**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM10-Q**

 

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

 

**For the Quarterly Period Ended October 29, 2005**

 

**OR**

 

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

 

**Commission file no. 1-9659**

 

**The Neiman Marcus Group, Inc.**

(Exact name of registrant asspecified 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 of  principal executive offices)                  |
|                                                       |
| **(214)  741-6911**                                        |
| (Registrant’s  telephone number, including area code) |

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

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

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

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

 

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

 

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

 

There were 900 shares of the registrant’s common stock, par value $.01per share, outstanding at October 29, 2005.

 

 

----

 

**THE NEIMANMARCUS GROUP, INC.**

 

**INDEX**

 
| Part I.  | Financial Information                                                                                                                                                                                                            |   |
|---------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                                                                                                                             |   |
| Item 1.       | Condensed Consolidated Balance Sheets as of October 29, 2005  (Successor),  July 30, 2005 (Successor) and October 30, 2004 (Predecessor)                                                                          |   |
|          |                                                                                                                                                                                                                             |   |
|          | Condensed Consolidated Statements of Earnings for the Four Weeks  Ended  October 29, 2005 (Successor), Nine Weeks Ended October 1, 2005  (Predecessor)  and Thirteen Weeks Ended October 30, 2004 (Predecessor)   |   |
|          |                                                                                                                                                                                                                             |   |
|          | Condensed Consolidated Statements of Cash Flows for the Four Weeks  Ended  October 29, 2005 (Successor), Nine Weeks Ended October 1, 2005  (Predecessor)  and Thirteen Weeks Ended October 30, 2004 (Predecessor) |   |
|          |                                                                                                                                                                                                                             |   |
|          | Notes to Condensed Consolidated Financial Statements                                                                                                                                                                             |   |
|          |                                                                                                                                                                                                                             |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                                      |   |
|          |                                                                                                                                                                                                                             |   |
| Item 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                                                                      |   |
|          |                                                                                                                                                                                                                             |   |
| Item 4.       | Controls  and Procedures                                                                                                                                                                                                         |   |
|          |                                                                                                                                                                                                                             |   |
| Part II. | Other  Information                                                                                                                                                                                                               |   |
|          |                                                                                                                                                                                                                             |   |
| Item 1.       | Legal Proceedings                                                                                                                                                                                                                |   |
|          |                                                                                                                                                                                                                             |   |
| Item 2.       | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                                                                                                     |   |
|          |                                                                                                                                                                                                                             |   |
| Item 4.       | Submission of Matters to a Vote of Security  Holders                                                                                                                                                                             |   |
|          |                                                                                                                                                                                                                             |   |
| Item 6.       | Exhibits                                                                                                                                                                                                                         |   |
|          |                                                                                                                                                                                                                             |   |
| Signatures    |                                                                                                                                                                                                                             |

 

----

 

**THE NEIMANMARCUS GROUP, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

 
| **(in thousands)**                                                                                                                         | ** ** | **October 29,  2005** | ** ** | ** ** | **July 30,  2005** | ** ** | **October 30,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                 | ** ** | **(Successor)**            | ** ** | ** ** | **(Predecessor)**       | ** ** | **(Predecessor)**          | ** ** |
| **ASSETS**                                                                                                                                 |       |                       |       |       |                    |       |                       |       |
| Current assets:                                                                                                                            |       |                       |       |       |                    |       |                       |       |
| Cash and  cash equivalents                                                                                                                 |       | $                          | 192,097    |       |                    | $          | 853,482                    |       | $ | 258,367 |   |
| Reserved  cash                                                                                                                             |       | 134,734                    |       |       | —                  |       | —                     |       |
| Accounts  receivable, net of allowance                                                                                                     |       | 39,940                     |       |       | 29,886                  |       | 641,236                    |       |
| Merchandise  inventories                                                                                                                   |       | 978,796                    |       |       | 748,366                 |       | 881,266                    |       |
| Other  current assets                                                                                                                      |       | 97,540                     |       |       | 76,747                  |       | 72,429                     |       |
| Total  current assets                                                                                                                      |       | 1,443,107                  |       |       | 1,708,481               |       | 1,853,298                  |       |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| Property and equipment, net                                                                                                                |       | 1,114,363                  |       |       | 855,009                 |       | 776,665                    |       |
| Customer lists, net                                                                                                                        |       | 462,964                    |       |       | —                  |       | —                     |       |
| Favorable lease commitments, net                                                                                                           |       | 385,201                    |       |       | —                  |       | —                     |       |
| Trademarks                                                                                                                                 |       | 1,734,236                  |       |       | 56,642                  |       | 56,642                     |       |
| Goodwill                                                                                                                                   |       | 1,725,330                  |       |       | 14,872                  |       | 14,872                     |       |
| Debt issuance costs                                                                                                                        |       | 108,028                    |       |       | 3,526                   |       | 3,920                      |       |
| Other assets                                                                                                                               |       | 13,186                     |       |       | 22,130                  |       | 52,678                     |       |
| Total assets                                                                                                                               |       | $                          | 6,986,415  |       |                    | $          | 2,660,660                  |       | $ | 2,758,075 |   |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                              |       |                       |       |       |                    |       |                       |       |
| Current liabilities:                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| Accounts  payable                                                                                                                          |       | $                          | 347,810    |       |                    | $          | 282,887                    |       | $ | 293,344 |   |
| Accrued  liabilities                                                                                                                       |       | 339,741                    |       |       | 332,937                 |       | 347,232                    |       |
| Notes  payable and current maturities of long-term liabilities                                                                             |       | 5,700                      |       |       | 1,450                   |       | 4,200                      |       |
| Senior notes  due 2008                                                                                                                     |       | 134,734                    |       |       | —                  |       | —                     |       |
| Current  portion of borrowings under Credit Card Facility                                                                                  |       | —                     |       |       | —                  |       | 225,000                    |       |
| Total current  liabilities                                                                                                                 |       | 827,985                    |       |       | 617,274                 |       | 869,776                    |       |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| Long-term liabilities:                                                                                                                     |       |                       |       |       |                    |       |                       |       |
| Asset-based  revolving credit facility                                                                                                     |       | 150,000                    |       |       | —                  |       | —                     |       |
| Senior  secured term loan facility                                                                                                         |       | 1,975,000                  |       |       | —                  |       | —                     |       |
| Senior  debentures due 2028                                                                                                                |       | 120,565                    |       |       | 124,823                 |       | 124,817                    |       |
| Senior notes                                                                                                                               |       | 700,000                    |       |       | —                  |       | —                     |       |
| Senior  subordinated notes                                                                                                                 |       | 500,000                    |       |       | —                  |       | —                     |       |
| Senior notes  due 2008                                                                                                                     |       | —                     |       |       | 124,957                 |       | 124,945                    |       |
| Deferred  real estate credits                                                                                                              |       | 1,319                      |       |       | 86,575                  |       | 70,587                     |       |
| Deferred  income taxes                                                                                                                     |       | 1,117,244                  |       |       | —                  |       | 20,750                     |       |
| Other  long-term liabilities                                                                                                               |       | 170,870                    |       |       | 120,973                 |       | 94,719                     |       |
| Total  long-term liabilities                                                                                                               |       | 4,734,998                  |       |       | 457,328                 |       | 435,818                    |       |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| Minority interest                                                                                                                          |       | 11,751                     |       |       | 12,112                  |       | 11,474                     |       |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| ***Predecessor:***                                                                                                                         |       |                       |       |       |                    |       |                       |       |
| Common  stocks (par value $0.01 per share, issued 49,716,309 shares at July 30,  2005 and 49,576,284 shares at October 30, 2004) |       | —                     |       |       | 497                     |       | 496                        |       |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| ***Successor:***                                                                                                                           |       |                       |       |       |                    |       |                       |       |
| Common stock (par value $0.01 per share,  issued 900 shares)                                                                               |       | —                     |       |       | —                  |       | —                     |       |
|                                                                                                                                       |       |                       |       |       |                    |       |                       |       |
| Additional paid-in capital                                                                                                                 |       | 1,470,630                  |       |       | 520,414                 |       | 505,573                    |       |
| Carryover basis adjustment for management  shareholders                                                                                    |       | (69,200                    | )          |       | —                  |       | —                     |       |
| Accumulated other comprehensive loss                                                                                                       |       | (598                       | )          |       | (47,030                 | )          | (3,068                     | )          |
| Retained earnings                                                                                                                          |       | 10,849                     |       |       | 1,125,726               |       | 963,431                    |       |
| Treasury stock, at cost (0 shares, 768,731  shares and 764,631 shares)                                                                     |       | —                     |       |       | (25,661                 | )          | (25,425                    | )          |
| Total shareholders’ equity                                                                                                            |       | 1,411,681                  |       |       | 1,573,946               |       | 1,441,007                  |       |
| Total liabilities and shareholders’ equity                                                                                            |       | $                          | 6,986,415  |       |                    | $          | 2,660,660                  |       | $ | 2,758,075 |   |

 

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

1

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**THE NEIMANMARCUS GROUP, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS**

**(UNAUDITED)**

 
| **(in thousands)**                                        | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                | ** ** | **(Successor)**                               | ** ** | ** ** | **(Predecessor)**                            | ** ** | **(Predecessor)**                                 | ** ** |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Revenues                                                  |       | $                                             | 324,790    |       |                                         | $          | 651,648                                           |       | $ | 907,936 |   |
| Cost of goods sold including buying and  occupancy costs  |       | 195,209                                       |       |       | 378,767                                      |       | 531,183                                           |       |
| Selling, general and administrative  expenses             |       | 79,200                                        |       |       | 161,035                                      |       | 227,104                                           |       |
| Depreciation expense                                      |       | 9,709                                         |       |       | 19,960                                       |       | 24,386                                            |       |
| Amortization of customer lists                            |       | 3,378                                         |       |       | —                                       |       | —                                            |       |
| Amortization of favorable lease commitments               |       | 1,559                                         |       |       | —                                       |       | —                                            |       |
| Transaction and other costs                               |       | —                                        |       |       | 23,544                                       |       | —                                            |       |
| Loss on disposition of Chef’s Catalog                |       | —                                        |       |       | —                                       |       | 15,348                                            |       |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Operating earnings                                        |       | 35,735                                        |       |       | 68,342                                       |       | 109,915                                           |       |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Interest expense (income), net                            |       | 17,285                                        |       |       | (866                                         | )          | 4,037                                             |       |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Earnings before income taxes and minority  interest       |       | 18,450                                        |       |       | 69,208                                       |       | 105,878                                           |       |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Income taxes                                              |       | 7,269                                         |       |       | 25,607                                       |       | 40,975                                            |       |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Earnings before minority interest                         |       | 11,181                                        |       |       | 43,601                                       |       | 64,903                                            |       |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Minority interest in net (loss) earnings of  subsidiaries |       | (332                                          | )          |       | 553                                          |       | (787                                              | )          |
|                                                      |       |                                          |       |       |                                         |       |                                              |       |
| Net earnings                                              |       | $                                             | 10,849     |       |                                         | $          | 44,154                                            |       | $ | 64,116 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

2

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**THE NEIMAN MARCUS GROUP, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| **(in thousands)**                                                                               | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **(Successor)**                               | ** ** | ** ** | **(Predecessor)**                            | ** ** | **(Predecessor)**                                 | ** ** |
| **CASH FLOWS - OPERATING ACTIVITIES**                                                            |       |                                          |       |       |                                         |       |                                              |       |
| Net earnings                                                                                     |       | $                                             | 10,849     |       |                                         | $          | 44,154                                            |       | $ | 64,116 |   |
| Adjustments  to reconcile net earnings to net cash provided by (used for) operating  activities: |       |                                          |       |       |                                         |       |                                              |       |
| Depreciation                                                                                     |       | 9,709                                         |       |       | 19,960                                       |       | 24,386                                            |       |
| Amortization  of debt issue costs                                                                |       | 1,091                                         |       |       | —                                       |       | —                                            |       |
| Amortization  of customer lists and favorable lease commitments                                  |       | 4,937                                         |       |       | —                                       |       | —                                            |       |
| Non-cash  charges related to step-up in carrying value of inventory                              |       | 7,481                                         |       |       | —                                       |       | —                                            |       |
| Stock-based  compensation charges                                                                |       | —                                        |       |       | 19,968                                       |       | 932                                               |       |
| Deferred  income taxes                                                                           |       | (1,584                                        | )          |       | (7,327                                       | )          | —                                            |       |
| Loss on disposition  of Chef’s Catalog                                                      |       | —                                        |       |       | —                                       |       | 15,348                                            |       |
| Minority  interest                                                                               |       | 332                                           |       |       | (553                                         | )          | 787                                               |       |
| Other,  primarily costs related to defined benefit pension and other long-term  benefit plans    |       | 2,706                                         |       |       | 1,656                                        |       | 7,298                                             |       |
|                                                                                             |       | 35,521                                        |       |       | 77,858                                       |       | 112,867                                           |       |
| Changes in operating assets and  liabilities:                                                    |       |                                          |       |       |                                         |       |                                              |       |
| Increase in  accounts receivable                                                                 |       | (2,677                                        | )          |       | (7,377                                       | )          | (89,549                                           | )          |
| Increase in  merchandise inventories                                                             |       | (27,112                                       | )          |       | (173,829                                     | )          | (160,989                                          | )          |
| Decrease  (increase) in other current assets                                                     |       | 1,032                                         |       |       | 6,164                                        |       | (1,377                                            | )          |
| (Increase)  decrease in other assets                                                             |       | —                                        |       |       | (2,274                                       | )          | 15,187                                            |       |
| Increase in  accounts payable and accrued liabilities                                            |       | 14,204                                        |       |       | 114,604                                      |       | 65,401                                            |       |
| Payment of  deferred compensation and stock-based awards                                         |       | (12,901                                       | )          |       | —                                       |       | —                                            |       |
| Increase  (decrease) in deferred real estate credits                                             |       | 1,319                                         |       |       | 4,289                                        |       | (1,311                                            | )          |
| **Net cash provided by (used for) operating  activities**                                        |       | 9,386                                         |       |       | 19,435                                       |       | (59,771                                           | )          |
|                                                                                             |       |                                          |       |       |                                         |       |                                              |       |
| **CASH FLOWS - INVESTING ACTIVITIES**                                                            |       |                                          |       |       |                                         |       |                                              |       |
| Capital expenditures                                                                             |       | (23,011                                       | )          |       | (26,311                                      | )          | (50,568                                           | )          |
| Increase in reserved cash                                                                        |       | (134,734                                      | )          |       | —                                       |       | —                                            |       |
| Acquisition of The Neiman Marcus Group, Inc.                                                |       | (5,152,939                                    | )          |       | —                                       |       | —                                            |       |
| **Net cash used for investing activities**                                                       |       | (5,310,684                                    | )          |       | (26,311                                      | )          | (50,568                                           | )          |
|                                                                                             |       |                                          |       |       |                                         |       |                                              |       |
| **CASH FLOWS - FINANCING ACTIVITIES**                                                            |       |                                          |       |       |                                         |       |                                              |       |
| Proceeds from borrowings on lines of credit                                                      |       | 3,500                                         |       |       | 5,750                                        |       | 2,750                                             |       |
| Repayment of borrowings on lines of credit                                                       |       | (4,250                                        | )          |       | (750                                         | )          | —                                            |       |
| Borrowings under asset-based revolving  credit facility                                          |       | 150,000                                       |       |       |                                         |       | —                                            |       |
| Borrowings of senior term loan facility                                                          |       | 1,975,000                                     |       |       |                                         |       | —                                            |       |
| Borrowings of senior and subordinated debt                                                       |       | 1,200,000                                     |       |       | —                                       |       | —                                            |       |
| Debt issuance costs paid                                                                         |       | (102,854                                      | )          |       |                                         |       |                                              |       |
| Cash equity contributions                                                                        |       | 1,427,739                                     |       |       | —                                       |       | —                                            |       |
| Acquisitions of treasury stock                                                                   |       | —                                        |       |       | —                                       |       | (2,851                                            | )          |
| Proceeds from stock-based compensation  awards                                                   |       | —                                        |       |       | —                                       |       | 6,864                                             |       |
| Cash dividends paid                                                                              |       | —                                        |       |       | (7,346                                       | )          | (6,314                                            | )          |
| Distribution paid                                                                                |       | —                                        |       |       | —                                       |       | (110                                              | )          |
| **Net cash provided by (used for) financing  activities**                                        |       | 4,649,135                                     |       |       | (2,346                                       | )          | 339                                               |       |
|                                                                                             |       |                                          |       |       |                                         |       |                                              |       |
| **CASH AND CASH EQUIVALENTS**                                                                    |       |                                          |       |       |                                         |       |                                              |       |
| Decrease during the period                                                                       |       | (652,163                                      | )          |       | (9,222                                       | )          | (110,000                                          | )          |
| Beginning balance                                                                                |       | 844,260                                       |       |       | 853,482                                      |       | 368,367                                           |       |
| Ending balance                                                                                   |       | $                                             | 192,097    |       |                                         | $          | 844,260                                           |       | $ | 258,367 |   |
| **Supplemental Schedule of Cash Flow  Information**                                         |       |                                          |       |       |                                         |       |                                              |       |
| Cash paid during the period for:                                                                 |       |                                          |       |       |                                         |       |                                              |       |
| Interest                                                                                         |       | $                                             | 24         |       |                                         | $          | 207                                               |       | $ | 1,170 |   |
| Income taxes                                                                                     |       | $                                             | 275        |       |                                         | $          | 10,693                                            |       | $ | 2,311 |   |
| Noncash activities:                                                                              |       |                                          |       |       |                                         |       |                                              |       |
| Equity  contribution from Parent                                                                 |       | $                                             | 25,000     |       |                                         | $          | —                                            |       | $ | — |   |
| Equity  contribution from management shareholders                                                |       | $                                             | 17,891     |       |                                         | $          | —                                            |       | $ | — |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

3

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**THE NEIMANMARCUS GROUP, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

1.               Basisof Presentation

 

The Neiman MarcusGroup, Inc. was acquired on October 6, 2005 through a mergertransaction with Newton Acquisition Merger Sub, Inc., a wholly-owned subsidiary of Newton Acquisition, Inc.(Parent). The Parent was formed by investment funds affiliated with TexasPacific Group and Warburg Pincus (the Sponsors). The acquisition wasaccomplished through the merger of Newton Acquisition Merger Sub, Inc.with and into The Neiman Marcus Group, Inc. (Company) with The NeimanMarcus Group, Inc. being the surviving company (the Acquisition).Subsequent to the Acquisition, we are a subsidiary of the Parent, which iscontrolled by Newton Holding, LLC. Although we continued as the same legal entity after the Acquisition,the accompanying consolidated statements of operations and cash flows arepresented for two periods: Predecessor and Successor, which relate to theperiod preceding the Acquisition and the period succeeding the Acquisition,respectively.   The Acquisition and theallocation of the purchase price have been recorded as of October 1, 2005,the beginning of our October accounting period.

