in accounts payable and accrued liabilities                     |       | (16,486                                                 | )          |                                              | 114,604           |                                                     | (1,970            | ) |
| Payment of  deferred compensation and stock-based awards                             |       | (12,901                                                 | )          |                                              | —            |                                                     | —            |   |
| Increase  (decrease) in deferred real estate credits                                 |       | 8,996                                                   |       |                                              | 4,289             |                                                     | (2,622            | ) |
| **Net  cash provided by operating activities**                                       |       | 212,119                                                 |       |                                              | 19,435            |                                                     | 90,209            |   |
| **CASH FLOWS  - INVESTING ACTIVITIES**                                               |       |                                                    |       |                                              |              |                                                     |              |   |
| Capital  expenditures                                                                |       | (72,295                                                 | )          |                                              | (26,311           | )                                                        | (95,121           | ) |
| Acquisition of  The Neiman Marcus Group, Inc.                                        |       | (5,155,923                                              | )          |                                              | —            |                                                     | —            |   |
| Proceeds from  the sale of Chef’s Catalog                                       |       | —                                                  |       |                                              | —            |                                                     | 14,419            |   |
| **Net  cash used for investing activities**                                          |       | (5,228,218                                              | )          |                                              | (26,311           | )                                                        | (80,702           | ) |
| **CASH  FLOWS - FINANCING ACTIVITIES**                                               |       |                                                    |       |                                              |              |                                                     |              |   |
| Proceeds from  borrowings on lines of credit                                         |       | 9,250                                                   |       |                                              | 5,750             |                                                     | 4,750             |   |
| Repayment of  borrowings on lines of credit                                          |       | (11,000                                                 | )          |                                              | (750              | )                                                        | (4,113            | ) |
| Borrowings under  asset-based revolving credit facility                              |       | 150,000                                                 |       |                                              | —            |                                                     | —            |   |
| Repayment of  borrowings under asset-based revolving credit facility                 |       | (150,000                                                | )          |                                              | —            |                                                     | —            |   |
| Borrowings of  senior term loan facility                                             |       | 1,975,000                                               |       |                                              | —            |                                                     | —            |   |
| Repayment of  borrowings on senior term loan facility                                |       | (100,000                                                | )          |                                              | —            |                                                     | —            |   |
| Borrowings of  senior and subordinated debt                                          |       | 1,200,000                                               |       |                                              | —            |                                                     | —            |   |
| Repayment of  notes due 2008                                                         |       | (134,734                                                | )          |                                              | —            |                                                     | —            |   |
| Debt issuance  costs paid                                                            |       | (102,854                                                | )          |                                              | —            |                                                     | —            |   |
| Cash equity  contributions                                                           |       | 1,427,739                                               |       |                                              | —            |                                                     | —            |   |
| Acquisitions of  treasury stock                                                      |       | —                                                  |       |                                              | —            |                                                     | (3,088            | ) |
| Proceeds from  stock-based compensation awards                                       |       | —                                                  |       |                                              | —            |                                                     | 16,273            |   |
| Cash dividends  paid                                                                 |       | —                                                  |       |                                              | (7,346            | )                                                        | (12,664           | ) |
| Distribution  paid                                                                   |       | (39                                                     | )          |                                              | —            |                                                     | (1,175            | ) |
| **Net  cash provided by (used for) financing activities**                            |       | 4,263,362                                               |       |                                              | (2,346            | )                                                        | (17               | ) |
| **CASH  AND CASH EQUIVALENTS**                                                       |       |                                                    |       |                                              |              |                                                     |              |   |
| (Decrease)  increase during the period                                               |       | (752,737                                                | )          |                                              | (9,222            | )                                                        | 9,490             |   |
| Beginning  balance                                                                   |       | 844,260                                                 |       |                                              | 853,482           |                                                     | 368,367           |   |
| Ending balance                                                                       |       | $                                                       | 91,523     |                                              |              | $                                                        | 844,260           |   | $ | 377,857 |   |
| **Supplemental  Schedule of Cash Flow Information**                                  |       |                                                    |       |                                              |              |                                                     |              |   |
| Cash paid during  the period for:                                                    |       |                                                    |       |                                              |              |                                                     |              |   |
| Interest                                                                             |       | $                                                       | 49,462     |                                              |              | $                                                        | 207               |   | $ | 10,250 |   |
| Income taxes                                                                         |       | $                                                       | 25,657     |                                              |              | $                                                        | 10,693            |   | $ | 72,151 |   |
| Noncash  activities:                                                                 |       |                                                    |       |                                              |              |                                                     |              |   |
| Equity  contribution from Parent                                                     |       | $                                                       | 25,000     |                                              |              | $                                                        | —            |   | $ | — |   |
| Equity  contribution from management shareholders                                    |       | $                                                       | 17,891     |                                              |              | $                                                        | —            |   | $ | — |   |
| Capital lease  additions                                                             |       | $                                                       | 11,220     |                                              |              | $                                                        | —            |   | $ | — |   |

 

*SeeNotes to Condensed Consolidated Financial Statements.*

 

4

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**THENEIMAN MARCUS 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 onthe Saturday closest to July 31. All references to the second quarter of fiscal2006 relate to the thirteen weeks ended January 28, 2006 of the Successor. Allreferences to the second quarter of fiscal 2005 relate to the thirteen weeksended January 29, 2005 of the Predecessor. All references to year-to-datefiscal 2006 relate to the combined twenty-six weeks ended January 28, 2006 andall references to year-to-date fiscal 2005 relate to the twenty-six weeks endedJanuary 29, 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 accounting principles generally accepted 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 following critical accounting policies, among others,encompass the more significant judgments and estimates used in the preparationof 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);

 

•      Recognition ofrevenues;

 

•      Valuation ofmerchandise 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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•      Measurement ofaccruals for litigation, general liability, workers’ compensation and healthinsurance, short-term disability, pension and postretirement health carebenefits.

 

A description of ourcritical accounting policies is included in our Annual Report on Form 10-K forthe fiscal year ended July 30, 2005.

 

Certain prior periodbalances have been reclassified to conform to the current period presentation. Depreciationexpense and income from credit card operations, net are now shown as separateline items on our statements of earnings. In prior periods, depreciationexpense was included in buying and occupancy costs and the income from ourcredit card operations was included as a reduction to selling, general andadministrative expenses.

 

***RecentAccounting Pronouncements.***In December 2004, theFinancial Accounting Standards Board (FASB) issued SFAS No. 123R, “Share-BasedPayment.” 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,” and its relatedimplementation guidance. SFAS No. 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values and was effective for the firstinterim period or annual reporting period beginning after June 15, 2005. Weadopted SFAS No. 123R as of the beginning of our first quarter of fiscal 2006using the modified prospective method, which requires companies to record stockcompensation for all unvested and new awards as of the adoption date.Accordingly, we have not restated the prior period amounts presented herein. SeeNote 5 for further description of our stock-based compensation.

 

In March 2005, the FASBissued FASB Interpretation No. 47, “Accounting for Conditional Asset RetirementObligations, an interpretation of FASB Statement No. 143” (FIN 47). FIN 47clarifies that conditional asset retirement obligations meet the definition ofliabilities and should be recognized when incurred if their fair values can bereasonably estimated. FIN 47 is effective no later than the end of fiscal yearsending after December 15, 2005 with the cumulative effect of initially applyingFIN 47 being recognized as a change in accounting principle. We are in theprocess of evaluating the expected effect of FIN 47, if any, on ourconsolidated 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 SubordinatedNotes); and

 

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

 

The Acquisition occurred 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(2008 Notes);

 

•    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 period from July 30, 2005 to October 1,2005, we expensed $23.5 million in connection with the Transactions. Thesecosts consisted primarily of $4.5 million of accounting, investment banking,legal and other costs associated with the Transactions and a $19.0 millionnon-cash charge for stock compensation resulting from the accelerated vestingof Predecessor stock options and restricted stock in connection with theAcquisition.

 

***Carryover Basis Adjustment for Management Shareholders.*** Executive management participants heldcertain equity interests, including stock options, in the Predecessor prior tothe Transactions and will continue to hold indirect equity interests in theSuccessor after the Transactions. In accordance with the provisions of EmergingIssues Task Force No. 88-16, “Basis in Leveraged Buyout Transactions,” thebasis of executive management’s indirect interests in the Successor after theTransactions is carried over at the basis of their interests in the Predecessorprior to the Transactions. The carryover basis of such interests less the netcash received by the management participants represents a deemed dividend of$69.2 million to the management participants and has been recognized as areduction 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 allocation of the purchase price have beenrecorded as of October 1, 2005, the beginning of our October accounting period.The purchase price was approximately $5,461.2 million. The sources and uses offunds in connection with the Transactions and the redemption of our 2008 Notesare 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                           |   | 665.6   |    |
| Equity  contribution – cash       |   | 1,427.7 |    |
| Equity  contribution – non-cash   |   | 42.9    |    |
| Total sources                          |   | $       | 5,461.2 |   |

 
| **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)                                 |   | 81.8   |    |
| 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                                                                                     |   | $      | 5,461.2 |   |

 

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 the future cash flows,discount rates and asset lives utilizing currently available information, andin some cases, preliminary valuation results from independent valuationspecialists. As of January 28, 2006, we have recorded preliminary purchaseaccounting adjustments to increase the carrying value of our property andequipment and inventory, to establish intangible assets for our tradenames,customer lists and favorable lease commitments and to revalue our long-termbenefit plan obligations, among other things. This allocation of the purchaseprice is preliminary and subject to our review and finalization of independentappraisals.

 

7

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During the second quarter of fiscal 2006, we receivedupdated valuation results from our independent appraisers and adjusted theestimated fair values of our long-lived and intangible assets as follows:

 
| ** **                   | ** ** | **Estimated Fair Value** | ** ** |
|------------------------------|------------|------------------------------------|------------|
| **(in millions)**       | ** ** | **October 29,  2005**         | ** ** | **January 28,  2006** | ** ** |
|                         |       |                               |       |   |   |
| Property and  equipment      |       | $                                  | 1,044.9    |   | $ | 945.7 |   |
| Customer lists               |       | 466.3                              |       | 586.3 |   |
| Favorable lease  commitments |       | 386.8                              |       | 480.0 |   |
| Tradenames                   |       | 1,734.2                            |       | 1,691.1 |   |
| Goodwill                     |       | 1,725.3                            |       | 1,680.5 |   |
|                              |            |                                    |            |  |  |  |  |

 

Further revisions to the purchase price allocationwill be made as additional information becomes available and such revisionscould be material.

 

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

 
| Cash  consideration:                                                         |   |     |   |    |    |
|------------------------------------------------------------------------------|--------|----------|--------|---------|---------|
| Paid to  shareholders                                                        |   |     |   | $       | 5,092.9 |   |
| Transaction  costs                                                           |   |     |   | 63.0    |    |
|                                                                         |   |     |   | 5,155.9 |    |
| Non-cash  consideration                                                      |   |     |   | 36.7    |    |
| Total  consideration                                                         |   |     |   | 5,192.6 |    |
|                                                                         |   |     |   |    |    |
| 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 lease 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                                  |   |     |   | $       | 1,680.5 |   |
|                                                                              |        |          |        |         |         |  |  |

 

8

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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 all acquisition-relatedintangible assets during the period from October 6, 2005 through July 29, 2006and for each of our fiscal years ending in July 2006 to 2010 is currentlyestimated 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 |   |

 

***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. 

 
| **(in thousands)** | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** ** | **Twenty-six  weeks ended  January 28,  2006** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
|                    |       |                                                   |       |                                                   |       |                                                     |       |                                                     |       |
| Revenues                |       | $                                                      | 1,231,416  |                                                   | $          | 1,129,225                                                |       | $                                                        | 2,207,854  |   | $ | 2,037,161 |   |
| Net income              |       | $                                                      | 22,019     |                                                   | $          | 4,499                                                    |       | $                                                        | 57,967     |   | $ | 3,538 |   |

 

Included in the determinationof pro forma net income for the thirteen weeks and twenty-six weeks endedJanuary 29, 2005 are pro forma adjustments for non-cash charges to increasecost of goods sold for the step-up in the carrying value of inventoriesacquired of $19.6 million and $39.6 million, respectively. These pro formaadjustments resulted in pro forma decreases to cost of goods sold in thethirteen and twenty-six weeks ended January 28, 2006 by the amount of theactual non-cash charges recorded during these periods.

 

**4.**     Transactions with Sponsors

** **

In connection with theTransactions, we entered into a management services agreement with affiliatesof the Sponsors pursuant to which affiliates of one of the Sponsors received onthe closing date a transaction fee of $25 million in cash in connection withthe Transactions. Affiliates of the other Sponsor waived any cash transactionfee in connection with the Transactions.

 

In addition, pursuant tosuch agreement, and in exchange for on-going consulting and management advisoryservices that will be provided to us by the Sponsors and their affiliates,affiliates of the Sponsors will receive an aggregate annual management feeequal to the lesser of (i) 0.25% of our consolidated annual revenues or (ii)$10 million. Affiliates of the Sponsors will also receive reimbursement forout-of-pocket expenses incurred by them or their affiliates in connection withservices provided pursuant to the agreement. These management fees are payablequarterly in arrears. During the second quarter of fiscal 2006 and theseventeen weeks ended January 28, 2006, we recorded management fees of $3.1million and $3.8 million, respectively, which are included in selling, generaland administrative expenses in the statement 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.

 

9

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**5.**     Stock-Based Compensation

** **

We previously accountedfor stock-based compensation awards to employees in accordance with AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and its related interpretations. Accordingly, we recognizedcompensation expense on our restricted stock awards but did not recognizecompensation expense for stock options since all options granted had anexercise price equal to the market value of our common stock on the grant date.We did not adopt the previous voluntary expense recognition provisions of SFASNo. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), whereby thefair value of stock-based compensation awards would have been expensed over theterms of awards. However, consistent with the disclosure requirements of SFASNo. 123, we made pro forma disclosures of the effect that application of thefair value expense recognition provisions of SFAS No. 123 would have had on ournet earnings.

 

In December 2004, theFASB issued SFAS No. 123R, “Share-Based Payment.” This standard is a revisionof SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedesAccounting Principles Board Opinion No. 25 and its related implementationguidance. SFAS No. 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values and is effective for the first interimperiod or annual reporting period beginning after June 15, 2005. We adoptedSFAS No. 123R as of the beginning of our first quarter of fiscal 2006 using themodified prospective method, which required us to record stock compensation forall unvested and new awards as of the adoption date. Accordingly, we have notrestated prior period amounts presented herein.

 

***PredecessorStock-Based Compensation Accounting.***In connection withthe adoption of the provisions of SFAS No. 123R, we recorded non-cash chargesfor stock compensation of approximately $20.0 million in the period from July31, 2005 to October 1, 2005 primarily as a result of the accelerated vesting ofall Predecessor options and restricted stock in connection with theTransactions (see Note 2).

 

The following tableillustrates the pro forma effect on net earnings for periods prior to theadoption of SFAS No. 123R as if we had applied the fair value recognitionprovisions of SFAS No. 123 during such periods:

 
| **(in thousands)**                                                                                          | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **(Predecessor)**                                      | ** ** | **(Predecessor)**                                        | ** ** |
| Net earnings:                                                                                                    |       |                                                   |       |                                                     |       |
| As reported                                                                                                      |       | $                                                      | 70,587     |                                                     | $          | 134,703 |   |
| Add: stock-based  employee compensation recorded under intrinsic value method, net of related  taxes             |       | 1,371                                                  |       | 2,303                                                    |       |
| Less:  stock-based employee compensation expense determined under fair value based  method, net of related taxes |       | (3,518                                                 | )          | (6,413                                                   | )          |
| Pro forma                                                                                                        |       | $                                                      | 68,440     |                                                     | $          | 130,593 |   |

 

***SuccessorStock-Based Compensation Accounting.***On November 29,2005, the Parent adopted a new equity-based management compensation plan, whichauthorizes equity awards to be granted for up to 80,708.8 shares of the commonstock of the Parent, of which options for 75,207.5 shares were issued tocertain management employees. All options are outstanding at January 28, 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 fixed priceoptions and $247 for the options with escalating exercise prices. In estimatingthe fair value of our options, we made the following assumptions: expected termto exercise of five years; expected volatility of 30%; risk-free interest rateof 4.23%; and no dividend yield. Expected volatility is based on a combinationof the Predecessor’s historical volatility adjusted for our new leverage andestimates of implied volatility of our peer group.