 

We have preparedthe accompanying unaudited condensed consolidated financial statements inaccordance with generally accepted accounting principles for interim financialinformation and the instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, thesefinancial statements do not include all of the information and footnotesrequired by accounting principles generally accepted for complete financialstatements. Therefore, these financial statements should be read in conjunctionwith our Annual Report on Form 10-K for the fiscal year ended July 30,2005.

 

In our opinion,the accompanying unaudited condensed consolidated financial statements containall adjustments, consisting of normal recurring adjustments, necessary topresent fairly our financial position, results of operations and cash flows forthe applicable interim periods.  Theresults of operations for these periods are not necessarily comparable to, orindicative of, results of any other interim period or for the fiscal year as awhole.

 

**We are required to make estimatesand assumptions about future events in preparing financial statements inconformity with generally accepted 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 believethat our past estimates and assumptions have been materially accurate, ourcurrent estimates are subject to change if different assumptions as to theoutcome of future events were made. We evaluate our estimates and judgments onan ongoing basis and predicate those estimates and judgments on historicalexperience and on various other factors that we believe to be reasonable underthe circumstances.  We make adjustmentsto our assumptions and judgments when facts and circumstances dictate.  Since future events and their effects cannotbe determined with absolute certainty, actual results may differ from theestimates used in preparing the accompanying unaudited condensed consolidatedfinancial 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 Note 3);

 

•                  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

 

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

 

4

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

 

Certainprior period balances have been reclassified to conform to the current periodpresentation.  In prior periods,depreciation expense was included in buying and occupancy costs.

 

***Recent Accounting Pronouncements.***InDecember 2004, the Financial Accounting Standards Board (FASB) issued SFASNo. 123R, “Share-Based Payment.” This standard is a revision of SFAS No. 123,“Accounting for Stock-Based Compensation,” and supersedes Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” and itsrelated implementation guidance.  SFAS No. 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the financial statements based on their fairvalues and is effective for the first interim period or annual reporting periodbeginning after June 15, 2005.  Weadopted SFAS No. 123R as of the beginning of our first quarter of 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 presentedherein.  See Note 5 for furtherdescription of our stock-based compensation.

 

In March 2005, the FASB issued FASB Interpretation No. 47,“Accounting for Conditional Asset Retirement Obligations, an interpretation ofFASB Statement No. 143” (FIN 47). FIN 47 clarifies that conditional asset retirement obligations meet thedefinition of liabilities and should be recognized when incurred if their fairvalues can be reasonably estimated.  FIN47 is effective no later than the end of fiscal years ending after December 15,2005.  The cumulative effect of initiallyapplying FIN 47 will be recognized as a change in accounting principle. We arein the process of evaluating the expected effect of FIN 47, if any, on ourconsolidated financial statements.

 

2.               TheTransactions

 

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

 

•                  Borrowings under our senior securedasset-based revolving credit facility (Asset-Based Revolving Credit Facility)and our secured term loan credit facility (Senior Secured Term Loan Facility)(collectively, the Secured Credit Facilities);

 

•                  issuance of 9.0%/9.75% senior notesdue 2015 (Senior Notes);

 

•                  issuance of 10.375% seniorsubordinated notes due 2015 (Senior Subordinated Notes); and

 

•                  equity investments from Parent fundedby direct and indirect equity investments from the Sponsors, co-investors andmanagement.

 

The Acquisition occurredsimultaneously with:

 

•                  the closing of the financingtransactions and equity investments described above;

 

•                  the call for redemption of, thedeposit into a segregated account of the estimated amount of the redemptionpayment related to, and the ratable provision of security pursuant to the termsthereof for our 6.65% senior notes due 2008 (2008 Notes);

 

•                  the ratable provision of security toour 7.125% senior debentures due 2028 (2028 Debentures) pursuant to the termsthereof; and

 

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

 

We refer to the above transactions, the Acquisitionand our payment of any costs related to these transactions collectively hereinas the “Transactions.”   We refer to theSenior Notes and Senior Subordinated Notes collectively herein as the “Notes.”

 

5

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

 

***Carryover Basis Adjustment forManagement Shareholders.*** Executive managementparticipants held certain equity interests, including stock options, in thePredecessor prior to the Transactions and will continue to hold indirect equityinterests in the Successor after the Transactions. In accordance with theprovisions of Emerging Issues Task Force No. 88-16, *Basis inLeveraged Buyout Transactions,*the basis of executive management’sindirect interests in the Successor after the Transactions is carried over atthe basis of their interests in the Predecessor prior to the Transactions. Thecarryover basis of such interests less the net cash received by the managementparticipants represents a deemed dividend of $69.2 million to the managementparticipants and has been recognized as a reduction to shareholders’ equity ofthe Successor.

 

**3.**               Purchase Accounting

 

We have accounted for theAcquisition in accordance with the provisions of Statement of FinancialAccounting Standards (SFAS) 141, “Business Combinations,” whereby the purchaseprice paid to effect the Acquisition is allocated to state the acquired assetsand liabilities at fair value.  TheAcquisition and the allocation of the purchase price have been recorded as of October 1,2005, the beginning of our October accounting period.  The purchase price was approximately $5,458.2million.  The sources and uses of fundsin connection with the Transactions and the redemption of our 2008 Notes aresummarized 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                                                                         |   | 662.6   |    |
| Equity contribution – cash                                                      |   | 1,427.7 |    |
| Equity contribution – non-cash                                                  |   | 42.9    |    |
| Total sources                                                                        |   | $       | 5,458.2 |   |
|                                                                                 |   |    |    |
| **Uses**                                                                             |   |    |    |
| Consideration paid to stockholders  (including management rollover of $17.9 million) |   | $       | 5,109.5 |   |
| Transaction costs (including non-cash items  of $18.7 million)                       |   | 80.1    |    |
| 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                                                                           |   | $       | 5,458.2 |   |

 

In connection with thepreliminary purchase price allocation, we have made estimates of the fairvalues of our long-lived and intangible assets based upon assumptions relatedto the future cash flows, discount rates and asset lives utilizing currentlyavailable information, and in some cases, preliminary valuation results fromindependent valuation specialists.  As ofOctober 29, 2005, we have recorded preliminary purchase accountingadjustments to increase the carrying value of our property and equipment andinventory, to establish intangible assets for our tradenames, customer listsand favorable lease commitments and to revalue our long-term benefit planobligations, among other things.  Thisallocation of the purchase price is preliminary and subject to finalization ofindependent appraisals.  Furtherrevisions to the purchase price allocation will be made as additionalinformation becomes available and such revisions could be material.

 

6

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The purchase price hasbeen preliminarily allocated as follows (in millions):

 
| Cash  consideration:                                                         |   |     |   |    |    |
|------------------------------------------------------------------------------|--------|----------|--------|---------|---------|
| Paid to  shareholders                                                        |   |     |   | $       | 5,091.6 |   |
| Transaction  costs                                                           |   |     |   | 61.4    |    |
|                                                                         |   |     |   | 5,153.0 |    |
| Non-cash consideration                                                       |   |     |   | 36.6    |    |
| Total consideration                                                          |   |     |   | 5,189.6 |    |
|                                                                         |   |     |   |    |    |
| 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                        |   | $        | 235.1  |    |    |   |
| 2) Increase  carrying value of inventory                                     |   | 37.0     |   |    |    |
| 3) Write-off  historical goodwill and tradenames                             |   | (71.5    | )      |    |    |
| 4) Record  intangible assets acquired                                        |   |     |   |    |    |
| Customer  lists                                                              |   | 466.3    |   |    |    |
| Favorable  lease commitments                                                 |   | 386.8    |   |    |    |
| Tradenames                                                                   |   | 1,734.2  |   |    |    |
| 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                                      |   | (1,058.1 | )      |    |    |
| Deemed dividend to management shareholders                                   |   | 69.2     |   | 1,826.2 |    |
| Net assets acquired at fair value                                            |   |     |   | 3,464.3 |    |
|                                                                         |   |     |   |    |    |
| Excess purchase price recorded as goodwill                                   |   |     |   | $       | 1,725.3 |   |
|                                                                              |        |          |        |         |         |  |  |

 

Our tradenames haveindefinite lives and are not subject to amortization. Our tradenames andgoodwill will be reviewed at least annually for impairment.

 

Based on preliminaryvaluation data and amounts recorded at October 1, 2005, total estimatedamortization of all acquisition-related intangible assets during the periodfrom October 6, 2005 through July 29, 2006 and for each of our fiscalyears ending in July 2006 to 2010 is currently estimated as follows (inthousands):

 
| October 6,  2005 through July 29, 2006 |   | $        | 53,070.4 |   |
|--------------------------------------------------|--------|----------|----------|--------|
| 2007                                             |   | 64,178.1 |     |
| 2008                                             |   | 64,178.1 |     |
| 2009                                             |   | 64,178.1 |     |
| 2010                                             |   | 58,537.4 |     |

 

7

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***ProForma Financial Information.***The following unaudited proforma results of operations assumes that the Transactions occurred on August 1,2004.  The following unaudited pro formaresults does not give effect to the sale of our credit card receivables, whichwas completed on July 7, 2005 or the disposition of Chef’s Catalog, whichwas completed on November 8, 2004. This unaudited pro forma information should not be relied upon asnecessarily being indicative of the historical results that would have beenobtained if the Transactions had actually occurred on that date, nor theresults that may be obtained in the future.

 
| **(in thousands)** | ** ** | **Thirteen  weeks ended  October 29,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|--------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
|               |       |                                              |       |                                              |       |
| Revenues           |       | $                                                 | 976,438    |                                              | $          | 907,936 |   |
| Net income         |       | $                                                 | 37,599     |                                              | $          | 1,427 |   |

 

**4.**               Transactions with Sponsors

 

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

 

In addition, pursuant to such agreement, and in exchange for on-goingconsulting and management advisory services that will be provided to us by theSponsors and their affiliates, affiliates of the Sponsors will receive an aggregateannual management fee equal to the lesser of (i) 0.25% of our consolidatedannual 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 payable annually in arrears.  During the four weeks ended October 29,2005, we recorded $0.7 million in management fees, included in selling, generaland administrative expenses in the statement of earnings.

 

The management servicesagreement also provides that affiliates of the Sponsors may receive future feesin connection with certain subsequent financing and acquisition or dispositiontransactions.  The management services agreementincludes customary exculpation and indemnification provisions in favor of theSponsors and their affiliates.

 

**5.**               Stock-Based Compensation

 

We previously accounted for stock-based compensation awards toemployees in accordance with Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations.  Accordingly, we recognized compensationexpense on our restricted stock awards but did not recognize compensationexpense for stock options since all options granted had an exercise price equalto the market value of our common stock on the grant date.

 

In December 2004, the 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 Opinion No. 25and its related implementation guidance. 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 adopted SFAS No. 123R as of thebeginning of our first quarter of 2006 using the modified prospective method,which required us to record stock compensation for all unvested and new awardsas of the adoption date. Accordingly, we have not restated prior period amountspresented herein.

 

***Predecessor Stock-Based CompensationAccounting. ***Werecorded non-cash charges for stock compensation of approximately $20.0 millionin the period from July 31, 2005 to October 1, 2005 primarily as aresult of the accelerated vesting of all Predecessor options and restrictedstock in connection with the Transactions (see Note 2).

 

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SFAS Number 123, “Accounting for Stock-Based Compensation” (SFAS 123),as amended by SFAS Number 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an Amendment of FASB Statement 123”changed the method for recognition of the cost of stock option and awardplans.  Adoption of the cost recognitionrequirements under SFAS 123 was optional; however, the following supplementalinformation is provided (in thousands):

 
| **(in thousands)**                                                                                               | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **(Predecessor)**                                 | ** ** |
| Net earnings:                                                                                                    |       |                                              |       |
| As reported                                                                                                      |       | $                                                 | 64,116     |   |
| Add:  stock-based employee compensation recorded under intrinsic value method, net  of related taxes             |       | 932                                               |       |
| Less:  stock-based employee compensation expense determined under fair value based  method, net of related taxes |       | (2,894                                            | )          |
| Pro forma                                                                                                        |       | $                                                 | 62,154     |   |

 

***Successor Stock-Based CompensationAccounting. ***OnNovember 29, 2005, the Parent adopted a new equity-based managementcompensation plan, which authorizes equity awards to be granted for up to80,708.8 shares of the common stock of the Parent, of which options for75,207.5 shares were issued to certain management employees. Options grantedhave an exercise price of $1,445 per share, with the exercise price withrespect to approximately 50% of such options escalating at a 10% compound rateper year until the earlier to occur of (i) exercise, (ii) the fifthanniversary of grant or (iii) the occurrence of a change in control;provided that in the event the Sponsors cause the sale of shares of the Parentto an unaffiliated entity, the exercise price will cease to accrete at the timeof the sale with respect to a pro rata portion of the accreting options.

 

**6.**               The Credit Card Sale

 

***Credit Card 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 wasapproximately $647 million, consisting of $534 million in net cash proceeds andthe assumption of approximately $113 million of our outstanding debt under ourprevious revolving credit card securitization facility (Credit Card Facility).  We recognized a gain of $6.2 million inconnection with the sale of our credit card portfolio to HSBC in the fourthquarter of 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.  In the future, the HSBC Program Income may beeither decreased based upon the level of future services we provide to HSBC orincreased based upon contemplated changes, which are currently being undertakenby us and HSBC, to our historical credit card program related to, among otherthings, the interest rate applied to unpaid balances and the assessment of latefees.

 

9

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A summary of the income earned in connection with our propriety creditcard program is as follows:

 
| **(in thousands)**    | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|-----------------------|------------|-----------------------------------------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **            | ** ** | **(Successor)**                               | ** ** | ** ** | **(Predecessor)**                            | ** ** | **(Predecessor)**                                 | ** ** |
|                  |       |                                          |       |       |                                         |       |                                              |       |
| HSBC Program Income   |       | $                                             | 4,178      |       |                                         | $          | 7,803                                             |       | $ | — |   |
| Finance charge income |       | —                                        |       |       | —                                       |       | 19,747                                            |       |
| Bad debt, net         |       | —                                        |       |       | —                                       |       | (4,404                                            | )          |
|                  |       | $                                             | 4,178      |       |                                         | $          | 7,803                                             |       | $ | 15,343 |   |

 

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

 

In November 2004, we sold our Chef’s Catalog direct marketingbusiness to a private equity firm.  Chef’sCatalog is a multi-channel retailer of professional-quality kitchenware withrevenues in 2004 of approximately $73 million. At October 30, 2004, Chef’s Catalog had net tangible assets,primarily inventory, of $12.5 million and net intangible assets of $17.2million. We received proceeds, net of selling costs, of $14.4 million from thesale.  As the carrying value of the Chef’sCatalog assets exceeded the fair value of such assets as determined by thesale, we incurred a pre-tax loss of $15.3 million in the first quarter of 2005related to the disposition of Chef’s Catalog.

 

8.               Long-termDebt

 

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

 
| **(in thousands)**                     | ** ** | **Interest  Rate** | ** ** | **October 29,  2005** | ** ** | ** ** | **July 30,  2005** | ** ** | **October 30,  2004** | ** ** |
|----------------------------------------|------------|--------------------|------------|----------------------------|------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | ** **         | ** ** | **(Successor)**            | ** ** | ** ** | **(Predecessor)**       | ** ** | **(Predecessor)**          | ** ** |
| Asset-Based Revolving Credit Facility  |       | variable           |       | $                          | 150,000    |       |                    | $          | —                     |       | $ | — |   |
| Senior Secured Term Loan Facility      |       | variable           |       | 1,975,000                  |       |       | —                  |       | —                     |       |
| 2028 Debentures                        |       | 7.125%             |       | 120,565                    |       |       | 124,823                 |       | 124,817                    |       |
| Senior Notes                           |       | 9.0%/9.75%         |       | 700,000                    |       |       | —                  |       | —                     |       |
| Senior Subordinated Notes              |       | 10.375%            |       | 500,000                    |       |       | —                  |       | —                     |       |
| 2008 Notes                             |       | 6.65%              |       | 134,734                    |       |       | 124,957                 |       | 124,945                    |       |
| Credit Card Facility                   |       | variable           |       | —                     |       |       | —                  |       | 225,000                    |       |
|                                   |       |               |       | 3,580,299                  |       |       | 249,780                 |       | 474,762                    |       |
| Less: current portion                  |       |               |       |                       |       |       |                    |       |                       |       |
| 2008 Notes                             |       |               |       | 134,734                    |       |       | —                  |       | —                     |       |
| Borrowings  under Credit Card Facility |       |               |       | —                     |       |       | —                  |       | 225,000                    |       |
| Long-term debt                         |       |               |       | $                          | 3,445,565  |       |                    | $          | 249,780                    |       | $ | 249,762 |   |

 

***Senior SecuredAsset-Based Revolving Credit Facility.*** On October 6,2005, in connection with the Transactions, we entered into a credit agreementand related security and other agreements for a senior secured Asset-BasedRevolving Credit Facility with Deutsche Bank Trust Company Americas asadministrative agent and collateral agent. The Asset-Based Revolving Credit Facility provides financing of up to$600.0 million, subject to a borrowing base equal to at any time thelesser 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.  The Asset-BasedRevolving Credit Facility includes borrowing capacity available for letters ofcredit and for borrowings on same-day notice.  At the closing of the Transactions,we utilized $150.0 million of the Asset-Based Revolving Credit Facilityfor loans and approximately $16.5 millionfor letters of credit, which remained outstanding on October 29,2005.  As a result, on October 29,2005 we had $433.5 million ofunused borrowing availability under the Asset-Based Revolving Credit Facility.