 

For the fiscal quarterended January 28, 2006, we recognized non-cash stock compensation expense of$1.5 million, which is included in selling, general and administrative expenses.The adoption of FAS No. 123R had no impact on our cash flows from operations orfinancing activities. At January 28, 2006, unearned non-cash stock-basedcompensation that we expect to recognize as expense over the next 5 yearsaggregates approximately $26.6 million.

 

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**6.**     The Credit Card Sale

** **

***CreditCard Sale.***On July 7, 2005, HSBC Bank Nevada, NationalAssociation (HSBC) purchased our approximately three million private labelNeiman Marcus and Bergdorf Goodman credit card accounts and related assets, aswell as the outstanding balances associated with such accounts (Credit CardSale). The total purchase price was approximately $647 million, consisting of$534 million in net cash proceeds and the assumption of approximately $113million of our outstanding debt under our previous revolving credit cardsecuritization facility (Credit Card Facility). We recognized a gain of$6.2 million in connection with the sale of our credit card portfolio toHSBC in the fourth quarter of fiscal 2005.

 

As a part of the Credit Card Sale, we entered into a long-termmarketing and servicing alliance with HSBC. Under the terms of this alliance,HSBC offers credit card and non-card payment plans bearing our brands and wereceive ongoing payments from HSBC related to credit card sales andcompensation for marketing and servicing activities (HSBC Program Income). Inaddition, we continue to handle certain key customer service functions. Intandem with HSBC, we have initiated various changes in our credit card programto alter the credit terms available to our cardholders and to enhance theearnings of the portfolio. These changes have increased the level of HSBCProgram Income earned by the Company. In the future, the HSBC Program Incomemay be either decreased based upon the level of future services we provide toHSBC or increased based upon other changes to our historical credit cardprogram related to, among other things, the interest rate applied to unpaidbalances and the assessment of late fees.

 

A summary of the incomeearned in connection with our proprietary credit card program is as follows:

 
| ** **              | ** ** | **Quarter-to-Date**                                    | ** ** | **Year-to-Date**                                       | ** **        |
|-------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|-------------------|
| **(in thousands)** | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** **        | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
| ** **              | ** ** | **(Successor)**                                        | ** ** | ** **                                             | **(Predecessor)** | ** ** | **(Successor)** | ** ** | ** ** | **(Predecessor)** | ** ** | **(Predecessor)** | ** ** |
|                    |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| HSBC Program  Income    |       | $                                                      | 16,972     |                                                   |              | $ | — |   | $ | 20,757 |   |   | $ | 7,818 |   | $ | — |   |
| Finance charge  income  |       | —                                                 |       |                                                   | 21,257            |   | — |   |   | — |   | 41,004 |   |
| Bad debt, net           |       | —                                                 |       |                                                   | (3,216            | ) | — |   |   | — |   | (7,620 | ) |
|                    |       | $                                                      | 16,972     |                                                   |              | $ | 18,041 |   | $ | 20,757 |   |   | $ | 7,818 |   | $ | 33,384 |   |

 

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

** **

In November 2004, we soldour Chef’s Catalog direct marketing business to a private equity firm. Chef’sCatalog is a multi-channel retailer of professional-quality kitchenware withrevenues in fiscal year 2004 of approximately $73 million. At October 30, 2004,Chef’s Catalog had net tangible assets, primarily inventory, of $12.5 millionand net intangible assets of $17.2 million. We received proceeds, net ofselling costs, of $14.4 million from the sale. As the carrying value of theChef’s Catalog assets exceeded the fair value of such assets as determined bythe sale, we incurred a pre-tax loss of $15.3 million in the first quarter offiscal 2005 related to the disposition of Chef’s Catalog.

 

11

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8.     Long-termDebt

 

The significantcomponents of our long-term debt are as follows:

 
| **(in thousands)**                                      | ** ** | **Interest  Rate** | ** ** | **January 28,  2006** | ** ** | **July 30,  2005** | ** **        | **January 29,  2005** | ** **        |
|--------------------------------------------------------------|------------|--------------------|------------|----------------------------|------------|-------------------------|-------------------|----------------------------|-------------------|
| ** **                                                   | ** ** | ** **         | ** ** | **(Successor)**            | ** ** | ** **              | **(Predecessor)** | ** **                 | **(Predecessor)** | ** ** |
|                                                         |       |               |       |                       |       |                    |              |                       |              |   |
| Asset-Based  Revolving Credit Facility                       |       | variable           |       | $                          | —     |                    |              | $                          | —            |   | $ | — |   |
| Senior Secured  Term Loan Facility                           |       | variable           |       | 1,875,000                  |       |                    | —            |                       | —            |   |
| 2028 Debentures                                              |       | 7.125%             |       | 120,614                    |       |                    | 124,823           |                       | 124,819           |   |
| Senior Notes                                                 |       | 9.0%/9.75%         |       | 700,000                    |       |                    | —            |                       | —            |   |
| Senior  Subordinated Notes                                   |       | 10.375%            |       | 500,000                    |       |                    | —            |                       | —            |   |
| 2008 Notes                                                   |       | 6.65%              |       | —                     |       |                    | 124,957           |                       | 124,949           |   |
| Credit Card  Facility                                        |       | variable           |       | —                     |       |                    | —            |                       | 225,000           |   |
|                                                         |       |               |       | 3,195,614                  |       |                    | 249,780           |                       | 474,768           |   |
| Less: current  portion Borrowings under Credit Card Facility |       |               |       | —                     |       |                    | —            |                       | 225,000           |   |
| Long-term debt                                               |       |               |       | $                          | 3,195,614  |                    |              | $                          | 249,780           |   | $ | 249,768 |   |

 

***Senior Secured Asset-Based Revolving Credit Facility.***On October 6, 2005, in connection withthe Transactions, we entered into a credit agreement and related security andother agreements for a senior secured Asset-Based Revolving Credit Facilitywith Deutsche Bank Trust Company Americas as administrative agent andcollateral agent. The Asset-Based Revolving Credit Facility provides financingof up to $600.0 million, subject to a borrowing base equal to at any timethe lesser of 80% of eligible inventory (valued at the lower of cost or marketvalue) and 85% of net orderly liquidation value of the eligible inventory, lesscertain 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, we utilized $150.0 million of the Asset-BasedRevolving Credit Facility for loans and approximately $16.5 million for letters of credit. In the second quarter offiscal 2006, we repaid all loans under the Asset-Based Revolving CreditFacility. As of January 28, 2006, we had $556.8 million of unused borrowing availability under the Asset-BasedRevolving Credit Facility based on a borrowing base of $572.2 million and aftergiving effect to $15.4 million used for letters of credit.

 

The Asset-Based RevolvingCredit Facility provides that we have the right at any time to request up to$200.0 million of additional commitments, but the lenders are under noobligation to provide any such additional commitments, and any increase incommitments will be subject to customary conditions precedent. If we were torequest any such additional commitments and the existing lenders or new lenderswere to agree to provide such commitments, the Asset-Based Revolving CreditFacility size could be increased to up to $800.0 million, but our abilityto borrow would still be limited by the amount of the borrowing base.

 

Borrowings under theAsset-Based Revolving Credit Facility bear interest at a rate per annum equalto, at our 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 LIBORrate, subject to certain adjustments, in each case plus an applicablemargin.  The initial applicable margin is 0% with respect to base rateborrowings and 1.75% with respect to LIBOR borrowings.  The applicablemargin is subject to adjustment based on the historical availability under theAsset-Based Revolving Credit Facility. In addition, we are required to pay acommitment fee of 0.375% per annum in respect of the unutilized commitments. Ifthe average revolving loan utilization is 50% or more for any applicableperiod, the commitment fee will be reduced to 0.250% for such period. We mustalso pay customary letter of credit fees and agency fees.

 

If at any time theaggregate amount of outstanding loans, unreimbursed letter of credit drawingsand undrawn letters of credit under the Asset-Based Revolving Credit Facilityexceeds the lesser of (i) the commitment amount and (ii) theborrowing base, we 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, we will be required to repay outstanding loans andcash collateralize letters of credit with the cash we are required to depositdaily in a collection account maintained with the agent under the Asset-BasedRevolving Credit Facility. We may voluntarily reduce the unutilized portion ofthe commitment amount and repay outstanding loans at any time without premiumor penalty other than customary “breakage” costs with respect to LIBOR loans. Thereis no scheduled amortization under the Asset-Based Revolving Credit Facility;the principal amount of the loans outstanding are due and payable in full onOctober 6, 2010.

 

All obligations under theAsset-Based Revolving Credit Facility are guaranteed by Parent and certain ofour existing and future domestic subsidiaries (excluding, amongothers, Gurwitch Products, L.L.C., and Kate Spade LLC (Brand DevelopmentCompanies)).

 

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As of January 28, 2006,the liabilities of our non-guarantor subsidiaries totaled approximately $35.7million, or 0.7% of consolidated liabilities, and the assets of ournon-guarantor subsidiaries aggregated approximately $192.2 million, or 2.9% ofconsolidated total assets. All obligations under our Asset-Based RevolvingCredit Facility, and the guarantees of those obligations, are secured, subjectto certain significant exceptions, by substantially all of our assets and theassets of our Parent and our subsidiaries that have guaranteed the Asset-BasedRevolving Credit Facility (subsidiary guarantors), including:

 

•      a first-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by us or the subsidiary guarantors from creditcard clearinghouses and processors or otherwise in respect of all credit cardcharges for sales of inventory by us and the subsidiary guarantors, certainrelated assets and proceeds of the foregoing; and

 

•      a second-priority pledge of 100% of ourcapital stock and certain of the capital stock held by us, Parent or anysubsidiary guarantor (which pledge, in the case of any foreign subsidiary islimited to 100% of the non-voting stock (if any) and 65% of the voting stock ofsuch foreign subsidiary); and

 

•      a second-priority security interest in,and mortgages on, substantially all other tangible and intangible assets of us,Parent and each subsidiary guarantor, including a significant portion of ourmaterial owned and leased real property (which consists of a majority of ourfull-line retail stores) and equipment.

 

Capital stock and othersecurities of a subsidiary of the Company that are owned by the Company or anysubsidiary guarantor will not constitute collateral under our Asset-BasedRevolving Credit Facility to the extent that such securities cannot secure our2028 Debentures or other secured public debt obligations without requiring thepreparation and filing of separate financial statements of such subsidiary inaccordance with applicable SEC rules. As a result, the collateral under ourAsset-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 our Brand Development Companies and their assets also will not constitutecollateral under our Asset-Based Revolving Credit Facility.

 

Our Asset-Based RevolvingCredit Facility contains a number of covenants that, among other things andsubject to certain significant exceptions, restrict our ability and the abilityof our subsidiaries to:

 

•      incur additional indebtedness;

 

•      pay dividends on our capital stock orredeem, repurchase or retire our capital stock or indebtedness;

 

•      make investments, loans, advances andacquisitions;

 

•      create restrictions on the payment ofdividends or other amounts to us from our subsidiaries that are not guarantors;

 

•      engage in transactions with ouraffiliates;

 

•      sell assets, including capital stock ofour subsidiaries;

 

•      consolidate or merge;

 

•      create liens; and

 

•      enter into sale and lease backtransactions.

 

The covenants limitingdividends and other restricted payments; investments, loans, advances andacquisitions; and prepayments or redemptions of other indebtedness, each permitthe restricted actions in an unlimited amount, subject to the satisfaction ofcertain payment conditions, principally that we must have at least$75.0 million of pro forma excess availability under the Asset-BasedRevolving Credit Facility and that we must be in pro forma compliance with thefixed charge coverage ratio described below.

 

Although the creditagreement governing the Asset-Based Revolving Credit Facility does not requireus to comply with any financial ratio maintenance covenants, if less than$60.0 million were available to be borrowed under the Asset-BasedRevolving Credit Facility at any time, we would not be permitted to borrow anyadditional amounts unless our pro forma ratio of consolidated EBITDA toconsolidated Fixed Charges (as such terms are defined in the credit agreement)were at least 1.1 to 1.0. The credit agreement also contains customaryaffirmative covenants and events of default.

 

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***Senior Secured Term Loan Facility.***On October 6, 2005, in connection withthe Transactions, we entered into a credit agreement and related security andother agreements for a $1,975.0 million Senior Secured Term Loan Facilitywith Credit Suisse as administrative agent and collateral agent.  The fullamount of the Senior Secured Term Loan Facility was borrowed on October 6, 2005.In the second quarter of fiscal 2006, we repaid $100.0 million principal amountof the loans under the Senior Secured Term Loan Facility.

 

Borrowings under theSenior Secured Term Loan Facility bear interest at a rate per annum equal to,at our option, either (a) a base rate determined by reference to the higherof (1) the prime rate of Credit Suisse and (2) the federal fundseffective rate plus 1/2 of 1% or (b) a LIBOR rate, subject to certainadjustments, in each case plus an applicable margin. The applicable margin is1.5% with respect to base rate borrowings and 2.5% with respect to LIBORborrowings. The interest rate on the outstanding borrowings pursuant to theSenior Secured Term Loan Facility was 6.947% at January 28, 2006.

 

The credit agreementgoverning the Senior Secured Term Loan Facility requires us to prepayoutstanding term loans with 50% (which percentage will be reduced to 25% if ourtotal leverage ratio is less than a specified ratio and will be reduced to 0%if our total leverage ratio is less than a specified ratio) of our annualexcess cash flow (as defined in the credit agreement). If a change of control(as defined in the credit agreement) occurs, we will be required to offer toprepay all outstanding term loans, at a prepayment price equal to 101% of theprincipal amount to be prepaid, plus accrued and unpaid interest to the date ofprepayment. We 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.

 

We may voluntarily prepayoutstanding loans under the Senior Secured Term Loan Facility at any timewithout premium or penalty other than customary “breakage” costs with respectto LIBOR loans. If we repay all or any portion of the Senior Secured Term LoanFacility prior to October 6, 2006 (other than a prepayment that is made withcertain designated asset sale proceeds), we must pay 101% of the principalamount to be repaid. There is no scheduled amortization under the SeniorSecured Term Loan Facility. The principal amount of the loans outstanding isdue and payable in full on April 6, 2013.

 

All obligations under theSenior Secured Term Loan Facility are unconditionally guaranteed by Parent andeach direct and indirect domestic subsidiary of the Company that guarantees theobligations of the Company under our Asset-Based Revolving Credit Facility. Allobligations under the Senior Secured Term Loan Facility, and the guarantees ofthose obligations, are secured, subject to certain significant exceptions, bysubstantially all of our assets and the assets of our Parent and the subsidiaryguarantors, including:

 

•      a first-priority pledge of 100% of ourcapital stock and certain of the capital stock held by us, Parent or anysubsidiary guarantor (which pledge, in the case of any foreign subsidiary islimited to 100% of the non-voting stock (if any) and 65% of the voting stock ofsuch foreign subsidiary); and

 

•      a first-priority security interest in,and mortgages on, substantially all other tangible and intangible assets of us,Parent and each subsidiary guarantor, including a significant portion of ourmaterial owned and leased real property (which consists of a majority of ourfull-line retail stores) and equipment, but excluding, among other things, the collateraldescribed in the following bullet point; and

 

•      a second-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by us or the subsidiary guarantors from creditcard clearinghouses and processors or otherwise in respect of all credit cardcharges for sales of inventory by us and the subsidiary guarantors, certainrelated assets and proceeds of the foregoing.

 

Capital stock and othersecurities of a subsidiary of the Company that are owned by the Company or anysubsidiary guarantor will not constitute collateral under our Senior SecuredTerm Loan Facility to the extent that such securities cannot secure our 2028Debentures or other secured public debt obligations without requiring thepreparation and filing of separate financial statements of such subsidiary inaccordance with applicable SEC rules. As a result, the collateral under ourSenior Secured Term Loan Facility will include shares of capital stock or othersecurities of subsidiaries of the Company or any subsidiary guarantor only tothe 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 our Brand Development Companies and their assets also will not constitutecollateral under our Senior Secured Term Loan Facility.