 

The Asset-Based Revolving Credit Facility providesthat we have the right at any time to request up to $200.0 million ofadditional commitments, but the lenders are under no obligation to provide anysuch additional commitments, and any increase in commitments will be subject tocustomary conditions precedent. If we were to request any such additionalcommitments and the

 

10

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existing lenders or new lenders were to agree toprovide such commitments, the Asset-Based Revolving Credit Facility size couldbe increased to up to $800.0 million, but our ability to borrow wouldstill be limited by the amount of the borrowing base.

 

Borrowings under the Asset-Based Revolving CreditFacility bear interest at a rate per annum equal to, at our option, either (a) abase rate determined by reference to the higher of (1) the prime rate ofDeutsche Bank Trust Company Americas and (2) the federal funds effectiverate plus  1/2 of 1% or (b) a LIBOR rate,subject to certain adjustments, in each case plus an applicable margin. The initial applicable margin is 0% with respect to base rate borrowings and1.75% with respect to LIBOR borrowings.  The applicable margin is subjectto adjustment based on the historical availability under the Asset-BasedRevolving Credit Facility.   The interestrate on the outstanding borrowings pursuant to the Asset-Based Revolving CreditFacility was 6.06% at October 29, 2005. In addition, we are required to pay a commitment fee of 0.375% per annumin respect of the unutilized commitments. If the average revolving loan utilization is 50% or more for anyapplicable period, the commitment fee will be reduced to 0.250% for such period.We must also pay customary letter of credit fees and agency fees.

 

If at any time the aggregate amount of outstandingloans, unreimbursed letter of credit drawings and undrawn letters of creditunder the Asset-Based Revolving Credit Facility exceeds the lesser of (i) thecommitment amount and (ii) the borrowing base, we will be required torepay outstanding loans or cash collateralize letters of credit in an aggregateamount equal to such excess, with no reduction of the commitment amount.  If the amount available under the Asset-BasedRevolving Credit Facility is less than $60 million or an event of defaulthas occurred, we will be required to repay outstanding loans and cashcollateralize letters of credit with the cash we are required to deposit dailyin a collection account maintained with the agent under the Asset-BasedRevolving Credit Facility.  We mayvoluntarily reduce the unutilized portion of the commitment amount and repayoutstanding loans at any time without premium or penalty other than customary“breakage” costs with respect to LIBOR loans. There is no scheduled amortization under the Asset-Based RevolvingCredit Facility; the principal amount of the loans outstanding are due andpayable in full on October 6, 2010.

 

All obligations under the Asset-Based RevolvingCredit Facility are guaranteed by Parent and certain of our existing and futuredomestic subsidiaries (excluding, among others, Gurwitch Products, L.L.C.,and Kate Spade LLC (Brand Development Companies)).  As of October 29, 2005, the liabilitiesof our non-guarantor subsidiaries totaled approximately $35.8 million, or 0.6%of consolidated liabilities, and the assets of our non-guarantor subsidiariesaggregated approximately $146.5 million, or 2.1% of consolidated totalassets.  All obligations under ourAsset-Based Revolving Credit Facility, and the guarantees of those obligations,are secured, subject to certain significant exceptions, by substantially all ofour assets and the assets of Parent and our subsidiaries that have guaranteedthe 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.

 

Our Asset-Based Revolving Credit Facility contains anumber of covenants that, among other things and subject to certain significantexceptions, restrict our ability 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;

 

11

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•                  create liens; and

 

•                  enter into sale and lease back transactions.

 

The covenants limiting dividends and otherrestricted payments; investments, loans, advances and acquisitions; andprepayments or redemptions of other indebtedness, each permit the restrictedactions in an unlimited amount, subject to the satisfaction of certain paymentconditions, principally that we must have at least $75.0 million of proforma excess availability under the Asset-Based Revolving Credit Facility andthat we must be in pro forma compliance with the fixed charge coverage ratiodescribed below.

 

Although the credit agreement governing theAsset-Based Revolving Credit Facility does not require us to comply with anyfinancial ratio maintenance covenants, if less than $60.0 million wereavailable to be borrowed under the Asset-Based Revolving Credit Facility at anytime, we would not be permitted to borrow any additional amounts unless our proforma ratio of consolidated EBITDA to consolidated Fixed Charges (as such termsare defined in the credit agreement) were at least 1.1 to 1.0.  The credit agreement also contains customaryaffirmative covenants and events of default.

 

***Senior SecuredTerm 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.

 

Borrowings under the Senior Secured Term LoanFacility bear interest at a rate per annum equal to, at our option, either (a) abase rate determined by reference to the higher of (1) the prime rate ofCredit Suisse and (2) the federal funds effective rate plus  1/2of 1% or (b) a LIBOR rate, subject to certain adjustments, in each caseplus an applicable margin.  Theapplicable margin is 1.5% with respect to base rate borrowings and 2.5% withrespect to LIBOR borrowings.  Theinterest rate on the outstanding borrowings pursuant to the Senior Secured TermLoan Facility was 6.51% at October 29, 2005.

 

The credit agreement governing the Senior SecuredTerm Loan Facility requires us to prepay outstanding term loans with 50% (whichpercentage will be reduced to 25% if our total leverage ratio is less than aspecified ratio and will be reduced to 0% if our total leverage ratio is lessthan a specified ratio) of our annual excess cash flow (as defined in thecredit agreement).  If a change ofcontrol (as defined in the credit agreement) occurs, we will be required tooffer to prepay all outstanding term loans, at a prepayment price equal to 101%of the principal amount to be prepaid, plus accrued and unpaid interest to thedate of prepayment. We also must offer to prepay outstanding term loans at 100%of the principal amount to be prepaid, plus accrued and unpaid interest, withthe proceeds of certain asset sales under certain circumstances.

 

We may voluntarily prepay outstanding loans underthe Senior Secured Term Loan Facility at any time without premium or penaltyother 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 aprepayment that is made with certain designated asset sale proceeds), we mustpay 101% of the principal amount to be repaid. There is no scheduled amortization under the Senior Secured Term LoanFacility.  The principal amount of theloans outstanding is due and payable in full on April 6, 2013.

 

All obligations under the Senior Secured Term LoanFacility are unconditionally guaranteed by Parent and each direct and indirectdomestic subsidiary of the Company that guarantees the obligations of theCompany under our Asset-Based Revolving Credit Facility.  All obligations under the Senior Secured TermLoan Facility, and the guarantees of those obligations, are secured, subject tocertain significant exceptions, by substantially all of our assets and theassets of Parent and the subsidiary guarantors, 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, 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

 

12

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orotherwise in respect of all credit card charges for sales of inventory by usand the subsidiary guarantors, certain related assets and proceeds of theforegoing.

 

The credit agreement governing the Senior SecuredTerm Loan Facility contains a number of negative covenants that aresubstantially similar to those governing the Senior Notes and additionalcovenants related to the security arrangements for the Senior Secured Term LoanFacility.  The credit agreement alsocontains customary affirmative covenants and events of default.

 

***2028 Debentures. ***InMay 1998, we issued $125.0 million aggregate principal amount of our 2028Debentures.  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 thecapital stock of certain of our existing and future domestic subsidiaries, and (ii) 100%of the non-voting stock and 65% of the voting stock of certain of our existingand future foreign subsidiaries and (b) certain of our principalproperties that include a majority of our full-line stores, in each case, tothe extent required by the terms of the indenture governing our 2028Debentures.

*** ***

***SeniorNotes. ***On October 6, 2005, Newton AcquisitionMerger Sub., Inc. issued $700.0 million aggregate original principalamount 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.

 

For any interest payment period through October 15,2010, the Company may, at its option, elect to pay interest on the Senior Notesentirely in cash (Cash Interest) or entirely by increasing the principal amountof the outstanding Senior Notes or by issuing additional Senior Notes (PIKInterest).  Cash Interest on the SeniorNotes accrues at the rate of 9% per annum.  PIK Interest on the SeniorNotes accrues at the rate of 9.75% per annum.  After October 15,2010, the Company will make all interest payments on the Senior Notes entirelyin cash.  All Senior Notes mature on October 15, 2015 and have thesame rights and benefits as the Senior Notes issued on October 6,2005.  Interest on the Senior Notes ispayable quarterly in arrears on each January 15, April 15, July 15and October 15, commencing on January 15, 2006.

 

The Senior Notes are guaranteed, jointly andseverally, on an unsecured, senior basis, by each of our wholly-owned domesticsubsidiaries that guarantee our obligations under our Senior Secured CreditFacilities and by Parent.  The SeniorNotes and the guarantees thereof are our and the guarantors’ unsecured, seniorobligations and rank (i) equal in the right of payment with all of our andthe 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 also are effectively juniorin priority to our and our guarantors’ obligations under all securedindebtedness, including our Senior Secured Credit Facilities, our 2028 Debentures,and any other secured obligations of ours, in each case, to the extent of thevalue of the assets securing such obligations. In addition, the Senior Notes are structurally subordinated to allexisting and future liabilities, including trade payables, of our subsidiariesthat are not providing guarantees.

 

The Company is not required to make any mandatoryredemption or sinking fund payments with respect to the Senior Notes, but undercertain circumstances, the Company may be required to offer to purchase SeniorNotes as described below.  The Companymay from 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 described below, the Senior Notes are notredeemable at the Company’s option prior to October 15, 2010. From andafter October 15, 2010, the Company may redeem the Senior Notes, in wholeor in part, at a redemption price equal to 104.5% of principal amount,declining annually to 100% of the principal amount on October 15, 2013,plus accrued and unpaid interest, and Additional Interest (as defined in theSenior Indenture), if any, thereon to the applicable redemption date.

 

Prior to October 15, 2008, the Companymay, at its option, subject to certain conditions, redeem up to 35% of theoriginal aggregate principal amount of Senior Notes at a redemption price equalto 109.000% of the aggregate principal amount thereof, *plus* accrued and unpaid interest, andAdditional Interest, if any, thereon to the redemption date, with the net cashproceeds of one or more equity offerings of the Company or any direct orindirect parent of the Company to the extent such net proceeds are contributedto the Company.  At any time priorto October 15, 2010, the Company also may redeem all or a part of theSenior Notes at a redemption price equal to 100% of the principal amount ofSenior Notes 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.

 

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Upon the occurrence of a change of control (asdefined in the Senior Indenture), each holder of the Senior Notes has the rightto require the Company to repurchase some or all of such holder’s Senior Notesat a 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.

 

The indenture governing the Senior Notes containscovenants that limit our ability and 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.

 

Our Brand Development Companies are not subject tothe covenants contained in the Senior Indenture.  The Senior Indenture also provides for eventsof default, which, if any of them occurs, would permit or require theprincipal, premium, if any, interest and any other monetary obligations on alloutstanding Senior Notes to be due and payable immediately.

 

***SeniorSubordinated Notes. ***On October 6, 2005, Newton AcquisitionMerger Sub., Inc. issued $500.0 million aggregate principal amount of10.375% Senior Subordinated Notes under a senior subordinated indenture (SeniorSubordinated Indenture) with Wells Fargo Bank, National Association, astrustee.  At the closing of theTransactions, as the surviving corporation in the Acquisition, we assumed allthe obligations of Newton Acquisition Merger Sub, Inc. under the SeniorSubordinated Indenture.  The Senior Subordinated Notes mature on October 15,2015.  Interest on the SeniorSubordinated Notes is payable in cash semi-annually in arrears on each April 15and October 15, commencing April 15, 2006.

 

The Senior Subordinated Notes are guaranteed,jointly and severally, on an unsecured, senior subordinated basis, by each ofour wholly-owned domestic subsidiaries that guarantee our obligations under ourSenior Secured Credit Facilities and by Parent. The Senior Subordinated Notes and the guarantees thereof are our and theguarantors’ 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) 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 SeniorSubordinated Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of our subsidiaries that are notproviding guarantees.

 

The Company is not required to make any mandatoryredemption or sinking fund payments with respect to the Senior SubordinatedNotes, but, under certain circumstances, the Company may be required to offerto purchase Senior Subordinated Notes as described below.  The Company mayfrom time to time acquire Senior Subordinated Notes by means other than aredemption, whether by tender offer, in open market purchases, throughnegotiated transactions or otherwise, in accordance with applicable securitieslaws.

 

Except as described below, the Senior SubordinatedNotes are not redeemable at the Company’s option prior to October 15,2010. From and after October 15, 2010, the Company may redeem the SeniorSubordinated Notes, in whole or in part, at a redemption price equal to105.188% of principal amount, declining annually to 100% of principal amount onOctober 15, 2013, plus accrued and unpaid interest, and AdditionalInterest (as defined in the Senior Subordinated Indenture), if any, thereon tothe applicable redemption date.

 

Prior to October 15, 2008, the Company may, atits option, subject to certain conditions, redeem up to 35% of the originalaggregate principal amount of Senior Subordinated Notes at a redemption priceequal to 110.375% of the aggregate principal amount thereof, *plus* accrued and unpaid interest, andAdditional Interest, if any, thereon to the redemption date, with the net cashproceeds of one or more equity offerings of the Company or any direct orindirect parent of the Company to the extent such net proceeds are contributedto the Company.

 

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At any time prior to October 15, 2010, theCompany also may redeem all or a part of the Senior Subordinated Notes at aredemption price equal to 100% of the principal amount of Senior SubordinatedNotes redeemed plus an applicable premium, as provided in the SeniorSubordinated Indenture, as of, and accrued and unpaid interest and AdditionalInterest, if any, to the redemption date.

 

Upon the occurrence of a change of control (asdefined in the Senior Subordinated Indenture), the Company will make an offerto purchase all of the Senior Subordinated Notes at a price in cash equal to101% of the aggregate principal amount thereof plus accrued and unpaidinterest, and Additional Interest, if any, to the date of purchase.

 

The indenture governing the Senior SubordinatedNotes contains covenants substantially similar to those applicable to ourSenior Notes described above.  The SeniorSubordinated Indenture also provides for events of default, which, if any ofthem occurs, would permit or require the principal, premium, if any, interestand any other monetary obligations on all outstanding Senior Notes to be dueand payable immediately, subject to certain exceptions.

 

***Redemption of 2008 Notes.  ***In May 1998, we issued $125.0million aggregate principal amount of our 2008 Notes. Upon closing of theTransactions, we called our 2008 Notes for redemption pursuant to their terms.

*** ***

***At October 29, 2005, we had $134.7 million in cashreserved for the redemption of our 2008 Notes which we paid on November 7,2005 to effect the redemption of our 2008 Notes, including a call premium of$6.2 million plus accrued interest of $3.5 million through the redemption date.***

*** ***

***Maturities of Long-Term Debt.  ***At October 29,2005, annual maturities of long-term debt during the next five years andthereafter are as follows (in millions):

 
| 2006       |   | $       | — |   |
|------------|--------|---------|--------|--------|
| 2007       |   | —  |   |
| 2008       |   | —  |   |
| 2009       |   | —  |   |
| 2010       |   | 150.0   |   |
| Thereafter |   | 3,295.6 |   |

 

***Interest Rate Swaps.***  We use derivative financial instruments tohelp manage our interest rate 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.  Theinterest rate swap agreements terminate after five years.

 

9.               Employee BenefitPlans

 

***Description of Benefit Plans.***  We sponsor a defined benefit pension plan(Pension Plan) covering substantially all full-time employees.  We also sponsor an unfunded supplementalexecutive retirement plan (SERP Plan) that provides additional pension benefitsto certain employees.  Benefits underboth plans are based on the employees’ years of service and compensation overdefined periods of employment.  PensionPlan assets consist primarily of equity and fixed income securities.

 

Retirees and active employees hired prior to March 1, 1989 areeligible to participate in a plan providing certain limited postretirementhealth care benefits (Postretirement Plan) if they have met certain service andminimum age requirements.

 

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***Costs of Benefits. ***The componentsof the expenses incurred under our Pension Plan, SERP Plan and PostretirementPlan are as follows:

 
| **(in thousands)**                                  | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                          | ** ** | **(Successor)**                               | ** ** | ** ** | **(Predecessor)**                            | ** ** | **(Predecessor)**                                 | ** ** |
| Pension Plan:                                       |       |                                          |       |       |                                         |       |                                              |       |
| Service cost                                        |       | $                                             | 1,239      |       |                                         | $          | 2,823                                             |       | $ | 3,196 |   |
| Interest  cost                                      |       | 1,615                                         |       |       | 3,468                                        |       | 4,636                                             |       |
| Expected return  on plan assets                     |       | (1,749                                        | )          |       | (3,636                                       | )          | (4,712                                            | )          |
| Net  amortization of losses and prior service costs |       | —                                        |       |       | 1,205                                        |       | 1,208                                             |       |
| Pension Plan  expense                               |       | $                                             | 1,105      |       |                                         | $          | 3,860                                             |       | $ | 4,328 |   |
|                                                |       |                                          |       |       |                                         |       |                                              |       |
| SERP Plan:                                          |       |                                          |       |       |                                         |       |                                              |       |
| Service cost                                        |       | $                                             | 146        |       |                                         | $          | 330                                               |       | $ | 361 |   |
| Interest  cost                                      |       | 343                                           |       |       | 730                                          |       | 1,014                                             |       |
| Net  amortization of losses and prior service costs |       | —                                        |       |       | 394                                          |       | 384                                               |       |
| SERP Plan  expense                                  |       | $                                             | 489        |       |                                         | $          | 1,454                                             |       | $ | 1,759 |   |
|                                                |       |                                          |       |       |                                         |       |                                              |       |
| Postretirement Plan:                                |       |                                          |       |       |                                         |       |                                              |       |
| Service cost                                        |       | $                                             | 4          |       |                                         | $          | 8                                                 |       | $ | 15 |   |
| Interest  cost                                      |       | 65                                            |       |       | 139                                          |       | 318                                               |       |
| Net  amortization of (gains) losses                 |       | —                                        |       |       | (5                                           | )          | 26                                                |       |
| Postretirement  expense                             |       | $                                             | 69         |       |                                         | $          | 142                                               |       | $ | 359 |   |

 

***Purchase Accounting Adjustments. ***In connectionwith the Acquisition, the obligations and assets related to our benefit planswere valued at fair value as of the date of the Acquisition, using a discountrate of 5.75%, as follows:

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

 

***Funding Policy and Plan Assets.***  Our policy is to fund the Pension Plan at orabove the minimum required by law.  In2005, we made voluntary contributions of $20.0 million for the plan year ended July 31,2004.  Based upon currently availableinformation, we will not be required to make contributions to the Pension Planfor either the 2006 or 2005 plan years.

 

***Effect of Medicare Subsidy on PostretirementPlan.***  In December 2003,the U.S. Congress enacted the Medicare Prescription Drug, Improvement andModernization Act of 2003 (Act) that will provide a prescription drug subsidy,beginning in 2006, to companies that sponsor postretirement health care plansthat provide drug benefits. Based upon the provisions of the legislationenacted in January 2005, we reviewed the provisions of our PostretirementPlan with our actuaries to determine whether the benefits offered by our planmet the statutory definition of “actuarially equivalent” prescription drug benefitsthat qualify for the federal subsidy. Based upon this review, we believe that our benefits qualify for thesubsidy. We expect to avail ourselves of the benefit of the subsidy although weare still evaluating the manner in which we and/or the participants in thePostretirement Plan will receive the subsidy. We estimate the annual federalsubsidy to be received in the next ten years under the Act to be approximately$0.2 million, which subsidy was considered in the determination of thefair value of the Postretirement Plan as of the date of the Acquisition.

 

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10.         OperatingSegments

 

We have identified two reportablesegments: Specialty Retail Stores and Direct Marketing.  The Specialty Retail Stores segment includesall of our Neiman Marcus and Bergdorf Goodman retail stores, including NeimanMarcus clearance stores. The Direct Marketing segment conducts both printcatalog and online operations under the Neiman Marcus, Horchow and BergdorfGoodman brand names.  Other includes our51% interest in Gurwitch Products, LLC, which designs and markets the LauraMercier cosmetic line, and our 56% interest in Kate Spade LLC, which designsand retails high-end designer handbags and accessories.

 

Both the Specialty Retail Stores andDirect Marketing segments, as well as Kate Spade LLC and Gurwitch Products,LLC, derive their revenues from the sale of high-end fashion apparel,accessories, cosmetics and fragrances from leading designers, precious andfashion jewelry and decorative home accessories.

 

The following table sets forth theinformation for our reportable segments:

** **
| **(in thousands)**                                                                                | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **(Successor)**                               | ** ** | ** ** | **(Predecessor)**                            | ** ** | **(Predecessor)**                                 | ** ** |
|                                                                                              |       |                                          |       |       |                                         |       |                                              |       |
| REVENUES:                                                                                         |       |                                          |       |       |                                         |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | $                                             | 262,410    |       |                                         | $          | 544,857                                           |       | $ | 736,890 |   |
| Direct  Marketing                                                                                 |       | 51,402                                        |       |       | 87,515                                       |       | 139,799                                           |       |
| Other                                                                                             |       | 10,978                                        |       |       | 19,276                                       |       | 31,247                                            |       |
| Total                                                                                             |       | $                                             | 324,790    |       |                                         | $          | 651,648                                           |       | $ | 907,936 |   |
|                                                                                              |       |                                          |       |       |                                         |       |                                              |       |
| OPERATING EARNINGS:                                                                               |       |                                          |       |       |                                         |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | $                                             | 44,065     |       |                                         | $          | 91,372                                            |       | $ | 120,189 |   |
| Direct  Marketing                                                                                 |       | 6,414                                         |       |       | 8,246                                        |       | 11,358                                            |       |
| Other                                                                                             |       | 1,188                                         |       |       | (1,923                                       | )          | 2,860                                             |       |
| Subtotal                                                                                          |       | 51,667                                        |       |       | 97,695                                       |       | 134,407                                           |       |
| Corporate  expenses                                                                               |       | (3,163                                        | )          |       | (5,809                                       | )          | (9,144                                            | )          |
| Amortization  of customer lists                                                                   |       | (3,378                                        | )          |       | —                                       |       | —                                            |       |
| Amortization  of favorable lease commitments                                                      |       | (1,559                                        | )          |       | —                                       |       | —                                            |       |
| Non-cash  charges related to other valuation adjustments made in connection with the  Acquisition |       | (7,832                                        | )          |       | —                                       |       | —                                            |       |
| Transaction  and other costs                                                                      |       | —                                        |       |       | (23,544                                      | )          |                                              |       |
| Loss on  disposition of Chef’s Catalog                                                       |       | —                                        |       |       | —                                       |       | (15,348                                           | )          |
| Total                                                                                             |       | $                                             | 35,735     |       |                                         | $          | 68,342                                            |       | $ | 109,915 |   |

** **

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** **

**11.**         Commitments and Contingencies

 

***Investments in Brand Development Companies.***  Our investments in and relationships with ourBrand Development Companies are governed by operating agreements that providefor an orderly transition process in the event any investor wishes to sell itsinterest, or purchase another investor’s interest. Among other things, theseoperating agreements contain currently exercisable put option provisionsentitling each minority investor to put their interest to us, and currentlyexercisable call option provisions entitling us to purchase each minorityinvestor’s interest, at a purchase price mutually agreed to by the parties. Thepurchase price will be determined, in the case of the Gurwitch interests, byone or more nationally recognized investment banking firms and, in the case ofthe Kate Spade interests, by the parties or, in the event the parties areunable to agree on a mutually acceptable price, by a mutually acceptablenationally recognized investment banking firm, subject to certain conditions.We may elect, in certain circumstances, to defer the consummation of a putoption for a period of six months by cooperating with the other investors inseeking either a sale of the Brand Development Company to a third party or apublic offering of the Brand Development Company’s securities. If a sale to athird party or public offering of the Brand Development Company’s securities isnot consummated within six months after the exercise of the put option (whichperiod may be automatically extended for an additional two months if aregistration statement for the Brand Development Company is filed with theSecurities and Exchange Commission), we are obligated to consummate the putoption. Under the terms of the Kate Spade operating agreement, suchconsummation shall occur within thirty days after the determination of thevaluation 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, while suchdiscussions are ongoing, no assurance can be given that they will ultimatelylead to any transactions.

 

***Litigation.***  We are currently involved in various legalactions and proceedings that arose in the ordinary course of our business. Webelieve that any liability arising as a result of these actions and proceedingswill not have a material adverse effect on our financial position, results ofoperations 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 The Neiman Marcus Group, Inc.and its directors challenging the proposed merger. An amended complaint wasfiled on July 25, 2005. The amended complaint alleged a cause of actionfor breach of fiduciary duty against us and our directors, claiming, amongother things, that the defendants had endeavored to complete the sale of TheNeiman Marcus Group, Inc. and its assets at a grossly inadequate andunfair price and pursuant to an unfair process that failed to maximizeshareholder value. In addition, the amended complaint alleged that thedirectors were not independent and breached their fiduciary duties inconnection with the approval of the merger by, among other things, (i) tailoringthe transaction to serve the interests of the defendants and the family ofRichard A. Smith, the then chairman of our board of directors and our largeststockholder, rather than structuring the merger to obtain the highest price forstockholders, (ii) depriving public stockholders of the value of certainassets (including the credit card business and our third quarter 2005 profits),(iii) failing to realize the financial benefits from the sale of thecredit card business, (iv) not engaging in a fair process of negotiatingat arm’ s length, including provisions precluding superior competing bids(including a termination fee and no solicitation provision), and (v) structuringa preferential deal for insiders. The amended complaint further claimed thatour financial advisor had a conflict of interest by also acting as a financingsource for the merger, and that our proxy statement in respect of the mergeromitted material information purportedly necessary to ensure a fully informedshareholder vote. The amended complaint sought, among other things, injunctiverelief to enjoin the consummation of the merger, to rescind any actions takento effect the merger, to direct the defendants to sell or auction The NeimanMarcus Group, Inc. for the highest possible price, and to impose aconstructive trust in favor of plaintiffs upon any benefits improperly receivedby defendants.  Following the closing ofthe merger, plaintiff voluntarily dismissed the lawsuit with prejudice as mooton December 1, 2005, and provided a release of all of the defendants forclaims arising out of the merger.  TheNeiman Marcus Group, Inc. paid plaintiff’s attorneys’ fees in connectionwith certain disclosures requested by plaintiff and included in the proxystatement sent to the shareholders regarding the merger.

 

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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 on Form 10-Kfor the fiscal year ended July 30, 2005.  Unless otherwise specified, the meanings ofall defined terms in Management’s Discussion and Analysis of FinancialCondition and Results of Operations (MD&A) are consistent with the meaningsof such terms as defined in the Notes to the Condensed Consolidated FinancialStatements. This discussion contains forward-looking statements. Please see“Forward-Looking Statements” for a discussion of the risks, uncertainties andassumptions relating to our forward-looking statements.

 

**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, LLC, which designs and markets theLaura 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 MarcusGroup, Inc. was acquired on October 6, 2005 through a mergertransaction with Newton Acquisition Merger Sub, Inc., a wholly-owned subsidiary of Newton Acquisition, Inc.(Parent). The Parent was formed by investment funds affiliated with TexasPacific Group and Warburg Pincus (the Sponsors). The acquisition wasaccomplished through the merger of Newton Acquisition Merger Sub, Inc.with and into The Neiman Marcus Group, Inc. with The Neiman Marcus Group , Inc.being the surviving company (the Acquisition). Subsequent to the Acquisition,we are a subsidiary of the Parent, which is controlled by Newton Holding, LLC.Although we continued as the same legal entity after the Acquisition, theaccompanying condensed consolidated statements of earnings and cash flowspresent our results of operations and cash flows for the period preceding theAcquisition (Predecessor) and the period succeeding the Acquisition(Successor), respectively.

 

We have prepared our discussion of the results of operations bycomparing the mathematical combination of the Successor and Predecessor periodsin the thirteen weeks ended October 29, 2005 to the thirteen weeks ended October 30,2004. Although this presentation does not comply with generally acceptedaccounting principles (GAAP), we believe that it provides a meaningful methodof comparison. The combined operating results have not been prepared on a proforma basis under applicable regulations and may not reflect the actual resultswe would have achieved absent the Transactions and may not be predictive offuture results of operations.

 

Our fiscal year ends on the Saturday closest to July 31.  All references to the first quarter of 2006relate to the combined four week period ended October 29, 2005 of theSuccessor and the nine week period ended October 1, 2005 of thePredecessor.  All references to the firstquarter of 2005 relate to the thirteen weeks ended October 30, 2004.  All references to 2006 relate to the combinedfifty-two weeks ending July 29, 2006 and all references to 2005 relate tothe fifty-two weeks ended July 30, 2005.

 

In connection with the Transactions, the Company incurred significantindebtedness and became highly leveraged. See “Liquidity and Capital Resources.” In addition, the purchase price paid in connection with the Acquisitionhas been allocated to state the acquired assets and liabilities at fairvalue.  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-cashdepreciation and amortization charges have significantly increased.   As a result, our Successor financialstatements subsequent to the Transactions are not comparable to our Predecessorfinancial statements.

 

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**Factors Affecting Our Results**

 

***Revenues.***  We generate our revenues primarily from thesale of high-end merchandise through our Specialty Retail Stores and DirectMarketing operation. Components of our revenues include:

 

•                  Sale ofmerchandise—Revenues from our Specialty Retail Stores are recognized at thelater of the point of sale or the delivery of goods to the customer. Revenuesfrom our Direct Marketing operation are recognized when the merchandise isdelivered to the customer. We maintain reserves for anticipated sales returnsprimarily based on our historical trends related to returns by both our retailand direct marketing customers.

 

•                  Commissions from leaseddepartments—A small portion of the sales of our Specialty Retail Stores consistof commissions from certain departments in our stores that we lease toindependent companies.

 

•                  Delivery and processing—Wegenerate revenues from delivery and processing charges related to merchandisedelivered to our customers from our retail and direct marketing operations.

 

Our revenues can be affected by the following factors:

 

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

 

•                  changes in the level offull-price sales;

 

•                  changes in the level ofpromotional events conducted by our Specialty Retail Stores;

 

•                  our ability tosuccessfully implement our store expansion and remodeling strategies;

 

•                  the rate of growth ininternet sales by our Direct Marketing operation; and

 

•                  general economicconditions.

 

In addition, our revenues are seasonal. For a description of theseasonality of our business, see “—Seasonality.”

 

***Gross margin.***  Our gross margin represents our revenues lessthe costs of the following components:

 

•                  Inventory costs—We utilizethe retail method of accounting, which is widely used in the retail industrydue to its practicality, for substantially all of our merchandise inventories.Merchandise inventories are stated at the lower of cost or market. Under theretail inventory method, the valuation of inventories at cost and the resultinggross margins are determined by applying a calculated cost-to-retail ratio, forvarious groupings of similar items, to the retail value of inventories. Thecost of the inventory reflected on the consolidated balance sheet is decreasedby charges to cost of goods sold at the time the retail value of the inventoryis lowered through the use of markdowns. Hence, earnings are negativelyimpacted when merchandise is marked down.

 

•                  Buying costs—Buying costsconsist primarily of salaries and expenses incurred by our merchandising andbuying operations.

 

•                  Occupancy costs—Occupancycosts consist primarily of rent, property taxes and operating costs of ourretail, distribution and support facilities. A significant portion of ourbuying and occupancy costs are fixed.

 

•                  Delivery and processingcosts—Delivery and processing costs consist primarily of delivery charges wepay to third-party carriers and other costs related to the fulfillment ofcustomer orders not delivered at the point-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 earn in connection with the sales of thevendor’s merchandise. These allowances result in an increase to gross marginwhen we earn the allowances and they are approved by the vendor. Otherallowances we receive represent reductions to the amounts we

 

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pay to acquire the merchandise. These allowances reduce the cost of theacquired merchandise and are recognized as an increase to gross margin at thetime the goods are sold.

 

Changes in our gross margins are affected primarily by the followingfactors:

 

•                  customer acceptance of anddemand for the merchandise we offer in a given season and the related impact ofsuch factors on the level of full-price sales;

 

•                  our ability to order anappropriate amount of merchandise to match customer demand and the relatedimpact on the level of net markdowns incurred;

 

•                  factors affecting revenuesgenerally;

 

•                  changes in occupancy costsprimarily associated with the opening of new stores or distribution facilities;and

 

•                  the amount of vendorreimbursements we receive during the fiscal year.

 

***Selling, general andadministrative expenses.***  Selling, general and administrative(SG&A) expenses principally comprise costs related to employee compensationand benefits in the selling and administrative support areas, advertising andcatalog costs, insurance expense and income and expenses related to ourproprietary credit card portfolio. A significant portion of our selling,general and administrative expenses are variable in nature and are dependent onthe sales we generate.

 

Prior to the Credit Card Sale on July 7, 2005, our creditoperations generated finance charge income, net of credit losses, which werecognized as income when earned and recorded as a reduction of selling,general and administrative expenses. As a part of the Credit Card Sale, weentered into a long-term marketing and servicing alliance with HSBC. Under theterms of this alliance, HSBC offers credit card and non-card payment plansbearing our brands and we receive ongoing payments from HSBC related to creditcard sales and compensation for marketing and servicing activities (HSBCProgram Income). We record the HSBC Program Income as a reduction of selling,general and administrative expenses.

 

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 are affectedprimarily by the following factors:

 

•                  changes in the number ofsales associates primarily due to expansion of existing stores and new storeopenings, including increased health care and related benefits expenses;

 

•                  changes in expensesrelating to the production of print catalogs including, paper, printing andpostage costs;

 

•                  changes in expensesrelated to insurance and long-term benefits due to general economic conditionssuch as rising health care costs; and

 

•                  changes in the HSBCProgram Income related to changes in aggregate credit card sales or the ratesof reimbursement under the Program (as further described below).

 

In the future, our selling, general and administrative expenses will beimpacted by the Credit Card Sale.  In2005, our credit card operations generated net finance charge income ofapproximately $75.4 million. If the Credit Card Sale had been consummatedas of the first day of 2005, we believe, the HSBC Program Income for 2005 wouldhave been at least $42 million. HSBC and the Company are currently in the process of implementingchanges to the proprietary credit card program that we expect will be fully

 

21

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implemented during the fourth quarter of 2006. Had such changes beenfully implemented on the first day of 2005, we believe the HSBC Program Incomefor 2005 would have been approximately $56 million.

 

The HSBC Program Income may be:

 

•                  decreased based upon thelevel of future services, such as statement preparation and mailing, we provideto HSBC; and

 

•                  increased based uponcontemplated changes to our historical credit card program related to, amongother things, the interest rates applied to unpaid balances and the assessmentof 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 quarter is generally characterized by a higher level offull-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 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 quarter. However, due to the seasonal increase in salesthat occurs during the holiday season, the second quarter is typically thequarter in which our revenues are the highest and in which expenses as apercentage of revenues are the lowest. Our working capital requirements arealso the greatest in the first and second quarters as a result of higherseasonal requirements.