 

The credit agreementgoverning the Senior Secured Term Loan Facility contains a number of negativecovenants that are substantially similar to those governing the Senior Notesand additional covenants related to the security arrangements for the SeniorSecured Term Loan Facility. The credit agreement also contains customaryaffirmative covenants and events of default.

 

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***2028Debentures.***In May 1998, we issued $125.0 millionaggregate principal amount of our 2028 Debentures. In connection with theTransactions, we equally and ratably secured the 2028 Debentures by a firstlien security interest on certain collateral subject to liens granted under ourSenior Secured Credit Facilities constituting (a) (i) 100% of the capital stockof certain of our existing and future domestic subsidiaries, and (ii) 100% ofthe non-voting stock and 65% of the voting stock of certain of our existing andfuture foreign subsidiaries and (b) certain of our principal properties thatinclude a majority of our full-line stores, in each case, to the extentrequired by the terms of the indenture governing our 2028 Debentures. The 2028Debentures contain covenants that restrict our ability to create liens andenter into sale and lease back transactions. The collateral securing the 2028Debentures will be released upon the release of liens on such collateral underour Senior Secured Credit Facilities and any other debt (other than the 2028Debentures) secured by such collateral. Capital stock and other securities of asubsidiary of the Company that are owned by the Company or any subsidiary willnot constitute collateral under our 2028 Debentures to the extent such propertydoes not constitute collateral under our Senior Secured Credit Facilitiesdescribed above.

 

***Senior Notes.***On October 6, 2005, Newton Acquisition Merger Sub., Inc.issued $700.0 million aggregate original principal amount of 9.0% / 9.75%Senior Notes under a senior indenture (Senior Indenture) with Wells Fargo Bank,National Association, as trustee. At the closing of the Transactions, as thesurviving corporation in the Acquisition, we assumed all the obligations ofNewton Acquisition Merger Sub, Inc. under the Senior Indenture.  TheSenior Notes mature on October 15, 2015.

 

Forany interest payment period through October 15, 2010, the Company may, atits option, elect to pay interest on the Senior Notes entirely in cash (CashInterest) or entirely by increasing the principal amount of the outstandingSenior 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 on October 15,2015 and have the same rights and benefits as the Senior Notes issued onOctober 6, 2005. Interest on the Senior Notes is payable quarterly in arrearson each January 15, April 15, July 15 and October 15,commencing on January 15, 2006.

 

The Senior Notes areguaranteed, jointly and severally, on an unsecured, senior basis, by each ofour wholly-owned domestic subsidiaries that guarantee our obligations under ourSenior Secured Credit Facilities and by Parent. The Senior Notes and theguarantees thereof are our and the guarantors’ unsecured, senior obligationsand rank (i) equal in the right of payment with all of our and the guarantors’existing and future senior indebtedness, including any borrowings under ourSenior Secured Credit Facilities and the guarantees thereof and our 2028Debentures; and (ii) senior to all of our and our guarantors’ existing andfuture subordinated indebtedness, including the Senior Subordinated Notes due2015 and the guarantees thereof. The Senior Notes also are effectively juniorin priority to our and our guarantors’ obligations under all securedindebtedness, including our Senior Secured Credit Facilities, our 2028Debentures, and any other secured obligations of ours, in each case, to theextent of the value of the assets securing such obligations. In addition, theSenior Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of our subsidiaries that are notproviding guarantees.

 

The Company is notrequired to make any mandatory redemption or sinking fund payments with respectto the Senior Notes, but under certain circumstances, the Company may berequired to offer to purchase Senior Notes as described below. The Company mayfrom time to time acquire Senior Notes by means other than a redemption,whether by tender offer, in open market purchases, through negotiatedtransactions or otherwise, in accordance with applicable securities laws.

 

Except as describedbelow, the Senior Notes are not redeemable at the Company’s option prior toOctober 15, 2010. From and after October 15, 2010, the Company mayredeem the Senior Notes, in whole or in part, at a redemption price equal to104.5% of principal amount, declining annually to 100% of the principal amounton October 15, 2013, plus accrued and unpaid interest, and Additional Interest(as defined in the Senior Indenture), if any, thereon to the applicableredemption 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 Notes at a redemption price equal to 109.000% of the aggregate principalamount thereof, *plus* accrued andunpaid interest, and Additional Interest, if any, thereon to the redemptiondate, with the net cash proceeds of one or more equity offerings of the Companyor any direct or indirect parent of the Company to the extent such net proceedsare contributed to the Company. At any time prior to October 15, 2010, theCompany also may redeem all or a part of the Senior Notes at a redemption 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.

 

Upon the occurrence of achange of control (as defined in the Senior Indenture), each holder of theSenior Notes has the right to require the Company to repurchase some or all ofsuch holder’s Senior Notes at a price in cash equal to 101% of the aggregateprincipal amount thereof plus accrued and unpaid interest, and AdditionalInterest, if any, to the date of purchase.

 

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The indenture governingthe Senior Notes contains covenants that limit our ability and certain of our subsidiaries’ability to:

 

•      incur additional indebtedness;

 

•      pay dividends on our capital stock orredeem, repurchase or retire our capital stock or subordinated indebtedness;

 

•      make investments;

 

•      create restrictions on the payment ofdividends or other amounts to us from our restricted subsidiaries that are notguarantors of the notes;

 

•      engage in transactions with ouraffiliates;

 

•      sell assets, including capital stock ofour subsidiaries;

 

•      consolidate or merge;

 

•      create liens; and

 

•      enter into sale and lease backtransactions.

 

Our Brand DevelopmentCompanies are not subject to the covenants contained in the Senior Indenture. TheSenior Indenture also provides for events of default, which, if any of themoccurs, would permit or require the principal, premium, if any, interest andany other monetary obligations on all outstanding Senior Notes to be due andpayable immediately.

 

***Senior Subordinated Notes.***On October 6, 2005, Newton AcquisitionMerger Sub., Inc. issued $500.0 million aggregate principal amount of 10.375%Senior Subordinated Notes under a senior subordinated indenture (SeniorSubordinated Indenture) with Wells Fargo Bank, National Association, as trustee.At the closing of the Transactions, as the surviving corporation in theAcquisition, we assumed all the obligations of Newton Acquisition Merger Sub,Inc. under the Senior Subordinated Indenture.  The Senior SubordinatedNotes mature 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.

 

The Senior SubordinatedNotes are guaranteed, jointly and severally, on an unsecured, seniorsubordinated basis, by each of our wholly-owned domestic subsidiaries thatguarantee our obligations under our Senior Secured Credit Facilities and byParent. The Senior Subordinated Notes and the guarantees thereof are our andthe guarantors’ unsecured, senior subordinated obligations and rank (i) juniorto all of our and the guarantors’ existing and future senior indebtedness,including the Senior Notes and any borrowings under our Senior Secured CreditFacilities, and the guarantees thereof and our 2028 Debentures; (ii) equallywith any of our and the guarantors’ future senior subordinated indebtedness;and (iii) senior to any of our and the guarantors’ future subordinatedindebtedness. In addition, the Senior Subordinated Notes are structurallysubordinated to all existing and future liabilities, including trade payables,of our subsidiaries that are not providing guarantees.

 

The Company is notrequired to make any mandatory redemption or sinking fund payments with respectto the Senior Subordinated Notes, but, under certain circumstances, the Companymay be required to offer to purchase Senior Subordinated Notes as describedbelow.  The Company may from time to time acquire Senior SubordinatedNotes by means other than a redemption, whether by tender offer, in open marketpurchases, through negotiated transactions or otherwise, in accordance with applicablesecurities laws.

 

Except as describedbelow, the Senior Subordinated Notes are not redeemable at the Company’s optionprior to October 15, 2010. From and after October 15, 2010, theCompany may redeem the Senior Subordinated Notes, in whole or in part, at aredemption price equal to 105.188% of principal amount, declining annually to100% of principal amount on October 15, 2013, plus accrued and unpaid interest,and Additional Interest (as defined in the Senior Subordinated Indenture), ifany, thereon to the applicable redemption date.

 

Prior to October 15,2008, the Company may, at its option, subject to certain conditions, redeem upto 35% of the original aggregate principal amount of Senior Subordinated Notesat a redemption price equal to 110.375% of the aggregate principal amountthereof, *plus* accrued and unpaidinterest, and Additional Interest, if any, thereon to the redemption date, withthe net cash proceeds of one or more equity offerings of the Company or anydirect or indirect parent of the Company to the extent such net proceeds arecontributed to the Company.

 

At any time prior toOctober 15, 2010, the Company also may redeem all or a part of the SeniorSubordinated Notes at a redemption price equal to 100% of the principal amountof Senior Subordinated Notes redeemed plus an applicable premium, as providedin the Senior Subordinated Indenture, as of, and accrued and unpaid interestand Additional Interest, if any, to the redemption date.

 

Upon the occurrence of achange of control (as defined in the Senior Subordinated Indenture), theCompany will make an offer to purchase all of the Senior Subordinated Notes ata price in cash equal to 101% of the aggregate principal amount thereof plusaccrued and unpaid interest, and Additional Interest, if any, to the date ofpurchase.

 

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The indenture governingthe Senior Subordinated Notes contains covenants substantially similar to thoseapplicable to our Senior Notes described above. The Senior SubordinatedIndenture also provides for events of default, which, if any of them occurs,would permit or require the principal, premium, if any, interest and any othermonetary obligations on all outstanding Senior Notes to be due and payableimmediately, subject to certain exceptions.

 

***Redemptionof 2008 Notes.***In May 1998, we issued $125.0 million aggregate principalamount of our 2008 Notes. Upon closing of the Transactions, we called our 2008Notes for redemption pursuant to their terms. On November 7, 2005, we used$134.7 million of reserved cash to redeem our 2008 Notes, which included a callpremium of $6.2 million plus accrued interest of $3.5 million through theredemption date.

*** ***

***Maturitiesof Long-Term Debt.***At January 28, 2006, annual maturitiesof long-term debt during the next five years and thereafter are as follows (inmillions):

 
| 2006       |   | $       | — |   |
|------------|--------|---------|--------|--------|
| 2007       |   | —  |   |
| 2008       |   | —  |   |
| 2009       |   | —  |   |
| 2010       |   | —  |   |
| Thereafter |   | 3,195.6 |   |

 

***InterestRate Swaps.***We use derivative financial instruments tohelp manage our interest rate risk. Effective December 6, 2005, we entered intofloating to fixed interest rate swap agreements for an aggregate notionalamount of $1,000.0 million to limit our exposure to interest rate increasesrelated to a portion of our floating rate indebtedness. The interest rate swapagreements terminate after five years. As of the effective date, we designatedthe interest rate swaps as cash flow hedges. As a result, changes in the fairvalue of our swaps will be recorded subsequent to the effective date as acomponent of other comprehensive income.

 

At January 28, 2006, thefair value of these swaps was a gain of approximately $3.0 million, whichamount is included in other assets. As a result of our swap agreements, oureffective fixed interest rates as to the $1,000.0 million in floating rateindebtedness will range from 6.931% to 7.499% per quarter and result in anaverage fixed rate of 7.285%.

 

9.     EmployeeBenefit Plans

 

***Descriptionof Benefit Plans.***We sponsor a defined benefit pensionplan (Pension Plan) covering substantially all full-time employees. We alsosponsor an unfunded supplemental executive retirement plan (SERP Plan) thatprovides additional pension benefits to certain employees. Benefits under bothplans are based on the employees’ years of service and compensation overdefined periods of employment. Pension Plan assets consist primarily of equityand fixed income securities.

 

Retirees and activeemployees hired prior to March 1, 1989 are eligible to participate in a planproviding certain limited postretirement health care benefits (PostretirementPlan) if they have met certain service and minimum age requirements.

 

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***Costsof Benefits.***The components of the expenses incurredunder our Pension Plan, SERP Plan and Postretirement Plan are as follows:

** **
| ** **                                          | ** ** | **Quarter-to-Date**                                    | ** ** | **Year-to-Date**                                       | ** **        |
|-----------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|-------------------|
| **(in thousands)**                             | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** **        | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
| ** **                                          | ** ** | **(Successor)**                                        | ** ** | ** **                                             | **(Predecessor)** | ** ** | **(Successor)** | ** ** | ** ** | **(Predecessor)** | ** ** | **(Predecessor)** | ** ** |
| Pension Plan:                                       |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| Service cost                                        |       | $                                                      | 4,027      |                                                   |              | $ | 3,196 |   | $ | 5,266 |   |   | $ | 2,823 |   | $ | 6,392 |   |
| Interest cost                                       |       | 5,250                                                  |       |                                                   | 4,636             |   | 6,865 |   |   | 3,468 |   | 9,271 |   |
| Expected return  on plan assets                     |       | (5,684                                                 | )          |                                                   | (4,712            | ) | (7,434 | ) |   | (3,636 | ) | (9,425 | ) |
| Net amortization  of losses and prior service costs |       | —                                                 |       |                                                   | 1,208             |   | — |   |   | 1,205 |   | 2,418 |   |
| Pension Plan  expense                               |       | $                                                      | 3,593      |                                                   |              | $ | 4,328 |   | $ | 4,697 |   |   | $ | 3,860 |   | $ | 8,656 |   |
|                                                |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| SERP Plan:                                          |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| Service cost                                        |       | $                                                      | 474        |                                                   |              | $ | 361 |   | $ | 620 |   |   | $ | 330 |   | $ | 722 |   |
| Interest cost                                       |       | 1,114                                                  |       |                                                   | 1,014             |   | 1,457 |   |   | 730 |   | 2,028 |   |
| Net amortization  of losses and prior service costs |       | —                                                 |       |                                                   | 384               |   | — |   |   | 394 |   | 768 |   |
| SERP Plan  expense                                  |       | $                                                      | 1,588      |                                                   |              | $ | 1,759 |   | $ | 2,077 |   |   | $ | 1,454 |   | $ | 3,518 |   |
|                                                |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| Postretirement  Plan:                               |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| Service cost                                        |       | $                                                      | 12         |                                                   |              | $ | 15 |   | $ | 15 |   |   | $ | 8 |   | $ | 29 |   |
| Interest cost                                       |       | 214                                                    |       |                                                   | 318               |   | 280 |   |   | 139 |   | 636 |   |
| Net amortization  of (gains) losses                 |       | —                                                 |       |                                                   | 26                |   | — |   |   | (5 | ) | 53 |   |
| Postretirement  expense                             |       | $                                                      | 226        |                                                   |              | $ | 359 |   | $ | 295 |   |   | $ | 142 |   | $ | 718 |   |

 

***PurchaseAccounting Adjustments.***In connection with theAcquisition, the obligations and assets related to our benefit plans werevalued at fair value as of the date of the Acquisition, using a discount rateof 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  benefit plan obligations                                     |       | $                 | 47,281     |           | $          | 10,645                   |       | $ | (2,924 | ) |

 

***Funding Policy and Plan Assets.***Our policy is tofund the Pension Plan at or above the minimum required by law. In 2005, we madevoluntary contributions of $20.0 million for the plan year ended July 31, 2004.Based upon currently available information, we will not be required to makecontributions to the Pension Plan for either the 2006 or 2005 plan years;however, we could decide to make a voluntary contribution based on ourevaluation of the Pension Plan.

 

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***Effectof Medicare Subsidy on Postretirement Plan.***InDecember 2003, the U.S. Congress enacted the Medicare Prescription Drug,Improvement and Modernization Act of 2003 (Act) that provides a prescriptiondrug subsidy, beginning in January 2006, to companies that sponsorpostretirement health care plans that provide drug benefits. Based upon theprovisions of the legislation enacted in January 2005, we reviewed theprovisions of our Postretirement Plan with our actuaries to determine whetherthe benefits offered by our plan met the statutory definition of “actuariallyequivalent” prescription drug benefits that qualify for the federal subsidy. Basedupon this review, we believe that our benefits qualify for the subsidy. Weestimate the annual federal subsidy to be received in the next ten years underthe Act to be approximately $0.2 million, which subsidy was considered inthe determination of the fair value of the Postretirement Plan as of the dateof the Acquisition.