 

Similarly, the third quarter is generally characterized by a higherlevel of full-price selling with a focus on the initial introduction of SpringSeason fashions. Aggressive in-store marketing activities designed to stimulatecustomer buying, a lower level of markdowns and higher margins are againcharacteristic of this quarter. Revenues are generally the lowest in the fourthquarter with a focus on promotional activities offering Spring Season goods tothe customer on a marked down basis, resulting in lower margins during thequarter. Our working capital requirements are typically lower in the third andfourth 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. For example, women’s apparel, men’s appareland shoes are typically ordered six to nine months in advance of the productsbeing offered for sale while handbags, jewelry and other categories aretypically ordered three to six months in advance. As a result, inherent in thesuccessful execution of our business plans is our ability both to predict thefashion trends that will be of interest to our customers and to anticipatefuture spending 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, resulting inlower operating profits. We believe that the experience of our merchandisingand selling organizations helps to minimize the inherent risk in predictingfashion trends.

 

22

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**OPERATING RESULTS**

 

**Performance Summary**

 

The following table sets forth certainitems expressed as percentages of net sales for the periods indicated.

 
| ** **                                                | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 29,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                | ** ** | **(Successor)**                               | ** ** | **(Predecessor)**                            | ** ** | **(Combined)**                                    | ** ** | **(Predecessor)**                                 | ** ** |
|                                                      |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Revenues                                                  |       | 100.0                                         | %          | 100.0                                        | %          | 100.0                                             | %          | 100.0                                             | %          |
| Cost of  goods sold including buying and occupancy costs  |       | 60.1                                          |       | 58.1                                         |       | 58.8                                              |       | 58.5                                              |       |
| Selling, general and administrative expenses              |       | 24.4                                          |       | 24.7                                         |       | 24.6                                              |       | 25.0                                              |       |
| Depreciation expense                                      |       | 3.0                                           |       | 3.1                                          |       | 3.0                                               |       | 2.7                                               |       |
| Amortization of customer lists                            |       | 1.0                                           |       | —                                       |       | 0.3                                               |       | —                                            |       |
| Amortization of favorable lease commitments               |       | 0.5                                           |       | —                                       |       | 0.2                                               |       | —                                            |       |
| Transaction and other costs                               |       | —                                        |       | 3.6                                          |       | 2.4                                               |       | —                                            |       |
| Loss on disposition of Chef’s Catalog                |       | —                                        |       | —                                       |       | —                                            |       | 1.7                                               |       |
| Operating earnings                                        |       | 11.0                                          |       | 10.5                                         |       | 10.7                                              |       | 12.1                                              |       |
| Interest (income) expense, net                            |       | 5.3                                           |       | (0.1                                         | )          | 1.7                                               |       | 0.4                                               |       |
| Earnings before income taxes and minority  interest       |       | 5.7                                           |       | 10.6                                         |       | 9.0                                               |       | 11.7                                              |       |
| Income taxes                                              |       | 2.2                                           |       | 3.9                                          |       | 3.5                                               |       | 4.5                                               |       |
| Earnings before minority interest                         |       | 3.5                                           |       | 6.7                                          |       | 5.5                                               |       | 7.2                                               |       |
| Minority interest in net loss (earnings) of  subsidiaries |       | (0.1                                          | )          | 0.1                                          |       | (0.0                                              | )          | (0.1                                              | )          |
| Net earnings                                              |       | 3.4                                           | %          | 6.8                                          | %          | 5.5                                               | %          | 7.1                                               | %          |

 

23

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

 
| **(dollars in millions)**                                                                         | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 29,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **(Successor)**                               | ** ** | **(Predecessor)**                            | ** ** | **(Combined)**                                    | ** ** | **(Predecessor)**                                 | ** ** |
| REVENUES                                                                                          |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | $                                             | 262.4      |                                         | $          | 544.9                                             |       | $                                                 | 807.3      |   | $ | 736.9 |   |
| Direct  Marketing                                                                                 |       | 51.4                                          |       | 87.5                                         |       | 138.9                                             |       | 139.8                                             |       |
| Other (1)                                                                                         |       | 11.0                                          |       | 19.2                                         |       | 30.2                                              |       | 31.2                                              |       |
| Total                                                                                             |       | $                                             | 324.8      |                                         | $          | 651.6                                             |       | $                                                 | 976.4      |   | $ | 907.9 |   |
|                                                                                              |       |                                          |       |                                         |       |                                              |       |                                              |       |
| OPERATING EARNINGS                                                                                |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | $                                             | 44.1       |                                         | $          | 91.4                                              |       | $                                                 | 135.4      |   | $ | 120.2 |   |
| Direct  Marketing                                                                                 |       | 6.4                                           |       | 8.2                                          |       | 14.7                                              |       | 11.3                                              |       |
| Other (1)                                                                                         |       | 1.2                                           |       | (2.0                                         | )          | (0.8                                              | )          | 2.9                                               |       |
| Subtotal                                                                                          |       | 51.7                                          |       | 97.6                                         |       | 149.3                                             |       | 134.4                                             |       |
| Corporate  expenses                                                                               |       | (3.2                                          | )          | (5.8                                         | )          | (9.0                                              | )          | (9.2                                              | )          |
| Amortization  of customer lists                                                                   |       | (3.4                                          | )          | —                                       |       | (3.4                                              | )          | —                                            |       |
| Amortization  of favorable lease commitments                                                      |       | (1.6                                          | )          | —                                       |       | (1.6                                              | )          | —                                            |       |
| Non-cash  charges related to other valuation adjustments made in connection with the  Acquisition |       | (7.8                                          | )          | —                                       |       | (7.8                                              | )          | —                                            |       |
| Transaction  and other costs                                                                      |       | —                                        |       | (23.5                                        | )          | (23.5                                             | )          | —                                            |       |
| Loss on  disposition of Chef’s Catalog                                                       |       | —                                        |       | —                                       |       | —                                            |       | (15.3                                             | )          |
| Total                                                                                             |       | $                                             | 35.7       |                                         | $          | 68.3                                              |       | $                                                 | 104.0      |   | $ | 109.9 |   |
|                                                                                              |       |                                          |       |                                         |       |                                              |       |                                              |       |
| OPERATING PROFIT MARGIN                                                                           |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | 16.8                                          | %          | 16.8                                         | %          | 16.8                                              | %          | 16.3                                              | %          |
| Direct  Marketing                                                                                 |       | 12.5                                          | %          | 9.4                                          | %          | 10.6                                              | %          | 8.1                                               | %          |
| Total                                                                                             |       | 11.0                                          | %          | 10.5                                         | %          | 10.7                                              | %          | 12.1                                              | %          |
|                                                                                              |       |                                          |       |                                         |       |                                              |       |                                              |       |
| COMPARABLE REVENUES (2)                                                                           |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | 6.7                                           | %          | 9.8                                          | %          | 8.8                                               | %          | 11.1                                              | %          |
| Direct  Marketing                                                                                 |       | 11.7                                          | %          | 9.6                                          | %          | 10.4                                              | %          | 13.1                                              | %          |
| Total                                                                                             |       | 7.1                                           | %          | 9.0                                          | %          | 8.4                                               | %          | 11.4                                              | %          |
|                                                                                              |       |                                          |       |                                         |       |                                              |       |                                              |       |
| SALES PER SQUARE FOOT                                                                             |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Specialty  Retail Stores                                                                          |       | $                                             | 49         |                                         | $          | 103                                               |       | $                                                 | 152        |   | $ | 138 |   |
|                                                                                              |       |                                          |       |                                         |       |                                              |       |                                              |       |
| STORE COUNT                                                                                       |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Neiman Marcus and Bergdorf Goodman stores:                                                        |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Open at  beginning of period                                                                      |       | 37                                            |       | 36                                           |       | 36                                                |       | 37                                                |       |
| Opened  during the period                                                                         |       | —                                        |       | 1                                            |       | 1                                                 |       | —                                            |       |
| Open at end  of period                                                                            |       | 37                                            |       | 37                                           |       | 37                                                |       | 37                                                |       |
| Clearance centers:                                                                                |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Open at  beginning of period                                                                      |       | 17                                            |       | 16                                           |       | 16                                                |       | 14                                                |       |
| Opened  during the period                                                                         |       | —                                        |       | 1                                            |       | 1                                                 |       | —                                            |       |
| Open at end  of period                                                                            |       | 17                                            |       | 17                                           |       | 17                                                |       | 14                                                |       |

 

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

 

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

 

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**First Quarter Fiscal Year 2006 Highlights**

 

We believe that our product assortment of luxury, designer and fashionmerchandise, coupled with our sales promotion activities and our commitment tosuperior customer service, have been critical to our success in the past. Inaddition, we believe these factors are critical to our future growth andsuccess. Major financial accomplishments in the first quarter of 2006 include:

 

•                  **Revenues**—Our revenues for the first quarter of 2006 were $976.4 million.  Comparable revenues increased  8.4% in the first quarter 2006 as compared to2005.  This increase was on top of acomparable revenues increase of 11.4% in the first quarter of 2005 as comparedto the first quarter of 2004.

 

For Specialty Retail Stores, our sales persquare foot for the last twelve trailing months increased to $591 as of October 2005compared to $577 as of October 2004.

 

•                  **Gross margin**—Gross margin was 41.2% of our revenues in the firstquarter of 2006 and 41.5% in the first quarter of 2005.   Purchase accounting adjustments, primarilynon-cash charges related to step-up in carrying value of acquired inventories,decreased gross margin by 0.8% of revenues in the first quarter of 2006.

 

•                  **Selling, general and administrative expenses**—Selling, general and administrative expensesdecreased in the first quarter of 2006 to 24.6% of our revenues from 25.0% inthe first quarter of 2005.

 

•                  **Operating earnings—**Our operating earnings were $104.0 million inthe first quarter of 2006 compared to $109.9 million in the prior yearquarter.  Operating earnings forSpecialty Retail Stores increased 12.7% in the first quarter of 2006 andrepresented 16.8% of Specialty Retail Stores revenues.  Operating earnings for Direct Marketingincreased 29.1% in the first quarter of 2006 and represented 10.6% of DirectMarketing revenues.

 

**Thirteen Weeks Ended October 29,2005 Compared to Thirteen Weeks Ended October 30, 2004**

** **

***Revenues.**** *Our revenues for thefirst quarter of 2006 of $976.4 million increased $68.5 million, or 7.5%, from$907.9 million in the first quarter of 2005.

 

Comparable revenues in the first quarter of 2006 increased 8.4%compared to the prior year period. Comparable revenues increased 8.8% for Specialty Retail Stores and 10.4%for Direct Marketing.  Comparablerevenues decreased 9.2% for the Brand Development Companies in the firstquarter of 2006 compared to the prior year period.  Comparable revenues in the first quarter of2005 increased by 11.4% compared to the first quarter of 2004.

 

Revenues increased in the first quarter of 2006 compared to the prioryear at all our operating companies, except for Kate Spade, LLC.  We believe the increases in revenues weredriven by sales events conducted by our Specialty Retail Stores and by thegrowth of internet sales for Direct Marketing. In the first quarter of 2006, internet sales by Direct Marketing,were$79.3 million, an increase of 30.8% from the first quarter of 2005, excludingChef’s Catalog.  Total Chef’s Catalogrevenues of $13.9 million are included in consolidated revenues for the firstquarter of 2005.

 

***Gross margin.***  Gross margins for the first quarter of 2006and 2005 were:

 
| **(in millions, except percentages)**                                                                                      | ** ** | **2006** | ** ** | **% of  revenues** | ** ** | **2005** | ** ** | **% of  revenues** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|--------------------|------------|----------|------------|--------------------|------------|
|                                                                                                                       |       |     |       |               |       |     |       |               |       |
| Gross  margin, before purchase accounting adjustments                                                                      |       | $        | 410.4      |               | 42.0       | %        | $          | 376.8              |       | 41.5 | % |
| Purchase  accounting adjustments, primarily non-cash charges related to step-up in  carrying value of acquired inventories |       | (7.9     | )          | (0.8               | )          | —   |       | —             |       |
| Gross margin, as reported                                                                                                  |       | $        | 402.5      |               | 41.2       | %        | $          | 376.8              |       | 41.5 | % |

 

Although the presentation in the table above of gross margin, beforepurchase accounting adjustments, does not comply with GAAP, we believe that itprovides a more meaningful method of comparison.

 

The increase in gross margin before purchase accounting adjustments to42.0% of revenues from 41.5% of revenues in the prior year period was primarilydue to:

 

•                  the increase inproduct margins by approximately 0.6% of revenues, offset by;

 

25

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•            anincrease in buying and occupancy costs, primarily related to insurance costs,by approximately 0.1% of revenues.

 

We generated higher product margins during the first quarter of 2006compared to the first quarter of 2005. We believe this increase in product margins was due primarily to:

 

•                  the higher levelof full-price sales generated during the quarter by our Specialty RetailStores;

 

•                  our continuedemphasis on inventory management.

 

Consistent with industry business practice, we receive allowances fromcertain of our vendors in support of the merchandise we purchase forresale.  We receive certain allowances toreimburse us for markdowns taken and/or to support the gross margins earned inconnection with the sales of the vendor’s merchandise.  We recognize these allowances as an increaseto gross margin when the allowances are earned and approved by the vendor.  Other allowances we receive representreductions to the amounts paid to acquire the merchandise.  We recognize these allowances as a reductionin the cost of the acquired merchandise resulting in an increase to grossmargin at the time the goods are sold. As a percentage of revenues, the level of vendor allowances we receivedin the first quarter of 2006 was consistent with the prior year and did nothave a significant impact on the year-over-year change in the gross margin werealized in the first quarter of 2006. Vendor allowances received were $8.2 million in the first quarterof 2006 and $4.5 million in the first quarter of 2005.

 

***Selling, general and administrative expenses*.**  SG&A expenses were 24.6% of revenues inthe first quarter of 2006 compared to 25.0% of revenues in the prior yearperiod.

 

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

 

•            adecrease in marketing and advertising costs by approximately 0.7% of revenuesprimarily due to both 1) the elimination of expenditures related to ourprevious Chef’s Catalog business sold in November 2004, which were higheras a percentage of revenues than our other Direct Marketing brands and 2) theplanned shift from catalog expenditures to web-based expenditures, which aregenerally lower as a percentage of revenues;

 

•            adecrease in our employee benefit costs, including medical and dental andworkers compensation expense, of approximately 0.3% of revenues primarily dueto the higher level of revenues in the first quarter of 2006;

 

•            adecrease in professional and legal fees of approximately 0.2% of revenueprimarily driven by a lower level of legal settlement costs.

 

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

 

•                  incomeof approximately $12.0 million, or 1.2% of revenues, in the first quarter of2006 under our credit card program with HSBC as compared to the net financecharge income of $15.3 million, or 1.7% of revenues, generated by our creditcard portfolio in the prior year period; and

 

•                  preopeningexpenses and store remodeling expenses of approximately of $4.9 million, or0.5% of revenues, in the first quarter of 2006, an increase of 0.4% ofrevenues, primarily related to the opening of our new San Antonio store in September 2005  and Boca Raton store in November 2005and remodels at our San Francisco, Fashion Island and Houston stores.

 

***Depreciation expense. ***Depreciationexpense was 3.0% of revenues in the first quarter of 2006 compared to 2.7% ofrevenues in the prior year period primarily due to 1) a higher level of capitalspending in recent years and 2) additional depreciation expense resulting fromrevaluing our property and equipment at fair value in connection with theAcquisition.

 

***Amortization expense. ***Amortization ofacquisition related intangibles (resulting from our preliminary purchaseaccounting adjustments related to the Transactions) was $4.9 million, or 0.5%of revenues, for the first quarter of 2006. We had no amortization expense in the first quarter of 2005.

 

***Transaction and other costs.  ***During theperiod July 30, 2005 to October 1, 2005, we expensed $23.5 million inconnection with the Transactions. These costs consist 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.

 

26

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***Segment operating earnings.***  Operating earnings for our Specialty RetailStores segment were $135.4 million, or 16.8% of Specialty Retail Storesrevenues, for the first quarter of 2006 compared to $120.2 million, or 16.3%,for the prior year period.  This increasein operating margin was primarily the result of increased revenues, grossmargins and lower buying and occupancy costs as a percentage of revenues,offset by net increases in SG&A expenses, due primarily to decreases infinance charge income and higher preopening expenses.

 

Operating earnings for Direct Marketing increased to $14.7 million, or10.6%, in the first quarter of 2006 from $11.3 million, or 8.1%, for the prioryear period, primarily as a result of increased revenues and net decreases inSG&A expenses and buying and occupancy costs as percentages of revenues,offset by slightly lower margins.

 

***Interest expense, net*.**  Net interest expense was $16.4 million in thefirst quarter of 2006 and $4.0 million for the prior year period.   The significant components of interestexpense are as follows:

 
| **(in thousands)**                     | ** ** | **Four weeks  ended  October 29,  2005** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Thirteen  weeks ended  October 29,  2005** | ** ** | **Thirteen  weeks ended  October 30,  2004** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **(Successor)**                               | ** ** | **(Predecessor)**                            | ** ** | **(Combined)**                                    | ** ** | **(Predecessor)**                                 | ** ** |
| Asset-Based Revolving Credit Facility  |       | $                                             | 581        |                                         | $          | —                                            |       | $                                                 | 581        |   | $ | — |   |
| Senior Secured Term Loan Facility      |       | 8,214                                         |       | —                                       |       | 8,214                                             |       | —                                            |       |
| 2028 Debentures                        |       | 685                                           |       | 1,542                                        |       | 2,227                                             |       | 2,227                                             |       |
| Senior Notes                           |       | 4,025                                         |       | —                                       |       | 4,025                                             |       | —                                            |       |
| Senior Subordinated Notes              |       | 3,314                                         |       | —                                       |       | 3,314                                             |       | —                                            |       |
| Credit Agreement                       |       | —                                        |       | —                                       |       | —                                            |       | 1,111                                             |       |
| 2008 Notes                             |       | 639                                           |       | 1,439                                        |       | 2,078                                             |       | 2,078                                             |       |
| Debt issue cost amortization and other |       | 1,193                                         |       | 345                                          |       | 1,538                                             |       | 464                                               |       |
| Total  interest expense                |       | 18,651                                        |       | 3,326                                        |       | 21,977                                            |       | 5,880                                             |       |
|                                   |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Less:                                  |       |                                          |       |                                         |       |                                              |       |                                              |       |
| Interest  income                       |       | 962                                           |       | 3,046                                        |       | 4,008                                             |       | 915                                               |       |
| Capitalized  interest                  |       | 404                                           |       | 1,146                                        |       | 1,550                                             |       | 928                                               |       |
| Interest expense, net                  |       | $                                             | 17,285     |                                         | $          | (866                                              | )          | $                                                 | 16,419     |   | $ | 4,037 |   |

 

The increase in interest expense is due to the $3.3 billion increase indebt incurred in connection with the Transactions.  The increase in interest income was dueprimarily to interest earned on higher average invested balances prior to theTransactions.

 

***Income taxes.***  Our effective income tax rate was 39.4% forthe four weeks ended October 29, 2005. Our effective income tax rate for the nine weeks ended October 1,2005 was 37.0% and was favorably impacted by a higher level of tax-exemptinterest income earned during the period on higher cash balances maintained subsequentto the Credit Card Sale.  Our effectiveincome tax rate was 38.7% for the thirteen weeks ended October 30, 2004and was also favorably impacted by tax-exempt interest income.

 

**Inflation andDeflation**

 

We believe changes in revenues and net earnings that have resulted frominflation or deflation have not been material during the periodspresented.  In recent years, we haveexperienced certain inflationary conditions related to 1) increases in productcosts due primarily to changes in foreign currency exchange rates that havereduced the purchasing power of the U.S. dollar and 2) increases inSG&A.  We attempt to offset theeffects of inflation through control of expenses and price increases, althoughour ability to increase prices may be limited by competitive factors.  We attempt to offset the effects ofmerchandise deflation, which has occurred on a limited basis in recent years,through control of expenses.  There is noassurance, however, that inflation or deflation will not materially affect ouroperations in the future.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

Our cash requirements consist principally of:

 

•                  the funding of our merchandise purchases;

 

•                  capital expenditures for new store construction, storerenovations and upgrades of our management information systems;

 

•                  debt service requirements;

 

•                  income tax payments; and

 

•                  obligations related to our Pension Plan.

 

Our primary sources of short-term liquidity are comprised of cash onhand and availability under our Asset-Based Revolving Credit Facility.  The amounts of cash on hand and borrowingsunder the Asset-Based Revolving Credit Facility are influenced by a number offactors, including revenues, working capital levels, vendor terms, the level ofcapital expenditures, cash requirements related to financing instruments anddebt service obligations following the Transactions, Pension Plan fundingobligations and our tax payment obligations, among others.

 

Our working capital requirements fluctuate during the year, increasingsubstantially during the first and second quarters of each fiscal year as aresult of higher seasonal levels of inventories and accounts receivable (priorto the Credit Card Sale in July 2005). We have typically financed the increasesin working capital needs during the first and second fiscal quarters with cashflows from operations and cash provided from borrowings under our creditfacilities. During the first quarter of 2006, we financed our seasonalincreases in working capital needs with cash flows from operations and aportion of our of borrowings under our Asset-Based Revolving Credit Facility,which we expect to repay  in the secondquarter of 2006.

 

We believe that operating cash flows, available vendor financing andamounts available pursuant to our senior secured Asset-Based Revolving CreditFacility will be sufficient to fund our operations and debt servicerequirements, including Pension Plan funding requirements, contractualobligations and commitments, anticipated capital expenditure requirements andour debt service obligations, through the end of 2006.

 

At October 29, 2005, cash and equivalents were $192.1 millioncompared to $258.4 million at October 30, 2004.  We generated cash from operations, prior tochanges in operating assets and liabilities, of $113.4 million in the firstquarter of 2006 compared to $112.9 million in the first quarter of 2005.  Net cash provided by operating activities was$28.8 million in the first quarter of 2006 compared to net cash used foroperating activities of $59.8 million in the first quarter of 2005.  Cash flows related to operating activitiesgenerally are lower in the first quarter of each year as we fund the seasonalincrease in inventories and accounts receivable (prior to the Credit Card Salein July 2005).  In the first quarterof 2005 (prior to the Credit Card Sale), we funded an increase in accountsreceivable of $89.5 million while in the first quarter of 2006 (subsequent tothe Credit Card Sale), we funded an increase in accounts receivable of $10.1million.

 

Net cash used for investing activities was $5,337.0 million in thefirst quarter of 2006 which consisted of 1) $5,152.9 million paid in connectionwith the Acquisition, 2) $134.7 million of cash reserved for the payment ofour 2008 Notes pursuant to our call of such notes for redemption in connectionwith the Transactions and 3) $49.3 million for capital expenditures.   Net cash used in investing activities was$50.6 million in the first quarter of 2005 for capital expenditures.  We incurred capital expenditures in the firstquarter of 2006 related to the construction of new stores in San Antonio andBoca Raton and the remodels of our San Francisco, Houston, Beverly Hills,Newport Beach and Bergdorf Goodman stores. We opened our San Antonio store in September 2005 and opened ourBoca Raton store in November 2005.

 

Net cash provided by financing activities was $4,646.8 million in thefirst quarter of 2006 as compared to $0.3 million in the first quarter of2005.  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.

 

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**Financing Structure**

 

Our major sources of funds are comprised of vendor financing, a $600.0million Asset-Based Revolving Credit Facility, $1,975.0 million Senior SecuredTerm Loan Facility, $700.0 million Senior Notes, $500.0 million Senior SubordinatedNotes, , $125.0 million 2028 Debentures and operating leases.

 

***Senior SecuredAsset-Based Revolving Credit Facility.*** On October 6,2005, in connection with the Transactions, we entered into a credit agreementand related security and other agreements for a senior secured Asset-BasedRevolving Credit Facility with Deutsche Bank Trust Company Americas asadministrative agent and collateral agent. The Asset-Based Revolving Credit Facility provides financing of up to$600.0 million, subject to a borrowing base equal to at any time thelesser 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.  The Asset-BasedRevolving Credit Facility includes borrowing capacity available for letters ofcredit and for borrowings on same-day notice.  At the closing of theTransactions, we utilized $150.0 million of the Asset-Based RevolvingCredit Facility for loans and approximately $16.5 million for letters of credit, which remained outstanding on October 29,2005.  As a result, on October 29,2005 we had $433.5 million ofunused borrowing availability under the Asset-Based Revolving Credit Facility.

 

The Asset-Based Revolving Credit Facility providesthat we have the right at any time to request up to $200.0 million ofadditional commitments, but the lenders are under no obligation to provide anysuch additional commitments, and any increase in commitments will be subject tocustomary conditions precedent. If we were to request any such additionalcommitments and the existing lenders or new lenders were to agree to providesuch commitments, the Asset-Based Revolving Credit Facility size could beincreased to up to $800.0 million, but our ability to borrow would stillbe limited by the amount of the borrowing base.

 

Borrowings under the Asset-Based Revolving CreditFacility bear interest at a rate per annum equal to, at our option, either (a) abase rate determined by reference to the higher of (1) the prime rate ofDeutsche Bank Trust Company Americas and (2) the federal funds effectiverate plus  1/2 of 1% or (b) a LIBOR rate,subject to certain adjustments, in each case plus an applicable margin. The initial applicable margin is 0% with respect to base rate borrowings and1.75% with respect to LIBOR borrowings.  The applicable margin is subjectto adjustment based on the historical availability under the Asset-BasedRevolving Credit Facility.   The interestrate on the outstanding borrowings pursuant to the Asset-Based Revolving CreditFacility was 6.06% at October 29, 2005. In addition, we are required to pay a commitment fee of 0.375% per annumin respect of the unutilized commitments. 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.

 

If at any time the aggregate amount of outstandingloans, unreimbursed letter of credit drawings and undrawn letters of creditunder the Asset-Based Revolving Credit Facility exceeds the lesser of (i) thecommitment amount and (ii) the borrowing base, we will be required torepay outstanding loans or cash collateralize letters of credit in an aggregateamount equal to such excess, with no reduction of the commitment amount.  If the amount available under the Asset-BasedRevolving Credit Facility is less than $60 million or an event of defaulthas occurred, we will be required to repay outstanding loans and cash collateralizeletters of credit with the cash we are required to deposit daily in acollection account maintained with the agent under the Asset-Based RevolvingCredit Facility.  We may voluntarilyreduce the unutilized portion of the commitment amount and repay outstandingloans at any time without premium or penalty other than customary “breakage”costs with respect to LIBOR loans.  Thereis no scheduled amortization under the Asset-Based Revolving Credit Facility;the principal amount of the loans outstanding are due and payable in full on October 6,2010.

 

All obligations under the Asset-Based RevolvingCredit Facility are guaranteed by Parent and certain of our existing and futuredomestic subsidiaries (excluding, among others, Gurwitch Products, L.L.C.,and Kate Spade LLC (Brand Development Companies)).  As of October 29, 2005, the liabilitiesof our non-guarantor subsidiaries totaled approximately $35.8 million, or 0.6%of consolidated liabilities, and the assets of our non-guarantor subsidiariesaggregated approximately $146.5 million, or 2.1% of consolidated totalassets.  All obligations under ourAsset-Based Revolving Credit Facility, and the guarantees of those obligations,are secured, subject to certain significant exceptions, by substantially all ofour assets and the assets of Parent and our subsidiaries that have guaranteedthe 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

 

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•                  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.

 

Our Asset-Based Revolving Credit Facility contains anumber of covenants that, among other things and subject to certain significantexceptions, restrict our ability 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.

 

The covenants limiting dividends and otherrestricted payments; investments, loans, advances and acquisitions; andprepayments or redemptions of other indebtedness, each permit the restrictedactions in an unlimited amount, subject to the satisfaction of certain paymentconditions, principally that we must have at least $75.0 million of proforma excess availability under the Asset-Based Revolving Credit Facility andthat we must be in pro forma compliance with the fixed charge coverage ratiodescribed below.

 

Although the credit agreement governing theAsset-Based Revolving Credit Facility does not require us to comply with anyfinancial ratio maintenance covenants, if less than $60.0 million wereavailable to be borrowed under the Asset-Based Revolving Credit Facility at anytime, we would not be permitted to borrow any additional amounts unless our proforma ratio of consolidated EBITDA to consolidated Fixed Charges (as such termsare defined in the credit agreement) were at least 1.1 to 1.0.  The credit agreement also contains customaryaffirmative covenants and events of default.

 

***Senior SecuredTerm 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.

 

Borrowings under the Senior Secured Term LoanFacility bear interest at a rate per annum equal to, at our option, either (a) abase rate determined by reference to the higher of (1) the prime rate ofCredit Suisse and (2) the federal funds effective rate plus  1/2of 1% or (b) a LIBOR rate, subject to certain adjustments, in each caseplus an applicable margin.  Theapplicable margin is 1.5% with respect to base rate borrowings and 2.5% withrespect to LIBOR borrowings.  Theinterest rate on the outstanding borrowings pursuant to the Senior Secured TermLoan Facility was 6.51% at October 29, 2005.

 

The credit agreement governing the Senior Secured TermLoan Facility requires us to prepay outstanding term loans with 50% (whichpercentage will be reduced to 25% if our total leverage ratio is less than aspecified ratio and will be reduced to 0% if our total leverage ratio is lessthan a specified ratio) of our annual excess cash flow (as defined in thecredit agreement).  If a change ofcontrol (as defined in the credit agreement) occurs, we will be required tooffer to prepay all outstanding term loans, at a prepayment price equal to 101%of the principal amount to be prepaid, plus accrued and unpaid interest to thedate of prepayment. We also must offer to prepay outstanding term loans at 100%of the principal amount to be prepaid, plus accrued and unpaid interest, withthe proceeds of certain asset sales under certain circumstances.

 

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We may voluntarily prepay outstanding loans underthe Senior Secured Term Loan Facility at any time without premium or penaltyother 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 aprepayment that is made with certain designated asset sale proceeds), we mustpay 101% of the principal amount to be repaid. There is no scheduled amortization under the Senior Secured Term LoanFacility.  The principal amount of theloans outstanding is due and payable in full on April 6, 2013.

 

All obligations under the Senior Secured Term LoanFacility are unconditionally guaranteed by Parent and each direct and indirectdomestic subsidiary of the Company that guarantees the obligations of theCompany under our Asset-Based Revolving Credit Facility.  All obligations under the Senior Secured TermLoan Facility, and the guarantees of those obligations, are secured, subject tocertain significant exceptions, by substantially all of our assets and theassets of Parent and the subsidiary guarantors, 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, 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 our full-lineretail 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.

 

The credit agreement governing the Senior SecuredTerm Loan Facility contains a number of negative covenants that aresubstantially similar to those governing the Senior Notes and additionalcovenants related to the security arrangements for the Senior Secured Term LoanFacility.  The credit agreement alsocontains customary affirmative covenants and events of default.

 

***2028 Debentures. ***InMay 1998, we issued $125.0 million aggregate principal amount of our 2028Debentures.  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 thecapital stock of certain of our existing and future domestic subsidiaries, and (ii) 100%of the non-voting stock and 65% of the voting stock of certain of our existingand future foreign subsidiaries and (b) certain of our principalproperties that include a majority of our full-line stores, in each case, tothe extent required by the terms of the indenture governing our 2028Debentures.

*** ***

***SeniorNotes. ***On October 6, 2005, Newton AcquisitionMerger Sub., Inc. issued $700.0 million aggregate original principalamount 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.

 

For any interest payment period through October 15,2010, the Company may, at its option, elect to pay interest on the Senior Notesentirely in cash (Cash Interest) or entirely by increasing the principal amountof the outstanding Senior Notes or by issuing additional Senior Notes (PIKInterest).  Cash Interest on the SeniorNotes accrues at the rate of 9% per annum.  PIK Interest on the SeniorNotes accrues at the rate of 9.75% per annum.  After October 15,2010, the Company will make all interest payments on the Senior Notes entirelyin cash.  All Senior Notes mature on October 15, 2015 and have thesame rights and benefits as the Senior Notes issued on October 6,2005.  Interest on the Senior Notes ispayable quarterly in arrears on each January 15, April 15, July 15and October 15, commencing on January 15, 2006.

 

The Senior Notes are guaranteed, jointly andseverally, on an unsecured, senior basis, by each of our wholly-owned domesticsubsidiaries that guarantee our obligations under our Senior Secured CreditFacilities and by Parent.  The SeniorNotes and the guarantees thereof are our and the guarantors’ unsecured, seniorobligations and rank (i) equal in the right of payment with all of our andthe 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 also are effectively juniorin priority to our and our guarantors’ obligations under all secured indebtedness,including our Senior

 

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Secured Credit Facilities, our 2028 Debentures, andany other secured obligations of ours, in each case, to the extent of the valueof the assets securing such obligations. In addition, the Senior Notes are structurally subordinated to allexisting and future liabilities, including trade payables, of our subsidiariesthat are not providing guarantees.

 

The Company is not required to make any mandatoryredemption or sinking fund payments with respect to the Senior Notes, but undercertain circumstances, the Company may be required to offer to purchase SeniorNotes as described below.  The Companymay from 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 described below, the Senior Notes are notredeemable at the Company’s option prior to October 15, 2010. From andafter October 15, 2010, the Company may redeem the Senior Notes, in wholeor in part, at a redemption price equal to 104.5% of principal amount,declining annually to 100% of the principal amount on October 15, 2013,plus accrued and unpaid interest, and Additional Interest (as defined in theSenior Indenture), if any, thereon to the applicable redemption date.

 

Prior to October 15, 2008, the Companymay, at its option, subject to certain conditions, redeem up to 35% of theoriginal aggregate principal amount of Senior Notes at a redemption price equalto 109.000% of the aggregate principal amount thereof, *plus* accrued and unpaid interest, andAdditional Interest, if any, thereon to the redemption date, with the net cashproceeds of one or more equity offerings of the Company or any direct orindirect parent of the Company to the extent such net proceeds are contributedto the Company.  At any time priorto October 15, 2010, the Company also may redeem all or a part of theSenior Notes at a redemption price equal to 100% of the principal amount ofSenior Notes redeemed plus an applicable premium, as provided in the SeniorIndenture, as of, and accrued and unpaid interest and Additional Interest, ifany, to the redemption date.

 

Upon the occurrence of a change of control (asdefined in the Senior Indenture), each holder of the Senior Notes has the rightto require the Company to repurchase some or all of such holder’s Senior Notesat a 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.

 

The indenture governing the Senior Notes containscovenants that limit our ability and 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.

 

Our Brand Development Companies are not subject tothe covenants contained in the Senior Indenture.  The Senior Indenture also provides for eventsof default, which, if any of them occurs, would permit or require theprincipal, premium, if any, interest and any other monetary obligations on alloutstanding Senior Notes to be due and payable immediately.

 

***SeniorSubordinated Notes. ***On October 6, 2005, Newton AcquisitionMerger Sub., Inc. issued $500.0 million aggregate principal amount of10.375% Senior Subordinated Notes under a senior subordinated indenture (SeniorSubordinated Indenture) with Wells Fargo Bank, National Association, astrustee.  At the closing of theTransactions, as the surviving corporation in the Acquisition, we assumed allthe obligations of Newton Acquisition Merger Sub, Inc. under the SeniorSubordinated Indenture.  The Senior Subordinated Notes mature on October 15,2015.  Interest on the SeniorSubordinated Notes is payable in cash semi-annually in arrears on each April 15and October 15, commencing April 15, 2006.