 

10.   Segments

 

We have identified two reportable segments: Specialty Retail Stores andDirect Marketing. The Specialty Retail Stores segment includes all of ourNeiman Marcus and Bergdorf Goodman retail stores, including Neiman Marcusclearance stores. The Direct Marketing segment conducts both print catalog andonline operations under the Neiman Marcus, Horchow and Bergdorf Goodman brandnames. Other includes our 51% interest in Gurwitch Products, L.L.C., whichdesigns and markets the Laura Mercier cosmetic line, and our 56% interest inKate Spade LLC, which designs and retails high-end designer handbags andaccessories.

 

Both the Specialty Retail Stores and Direct Marketing segments, as wellas Kate Spade LLC and Gurwitch Products, L.L.C., derive their revenues from thesale of high-end fashion apparel, accessories, cosmetics and fragrances fromleading designers, precious and fashion jewelry and decorative homeaccessories.

 

Thefollowing table sets forth the information for our reportable segments:

** **
| ** **                                                                                        | ** ** | **Quarter-to-Date**                                    | ** ** | **Year-to-Date**                                       | ** **        |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|-------------------|
| **(in thousands)**                                                                           | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** **        | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
| ** **                                                                                        | ** ** | **(Successor)**                                        | ** ** | ** **                                             | **(Predecessor)** | ** ** | **(Successor)** | ** ** | ** ** | **(Predecessor)** | ** ** | **(Predecessor)** | ** ** |
|                                                                                              |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| REVENUES:                                                                                         |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | $                                                      | 981,501    |                                                   |              | $ | 911,982 |   | $ | 1,243,911 |   |   | $ | 544,857 |   | $ | 1,648,872 |   |
| Direct Marketing                                                                                  |       | 212,980                                                |       |                                                   | 188,183           |   | 264,382 |   |   | 87,515 |   | 327,982 |   |
| Other                                                                                             |       | 36,935                                                 |       |                                                   | 29,060            |   | 47,913 |   |   | 19,276 |   | 60,307 |   |
| Total                                                                                             |       | $                                                      | 1,231,416  |                                                   |              | $ | 1,129,225 |   | $ | 1,556,206 |   |   | $ | 651,648 |   | $ | 2,037,161 |   |
|                                                                                              |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| OPERATING  EARNINGS:                                                                              |       |                                                   |       |                                                   |              |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | $                                                      | 94,317     |                                                   |              | $ | 98,688 |   | $ | 138,382 |   |   | $ | 91,372 |   | $ | 218,877 |   |
| Direct Marketing                                                                                  |       | 37,915                                                 |       |                                                   | 27,893            |   | 44,329 |   |   | 8,246 |   | 39,251 |   |
| Other                                                                                             |       | 2,973                                                  |       |                                                   | 2,809             |   | 4,161 |   |   | (1,923 | ) | 5,669 |   |
| Subtotal                                                                                          |       | 135,205                                                |       |                                                   | 129,390           |   | 186,872 |   |   | 97,695 |   | 263,797 |   |
| Corporate  expenses                                                                               |       | (13,154                                                | )          |                                                   | (9,730            | ) | (16,317 | ) |   | (5,809 | ) | (18,874 | ) |
| Amortization of  customer lists and favorable lease commitments                                   |       | (18,887                                                | )          |                                                   | —            |   | (23,824 | ) |   | — |   | — |   |
| Non-cash charges  related to other valuation adjustments made in connection with the  Acquisition |       | (30,646                                                | )          |                                                   | —            |   | (38,478 | ) |   | — |   | — |   |
| Transaction and  other costs                                                                      |       | —                                                 |       |                                                   | —            |   |   |   |   | (23,544 | ) |   |   |
| Loss on  disposition of Chef’s Catalog                                                       |       | —                                                 |       |                                                   | —            |   | — |   |   | — |   | (15,348 | ) |
| Total                                                                                             |       | $                                                      | 72,518     |                                                   |              | $ | 119,660 |   | $ | 108,253 |   |   | $ | 68,342 |   | $ | 229,575 |   |

 

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**11.**   Commitments and Contingencies

** **

***Investmentsin Brand Development Companies.***Our investments in andrelationships with our Brand Development Companies are governed by operatingagreements that provide for an orderly transition process in the event any investorwishes to sell its interest, or purchase another investor’s interest. Amongother things, these operating agreements contain currently exercisable putoption provisions entitling each minority investor to put their interest to us,and currently exercisable call option provisions entitling us to purchase eachminority investor’s interest, at a purchase price mutually agreed to by theparties. The purchase price will be determined, in the case of the Gurwitchinterests, by one or more nationally recognized investment banking firms and,in the case of the Kate Spade interests, by the parties or, in the event theparties are unable to agree on a mutually acceptable price, by a mutuallyacceptable nationally recognized investment banking firm, subject to certainconditions. We may elect, in certain circumstances, to defer the consummationof a put option for a period of six months by cooperating with the otherinvestors in seeking either a sale of the relevant Brand Development Company toa third party or a public offering of the relevant Brand Development Company’ssecurities. If a sale to a third party or public offering of the relevant BrandDevelopment Company’s securities is not consummated within six months after theexercise of the put option (which period may be automatically extended for anadditional two months if a registration statement for the relevant BrandDevelopment Company is filed with the Securities and Exchange Commission), weare obligated to consummate the put option. Under the terms of the Kate Spadeoperating agreement, such consummation shall occur within thirty days after thedetermination of the valuation with respect to the exercise of the put option.

 

Recently, we have been in discussions with the minority investors ofeach of the Brand Development Companies regarding certain strategicalternatives, including the possible sale of each company. However, althoughsuch discussions are ongoing, no assurance can be given that they willultimately lead to any transactions.

 

***Litigation.***We are currently involved in variouslegal actions and proceedings that arose in the ordinary course of ourbusiness. We believe that any liability arising as a result of these actionsand proceedings will not have a material adverse effect on our financial position,results of operations or cash flows.

 

On May 4, 2005, a purported class action complaint, NECA-IBEWPension Fund (The Decatur Plan) v. The Neiman Marcus Group, Inc. et al.(CA No. 3-05 CV-0898B), was filed by a putative stockholder in federalcourt in the Northern District of Texas against our Company and its directorschallenging the proposed merger. An amended complaint was filed onJuly 25, 2005. The amended complaint alleged a cause of action for breachof fiduciary duty against us and our directors, claiming, among other things,that the defendants had endeavored to complete the sale of our Company and itsassets at a grossly inadequate and unfair price and pursuant to an unfairprocess that failed to maximize shareholder value. In addition, the amendedcomplaint alleged that our directors were not independent and breached theirfiduciary duties in connection with the approval of the merger by, among otherthings, (i) tailoring the transaction to serve the interests of the defendantsand the family of Richard A. Smith, the then chairman of our board of directorsand our largest stockholder, rather than structuring the merger to obtain thehighest price for stockholders, (ii) depriving public stockholders of the valueof certain assets (including the credit card business and our third quarter2005 profits), (iii) failing to realize the financial benefits from the sale ofthe credit 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. Followingthe closing of the merger, plaintiff voluntarily dismissed the lawsuit withprejudice as moot on December 1, 2005, and provided a release of all of thedefendants for claims arising out of the merger. The Company paid plaintiff’sattorneys’ fees in connection with certain disclosures requested by plaintiffand included in the proxy statement sent to the shareholders regarding themerger.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

**EXECUTIVEOVERVIEW**

 

The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with our Annual Report onForm 10-K for the fiscal year ended July 30, 2005. Unless otherwise specified,the meanings of all defined terms in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations (MD&A) are consistent withthe meanings of such terms as defined in the Notes to the CondensedConsolidated Financial Statements. This discussion contains forward-lookingstatements. Please see “Forward-Looking Statements” for a discussion of therisks, uncertainties and assumptions relating to our forward-lookingstatements.

 

**Overview**

 

The Neiman Marcus Group, Inc., together with our operatingsegments and subsidiaries, is a high-end specialty retailer. Our operationsinclude the Specialty Retail Stores segment and the Direct Marketing segment.The Specialty Retail Stores segment consists primarily of Neiman Marcus andBergdorf Goodman stores. The Direct Marketing segment conducts both printcatalog and online operations under the brand names of Neiman Marcus, BergdorfGoodman, Horchow and Chef’s Catalog (prior to its disposition in November 2004).We own a 51% interest in Gurwitch Products, L.L.C., which designs and marketsthe Laura Mercier cosmetic line, and a 56% interest in Kate Spade LLC, whichdesigns and retails high-end designer handbags and accessories (the BrandDevelopment 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 the Transactions, the Company incurred significantindebtedness and became highly leveraged. 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 ourdiscussion of the results of operations for the six months (twenty-six weeks)ended January 28, 2006 by comparing the results of operations of thePredecessor for the twenty-six weeks ended January 29, 2005 to the combinedamounts obtained by adding the earnings and cash flows for the Predecessornine-week period ended October 1, 2005 and the Successor seventeen-week periodended January 28, 2006. Although this combined presentation does not complywith generally accepted accounting principles (GAAP), we believe that itprovides a meaningful method of comparison. The combined operating results havenot been prepared on a pro forma basis under applicable regulations and may notreflect the actual results we would have achieved absent the Transactions andmay not be predictive of future results of operations.

 

Our fiscal year ends onthe Saturday closest to July 31. All references to the second quarter of fiscal2006 relate to the thirteen weeks ended January 28, 2006 of the Successor. Allreferences to the second quarter of fiscal 2005 relate to the thirteen weeksended January 29, 2005 of the Predecessor. All references to year-to-datefiscal 2006 relate to the combined twenty-six weeks ended January 28, 2006(calculated as described above) and all references to year-to-date fiscal 2005relate to the twenty-six weeks ended January 29, 2005.

 

21

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**FactorsAffecting 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:

 

•      Sale 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 are primarily affected by the 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 are seasonal. For a description of theseasonality of our business, see “—Seasonality.”

 

***Cost of goods soldincluding buying and occupancy costs.***Our cost of goodssold including buying and occupancy costs (COGS) consists of the followingcomponents:

 

•      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 new fashions in the first and third quartersand our emphasis on full-price selling in these quarters, a lower level ofmarkdowns and higher margins are characteristic of these quarters.

 

Consistent with industry business practice, we receive allowances fromcertain of our vendors in support of the merchandise we purchase for resale.Certain allowances are received to reimburse us for markdowns taken or tosupport the gross margins that we realize in connection with the sales of thevendor’s merchandise. These allowances result in an increase to gross marginwhen we earn

 

22

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the allowances and they are approved by the vendor. Other allowances wereceive represent reductions to the amounts we pay to acquire the merchandise.These allowances reduce the cost of the acquired merchandise and are recognizedat the time the goods are sold.

 

Changes in our COGS as a percentage of revenues are affected primarilyby 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, generaland administrative expenses.***Selling, general andadministrative (SG&A) expenses principally consist of costs related toemployee compensation and benefits in the selling and administrative supportareas, advertising and catalog costs and insurance expenses. A significantportion of our selling, general and administrative expenses are variable innature and are dependent on the sales we generate.

 

Advertising costs incurred by our Specialty Retail segment consistprimarily of print media costs related to promotional materials mailed to ourcustomers, while advertising costs incurred by our Direct Marketing operationrelate to the production, printing and distribution of our print catalogs andthe production of the photographic content on our websites, as well as onlinemarketing costs. We receive advertising allowances from certain of ourmerchandise vendors. Substantially all the advertising allowances we receiverepresent reimbursements of direct, specific and incremental costs that weincur to promote the vendor’s merchandise in connection with our variousadvertising programs, primarily catalogs and other print media. As a result,these allowances are recorded as a reduction of our advertising costs whenearned.

 

We also receive allowances from certain merchandise vendors inconjunction with compensation programs for employees who sell the vendor’smerchandise. These allowances are netted against the related compensationexpense that we incur.

 

Changes in our selling, general and administrative expenses areaffected 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.

 

***Incomefrom credit card operations, net.***Prior to the CreditCard Sale on July 7, 2005, our credit card operations generated financecharge income, net of credit losses, which we recognized as income when earned.As a part of the Credit Card Sale, we entered into a long-term marketing andservicing alliance with HSBC. Under the terms of this alliance, HSBC offerscredit card and non-card payment plans bearing our brands and we receiveongoing payments from HSBC based on net credit card sales and compensation formarketing and servicing activities (HSBC Program Income). We recognize HSBCProgram Income when earned. We previously presented income from credit cardoperations as a reduction to selling, general and administrative expenses. Beginningwith this report on Form 10-Q, we now present this income as a separate line onour statements of earnings and have reclassified prior periods to conform tothis presentation.

 

As a percentage ofrevenues, the HSBC Program Income is lower than the net finance charge incomewe earned prior to the Credit Card Sale. However, the resulting decrease inincome from credit card operations is mitigated, in part, by 1) decreases inSG&A expenses we incur due to the transfer of certain servicing functionsto HSBC after the sale, 2) decreases in our capital investments related to theservicing of the credit card portfolio and 3) decreases in carrying costsrelated to our previous funding of the seasonal working capital requirements ofthe credit card portfolio. In tandem with HSBC, we have initiated variouschanges in our credit card

 

23

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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 Program Income 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 selling activities in two primary selling seasons—Falland Spring. The Fall Season is comprised of our first and second fiscalquarters and the Spring Season is comprised of our third and fourth fiscalquarters.

 

Our first fiscal quarter is generally characterized by a higher levelof full-price selling with a focus on the initial introduction of Fall Seasonfashions. Aggressive in-store marketing activities designed to stimulatecustomer buying, a lower level of markdowns and higher margins arecharacteristic of this quarter. The second fiscal quarter is more focused onpromotional activities related to the December holiday season, the earlyintroduction of resort season collections from certain designers and the saleof Fall Season goods on a marked down basis. As a result, margins are typicallylower in the second fiscal quarter. However, due to the seasonal increase insales that occurs during the holiday season, the second fiscal quarter istypically the quarter in which our revenues are the highest and in whichexpenses as a percentage of revenues are the lowest. Our working capitalrequirements are also the greatest in the first and second fiscal quarters as aresult of higher seasonal requirements.

 

Similarly, the third fiscal quarter is generally characterized by ahigher level of full-price selling with a focus on the initial introduction ofSpring Season fashions. Aggressive in-store marketing activities designed tostimulate customer buying, a lower level of markdowns and higher margins areagain characteristic of this quarter. Revenues are generally the lowest in thefourth fiscal quarter with a focus on promotional activities offering SpringSeason goods to the customer on a marked down basis, resulting in lower marginsduring the quarter. Our working capital requirements are typically lower in thethird and fourth fiscal quarters than in the other quarters.

 

A large percentage of our merchandise assortment, particularly in theapparel, fashion accessories and shoe categories, is ordered months in advanceof the introduction of such goods, typically three to nine months in advance ofthe products being offered for sale. As a result, inherent in the successfulexecution of our business plans is our ability both to predict the fashiontrends that will be of interest to our customers and to anticipate futurespending patterns of our customer base.