 

The Senior Subordinated Notes are guaranteed,jointly and severally, on an unsecured, senior subordinated basis, by each ofour wholly-owned domestic subsidiaries that guarantee our obligations under ourSenior Secured Credit Facilities and by Parent. The Senior Subordinated Notes and the guarantees thereof are our and theguarantors’ unsecured, senior subordinated obligations

 

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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) 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 SeniorSubordinated Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of our subsidiaries that are notproviding guarantees.

 

The Company is not required to make any mandatoryredemption or sinking fund payments with respect to the Senior SubordinatedNotes, but, under certain circumstances, the Company may be required to offerto purchase Senior Subordinated Notes as described below.  The Company mayfrom time to time acquire Senior Subordinated Notes by means other than aredemption, whether by tender offer, in open market purchases, throughnegotiated transactions or otherwise, in accordance with applicable securitieslaws.

 

Except as described below, the Senior SubordinatedNotes are not redeemable at the Company’s option prior to October 15,2010. From and after October 15, 2010, the Company may redeem the SeniorSubordinated Notes, in whole or in part, at a redemption price equal to105.188% of principal amount, declining annually to 100% of principal amount onOctober 15, 2013, plus accrued and unpaid interest, and AdditionalInterest (as defined in the Senior Subordinated Indenture), if any, thereon tothe applicable redemption date.

 

Prior to October 15, 2008, the Company may, atits option, subject to certain conditions, redeem up to 35% of the originalaggregate principal amount of Senior Subordinated Notes at a redemption priceequal to 110.375% of the aggregate principal amount thereof, *plus* accrued and unpaid interest, andAdditional Interest, if any, thereon to the redemption date, with the net cashproceeds of one or more equity offerings of the Company or any direct orindirect parent of the Company to the extent such net proceeds are contributedto the Company.

 

At any time prior to October 15, 2010, theCompany also may redeem all or a part of the Senior Subordinated Notes at aredemption price equal to 100% of the principal amount of Senior SubordinatedNotes redeemed plus an applicable premium, as provided in the SeniorSubordinated Indenture, as of, and accrued and unpaid interest and AdditionalInterest, if any, to the redemption date.

 

Upon the occurrence of a change of control (asdefined in the Senior Subordinated Indenture), the Company will make an offerto purchase all of the Senior Subordinated Notes at a price in cash equal to101% of the aggregate principal amount thereof plus accrued and unpaidinterest, and Additional Interest, if any, to the date of purchase.

 

The indenture governing the Senior SubordinatedNotes contains covenants substantially similar to those applicable to ourSenior Notes described above.  The SeniorSubordinated Indenture also provides for events of default, which, if any ofthem occurs, would permit or require the principal, premium, if any, interestand any other monetary obligations on all outstanding Senior Notes to be dueand payable immediately, subject to certain exceptions.

 

***Redemption of 2008 Notes.   ***In May 1998, we issued $125.0 million aggregateprincipal amount of our 2008 Notes. Upon closing of the Transactions, we calledour 2008 Notes for redemption pursuant to their terms.

*** ***

***At October 29, 2005, we had $134.7 million in cashreserved for the redemption of our 2008 Notes which we paid on November 7,2005 to effect the redemption of our 2008 Notes, including a call premium of$6.2 million plus accrued interest of $3.5 million through the redemption date.***

 

**OTHERMATTERS**

 

**Factors That May Affect Future Results**

 

Matters discussed in MD&A include forward-looking statements.Forward-looking statements generally can be identified by the use of forward-lookingterminology such as “may,” “plan,” “predict,” “expect,” “estimate,” “intend,” “would,”“could,” “should,” “anticipate,” “believe,” “project” or “continue.” We makethese forward-looking statements based on our expectations and beliefsconcerning future events, as well as currently available data. These forward-lookingstatements involve a number of risks and uncertainties and, therefore, are notguarantees of future performance. A variety of factors could cause our actualresults to differ materially from the anticipated or expected results expressedin our forward-looking statements. Factors that could affect future performanceinclude, but are not limited, to:

 

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*Political and General Economic Conditions*

 

•                  current political and general economic conditions orchanges in such conditions including relationships between the United Statesand the countries from which we source our merchandise;

 

•                  terrorist activities in the United States andelsewhere;

 

•                  political, social, economic, or other eventsresulting in the short- or long-term disruption in business at our stores,distribution centers or offices;

 

*Customer Demographic Issues*

 

•                  changes in the demographic or retail environment;

 

•                  changes in consumer confidence resulting in areduction of discretionary spending on goods;

 

•                  changes in consumer preferences or fashion trends;

 

•                  changes in our relationships with key customers;

 

•                  changes in our proprietary credit card arrangementthat adversely impact the ability to provide credit to our customers;

 

*Merchandise Procurement and Supply ChainConsiderations*

 

•                  changes in our relationships with designers, vendorsand other sources of merchandise, including adverse changes in their financialviability;

 

•                  delays in receipt of merchandise ordered due to workstoppages or other causes of delay in connection with either themanufacture or shipment of such merchandise;

 

•                  changes in foreign currency exchange or inflationrates;

 

•                  significant increases in paper, printing and postagecosts;

 

*Industry and Competitive Factors*

 

•                  competitive responses to our loyalty programs,marketing, merchandising and promotional efforts or inventory liquidations byvendors or other retailers;

 

•                  seasonality of the retail business;

 

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

 

•                  delays in anticipated store openings andrenovations;

 

•                  our success in enforcing our intellectual propertyrights;

 

*Employee Considerations*

 

•                  changes in key management personnel and our abilityto retain key management personnel;

 

•                  changes in our relationships with certain of our keysales associates and our ability to retain our key sales associates;

 

*Legal and Regulatory Issues*

 

•                  changes in government or regulatory requirementsincreasing our costs of operations;

 

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•                  litigation that may have an adverse effect on ourfinancial results or reputation;

 

*The Transactions*

 

The consummation of the Transactions resulted in the Company becominghighly leveraged.   As a result, we aresubject to additional risk factors including:

 

•                  the effects of incurring a substantial amount ofindebtedness under our Senior Secured Credit Facilities and the Notes;

 

•                  the effects upon us of complying with the covenantscontained in our Senior Secured Credit Facilities and the indentures governingthe Notes;

 

•                  restrictions the terms and conditions of theindebtedness under our Senior Secured Credit Facilities and the Notes may placeon our ability to respond to changes in our business or to take certainactions;

 

*Other Factors*

 

•                  impact of funding requirements related to ournoncontributory defined benefit pension plan; and

 

•                  the design and implementation of new informationsystems as well as enhancements of existing systems.

 

The foregoing factors are not exhaustive, and new factors may emerge orchanges to the foregoing factors may occur that could impact our business.Except to the extent required by law, we undertake no obligation to update orrevise (publicly or otherwise) any forward-looking statements to reflectsubsequent events, new information or future circumstances.

 

**Critical AccountingPolicies**

 

The preparation of condensed consolidated financial statements inconformity with generally accepted accounting principles requires  us  tomake estimates and assumptions about future events.  These estimates and assumptions affectamounts of assets, liabilities, revenues and expenses and the disclosure ofgain and loss contingencies at the date of the Condensed Consolidated FinancialStatements.  Our current estimates aresubject to change if different assumptions as to the outcome of future eventswere made.  We evaluate our estimates andjudgments on an ongoing basis and predicate those estimates and judgments onhistorical experience and on various other factors that we believe arereasonable under the circumstances.  Wemake adjustments to our assumptions and judgments when facts and circumstancesdictate.  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 toCondensed Consolidated Financial Statements in Item 1 for a summary of ourcritical accounting policies.  A completedescription of our critical accounting policies is included in our AnnualReport to Shareholders on Form 10-K for the fiscal year ended July 30,2005.**

 

We have changed the basis of presentation of certain prior year amountsand calculations presented in this quarterly report to conform to the currentyear presentation. In prior periods, depreciation expense was included inbuying and occupancy costs.

 

***Purchase Accounting. ***We haveaccounted for the Acquisition in accordance with the provisions of Statement ofFinancial Accounting Standards (SFAS) 141, “Business Combinations,” whereby thepurchase price paid to effect the Acquisition is allocated to state theacquired assets and liabilities at fair value. The Acquisition and the allocation of the purchase price have beenrecorded as of October 1, 2005, the beginning of our October accountingperiod.  In connection with thepreliminary purchase price allocation, we have made estimates of the fairvalues of our long-lived and intangible assets based upon assumptions relatedto the future cash flows, discount rates and asset lives utilizing currentlyavailable information, and in some cases, preliminary valuation results fromindependent valuation specialists.  As ofOctober 29, 2005, we have recorded preliminary purchase accounting adjustmentsto increase the carrying value of our property and equipment and inventory, toestablish intangible assets for our tradenames, customer lists and favorablelease commitments and to revalue our long-term benefit plan obligations, amongother things.  This allocation of thepurchase price is preliminary and subject to finalization of independentappraisals.  Further revisions to thepurchase price allocation will be made as additional information becomesavailable and such revisions could be material.

 

***Recent Accounting Pronouncements.***InDecember 2004, the Financial Accounting Standards Board (FASB) issued SFASNo. 123R, “Share-Based Payment.” This standard is a revision of SFAS No. 123,“Accounting for Stock-Based Compensation,” and supersedes Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” and itsrelated implementation guidance.  SFAS No. 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the financial statements based on their fairvalues and is effective for the first interim period or annual reporting periodbeginning after June 15, 2005.  Weadopted SFAS No. 123R as of the beginning of our first quarter of 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 presentedherein.  See Note 5 for furtherdescription 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

 

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definition of liabilities and should be recognized when incurred iftheir fair values can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15,2005.  The cumulative effect of initiallyapplying FIN 47 will be recognized as a change in accounting principle. We arein the process of evaluating the expected effect of FIN 47, if any, on ourconsolidated financial statements.

 

**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 the Transactions, we are highly leveraged. As of October 29,2005, our total indebtedness was approximately $3,580.2 million (withoutgiving effect to the redemption of our 2008 Notes on November 7, 2005),which included $150.0 million borrowed under our Asset-Based RevolvingCredit Facility.  Our substantialindebtedness, combined with our lease and other financial obligations andcontractual commitments, could have other important consequences. For example,it could:

 

•                  make it more difficult forus to satisfy our obligations with respect to our indebtedness and any failureto comply with the obligations of any of our debt instruments, includingrestrictive covenants and borrowing conditions, could result in an event ofdefault under the agreements governing our indebtedness;

 

•                  make us more vulnerable toadverse changes in general economic, industry and competitive conditions andadverse changes in government regulation;

 

•                  require us to dedicate asubstantial portion of our cash flow from operations to payments on our indebtedness,thereby reducing the availability of our cash flows to fund working capital,capital expenditures, acquisitions and other general corporate purposes;

 

•                  limit our flexibility inplanning for, or reacting to, changes in our business and the industry in whichwe operate;

 

•                  place us at a competitivedisadvantage compared to our competitors that are less highly leveraged andtherefore may be able to take advantage of opportunities that our leverageprevents us from exploiting; and

 

•                  limit our ability toborrow additional amounts for working capital, capital expenditures,acquisitions, debt service requirements, execution of our business strategy orother purposes.

 

Any of the above listed factors could materially adversely affect ourbusiness, financial condition and results of operations.

 

In addition, our interest expense could increase if interest ratesincrease because the entire amount of the indebtedness under our senior securedcredit facilities bears interest at floating rates.   As of October 29, 2005, we hadapproximately $2,125.0 million of floating rate debt, consisting ofoutstanding borrowings under the Asset-Based Revolving Credit Facility andSenior Secured Term Loan Facility. 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.

 

**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 on and principal of our debt obligationswill primarily depend upon our future operating performance. As a result,prevailing economic conditions and financial, business and other factors, manyof which are beyond our control, will affect our ability to make thesepayments.

 

If we do not generate sufficient cash flow from operations to satisfyour debt service obligations, we may have to undertake alternative financingplans, such as refinancing or restructuring our indebtedness, selling assets,reducing or delaying capital investments or seeking to raise additionalcapital.  Our ability to restructure orrefinance our debt will depend on the condition of the capital markets and ourfinancial condition at such time.  Anyrefinancing of our debt could be at higher interest rates and

 

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may require us to comply with more onerous covenants, which couldfurther restrict our business operations. The terms of existing or future debt instruments may restrict us fromadopting some of these alternatives.  Inaddition, any failure to make payments of interest and principal on ouroutstanding indebtedness on a timely basis would likely result in a reductionof our credit rating, which could harm our ability to incur additionalindebtedness on acceptable terms.

 

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.  Our Asset-Based Revolving Credit Facilitypermits us to borrow up to $600.0 million; however, our ability to borrowthereunder is limited by a borrowing base, which at any time will equal thelesser of 80% of eligible inventory valued at the lower of cost or market valueand 85% of the net orderly liquidation value of the eligible inventory, lesscertain reserves.  In addition, ourability to borrow under this facility is limited by a minimum liquiditycondition, providing that, if less than $60.0 million is available at anytime, we are not permitted to borrow any additional amounts under theAsset-Based Revolving Credit Facility unless our ratio of consolidated EBITDAto consolidated Fixed Charges (as such terms are defined in the creditagreement for our senior secured asset-based revolving credit facility) is atleast 1.1 to 1.0.  Our ability to meetthis financial ratio can be affected by events beyond our control, and wecannot assure you that we will meet this ratio.

 

Our inability to generate sufficient cash flow to satisfy our debtservice obligations, or to refinance our obligations at all or on commerciallyreasonable terms, would have an adverse effect, which could be material, on ourbusiness, financial condition and results of operations.

 

**The terms of our****Asset-Based Revolving Credit Facility and Senior Secured Term LoanFacility and the indenturesgoverning our 2028 Debentures may restrict our current and future operations,particularly our ability to respond to changes in our business or to takecertain actions.**

 

The credit agreements governing our Asset-Based Revolving CreditFacility and Senior Secured Term Loan Facility credit facilities and theindentures governing our Notes and 2028 Debentures contain, and any futureindebtedness of ours would likely contain, a number of restrictive covenantsthat impose significant operating and financial restrictions, includingrestrictions on our ability to engage in acts that may be in our best long-terminterests. The indentures governing our Notes and 2028 Debentures and thecredit agreements governing our senior secured credit facilities includecovenants that, among other things, restrict our ability to:

 

•                  incur additionalindebtedness;

 

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

 

•                  make investments;

 

•                  create restrictions on thepayment of dividends or other amounts to us from our restricted subsidiaries;

 

•                  engage in transactionswith our affiliates;

 

•                  sell assets, includingcapital stock of our subsidiaries;

 

•                  consolidate or merge;

 

•                  create liens; and

 

•                  enter into sale and leaseback transactions.

 

In addition, our ability to borrow under our Asset-Based RevolvingCredit Facility is limited by a borrowing base and a minimum liquiditycondition, as described above.

 

Moreover, our Asset-Based Revolving Credit Facility provides discretionto the agent bank acting on behalf of the lenders to impose additionalavailability and other reserves, which could materially impair the amount ofborrowings that would otherwise be available to us. There can be no assurancethat the agent bank will not impose such reserves or, were it to do so, thatthe resulting impact of this action would not materially and adversely impairour liquidity.

 

A breach of any of the restrictive covenants would result in a defaultunder our Asset-Based Revolving Credit Facility and Senior Secured Term LoanFacility.  If any such default occurs,the lenders under our Asset-Based Revolving Credit Facility and Senior

 

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Secured Term Loan Facility may elect to declare all outstandingborrowings under such facilities, together with accrued interest and otherfees, to be immediately due and payable, or enforce their security interest,any of which would result in an event of default under our Notes and 2028Debentures. The lenders would also have the right in these circumstances toterminate any commitments they have to provide further borrowings.

 

The operating and financial restrictions and covenants in these debtagreements and any future financing agreements may adversely affect our abilityto finance future operations or capital needs or to engage in other businessactivities.

 

**Risks Related to Our Business and Industry**

 

**The specialty retail industry is highlycompetitive.**

 

The specialty retail industry is highly competitive and fragmented.Competition is strong both to attract and sell to customers and to establishrelationships with, and obtain merchandise from, key vendors.

 

We compete for customers with specialty retailers, traditional and high-enddepartment stores, national apparel chains, vendor-owned proprietary boutiques,individual specialty apparel stores and direct marketing firms. We compete forcustomers principally on the basis of quality and fashion, customer service,value, assortment and presentation of merchandise, marketing and customerloyalty programs and, in the case of Neiman Marcus and Bergdorf Goodman, storeambiance. In our Specialty Retail business, merchandise assortment is a criticalcompetitive factor, and retail stores compete for exclusive, preferred andlimited distribution arrangements with key designers. Many of our competitorsare larger 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 with established and emerging designers are a keyfactor in our position as a retailer of high-fashion merchandise, and asubstantial portion of our revenues is attributable to our sales of designermerchandise. Many of our key vendors limit the number of retail channels theyuse to sell their merchandise and competition among luxury retailers to obtainand sell these goods is intense. Our relationships with our designers have beena significant contributor to our past success. We have no guaranteed supplyarrangements with our principal merchandising sources. Accordingly, there canbe no assurance that such sources will continue to meet our quality, style andvolume requirements. Moreover, nearly all of the brands of our top designersare sold by competing retailers, and many of our top designers also have theirown dedicated retail stores. If one or more of our top designers were to ceaseproviding us with adequate supplies of merchandise or, conversely, were toincrease sales of merchandise through its own stores or to the stores of ourcompetitors, our business could be adversely affected. In addition, any declinein the popularity or quality of any of our designer brands could adverselyaffect our business.