 

We monitor the sales performance of our inventories throughout eachseason. We seek to order additional goods to supplement our original purchasingdecisions when the level of customer demand is higher than originallyanticipated. However, in certain merchandise categories, particularly fashionapparel, our ability to purchase additional goods can be limited. This canresult in lost sales in the event of higher than anticipated demand of thefashion goods we offer or a higher than anticipated level of consumer spending.Conversely, in the event we buy fashion goods that are not accepted by thecustomer or the level of consumer spending is less than we anticipated, wetypically incur a higher than anticipated level of markdowns, net of vendorallowances, to sell the goods that remain at the end of the season, resultingin lower operating profits. We believe that the experience of our merchandisingand selling organizations helps to minimize the inherent risk in predictingfashion 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  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** ** | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Twenty-six  weeks ended  January 28,  2006** | ** ** | **Twenty-six  weeks ended  January 29,  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  |       | 67.9                                                   |       | 65.1                                                   |       | 66.3 |   | 58.1 |   | 63.9 |   | 62.2 |   |
| Selling, general  and administrative expenses             |       | 23.2                                                   |       | 23.4                                                   |       | 23.7 |   | 25.9 |   | 24.3 |   | 24.9 |   |
| Income from  credit card operations, net                  |       | (1.4                                                   | )          | (1.6                                                   | )          | (1.3 | ) | (1.2 | ) | (1.3 | ) | (1.6 | ) |
| Depreciation  expense                                     |       | 2.9                                                    |       | 2.4                                                    |       | 2.9 |   | 3.1 |   | 2.9 |   | 2.5 |   |
| Amortization of  customer lists                           |       | 1.2                                                    |       | —                                                 |       | 1.2 |   | — |   | 0.8 |   | — |   |
| Amortization of  favorable lease commitments              |       | 0.3                                                    |       | —                                                 |       | 0.3 |   | — |   | 0.3 |   | — |   |
| Transaction and  other costs                              |       | —                                                 |       | —                                                 |       | — |   | 3.6 |   | 1.1 |   | — |   |
| Loss on  disposition of Chef’s Catalog               |       | —                                                 |       | —                                                 |       | — |   | — |   | — |   | 0.7 |   |
| Operating  earnings                                       |       | 5.9                                                    |       | 10.6                                                   |       | 7.0 |   | 10.5 |   | 8.0 |   | 11.3 |   |
| Interest expense  (income), net                           |       | 5.4                                                    |       | 0.4                                                    |       | 5.4 |   | (0.1 | ) | 3.7 |   | 0.4 |   |
| Earnings before  income taxes and minority interest       |       | 0.5                                                    |       | 10.2                                                   |       | 1.6 |   | 10.6 |   | 4.3 |   | 10.9 |   |
| Income taxes                                              |       | 0.2                                                    |       | 3.9                                                    |       | 0.6 |   | 3.9 |   | 1.6 |   | 4.2 |   |
| Earnings before  minority interest                        |       | 0.3                                                    |       | 6.3                                                    |       | 1.0 |   | 6.7 |   | 2.7 |   | 6.7 |   |
| Minority  interest in net (earnings) loss of subsidiaries |       | (0.1                                                   | )          | (0.1                                                   | )          | (0.1 | ) | 0.1 |   | (0.1 | ) | (0.1 | ) |
| Net earnings                                              |       | 0.2                                                    | %          | 6.3                                                    | %          | 0.9 | % | 6.8 | % | 2.6 | % | 6.6 | % |

 

In connection with the Transactions, the Company incurred significantindebtedness and became highly leveraged. 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.

 

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Set forth in thefollowing table is certain summary information with respect to our operationsfor the periods indicated.

 
| ** **                                                                                        | ** ** | **Quarter-to-Date**                                    | ** ** | **Year-to-Date**                                       | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **(dollars in millions)**                                                               | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** ** | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Twenty-six  weeks ended  January 28,  2006** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
| ** **                                                                                        | ** ** | **(Successor)**                                        | ** ** | **(Predecessor)**                                      | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** | **(Combined)** | ** ** | **(Predecessor)** | ** ** |
| REVENUES                                                                                          |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | $                                                      | 981.5      |                                                   | $          | 912.0 |   | $ | 1,243.9 |   | $ | 544.9 |   | $ | 1,788.8 |   | $ | 1,648.9 |   |
| Direct Marketing                                                                                  |       | 213.0                                                  |       | 188.2                                                  |       | 264.4 |   | 87.5 |   | 351.9 |   | 328.0 |   |
| Other (1)                                                                                         |       | 36.9                                                   |       | 29.0                                                   |       | 47.9 |   | 19.2 |   | 67.2 |   | 60.3 |   |
| Total                                                                                             |       | $                                                      | 1,231.4    |                                                   | $          | 1,129.2 |   | $ | 1,556.2 |   | $ | 651.6 |   | $ | 2,207.9 |   | $ | 2,037.2 |   |
|                                                                                              |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| OPERATING  EARNINGS                                                                               |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | $                                                      | 94.3       |                                                   | $          | 98.7 |   | $ | 138.4 |   | $ | 91.4 |   | $ | 229.8 |   | $ | 218.9 |   |
| Direct Marketing                                                                                  |       | 37.9                                                   |       | 27.9                                                   |       | 44.3 |   | 8.2 |   | 52.5 |   | 39.3 |   |
| Other (1)                                                                                         |       | 3.0                                                    |       | 2.8                                                    |       | 4.2 |   | (2.0 | ) | 2.2 |   | 5.7 |   |
| Subtotal                                                                                          |       | 135.2                                                  |       | 129.4                                                  |       | 186.9 |   | 97.6 |   | 284.5 |   | 263.9 |   |
| Corporate  expenses                                                                               |       | (13.2                                                  | )          | (9.7                                                   | )          | (16.3 | ) | (5.8 | ) | (22.1 | ) | (19.0 | ) |
| Amortization of  customer lists and favorable lease commitments                                   |       | (18.9                                                  | )          | —                                                 |       | (23.8 | ) | — |   | (23.8 | ) | — |   |
| Non-cash charges  related to other valuation adjustments made in connection with the  Acquisition |       | (30.6                                                  | )          | —                                                 |       | (38.5 | ) | — |   | (38.5 | ) | — |   |
| Transaction and  other costs                                                                      |       | —                                                 |       | —                                                 |       | — |   | (23.5 | ) | (23.5 | ) | — |   |
| Loss on  disposition of Chef’s Catalog                                                       |       | —                                                 |       | —                                                 |       | — |   | — |   | — |   | (15.3 | ) |
| Total                                                                                             |       | $                                                      | 72.5       |                                                   | $          | 119.7 |   | $ | 108.3 |   | $ | 68.3 |   | $ | 176.6 |   | $ | 229.6 |   |
|                                                                                              |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| OPERATING PROFIT  MARGIN                                                                          |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | 9.6                                                    | %          | 10.8                                                   | %          | 11.1 | % | 16.8 | % | 12.8 | % | 13.3 | % |
| Direct Marketing                                                                                  |       | 17.8                                                   | %          | 14.8                                                   | %          | 16.8 | % | 9.4 | % | 14.9 | % | 12.0 | % |
| Total                                                                                             |       | 5.9                                                    | %          | 10.6                                                   | %          | 7.0 | % | 10.5 | % | 8.0 | % | 11.3 | % |
|                                                                                              |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| CHANGE IN  COMPARABLE REVENUES (2)                                                                |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | 4.5                                                    | %          | 9.6                                                    | %          | 5.0 | % | 9.8 | % | 6.4 | % | 10.3 | % |
| Direct Marketing                                                                                  |       | 13.2                                                   | %          | 15.8                                                   | %          | 12.9 | % | 9.6 | % | 12.1 | % | 14.7 | % |
| Total                                                                                             |       | 6.4                                                    | %          | 10.4                                                   | %          | 6.6 | % | 9.0 | % | 7.3 | % | 10.8 | % |
|                                                                                              |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| SALES PER SQUARE  FOOT                                                                            |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Specialty Retail  Stores                                                                          |       | $                                                      | 177        |                                                   | $          | 170 |   | $ | 226 |   | $ | 103 |   | $ | 329 |   | $ | 308 |   |
|                                                                                              |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| STORE COUNT                                                                                       |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Neiman Marcus  and Bergdorf Goodman stores:                                                       |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Open at  beginning of period                                                                      |       | 37                                                     |       | 37                                                     |       | 37 |   | 36 |   | 36 |   | 37 |   |
| Opened during  the period                                                                         |       | 1                                                      |       | —                                                 |       | 1 |   | 1 |   | 2 |   | — |   |
| Open at end of  period                                                                            |       | 38                                                     |       | 37                                                     |       | 38 |   | 37 |   | 38 |   | 37 |   |
| Clearance  centers:                                                                               |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Open at  beginning of period                                                                      |       | 17                                                     |       | 14                                                     |       | 17 |   | 16 |   | 16 |   | 14 |   |
| Opened during  the period                                                                         |       | —                                                 |       | 1                                                      |       | — |   | 1 |   | 1 |   | 1 |   |
| Open at end of  period                                                                            |       | 17                                                     |       | 15                                                     |       | 17 |   | 17 |   | 17 |   | 15 |   |

 

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(1)   Other includes the operations of theBrand Development Companies.

 

(2)   Comparable revenues include 1) revenuesderived from our retail stores open for more than 52 weeks, including storesthat have been relocated or expanded, 2) revenues from our Direct Marketingoperation and 3) revenues from our Brand Development Companies. Comparablerevenues exclude the revenues of closed stores and the revenues of our Chef’sCatalog operations (sold in November 2004) for all periods prior to the Chef’sCatalog Disposition.

 

26

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**Second 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 second fiscal quarterand year-to-date fiscal 2006 operating results is as follows:

 

•      **Revenues**—We generated revenue growth in the quarterly and year-to-datefiscal periods ended January 28, 2006 of 9.0% and 8.4%, respectively. Theseincreases were attributable to 1) increases in comparable revenues, 2) revenuesderived from two new full-line stores and 3) the growth of internet sales.

 

Comparable revenuesincreased 6.4% in the second quarter of fiscal 2006 and 7.3% in theyear-to-date fiscal period.

 

For Specialty Retail Stores,our sales per square foot for the last twelve trailing months increased to $597as of January 2006 compared to $559 as of January 2005.

 

•      **Cost ofgoods sold including buying and occupancy costs**—Cost of goods sold including buying and occupancycosts represented 67.9% of revenues in the second quarter of fiscal 2006 and65.1% of revenues in the second quarter of fiscal 2005. This increase was dueprimarily to the purchase accounting adjustments in the second quarter offiscal 2006 of $31.7 million, or 2.6% of revenues, related to the step-up incarrying value of inventories acquired in connection with the Transactions. Inaddition, we incurred a higher level of net markdowns in the second quarter offiscal 2006 than in the corresponding quarter in fiscal 2005.

 

Cost ofgoods sold including buying and occupancy costs represented 63.9% of revenuesin the combined year-to-date fiscal period of 2006 and 62.2% of revenues in thecorresponding fiscal period in 2005. This increase was primarily due topurchase accounting adjustments in fiscal 2006 of $39.6 million, or 1.8% ofrevenues.

 

•      **Selling,general and administrative expenses**—Selling,general and administrative expenses decreased in the second quarter of fiscal2006 to 23.2% of revenues from 23.4% of revenues in the second quarter offiscal 2005 and decreased in the year-to-date fiscal period of 2006 to 24.3% ofrevenues from 24.9% of revenues in the corresponding fiscal period of 2005.

 

•      **Operatingearnings—**For the second quarter offiscal 2006, our operating earnings were $72.5 million, or 5.9% ofrevenues, compared to $119.7 million, or 10.6% of revenues, in the prior fiscalyear quarter. For year-to-date fiscal 2006, our operating earnings were $176.6million, or 8.0% of revenues, compared to $229.6 million, or 11.3% of revenuesfor the year-to-date fiscal 2005 period. Operating earnings in both the secondquarter and year-to-date periods in fiscal 2006 were negatively impacted by 1)higher depreciation and amortization expenses due to higher asset valuesresulting from the revaluation of our assets to fair value as of theAcquisition date and 2) costs incurred in connection with the Transactions. Theseexpenses aggregated $49.5 million, or 4.0% of revenues, in the second quarterof fiscal 2006 and $85.8 million, or 3.9% of revenues, in the year-to-datefiscal period of 2006. In addition, operating earnings, as a percentage of revenues,were negatively impacted by 1) higher depreciation charges as a result ofhigher levels of capital expenditures for new stores and store remodels inrecent years, 2) a lower level of income from our credit card operations due tothe sale of our credit card operations to HSBC in July 2005 and 3) a higherlevel of net markdowns in the second quarter of fiscal 2006 than in thecorresponding quarter in fiscal 2005.

 

**Thirteen Weeks Ended January 28, 2006 Compared toThirteen Weeks Ended January 29, 2005**

** **

***Revenues.***Ourrevenues for the second quarter of fiscal 2006 of $1,231.4 million increased$102.2 million, or 9.0%, from $1,129.2 million in the second quarter of fiscal2005. This increase in our revenues is attributable to increases in comparablerevenues, revenues from new stores and higher internet sales. Revenuesincreased in the second quarter of fiscal 2006 compared to the prior yearfiscal period at all our operating companies.

 

Comparable revenues in the second quarter of fiscal 2006 increased 6.4%compared to the prior year fiscal period. Comparable revenues increased 4.5%for Specialty Retail Stores and 13.2% for Direct Marketing. Comparable revenuesincreased 21.5% for the Brand Development Companies in the second quarter offiscal 2006 compared to the prior year fiscal period. The increase incomparable revenues for the Brand Development Companies during the secondquarter of fiscal 2006 relates primarily to Kate Spade and reflects 1) theshifting of certain wholesale sales from the first quarter of fiscal 2006 tothe second quarter of fiscal 2006 and 2) the acceleration of end-of-seasonclearance sales into the second quarter of fiscal 2006. These clearance saleswere conducted primarily in the third quarter of fiscal 2005.

 

27

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New stores generated sales of $37.7 million in the second quarter offiscal 2006. In the second quarter of fiscal 2006, internet sales by DirectMarketing were $134.1 million, an increase of 36.2% compared to the secondquarter of fiscal 2005.

 

***Cost of goods sold including buying andoccupancy costs.***Cost of goods sold includingbuying and occupancy costs (COGS) for the second quarter of fiscal 2006 andfiscal 2005 were:

 
| ** **                                                                                                                | ** ** | **Thirteen weeks ended  January 28, 2006  (Successor)** | ** ** | **Thirteen weeks ended  January 29, 2005  (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| **(in millions, except percentages)**                                                                      | ** ** | **$**                                                                  | ** ** | **% of  revenues**                                                  | ** ** | **$** | ** ** | **% of  revenues** | ** ** |
| COGS, before purchase accounting  adjustments                                                                             |       | $                                                                      | 804.2      |                                                                     | 65.3%      |   | $ | 735.7 |   | 65.1% |   |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of acquired inventories |       | 31.7                                                                   |       | 2.6                                                                      |       | — |   | — |   |
| COGS, as reported                                                                                                         |       | $                                                                      | 835.9      |                                                                     | 67.9%      |   | $ | 735.7 |   | 65.1% |   |

 

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 67.9% of revenues from65.1% in the prior year fiscal period primarily reflects $31.7 million inpurchase accounting adjustments in connection with the Transactions. Theincrease in COGS before purchase accounting adjustments to 65.3% of revenuesfrom 65.1% of revenues in the prior year fiscal period was primarily due to anincrease in product costs by approximately 0.2% of revenues. We had higherproduct costs as a percentage of revenues during the second quarter of fiscal2006 compared to the second quarter of fiscal 2005 primarily due to:

 

•    anincrease in the level of end-of-season clearance markdowns, net of vendorallowances, at our Specialty Retail Stores; and

 

•    higherproduct costs realized at our Brand Development Companies primarily as a resultof a higher level of allowances given to resellers; offset, in part, by

 

•    higherinitial mark-ups at both Specialty Retail Stores and Direct Marketing; and

 

•    lowermarkdowns in 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 acquiredmerchandise resulting in a decrease in COGS at the time the goods are sold. Wereceived vendor allowances of $36.0 million, or 2.9% of revenues, in thesecond quarter of fiscal 2006 and $37.9 million, or 3.4% of revenues, inthe second quarter of fiscal 2005. This decrease in vendor allowances earned inthe second quarter of fiscal 2006 was primarily related to the collection ofcertain allowances earlier in the Fall season of 2006 than in the Fall seasonof 2005.

 

***Selling, general and administrative expenses*.**SG&A expenses were 23.2% of revenues in the second quarter of fiscal2006 compared to 23.4% of revenues in the prior year fiscal period.

 

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

 

•    adecrease in marketing and advertising costs incurred by our Direct Marketingsegment by approximately 0.3% of revenues primarily due to higher internetsales, which have 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 revenuesprimarily due to the leveraging of these expenses on a higher level of revenuesin the second quarter of fiscal 2006;

 

•    lowerexpected annual incentive compensation costs of approximately 0.1% of revenues;and

 

28

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•    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:

 

•    managementservices fees of $3.1 million, or 0.3% of revenues, payable to the Sponsors asa result of the Acquisition; and

 

•    anincrease in preopening expenses and store remodeling expenses by approximately0.1% of revenues, primarily related to the opening of our new Boca Raton storein November 2005 and remodels at our San Francisco and Houston stores.

 

***Income from credit card operations, net.***Wereceived HSBC Program Income of $17.0 million, or 1.4% or revenues, in thesecond quarter of fiscal 2006 compared to net finance charge income of $18.0million, or 1.6% of revenues, in the second quarter of fiscal 2005.

 

***Depreciation expense.***Depreciationexpense was $35.4 million, or 2.9% of revenues, in the second quarter of fiscal2006 compared to $27.3 million, or 2.4% of revenues, in the prior year fiscalperiod primarily due to 1) a higher level of capital spending in recent yearsand 2) additional depreciation expense resulting from the revaluation of ourproperty and equipment at fair value 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 $18.9 million, or 1.5% of revenues,for the second quarter of fiscal 2006. We had no amortization expense in thesecond quarter of fiscal 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 10 to ourunaudited condensed consolidated financial statements.

 

Operating earnings for our Specialty Retail Stores segment were $94.3million, or 9.6% of Specialty Retail Stores revenues, for the second quarter offiscal 2006 compared to $98.7 million, or 10.8% of Specialty Retail Storesrevenues, for the prior year fiscal period. This decrease in operating earningsand operating margin was primarily due to 1) higher product costs driven by ahigher level of net markdowns, 2) a lower level of income from our credit cardoperations due to the sale of our credit card operations to HSBC in July 2005,3) higher preopening costs and 4) higher depreciation charges as a result ofhigher levels of capital expenditures for new stores and store remodels inrecent years. These negative effects on Specialty Retail operating earningswere offset, in part, by lower SG&A expenses for compensation and relatedbenefits, as a percentage of revenues, as a result of the leveraging of theseexpenses on a higher level of revenues in the second quarter of fiscal 2006.

 

Operating earnings for Direct Marketing increased to $37.9 million, or17.8% of Direct Marketing revenues, in the second quarter of fiscal 2006 from$27.9 million, or 14.8% of Direct Marketing revenues, for the prior year period.The increase in operating earnings and margin for Direct Marketing is primarilythe result of 1) higher product margins and lower markdowns and 2) the decreasein advertising and marketing costs, as a percentage of revenues, incurred tosupport internet sales.

 

29

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***Interest expense, net*.**Net interest expense was $66.1 million in the second quarter of fiscal 2006and $4.0 million for the prior year fiscal period. The significant componentsof interest expense are as follows:

 
| **(in thousands)**                | ** ** | **Thirteen  weeks ended  January 28,  2006** | ** ** | **Thirteen  weeks ended  January 29,  2005** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                             | ** ** | **(Successor)**                                        | ** ** | **(Predecessor)**                                      | ** ** |
|                                   |       |                                                   |       |                                                   |       |   |   |
| Asset-Based Revolving Credit Facility  |       | $                                                      | 751        |                                                   | $          | — |   |
| Senior Secured Term Loan Facility      |       | 35,381                                                 |       | —                                                 |       |
| 2028 Debentures                        |       | 2,260                                                  |       | 2,227                                                  |       |
| Senior Notes                           |       | 15,925                                                 |       | —                                                 |       |
| Senior Subordinated Notes              |       | 13,113                                                 |       | —                                                 |       |
| Credit Agreement                       |       | —                                                 |       | 1,424                                                  |       |
| 2008 Notes                             |       | —                                                 |       | 2,078                                                  |       |
| Debt issue cost amortization and other |       | 1,632                                                  |       | 452                                                    |       |
| Total interest expense                 |       | 69,062                                                 |       | 6,181                                                  |       |
|                                   |       |                                                   |       |                                                   |       |
| Less:                                  |       |                                                   |       |                                                   |       |
| Interest income                        |       | 1,852                                                  |       | 1,154                                                  |       |
| Capitalized interest                   |       | 1,085                                                  |       | 1,049                                                  |       |
| Interest expense, net                  |       | $                                                      | 66,125     |                                                   | $          | 3,978 |   |

 

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.***Oureffective income tax rate for the thirteen weeks ended January 28, 2006 was40.2% compared to 38.3% for the thirteen weeks ended January 29, 2005.

 

**Twenty-Six Weeks Ended January 28, 2006 Compared toTwenty-Six Weeks Ended January 29, 2005**

 

***Revenues.***Ourrevenues for year-to-date fiscal 2006 of $2,207.9 million increased $170.7million, or 8.4%, from $2,037.2 million in year-to-date fiscal 2005 reflectingincreases in comparable revenues, revenues from new stores and higher internetsales. Revenues increased in year-to-date fiscal 2006 compared to the prioryear period at all our operating companies.

 

Comparable revenues in year-to-date fiscal 2006 increased 7.3% comparedto the prior year-to-date fiscal period. Comparable revenues increased 6.4% forSpecialty Retail Stores and 12.1% for Direct Marketing. Comparable revenuesincreased 5.6% for the Brand Development Companies in year-to-date fiscal 2006.

 

New stores generated sales of $52.1 million in year-to-date fiscal 2006.In year-to-date fiscal 2006, internet sales by Direct Marketing were $213.4million, an increase of 34.0% from year-to-date fiscal 2005, excluding Chef’sCatalog. Total revenues of Chef’s Catalog (prior to its sale in November 2004)of $13.9 million are included in consolidated revenues for year-to-date fiscal2005.

 

30

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***Cost of goods sold including buying andoccupancy costs.***Cost of goods sold includingbuying and occupancy costs (COGS) for year-to-date fiscal 2006 and year-to-datefiscal 2005 were:

 
| ** **                                                                                                                | ** ** | **Twenty-six weeks ended  January 28, 2006  (Combined)** | ** ** | **Twenty-six weeks ended  January 29, 2005  (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| **(in millions, except percentages)**                                                                      | ** ** | **$**                                                                        | ** ** | **% of  revenues**                                                         | ** ** | **$** | ** ** | **% of  revenues** | ** ** |
| COGS, before purchase accounting  adjustments                                                                             |       | $                                                                            | 1,370.4    |                                                                            | 62.1%      |   | $ | 1,266.9 |   | 62.2% |   |
| Purchase accounting adjustments, primarily  non-cash charges related to step-up in carrying value of acquired inventories |       | 39.6                                                                         |       | 1.8                                                                             |       | — |   | — |   |
| COGS, as reported                                                                                                         |       | $                                                                            | 1,410.0    |                                                                            | 63.9%      |   | $ | 1,266.9 |   | 62.2% |   |

 

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 63.9% of revenues from62.2% in the prior year fiscal period primarily reflects $39.6 million inpurchase accounting adjustments in connection with the Transactions. COGSbefore purchase accounting adjustments was 62.1% of revenues compared to 62.2%of revenues in the prior year reflecting a decrease in product costs byapproximately 0.1% of revenues. We had lower product costs as a percentage ofrevenues during year-to-date fiscal 2006 compared to year-to-date fiscal 2005primarily due to:

 

•      ahigher level of full-price sales generated by our Specialty Retail Stores; and

 

•      higherinitial mark-ups at both Specialty Retail Stores and Direct Marketing; offset,in part, by

 

•      anincrease in the level of net markdowns at our Specialty Retail Stores; and

 

•      higherproduct costs realized at our Brand Development Companies primarily as a resultof a higher level of allowances given to resellers.

 

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 $44.0 million, or 2.0% of revenues, inyear-to-date fiscal 2006 and $43.4 million, or 2.1% of revenues, inyear-to-date fiscal 2005.

 

***Selling, general and administrative expenses*.**SG&A expenses were 24.3% of revenues in year-to-date fiscal 2006compared to 24.9% of revenues in the prior year fiscal period.

 

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

 

•    adecrease in marketing and advertising costs incurred by our Direct Marketingsegment by approximately 0.4% of revenues primarily due to higher internetsales, which have 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 revenuesprimarily due to the leveraging of these expenses on a higher level of revenuesin year-to-date fiscal 2006;

 

•    lowerexpected annual incentive compensation costs 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.

 

31

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

 

•    anincrease in preopening expenses and store remodeling expenses incurred inconnection with the opening of our San Antonio store in September 2005 and ourBoca Raton store in November 2005 and remodels at our San Francisco, FashionIsland and Houston stores by approximately 0.2% of revenues;

 

•    managementservices fees of $3.8 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 $28.6 million, or 1.3% or revenues, inyear-to-date fiscal 2006 compared to net finance charge income of $33.4million, or 1.6% of revenues, in year-to-date fiscal 2005.

 

***Depreciation expense.***Depreciationexpense was $65.0 million, or 2.9% of revenues, in year-to-date fiscal 2006compared to $51.7 million, or 2.4% of revenues, in the prior year fiscal period.The increase in depreciation was primarily due to 1) a higher level of capitalspending in recent years and 2) additional depreciation expense resulting fromthe revaluation of our property and equipment at fair value in connection withthe 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 $23.8 million, or 1.1% of revenues,for year-to-date fiscal 2006. We had no amortization expense in year-to-datefiscal 2005.

 

***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 10 to ourunaudited condensed consolidated financial statements.

 

Operating earnings for our Specialty Retail Stores segment were $229.8million, or 12.8% of Specialty Retail Stores revenues, for year-to-date fiscal2006 compared to $218.9 million, or 13.3% of Specialty Retail Stores revenues,for the prior year fiscal period. This decrease in operating margin wasprimarily due to 1) a lower level of income from our credit card operations dueto 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. These negative effects on Specialty Retail operating earnings wereoffset, in part, by lower SG&A expenses for compensation and relatedbenefits, as a percentage of revenues, as a result of leveraging these expenseson a higher level of revenues in year-to-date fiscal 2006.

 

Operating earnings for Direct Marketing increased to $52.5 million, or14.9% of Direct Marketing revenues, in year-to-date fiscal 2006 from $39.3million, or 12.0% of Direct Marketing revenues, for the prior year period. Theincrease in operating earnings and operating margin for Direct Marketing wasprimarily the result of 1) higher product margins and 2) the decrease inadvertising and marketing costs, as a percentage of revenues, incurred to supportinternet sales.

 

32

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***Interest expense, net*.**Net interest expense was $82.5 million in year-to-date fiscal 2006 and $8.0million for the prior year fiscal period. The significant components ofinterest expense are as follows:

 
| **(in thousands)**                | ** ** | **Seventeen  weeks ended  January 28,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Twenty-six  weeks ended  January 28,  2006** | ** ** | **Twenty-six  weeks ended  January 29,  2005** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                             | ** ** | **(Successor)**                                         | ** ** | **(Predecessor)**                                 | ** ** | **(Combined)**                                           | ** ** | **(Predecessor)**                                        | ** ** |
| Asset-Based Revolving Credit Facility  |       | $                                                       | 1,332      |                                              | $          | —                                                   |       | $                                                        | 1,332      |   | $ | — |   |
| Senior Secured Term Loan Facility      |       | 43,595                                                  |       | —                                            |       | 43,595                                                   |       | —                                                   |       |
| 2028 Debentures                        |       | 2,944                                                   |       | 1,542                                             |       | 4,486                                                    |       | 4,452                                                    |       |
| Senior Notes                           |       | 19,950                                                  |       | —                                            |       | 19,950                                                   |       | —                                                   |       |
| Senior Subordinated Notes              |       | 13,113                                                  |       | —                                            |       | 13,113                                                   |       | —                                                   |       |
| Credit Agreement                       |       | —                                                  |       | —                                            |       | —                                                   |       | 2,535                                                    |       |
| 2008 Notes                             |       | 639                                                     |       | 1,439                                             |       | 2,078                                                    |       | 4,154                                                    |       |
| Debt issue cost amortization and other |       | 6,140                                                   |       | 345                                               |       | 6,485                                                    |       | 920                                                      |       |
| Total interest expense                 |       | 87,713                                                  |       | 3,326                                             |       | 91,039                                                   |       | 12,061                                                   |       |
|                                   |       |                                                    |       |                                              |       |                                                     |       |                                                     |       |
| Less:                                  |       |                                                    |       |                                              |       |                                                     |       |                                                     |       |
| Interest income                        |       | 2,814                                                   |       | 3,046                                             |       | 5,860                                                    |       | 2,069                                                    |       |
| Capitalized interest                   |       | 1,489                                                   |       | 1,146                                             |       | 2,635                                                    |       | 1,977                                                    |       |
| Interest expense, net                  |       | $                                                       | 83,410     |                                              | $          | (866                                                     | )          | $                                                        | 82,544     |   | $ | 8,015 |   |

 

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 39.6% for theseventeen weeks ended January 28, 2006. Our effective income tax rate for thenine weeks ended October 1, 2005 was 37.0%, resulting in an effective tax rateof 37.7% for the combined year-to-date fiscal 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 twenty-six weeks ended January 29, 2005 andwas also favorably impacted by tax-exempt interest income.

** **

**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 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.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Our cash requirements consistprincipally of:

 

•      the funding ofour merchandise purchases;

 

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

 

•      debt servicerequirements;

 

•      income taxpayments; and

 

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•      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 financing instrumentsand debt service obligations following the Transactions, Pension Plan fundingobligations 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 the second quarter of fiscal 2006, we financed our seasonal increases inworking capital with cash flows from operations and borrowings under our Asset-BasedRevolving Credit Facility. During the first quarter of fiscal 2006, we borrowed$150 million under our Asset-Based Revolving Credit Facility. We repaid theseborrowings in the second quarter of fiscal 2006.

 

We believe that operating cash flows,available vendor financing and amounts available pursuant to our senior securedAsset-Based Revolving Credit Facility will be sufficient to fund our operationsand debt service requirements, including Pension Plan funding requirements,contractual obligations and commitments, anticipated capital expenditurerequirements and our debt service obligations, through the end of 2006.

 

At January 28, 2006, cash andequivalents were $91.5 million compared to $377.9 million at January 29, 2005. Netcash provided by operating activities was $231.6 million in 2006 compared to$90.2 million in 2005. Cash flows related to operating activities were higherin year-to-date fiscal 2006 primarily due to the Credit Card Sale in July 2005.In year-to-date fiscal 2005 (prior to the Credit Card Sale), we funded anincrease in accounts receivable of $106.8 million while in year-to-date fiscal2006 (subsequent to the Credit Card Sale), we funded an increase in accountsreceivable of $4.6 million.

 

Net cash used for investing activitieswas $5,254.5 million in year-to-date fiscal 2006 which consisted of 1) $5,155.9million paid in connection with the Acquisition and 2) $98.6 million forcapital expenditures. Net cash used in investing activities was $80.7 millionin year-to-date fiscal 2005 primarily for $95.1 million of capitalexpenditures, partially offset by $14.4 million in cash proceeds from the saleof Chef’s Catalog. We incurred capital expenditures in 2006 related to theconstruction of new stores in San Antonio and Boca Raton and the remodels ofour San Francisco, Houston, Beverly Hills, Newport Beach and Bergdorf Goodmanstores. We opened our San Antonio store in September 2005 and opened ourBoca Raton store in November 2005.

 

Net cash provided by financingactivities was $4,261.0 million in year-to-date fiscal 2006 as compared to$0.01 million in year-to-date fiscal 2005. Proceeds from debt incurred inconnection with the Transactions, net of issuance costs, aggregated $3,222.1million and cash equity contributions received in connection with theTransactions aggregated $1,427.7 million. In year-to-date fiscal 2006, we alsorepaid 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.

 

**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, we entered into a creditagreement and related security and other agreements for a senior securedAsset-Based Revolving Credit Facility with Deutsche Bank Trust Company Americasas administrative agent and collateral agent. The Asset-Based Revolving CreditFacility provides financing of up to $600.0 million, subject to aborrowing base equal to at any time the lesser of 80% of eligible inventory(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, we utilized $150.0 million of the Asset-BasedRevolving Credit Facility for loans and approximately $16.5 million for letters of credit. In the second quarter offiscal 2006, we repaid all loans under the Asset-Based Revolving Credit

 

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Facility. As of January 28,2006, we had $556.8 million of unused borrowings availability under theAsset-Based Revolving Credit Facility, based on a borrowing base of $572.2 millionand after giving effect to $15.4 million used for letters of credit.