 

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

 

We make decisions regarding the purchase of our merchandise well inadvance of the season in which it will be sold. For example, women’s apparel,men’s apparel and shoes are typically ordered six to nine months in advance ofthe products being offered for sale, while handbags, jewelry and othercategories of merchandise are typically ordered three to six months in advance.If our sales during any season, particularly a peak season, are significantlylower than we expect for any reason, we may not be able to adjust ourexpenditures for inventory and other expenses in a timely fashion and may beleft with a substantial amount of unsold inventory. If that occurs, we may beforced to rely on markdowns or promotional sales to dispose of excessinventory. This could have an adverse effect on our margins and operatingincome. At the same time, if we fail to purchase a sufficient quantity ofmerchandise, we may not have an adequate supply of products to meet consumerdemand. This may cause us to lose sales or harm our customer relationships.

 

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

 

Our success depends in large part on our ability to identify fashiontrends as well as to anticipate, gauge and react to changing consumer demandsin a timely manner. If we fail to adequately match our product mix toprevailing customer tastes, we may be required to sell our merchandise athigher average markdown levels and lower average margins. Furthermore, theproducts we sell often require long lead times to order and must appeal toconsumers whose preferences cannot be predicted with certainty and often changerapidly. Consequently, we must stay abreast of emerging lifestyle and consumertrends and anticipate trends and fashions that will appeal to our consumerbase. Any failure on our part to anticipate, identify and respond effectivelyto

 

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changing consumer demands and fashion trends could adversely affect ourbusiness.

 

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

 

Based upon our expansion strategy, we expect that planned new stores(including our Boca Raton store that opened in November 2005) will addover 665,000 square feet of new store space over approximately the next threeyears, representing an almost 13% increase above the current aggregate squarefootage of our full-line Neiman Marcus and Bergdorf Goodman stores, andthat our store remodeling program will add additional new store space fromremodels that are already underway. New store openings involve certain risks,including constructing, furnishing and supplying a store in a timely and costeffective manner, accurately assessing the demographic or retail environment ata given location, hiring and training quality staff, obtaining necessarypermits and zoning approvals, obtaining commitments from a core group ofvendors to supply the new store, integrating the new store into ourdistribution network and building customer awareness and loyalty. Inundertaking store remodels, we must complete the remodel in a timely, costeffective manner, minimize disruptions to our existing operations, and succeedin creating an improved shopping environment. If we fail to execute on these orother aspects of our store expansion and remodeling strategy, we could sufferharm to our sales, an increase in costs and expenses and an adverse effect onour business.

 

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

 

The economic downturn that followed the terrorist attacks of September 11,2001 had a material adverse effect on our business. Any further acts ofterrorism or other future conflicts may disrupt commerce and undermine consumerconfidence, cause a downturn in the economy generally, cause consumer spendingor shopping center traffic to decline or reduce the desire of our customers tomake discretionary purchases. Any of the foregoing factors could negativelyimpact our sales revenue, particularly in the case of any terrorist attacktargeting retail space, such as a shopping center. Furthermore, an act ofterrorism or war, or the threat thereof, could negatively impact our businessby interfering with our ability to obtain merchandise from foreignmanufacturers. Any future inability to obtain merchandise from our foreignmanufacturers or to substitute other manufacturers, at similar costs and in atimely manner, could adversely affect our business.

 

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

 

The merchandise we sell consists in large part of luxury retail goods.The purchase of these goods by customers is discretionary, and therefore highlydependent upon the level of consumer spending, particularly among affluentcustomers. Accordingly, sales of these products may be adversely affected by aneconomic downturn, increases in consumer debt levels, uncertainties regardingfuture economic prospects or a decline in consumer confidence. An economicdownturn in the United States generally or in any of the geographic areas inwhich we have stores, particularly in Texas, California, Florida and the NewYork City metropolitan area, from which we derive a significant portion of ourrevenues, could have a material adverse effect on our business and results ofoperations.

 

**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 specialty retail industry will continue to depend toa significant extent on our senior management team, buyers and key salesassociates. We rely on the experience of our senior management, who havespecific knowledge relating to us and our industry that would be difficult toreplace. If we were to lose a portion of our buyers or key sales associates,our ability to benefit from long-standing relationships with key vendors or toprovide relationship-based customer service may suffer. We cannot assure youthat we will be able to retain our current senior management team, buyers orkey sales associates. The loss of any of these individuals could adverselyaffect our business.

 

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

 

In recent years, we have experienced certain inflationary conditions inour cost base due primarily to (1) changes in foreign currency exchangerates that have reduced the purchasing power of the U.S. dollar and (2) increasesin selling, general and administrative expenses, particularly with regard toemployee benefits. Inflation can harm our margins and profitability if we areunable to increase prices or cut costs enough to offset the effects ofinflation in our cost base. If inflation in these or other costs worsens, wecannot assure you that our attempts to offset the effects of inflation and costincreases through control of expenses, passing cost increases on to customersor any other method will be successful. Any future inflation could adverselyaffect our profitability and our business.

 

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

 

We maintain loyalty programs that are designed to cultivate long-termrelationships with our customers and enhance the quality of service we provideto our customers. We must constantly monitor and update the terms of ourloyalty programs so that they continue to meet the demands and needs of ourcustomers and remain competitive with loyalty programs offered by otherhigh-end specialty retailers. Given that approximately 46% of our revenues atNeiman Marcus stores in calendar year 2004 were generated by our InCircleloyalty program members, our failure to continue to provide quality service andcompetitive loyalty programs to our customers through the InCircle loyaltyprogram could adversely affect our business.

 

**Changes in our credit card arrangements, applicableregulations and consumer credit patterns could adversely impact our ability tofacilitate the provision of consumer credit to our customers and adverselyaffect our business.**

 

We maintain a proprietary credit card program through which credit isextended to customers under the “Neiman Marcus” and “Bergdorf Goodman” names.Because a majority of our revenues were transacted through our proprietarycredit cards, changes in our proprietary credit card arrangement that adverselyimpact our ability to facilitate the provision of consumer credit may adverselyaffect our performance. We recently sold our approximately three millionprivate label credit card accounts and related assets, as well as theoutstanding balances associated with such accounts.  Initially, we will continue to handle keycustomer service functions, including new account processing, most transactionauthorization, billing adjustments, collection services and customer inquiries.As part of this transaction, we are changing, and will continue to change, theterms of credit offered to our customers following the Credit Card Sale. Inaddition, the purchaser of our credit card business will have discretion overcertain policies and arrangements with credit card customers and may change thesepolicies and arrangements in ways that affect our relationship with thesecustomers. Any such changes in our credit card arrangements may adverselyaffect our credit card program and ultimately, our business.

 

Credit card operations are subject to numerous federal and state lawsthat impose disclosure and other requirements upon the origination, servicingand enforcement of credit accounts and limitations on the maximum amount offinance charges that may be charged by a credit provider. The purchaser of ourcredit card business is subject to regulations to which we were not subjectprior to the Credit Card Sale. Any effect of these regulations or change in theregulation of credit arrangements that would materially limit the availabilityof credit to our customer base could adversely affect our business. Inaddition, changes in credit card use, payment patterns, and default rates mayresult from a variety of economic, legal, social, and other factors that wecannot control or predict with certainty.

 

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

 

Extreme weather conditions in the areas in which our stores are locatedcould adversely affect our business. For example, heavy snowfall, rainfall orother extreme weather conditions over a prolonged period might make itdifficult for our customers to travel to our stores and thereby reduce oursales and profitability. Our business is also susceptible to unseasonableweather conditions. For example, extended periods of unseasonably warm temperaturesduring the winter season or cool weather during the summer season could rendera portion of our inventory incompatible with those unseasonable conditions.Reduced sales from extreme or prolonged unseasonable weather conditions wouldadversely 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 regulations and zoning and occupancy ordinancesthat regulate retailers generally and/or govern the importation, promotion andsale of merchandise and the operation of retail stores and warehousefacilities. Although we undertake to monitor changes in these laws, if theselaws change without our knowledge, or are violated by importers, designers,manufacturers or distributors, we could experience delays in shipments andreceipt of goods or be subject to fines or other penalties under thecontrolling regulations, any of which could adversely affect our business.

 

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

 

The specialty retail industry is seasonal in nature, with a higherlevel of sales typically generated in the fall and holiday selling seasons. Wehave in the past experienced significant fluctuation in our revenues fromquarter to quarter with a disproportionate amount of our revenues falling inour second fiscal quarter, which coincides with the holiday season. Inaddition, we incur significant additional expenses in the period leading up tothe months of November and December in anticipation of higher salesvolume in those periods, including for additional inventory, advertising andemployees.

 

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

 

We purchase a substantial portion of our inventory from foreignsuppliers whose cost to us is affected by the fluctuation of their localcurrency against the dollar or who price their merchandise in currencies otherthan the dollar. Accordingly, changes in the value of the dollar relative toforeign currencies may increase our cost of goods sold and, if we are unable topass such cost increases on to our customers, decrease our gross margins andultimately our earnings. Fluctuations in the Euro-dollar exchange rate affectus most significantly; however, we source goods from numerous countries andthus are affected by changes in numerous currencies and, generally, byfluctuations in the U.S. dollar relative to such currencies. Although we hedgesome exposures to changes in foreign currency exchange rates arising in theordinary course of business, foreign currency fluctuations may have a materialadverse effect on our business, financial condition and results of operations.

 

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

 

A substantial majority of our merchandise is manufactured overseas,mostly in Europe. As a result, political instability or other events resultingin the disruption of trade from other countries or the imposition of additionalregulations relating to or duties upon imports could cause significant delaysor interruptions in the supply of our merchandise or increase our costs, eitherof which could have a material adverse effect on our business. If we are forcedto source merchandise from other countries, those goods may be more expensiveor of a different or inferior quality from the ones we now sell. The importanceto us of our existing designer relationships could present additionaldifficulties, as it may not be possible to source merchandise from a givendesigner from alternative jurisdictions. If we were unable to adequatelyreplace the merchandise we currently source with merchandise producedelsewhere, our business 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 promote in-store events, new merchandise and fashiontrends through print catalogs and other promotional materials mailed on atargeted basis to our customers. Significant increases in paper, printing andpostage costs could affect the cost of producing these materials and as a result,may adversely affect our operating 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 and controlled by the Sponsors and certainother equity investors, and the Sponsors have the ability to control ourpolicies and operations. The interests of the Sponsors may not in all cases bealigned with those of our creditors. For example, if we encounter financialdifficulties or are unable to pay our debts as they mature, the interests ofour equity holders might conflict with our creditors’ interests. In addition,our equity holders may have an interest in pursuing acquisitions, divestitures,financings or other transactions that, in their judgment, could enhance theirequity investments, even though such transactions might involve risks toholders of our indebtedness. Furthermore, the Sponsors may in the future ownbusinesses that directly or indirectly compete with us. One or more of theSponsors also may pursue acquisition opportunities that may be complementary toour business, and as a result, those acquisition opportunities may not beavailable 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 subsidiaries currently own our trademarks and service marks,including the “Neiman Marcus,” “Bergdorf Goodman” and “Kate Spade” marks. Ourtrademarks and service marks are registered in the United States and in variousforeign countries, primarily in Europe. The laws of some foreign countries donot protect proprietary rights to the same extent as do the laws of the UnitedStates. Moreover, we are unable to predict the effect that any future foreignor domestic intellectual property legislation or regulation may have on ourexisting or future business. The loss or reduction of any of our significantproprietary rights could have an adverse effect on our business.

 

Additionally, third parties may assert claims against us alleginginfringement, misappropriation or other violations of their trademark or otherproprietary rights, whether or not the claims have merit. Claims like these maybe time consuming and expensive to defend and could result in our beingrequired to cease using the trademark or other rights and selling the allegedlyinfringing products. This might have an adverse affect on our sales and causeus to incur significant litigation costs and expenses.

 

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

 

To keep pace with changing technology, we must continuously provide forthe design and implementation of new information technology systems as well asenhancements of our existing systems. Any failure to adequately maintain andupdate the information technology systems supporting our online operations,sales operations or inventory control could prevent our customers frompurchasing merchandise on our websites or prevent us from processing anddelivering merchandise, which could adversely affect our business.

 

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

 

Substantially all of our merchandise is delivered to us by our vendorsas finished goods and is manufactured in numerous locations, including Europeand the United States and, to a lesser extent, China, Mexico and South America.Our vendors rely on third party carriers to deliver merchandise to ourdistribution facilities. In addition, our success depends on our ability toefficiently source and distribute merchandise to our Specialty Retail storesand Neiman Marcus Direct customers. Events such as U.S. or foreign laborstrikes, natural disasters, work stoppages or boycotts affecting themanufacturing or transportation sectors could increase the cost or reduce thesupply of merchandise available to us and could adversely affect our results ofoperations.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

The market risk inherent in our financial instruments represents thepotential loss arising from adverse changes in interest rates and foreigncurrency exchange rates. We do not enter into derivative financial instrumentsfor trading purposes. We seek to manage exposure to adverse interest ratechanges through our normal operating and financing activities. We are exposedto interest rate risk through our borrowing activities, which are described inNote 8 to the condensed consolidated financial statements.

 

As of October 29, 2005, we had $150.0 million in borrowingsoutstanding under our Asset-Based Revolving Credit Facility that bear interestat floating rates.  Future borrowingsunder our Asset-Based Revolving Facility, to the extent of outstandingborrowings, would be affected by interest rate changes.

 

At October 29, 2005, we had $1,975.0 million of debt under ourSenior Secured Term Loan Facility issued in connection with the Transactionsthat bears interest at floating rates.  A1% increase in these floating rates would increase annual interest expense byapproximately $19.8 million.

 

We use derivative financial instruments to help manage our interestrate risk.   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.  The interest rate swap agreements terminateafter five years.

 

We use derivative financial instruments to manage foreign currency riskrelated to the procurement of merchandise inventories from foreign sources. Weenter into foreign currency contracts denominated in the euro and Britishpound.  We had foreign currency contractsin the form of forward exchange contracts in the amount of approximately$38.2 million as of October 29, 2005 and approximately $31.5 millionas of October 30, 2004.  The marketrisk inherent in these instruments was not material to our consolidatedfinancial position, results of operations or cash flows in the first quarter of2006.

 

Theeffects of changes in the U.S. equity and bond markets serve to increase ordecrease the value of Pension Plan assets, resulting in increased or decreasedcash funding by the Company. We seek to manage exposure to adverse equity andbond returns by maintaining diversified investment portfolios and utilizingprofessional investment managers.

 

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**ITEM 4.  CONTROLS AND PROCEDURES**

 

**a.****               Disclosure Controlsand Procedures**

 

In accordance with Exchange Act Rules 13a-15 and 15d-15, wecarried out an evaluation as of October 29, 2005, under the supervisionand with 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) andRule 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 InternalControl over Financial Reporting**

 

In the ordinary course of business, we routinely enhance ourinformation systems by either upgrading our current systems or implementing newsystems. No change occurred in our internal controls over financial reportingduring the quarter ended October 29, 2005 that has materially affected, oris reasonably likely to materially affect, our internal controls over financialreporting.

 

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**THE NEIMANMARCUS GROUP, INC.**

 

**PART II**

 

**ITEM 1.****                                   LEGAL PROCEEDINGS**

 

Note 8 of the Notes to Condensed Consolidated Financial Statements in Part I,Item 1 is incorporated herein by reference as if fully restated herein.  Note 8 contains forward-looking statementsthat are subject to the risks and uncertainties discussed in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations –Factors That May Affect Future Results.”

 

**ITEM 2.****                                   UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 4.****                                   SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

A special meeting of our stockholders was held on August 16, 2005to consider and vote on the adoption of the Agreement and Plan of Merger, datedas of May 1, 2005, by and among The Neiman Marcus Group, Inc., NewtonAcquisition, Inc., and Newton Acquisition Merger Sub, Inc., pursuantto which, among other things, Newton Acquisition Merger Sub, Inc. wasmerged with and into The Neiman Marcus Group, Inc.

 

A total of 36,363,612 of our shares were present or represented byproxy at the meeting.  This represented74% of the 48,947,578 shares of Class A and Class B Common Stockoutstanding as of the record date.

 

The proposal to adopt the Agreement and Plan of Merger was approvedwith 36,260,280 (or 99.7%) of the shares present at the meeting or representedby proxy voting for, 79,101 shares voting against, and 24,229 sharesabstaining.

 

**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    | Certificates of Designation with respect to  Series A Junior Participating Preferred Stock, Series B Junior  Participating Preferred Stock and Series C Junior Participating  Preferred Stock, incorporated herein by reference to the Company’s Annual  Report on Form 10-K for the fiscal year ended July 31, 2004. |
|   |                                                                                                                                                                                                                                                                                                                                                |
| 4.2    | 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.                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                |
| 4.3    | Form of 7.125 percent 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.                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                |
| 4.4    | Amended and Restated Rights Agreement,  dated as of August 8, 2002, between the Company and Mellon Investor  Services LLC, as Rights Agent, incorporated herein by reference to the  Company’s Annual Report on Form 10-K for the fiscal year ended August 3,  2002.                                                            |
|   |                                                                                                                                                                                                                                                                                                                                                |
| 4.5    | First Amendment to the Amended and Restated  Rights Agreement, dated as of May 1, 2005, between The Neiman Marcus  Group, Inc. and other parties signatory thereto, incorporated herein by  reference to the Company’s Current Report on Form 8-K dated May 4,  2005.                                                      |

 

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| 4.6    | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.7    | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.8    | Form of 9.0%/9.75% Senior Notes due  2015, incorporated herein by reference to the Company’s Current Report on Form 8-K  dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.9    | Form of 10.375% Senior Subordinated  Notes due 2015, incorporated herein by reference to the Company’s Current  Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.10   | 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.  *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

45

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| 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.                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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 |     | December 8, 2005 |
| T. Dale Stapleton     |       | and Duly Authorized Officer    |                          |     |
|                  |       | (principal accounting officer) |                          |     |
|                       |            |                                |                               |          |  |

 

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