 

TheAsset-Based Revolving Credit Facility provides that we have the right at anytime to request up to $200.0 million of additional commitments, but thelenders are under no obligation to provide any such additional commitments, andany increase in commitments will be subject to customary conditions precedent.If we were to request any such additional commitments and the existing lendersor new lenders were to agree to provide such commitments, the Asset-BasedRevolving Credit Facility size could be increased to up to $800.0 million,but our ability to borrow would still be limited by the amount of the borrowingbase.

 

Borrowingsunder the Asset-Based Revolving Credit Facility bear interest at a rate perannum equal to, at our option, either (a) a base rate determined byreference to the higher of (1) the prime rate of Deutsche Bank TrustCompany Americas and (2) the federal funds effective rate plus 1/2 of1% or (b) a LIBOR rate, subject to certain adjustments, in each case plusan applicable 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, we are requiredto pay a commitment fee of 0.375% per annum in respect of the unutilizedcommitments. If the average revolving loan utilization is 50% or more for anyapplicable period, the commitment fee will be reduced to 0.250% for suchperiod. We must also pay customary letter of credit fees and agency fees.

 

Ifat any time the aggregate amount of outstanding loans, unreimbursed letter ofcredit drawings and undrawn letters of credit under the Asset-Based RevolvingCredit Facility exceeds the lesser of (i) the commitment amount and(ii) the borrowing base, we will be required to repay outstanding loans orcash collateralize letters of credit in an aggregate amount equal to suchexcess, with no reduction of the commitment amount. If the amount availableunder the Asset-Based Revolving Credit Facility is less than $60 millionor an event of default has occurred, we will be required to repay outstandingloans and cash collateralize letters of credit with the cash we are required todeposit daily in a collection account maintained with the agent under theAsset-Based Revolving Credit Facility. We may voluntarily reduce the unutilizedportion of the commitment amount and repay outstanding loans at any timewithout premium or penalty other than customary “breakage” costs with respectto LIBOR loans. There is no scheduled amortization under the Asset-BasedRevolving Credit Facility; the principal amount of the loans outstanding aredue and payable in full on October 6, 2010.

 

Allobligations under the Asset-Based Revolving Credit Facility are guaranteed byParent and certain of our existing and future domestic subsidiaries (excluding,among others, Gurwitch Products, L.L.C., and Kate Spade LLC (BrandDevelopment Companies)). As of January 28, 2006, the liabilities of ournon-guarantor subsidiaries totaled approximately $35.7 million, or 0.7% ofconsolidated liabilities, and the assets of our non-guarantor subsidiariesaggregated approximately $192.2 million, or 2.9% of consolidated total assets. Allobligations under our Asset-Based Revolving Credit Facility, and the guaranteesof those obligations, are secured, subject to certain significant exceptions,by substantially all of our assets and the assets of Parent and oursubsidiaries that have guaranteed the Asset-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 us or the subsidiary guarantors from creditcard clearinghouses and processors or otherwise in respect of all credit cardcharges for sales of inventory by us and the subsidiary guarantors, certainrelated assets and proceeds of the foregoing; and

 

•      a second-priority pledge of 100% of ourcapital stock and certain of the capital stock held by us, Parent or anysubsidiary guarantor (which pledge, in the case of any foreign subsidiary islimited to 100% of the non-voting stock (if any) and 65% of the voting stock ofsuch foreign subsidiary); and

 

•      a second-priority security interest in, andmortgages on, substantially all other tangible and intangible assets of us,Parent and each subsidiary guarantor, including a significant portion of ourmaterial owned and leased real property (which consists of a majority of ourfull-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 our Asset-Based Revolving Credit Facility to the extent thatsuch securities cannot secure our 2028 Debentures or other secured public debtobligations without requiring the preparation and filing of separate financialstatements of such subsidiary in accordance with applicable SEC rules. As aresult, the collateral under our Asset-Based Revolving Credit Facility willinclude shares of capital stock or other securities of subsidiaries of theCompany or any subsidiary guarantor only to the extent that the applicablevalue of such securities (on a subsidiary-by-subsidiary basis) is less than 20%of the aggregate principal amount of the 2028 Debentures or other securedpublic debt obligations. Stock of our Brand Development Companies and theirassets also will not constitute collateral under our Asset-Based RevolvingCredit Facility.

 

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OurAsset-Based Revolving Credit Facility contains a number of covenants that, amongother things and subject to certain significant exceptions, restrict ourability and the ability of our subsidiaries to:

 

•      incur additional indebtedness;

 

•      pay dividends on our capital stock or redeem,repurchase or retire our capital stock or indebtedness;

 

•      make investments, loans, advances andacquisitions;

 

•      create restrictions on the payment ofdividends or other amounts to us from our subsidiaries that are not guarantors;

 

•      engage in transactions with our affiliates;

 

•      sell assets, including capital stock of oursubsidiaries;

 

•      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 wemust have at least $75.0 million of pro forma excess availability underthe Asset-Based Revolving Credit Facility and that we must be in pro formacompliance with the fixed charge coverage ratio described below.

 

Althoughthe credit agreement governing the Asset-Based Revolving Credit Facility doesnot require us to comply with any financial ratio maintenance covenants, ifless than $60.0 million were available to be borrowed under theAsset-Based Revolving Credit Facility at any time, we would not be permitted toborrow any additional amounts unless our pro forma ratio of consolidated EBITDAto 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, we entered into a credit agreement and related security and otheragreements for a $1,975.0 million Senior Secured Term Loan Facility withCredit Suisse as administrative agent and collateral agent.  The full amountof the Senior Secured Term Loan Facility was borrowed on October 6, 2005. Inthe second quarter of fiscal 2006, we repaid $100.0 million principal amount ofthe loans under the Senior Secured Term Loan Facility.

 

Borrowingsunder the Senior Secured Term Loan Facility bear interest at a rate per annumequal to, at our option, either (a) a base rate determined by reference tothe higher of (1) the prime rate of Credit Suisse and (2) the federalfunds effective rate plus 1/2 of 1% or (b) a LIBOR rate, subject tocertain adjustments, in each case plus an applicable margin. The applicablemargin is 1.5% with respect to base rate borrowings and 2.5% with respect toLIBOR borrowings. The interest rate on the outstanding borrowings pursuant tothe Senior Secured Term Loan Facility was 6.947% at January 28, 2006.

 

Thecredit agreement governing the Senior Secured Term Loan Facility requires us toprepay outstanding term loans with 50% (which percentage will be reduced to 25%if our total leverage ratio is less than a specified ratio and will be reducedto 0% if our total leverage ratio is less than a specified ratio) of our annualexcess cash flow (as defined in the credit agreement). If a change of control(as defined in the credit agreement) occurs, we will be required to offer toprepay all outstanding term loans, at a prepayment price equal to 101% of theprincipal amount to be prepaid, plus accrued and unpaid interest to the date ofprepayment. We 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.

 

Wemay voluntarily prepay outstanding loans under the Senior Secured Term LoanFacility at any time without premium or penalty other than customary “breakage”costs with respect to LIBOR loans. If we repay all or any portion of the SeniorSecured Term Loan Facility prior to October 6, 2006 (other than a prepaymentthat is made with certain designated asset sale proceeds), we must pay 101% ofthe principal amount to be repaid. There is no scheduled amortization under theSenior Secured Term Loan Facility. The principal amount of the loansoutstanding is due and payable in full on April 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 our 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 our assets and theassets of our Parent and the subsidiary guarantors, including:

 

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•      a first-priority pledge of 100% of ourcapital stock and certain of the capital stock held by us, Parent or anysubsidiary guarantor (which pledge, in the case of any foreign subsidiary islimited to 100% of the non-voting stock (if any) and 65% of the voting stock ofsuch foreign subsidiary); and

 

•      a first-priority security interest in, andmortgages on, substantially all other tangible and intangible assets of us,Parent and each subsidiary guarantor, including a significant portion of ourmaterial owned and leased real property (which consists of a majority of ourfull-line retail stores) and equipment, but excluding, among other things, thecollateral described in the following bullet point; and

 

•      a second-priority security interest inpersonal property consisting of inventory and related accounts, cash, depositaccounts, all payments received by us or the subsidiary guarantors from creditcard clearinghouses and processors or otherwise in respect of all credit cardcharges for sales of inventory by us and the subsidiary guarantors, certainrelated 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 our Senior Secured Term Loan Facility to the extent that suchsecurities cannot secure our 2028 Debentures or other secured public debtobligations without requiring the preparation and filing of separate financialstatements of such subsidiary in accordance with applicable SEC rules. As aresult, the collateral under our Senior Secured Term Loan Facility will includeshares of capital stock or other securities of subsidiaries of the Company orany subsidiary guarantor only to the extent that the applicable value of suchsecurities (on a subsidiary-by-subsidiary basis) is less than 20% of theaggregate principal amount of the 2028 Debentures or other secured public debtobligations. Stock of our Brand Development Companies and their assets alsowill not constitute collateral under our 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, we issued $125.0 million aggregate principal amount of our 2028Debentures. In connection with the Transactions, we equally and ratably securedthe 2028 Debentures by a first lien security interest on certain collateralsubject to liens granted under our Senior Secured Credit Facilitiesconstituting (a) (i) 100% of the capital stock of certain of our existing andfuture domestic subsidiaries, and (ii) 100% of the non-voting stock and 65% ofthe voting stock of certain of our existing and future foreign subsidiaries and(b) certain of our principal properties that include a majority of ourfull-line stores, in each case, to the extent required by the terms of theindenture governing our 2028 Debentures. The 2028 Debentures contain covenantsthat restrict our 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 our 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 our 2028 Debentures to the extent such property does not constitute collateralunder our Senior Secured Credit Facilities described above.

 

***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, we assumed all the obligations ofNewton Acquisition Merger Sub, Inc. under the Senior Indenture.  TheSenior 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 our wholly-owned domestic subsidiaries that guarantee ourobligations under our Senior Secured Credit Facilities and by Parent. TheSenior Notes and the guarantees thereof are our and the guarantors’ unsecured,senior obligations and rank (i) equal in the right of payment with all of ourand the guarantors’ existing and future senior indebtedness, including anyborrowings under our Senior Secured Credit Facilities and the guaranteesthereof and our 2028 Debentures; and (ii) senior to all of our and ourguarantors’ existing and future subordinated indebtedness, including the SeniorSubordinated Notes due 2015 and the guarantees thereof. The Senior Notes alsoare effectively

 

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juniorin priority to our and our guarantors’ obligations under all securedindebtedness, including our Senior Secured Credit Facilities, our 2028Debentures, and any other secured obligations of ours, in each case, to theextent of the value of the assets securing such obligations. In addition, theSenior Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of our subsidiaries that are notproviding 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, through negotiatedtransactions or otherwise, in accordance with applicable securities laws.

 

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 109.000% 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 our abilityand certain of our subsidiaries’ ability to:

 

•      incur additional indebtedness;

 

•      pay dividends on our capital stock or redeem,repurchase or retire our capital stock or subordinated indebtedness;

 

•      make investments;

 

•      create restrictions on the payment ofdividends or other amounts to us from our restricted subsidiaries that are notguarantors of the notes;

 

•      engage in transactions with our affiliates;

 

•      sell assets, including capital stock of oursubsidiaries;

 

•      consolidate or merge;

 

•      create liens; and

 

•      enter into sale and lease back transactions.

 

OurBrand Development Companies are not subject to the covenants contained in theSenior Indenture. The Senior Indenture also provides for events of default,which, if any of them occurs, would permit or require the principal, premium,if any, interest and any other monetary obligations on all outstanding SeniorNotes 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,we assumed all the obligations of Newton Acquisition Merger Sub, Inc. under theSenior Subordinated Indenture.  The Senior Subordinated Notes mature onOctober 15, 2015. Interest on the Senior Subordinated Notes is payable in cashsemi-annually in arrears on each April 15 and October 15, commencingApril 15, 2006.

 

TheSenior Subordinated Notes are guaranteed, jointly and severally, on anunsecured, senior subordinated basis, by each of our wholly-owned domesticsubsidiaries that guarantee our obligations under our Senior Secured CreditFacilities and by Parent. The

 

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SeniorSubordinated Notes and the guarantees thereof are our and the guarantors’unsecured, senior subordinated obligations and rank (i)   junior to all of our and the guarantors’ existing and future seniorindebtedness, including the Senior Notes and any borrowings under our SeniorSecured Credit Facilities, and the guarantees thereof and our 2028 Debentures;(ii) equally with any of our and the guarantors’ future senior subordinatedindebtedness; and (iii) senior to any of our and the guarantors’ future subordinatedindebtedness. In addition, the Senior Subordinated Notes are structurallysubordinated to all existing and future liabilities, including trade payables,of our subsidiaries that are not 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, decliningannually to 100% of principal amount on October 15, 2013, plus accrued andunpaid interest, and Additional Interest (as defined in the Senior SubordinatedIndenture), 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.

 

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 our Senior Notes described above. TheSenior Subordinated Indenture also provides for events of default, which, ifany of them occurs, would permit or require the principal, premium, if any,interest and any other monetary obligations on all outstanding Senior Notes tobe due and payable immediately, subject to certain exceptions.

 

***Redemptionof 2008 Notes.***In May 1998, we issued $125.0 million aggregate principalamount of our 2008 Notes. Upon closing of the Transactions, we called our 2008Notes for redemption pursuant to their terms. On November 7, 2005, we used$134.7 million of reserved cash to redeem our 2008 Notes, which included a callpremium of $6.2 million plus accrued interest of $3.5 million through theredemption date.

 

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**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*

 

•      changes in thedemographic or retail environment;

 

•      changes in consumerconfidence resulting in a reduction of discretionary spending on goods;

 

•      changes inconsumer preferences or fashion trends;

 

•      changes in ourrelationships with key customers;

 

•      changes in ourproprietary credit card arrangement that adversely impact the ability toprovide credit to our customers;

 

*Merchandise Procurement and Supply ChainConsiderations*

 

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

 

•      delays inreceipt of merchandise ordered due to work stoppages or other causes of delayin connection with either the manufacture or shipment of such merchandise;

 

•      changes inforeign currency exchange or inflation rates;

 

•      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;

 

•      seasonality ofthe retail business;

 

•      adverse weatherconditions or natural disasters, particularly during peak selling seasons;

 

•      delays inanticipated store openings and renovations;

 

•      our success inenforcing our intellectual property rights;

 

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*Employee Considerations*

 

•      changes in keymanagement personnel and our ability to retain key management personnel;

 

•      changes in ourrelationships with certain of our key sales associates and our ability toretain our key sales associates;

 

*Legal and Regulatory Issues*

 

•      changes ingovernment or regulatory requirements increasing our costs of operations;

 

•      litigation thatmay have an adverse effect on our financial results or reputation;

 

*The Transactions*

 

The consummation of theTransactions resulted in the Company becoming highly leveraged. As a result, weare subject to additional risk factors including:

 

•      the effects ofincurring a substantial amount of indebtedness under our Senior Secured CreditFacilities and the Notes;

 

•      the effects uponus of complying with the covenants contained in our Senior Secured CreditFacilities and the indentures governing the Notes;

 

•      restrictions theterms 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*

 

•      impact offunding requirements related to our noncontributory defined benefit pensionplan; and

 

•      the design andimplementation of new information systems as well as enhancements of existingsystems.

 

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 experience and on various other factors that we believeare reasonable under the circumstances. We make adjustments to our assumptionsand judgments when facts and circumstances dictate. Since future events and theireffects cannot be determined with absolute certainty, actual results may differfrom the 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 thebasis of presentation of certain prior year amounts and calculations presentedin this quarterly report to conform to the current year presentation. Depreciationexpense and income from credit card operations, net are now shown as separateline items on our statements of earnings. In prior periods, depreciationexpense was included in buying and occupancy costs and the income from ourcredit card operations was included as a reduction to SG&A.

 

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***Purchase Accounting.***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 accounting period.In connection with the preliminary purchase price allocation, we have made estimatesof the fair values of our long-lived and intangible assets based uponassumptions related to the future cash flows, discount rates and asset livesutilizing currently available information, and in some cases, preliminaryvaluation results from independent valuation specialists. As of January 28,2006, we have recorded preliminary purchase accounting adjustments to increasethe carrying value of our property and equipment and inventory, to establishintangible assets for our tradenames, customer lists and favorable leasecommitments and to revalue our long-term benefit plan obligations, among otherthings. This allocation of the purchase price is preliminary and subject to ourreview and finalization of independent appraisals.

 

During the second quarter of fiscal 2006, we receivedupdated valuation results from our independent appraisers and adjusted theestimated fair values of our long-lived and intangible assets as follows:

 
| ** **                  | ** ** | **Estimated Fair Value** | ** ** |
|-----------------------------|------------|------------------------------------|------------|
| **(in millions)**      | ** ** | **October 29,  2005**         | ** ** | **January 28,  2006** | ** ** |
|                        |       |                               |       |   |   |
| Property and equipment      |       | $                                  | 1,044.9    |   | $ | 945.7 |   |
| Customer lists              |       | 466.3                              |       | 586.3 |   |
| Favorable lease commitments |       | 386.8                              |       | 480.0 |   |
| Tradenames                  |       | 1,734.2                            |       | 1,691.1 |   |
| Goodwill                    |       | 1,725.3                            |       | 1,680.5 |   |
|                             |            |                                    |            |  |  |  |  |

 

Furtherrevisions to the purchase price allocation will be made as additionalinformation becomes available and such revisions could be material.

 

***Recent Accounting Pronouncements.***InDecember 2004, the Financial Accounting Standards Board (FASB) issued SFAS No.123R, “Share-Based Payment.” This standard is a revision of SFAS No. 123, “Accountingfor Stock-Based Compensation,” and supersedes Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees,” and its relatedimplementation guidance. SFAS No. 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values and was effective for the firstinterim period or annual reporting period beginning after June 15, 2005. Weadopted SFAS No. 123R as of the beginning of our first quarter of fiscal 2006using the modified prospective method, which requires companies to record stockcompensation for all unvested and new awards as of the adoption date.Accordingly, we have not restated the prior period amounts presented herein. SeeNote 5 for further description of our stock-based compensation.

 

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 our Indebtedness**

 

**We have a substantial amount of indebtedness,which may adversely affect our cash flow and our ability to operate ourbusiness, to comply with debt covenants and make payments on our indebtedness.**

 

As a result of theTransactions, we are highly leveraged. As of January 28, 2006, our totalindebtedness was approximately $3,203.8 million and our unused borrowingavailability under our $600 million Asset-Based Revolving Credit Facility was$556.8 million after giving effect to $15.4 million of letters of creditoutstanding thereunder. Our substantial indebtedness, combined with our leaseand other financial obligations and contractual commitments, could have otherimportant consequences. For example, it could:

 

•      make it more difficult for us to satisfy our obligationswith respect to our indebtedness and any failure to comply with the obligationsof any of our debt instruments, including restrictive covenants and borrowingconditions, could result in an event of default under the agreements governingour indebtedness;

 

•      make us more vulnerable to adverse changes in generaleconomic, industry and competitive conditions and adverse changes in governmentregulation;

 

•      require us to dedicate a substantial portion of our cashflow from operations to payments on our indebtedness, thereby reducing theavailability of our cash flows to fund working capital, capital expenditures,acquisitions and other general corporate purposes;

 

•      limit our flexibility in planning for, or reacting to,changes in our business and the industry in which we operate;

 

•      place us at a competitive disadvantage compared to ourcompetitors that are less highly leveraged and therefore may be able to takeadvantage of opportunities that our leverage prevents us from exploiting; and

 

•      limit our ability to borrow additional amounts for workingcapital, capital expenditures, acquisitions, debt service requirements,execution of our business strategy or other purposes.

 

Any of the above listed factorscould materially adversely affect our business, financial condition and resultsof operations.

 

In addition, our interestexpense could increase if interest rates increase because the entire amount ofthe indebtedness under our senior secured credit facilities bears interest atfloating rates. As of January 28, 2006, we had approximately$1,875.0 million of floating rate debt, consisting of outstandingborrowings under Senior Secured Term Loan Facility. Effective December 6, 2005,we entered into floating to fixed interest rate swap agreements for anaggregate notional amount of $1,000.0 million to limit our exposure to interestrate increases related to a portion of our floating rate indebtedness.

 

**To service our indebtedness, we will requirea significant amount of cash. Our ability to generate cash depends on manyfactors beyond our control, and any failure to meet our debt serviceobligations could harm our business, financial condition and results ofoperations.**

 

Our ability to pay interest onand principal of our debt obligations will primarily depend upon our futureoperating performance. As a result, prevailing economic conditions andfinancial, business and other factors, many of which are beyond our control,will affect our ability to make these payments.

 

If we do not generatesufficient cash flow from operations to satisfy our debt service obligations,we may have to undertake alternative financing plans, such as refinancing orrestructuring our indebtedness, selling assets, reducing or delaying capitalinvestments or seeking to raise additional capital. Our ability to restructureor refinance our debt will depend on the condition of the capital markets andour financial condition at such time. Any refinancing of our debt could be athigher interest rates and may require us to comply with more onerous covenants,which could further restrict our business operations. The terms of existing orfuture debt instruments may restrict us from adopting some of thesealternatives. In addition, any failure to make payments of interest andprincipal on our outstanding indebtedness on a timely basis would likely resultin a reduction of our credit rating, which could harm our ability to incuradditional indebtedness on acceptable terms.

 

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Contractual limitations on our ability to execute any necessaryalternative financing plans could exacerbate the effects of any failure togenerate sufficient cash flow to satisfy our debt service obligations. OurAsset-Based Revolving Credit Facility permits us to borrow up to$600.0 million; however, our ability to borrow thereunder is limited by aborrowing base, which at any time will equal the lesser of 80% of eligibleinventory valued at the lower of cost or market value and 85% of the netorderly liquidation value of the eligible inventory, less certain reserves. Inaddition, our ability to borrow under this facility is limited by a minimumliquidity condition, providing that, if less than $60.0 million isavailable at any time, we are not permitted to borrow any additional amountsunder the Asset-Based Revolving Credit Facility unless our ratio ofconsolidated EBITDA to consolidated Fixed Charges (as such terms are defined inthe credit agreement for our senior secured asset-based revolving creditfacility) is at least 1.1 to 1.0. Our ability to meet this financial ratio canbe affected by events beyond our control, and we cannot assure you that we willmeet this ratio.

 

Our inability to generatesufficient cash flow to satisfy our debt service obligations, or to refinanceour obligations at all or on commercially reasonable terms, would have anadverse effect, which could be material, on our business, financial conditionand results of operations.

 

**The terms of our****Asset-Based Revolving Credit Facility and Senior Secured Term LoanFacility and the indenturesgoverning our Notes and 2028 Debentures may restrict our current and futureoperations, particularly our ability to respond to changes in our business orto take certain actions.**

 

The credit agreements governingour Asset-Based Revolving Credit Facility and Senior Secured Term Loan Facilitycredit facilities and the indentures governing our Notes and 2028 Debenturescontain, and any future indebtedness of ours would likely contain, a number ofrestrictive covenants that impose significant operating and financialrestrictions, including restrictions on our ability to engage in acts that maybe in our best long-term interests. The indentures governing our Notes and 2028Debentures and the credit agreements governing our senior secured creditfacilities include covenants that, among other things, restrict our ability to:

 

•      incur additional indebtedness;

 

•      pay dividends on our capital stock or redeem, repurchase orretire our capital stock or indebtedness;

 

•      make investments;

 

•      create restrictions on the payment of dividends or otheramounts to us from our restricted subsidiaries;

 

•      engage in transactions with our affiliates;

 

•      sell assets, including capital stock of our subsidiaries;

 

•      consolidate or merge;

 

•      create liens; and

 

•      enter into sale and lease back transactions.

 

In addition, our ability toborrow under our Asset-Based Revolving Credit Facility is limited by aborrowing base and a minimum liquidity condition, as described above.

 

Moreover, our Asset-BasedRevolving Credit Facility provides discretion to the agent bank acting onbehalf of the lenders to impose additional availability and other reserves, whichcould materially impair the amount of borrowings that would otherwise beavailable to us. There can be no assurance that the agent bank will not imposesuch reserves or, were it to do so, that the resulting impact of this actionwould not materially and adversely impair our liquidity.

 

A breach of any of therestrictive covenants would result in a default under our Asset-Based RevolvingCredit Facility and Senior Secured Term Loan Facility. If any such defaultoccurs, the lenders under our Asset-Based Revolving Credit Facility and SeniorSecured Term Loan Facility may elect to declare all outstanding borrowingsunder such facilities, together with accrued interest and other fees, to beimmediately due and payable, or enforce their security interest, any of whichwould result in an event of default under our Notes and 2028 Debentures. Thelenders would also have the right in these circumstances to terminate anycommitments they have to provide further borrowings.

 

The operating and financialrestrictions and covenants in these debt agreements and any future financingagreements may adversely affect our ability to finance future operations orcapital needs or to engage in other business activities.

 

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**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. A large percentage of our merchandise assortment, particularly theapparel, fashion accessories and shoe categories, is ordered months in advanceto the introduction of such goods, typically three to nine months in advance ofthe products being offered for sale. If our sales during any season,particularly a peak season, are significantly lower than we expect for anyreason, we may not be able to adjust our expenditures for inventory and other expensesin a timely fashion and may be left with a substantial amount of unsoldinventory. If that occurs, we may be forced to rely on markdowns or promotionalsales to dispose of excess inventory. This could have an adverse effect on ourmargins and operating income. At the same time, if we fail to purchase asufficient quantity of merchandise, we may not have an adequate supply ofproducts to meet consumer demand. This may cause us to lose sales or harm ourcustomer 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.

 

**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 (including our Boca Raton storethat opened in November 2005) will add over 665,000 square feet of new storespace over approximately the next three years, representing an almost 13%increase above the current aggregate square footage of our full-line NeimanMarcus and Bergdorf Goodman stores, and that our store remodeling programwill add additional new store space from remodels that are already underway. Newstore openings involve certain risks, including constructing, furnishing andsupplying a store in a timely and cost effective manner, accurately assessingthe demographic or retail environment at a given location, hiring and trainingquality staff, obtaining necessary permits and zoning

 

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approvals, obtainingcommitments from a core group of vendors to supply the new store, integratingthe new store into our distribution network and building customer awareness andloyalty. In undertaking store remodels, we must complete the remodel in atimely, cost effective manner, minimize disruptions to our existing operations,and succeed in creating an improved shopping environment. If we fail to executeon these or other aspects of our store expansion and remodeling strategy, wecould suffer harm to our sales, an increase in costs and expenses and anadverse 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 bycustomers is discretionary, and therefore highly dependent upon the level ofconsumer spending, particularly among affluent customers. Accordingly, sales ofthese products 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.

 

**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 2004were 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.

 

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**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. We recentlysold our approximately three million private label credit card accounts andrelated assets, as well as the outstanding balances associated with suchaccounts. Initially, we will continue to handle key customer service functions,including new account processing, most transaction authorization, billingadjustments, collection services and customer inquiries. As part of thistransaction, we are changing, and will continue to change, the terms of creditoffered to our customers following the Credit Card Sale. In addition, thepurchaser of our credit card business will have discretion over certain policiesand arrangements with credit card customers and may change these policies andarrangements 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.

 

**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.

 

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**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 the claimshave merit. Claims like these may be time consuming and expensive to defend andcould result in our being required to cease using the trademark or other rightsand selling the allegedly infringing products. This might have an adverseaffect on our sales and cause us to incur significant litigation costs andexpenses.

 

**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 orinventory control could prevent our customers from purchasing merchandise onour websites or prevent us from processing and delivering merchandise, whichcould adversely affect our business.

 

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**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 to efficiently source anddistribute merchandise to our Specialty Retail stores and Neiman Marcus Directcustomers. 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 QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The market risk inherent in ourfinancial instruments represents the potential loss arising from adversechanges in interest rates and foreign currency exchange rates. We do not enterinto derivative financial instruments for trading purposes. We seek to manageexposure to adverse interest rate changes through our normal operating andfinancing activities. We are exposed to interest rate risk through ourborrowing activities, which are described in Note 8 to the condensedconsolidated financial statements.

 

As of January 28, 2006, we hadno borrowings outstanding under our Asset-Based Revolving Credit Facility thatbear interest at floating rates. Future borrowings under our Asset-BasedRevolving Facility, to the extent of outstanding borrowings, would be affectedby interest rate changes.

 

At January 28, 2006, we had $1,875.0 million of debt under our SeniorSecured Term Loan Facility issued in connection with the Transactions thatbears interest at floating rates. A 1% increase in these floating rates wouldincrease annual interest expense by approximately $18.7 million.

 

We use derivative financial instruments to help manage our interestrate risk. Effective December 6, 2005, we entered into floating to fixedinterest rate swap agreements for an aggregate notional amount of $1,000.0million to limit our exposure to interest rate increases related to a portionof our floating rate indebtedness. The interest rate swap agreements terminateafter five years. As of the effective date, we designated the interest rateswaps as cash flow hedges. As a result, changes in the fair value of our swapswill be recorded subsequent to the effective date as a component of othercomprehensive income.

 

At January 28, 2006, the fair value of these swaps was a gain ofapproximately $3.0 million, which amount is included in other assets. As aresult of our swap agreements, our effective fixed interest rates as to the$1,000.0 million in floating rate indebtedness will range from 6.931% to 7.499%per quarter and result in an average fixed rate of 7.285%.

 

We use derivative financialinstruments to manage foreign currency risk related to the procurement ofmerchandise inventories from foreign sources. We enter into foreign currencycontracts denominated in the euro and British pound. We had foreign currencycontracts in the form of forward exchange contracts in the amount ofapproximately $51.6 million as of January 28, 2006 and approximately$42.3 million as of January 29, 2005. The market risk inherent in theseinstruments was not material to our consolidated financial position, results ofoperations or cash flows in year-to-date fiscal 2006.

 

The effects of changesin the U.S. equity and bond markets serve to increase or decrease the value ofPension Plan assets, resulting in increased or decreased cash funding by theCompany. We seek to manage exposure to adverse equity and bond returns bymaintaining diversified investment portfolios and utilizing professionalinvestment managers.

 

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**ITEM4. CONTROLS AND PROCEDURES**

 

**a.  Disclosure Controls andProcedures**

 

In accordance with Exchange Act Rules 13a-15 and 15d-15, wecarried out an evaluation as of January 28, 2006, under the supervision andwith the participation of our Chief Executive Officer and Chief FinancialOfficer, as well as other key members of our management, of the effectivenessof our disclosure controls and procedures (as defined in Rule 13a-15(e)and Rule 15d-15(e) under the Exchange Act). Based on that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective to provide reasonableassurance that information required to be disclosed in our reports filed orsubmitted under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

**b.  Changes in Internal Controlover Financial Reporting**

 

In the ordinary course of business, we routinely enhance ourinformation systems by either upgrading our current systems or implementing newsystems. During the second quarter of fiscal 2006, we implemented a new humancapital management system, including the outsourcing of payroll and benefitsadministration. No change occurred in our internal controls over financialreporting during the quarter ended January 28, 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**THE NEIMAN MARCUS GROUP, INC.**

 

**PART II**

 

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

 

Note 8 of the Notes to Condensed Consolidated Financial Statements inPart I, Item 1 is incorporated herein by reference as if fully restated herein.Note 8 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.****  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

###### ** **

None.

 

**ITEM 4.****  SUBMISSION OF MATTERS TO A VOTEOF 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.                                                  |

 

51

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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 n 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. (1)                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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. (1)                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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                                            |
|--------|--------|-----------------------------------------------------------|
|   |   |                                                      |
| *      |   | Management contract or compensatory plan or  arrangement. |

 

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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 |     | March 8, 2006 |
| T. Dale Stapleton     |       | and Duly Authorized Officer    |                          |     |
|                  |       | (principal accounting officer) |                          |     |
|                       |            |                                |                               |          |  |  |

 

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