**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington,D.C. 20549**

**Form 10-K**
| **(Mark One)**                                                                                                                                                                                                                                                 | ** ** | ** **                                                                                     |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|
| **x**                                                                                                                                                                                                                                                          | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE  SECURITIES EXCHANGE ACT OF 1934**     |
| ** **                                                                                                                                                                                                                                                     | ** ** | ** **                                                                                     |
| **For the  fiscal year ended July 29, 2006**                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                           |
| **OR**                                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                           |
| **o**                                                                                                                                                                                                                                                          | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                     | ** ** | ** **                                                                                     |
| **For the  transition period  from                  to                  ** |

 

**Commission file no. 333-133184-12**

**Neiman Marcus, Inc.******(Exact name of registrant asspecified in its charter)

| **Delaware**                              |   | **20-3509435**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
| incorporation or  organization)           |   | Identification  No.) |
| ** **                                |   | ** **           |
| **1618  Main Street**                     |   |                 |
| **Dallas,  Texas**                        |   | **75201**            |
| (Address of  principal executive offices) |   | (Zip code)           |

 

Registrant’s telephone number, including areacode: **(214) 743-7600**

----

 

Securities registered pursuant toSection 12(b) of the Act:**None**

Securities registered pursuant to Section 12(g) of the Act:**None**

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes o   No x

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section15(d) of the Exchange Act. Yes o   No x

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K. x

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.
| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer x |
|---------------------------|--------|---------------------|--------|-------------------------|

 

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

The aggregate market value of the registrant’svoting and non-voting common equity held by non-affiliates of the registrant iszero.  The registrant is a privately heldcorporation.

As of September 25, 2006, the registrant hadoutstanding 1,012,264 shares of its common stock, par value $0.01 per share.

 

----

**NEIMAN MARCUS, INC.ANNUAL REPORT ON FORM 10-KFOR THE FISCAL YEAR ENDED JULY 29, 2006TABLE OF CONTENTS**
| ** **   | ** ** | ** **                                                                                       | ** ** | **Page No.** |
|--------------|------------|--------------------------------------------------------------------------------------------------|------------|--------------|
| **PART I**   |       |                                                                                             |       |         |
| Item 1.      |       | Business                                                                                         |       | 2            |
| Item  1A.    |       | Risk Factors                                                                                     |       | 12           |
| Item  2.     |       | Properties                                                                                       |       | 19           |
| Item 3.      |       | Legal Proceedings                                                                                |       | 21           |
| Item 4.      |       | Submission  of Matters to a Vote of Security Holders                                             |       | 21           |
| **PART II**  |       |                                                                                             |       |         |
| Item 6.      |       | Selected  Financial Data                                                                         |       | 22           |
| Item 7.      |       | Management’s Discussion and Analysis  of Financial Condition and Results of Operations      |       | 24           |
| Item 7A.     |       | Quantitative  and Qualitative Disclosures about Market Risk                                      |       | 52           |
| Item 8.      |       | Financial  Statements and Supplementary Data                                                     |       | 52           |
| Item 9.      |       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure            |       | 53           |
| Item 9A.     |       | Controls and  Procedures                                                                         |       | 53           |
| Item 9B.     |       | Other information                                                                                |       | 53           |
| **PART III** |       |                                                                                             |       |         |
| Item 10.     |       | Directors  and Executive Officers of the Registrant                                              |       | 54           |
| Item 11.     |       | Executive Compensation                                                                           |       | 57           |
| Item 12.     |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |       | 63           |
| Item 13.     |       | Certain Relationships and Related  Transactions                                                  |       | 66           |
| Item 14.     |       | Principal Accounting Fees and Services                                                           |       | 68           |
| **PART IV**  |       |                                                                                             |       |         |
| Item 15.     |       | Exhibits, Financial Statement Schedules  and Reports on Form 8-K                                 |       | 69           |
| Signatures   |       | Signatures                                                                                       |       | 74           |

 

1

----

**PART I**

**ITEM 1. BUSINESS**

**Business Overview**

We are one of thenation’s leading luxury retailers, offering distinctive merchandise andexcellent customer service that cater to the needs of the affluent consumer.Since our founding in the early 1900s, we have established ourselves as aleading fashion authority among luxury consumers and have become a premier U.S.retail channel for many of the world’s most exclusive designers. Currently, weoperate 37 Neiman Marcus full-line stores at prime retail locations in majorU.S. markets and two Bergdorf Goodman stores on Fifth Avenue in New York City. Wealso operate catalogs and e-commerce websites under the brands Neiman Marcus®,Bergdorf Goodman® and Horchow® and own a majority interest in Kate Spade LLC,which designs and markets high-end accessories. During fiscal years 2006, 2005and 2004, we generated revenues of $4,105.6 million, $3,774.8 million and$3,484.0 million, respectively, and operating earnings of $328.1 million,$409.0 million and $343.2 million, respectively.

We operate an integrated, multi-channel retailingmodel as described below:

***Specialty Retail.***  Ourspecialty retail store operations (Specialty Retail) consist primarily of our37 Neiman Marcus stores and two Bergdorf Goodman stores. We also operate 18clearance centers to provide an outlet for the sale of end-of-season clearance merchandise.Over our past five fiscal years, Specialty Retail has achieved a compoundedannual growth rate, or CAGR, in revenues of 6.4%. During fiscal years 2006,2005 and 2004, Specialty Retail accounted for 82.2%, 82.2% and 81.8%,respectively, of our total revenues.

·                    Neiman Marcus Stores.  Neiman Marcus stores offer distinctive luxurymerchandise, including women’s couture and designer apparel, contemporarysportswear, handbags, fashion accessories, shoes, cosmetics, men’s clothing andfurnishings, precious and designer jewelry, decorative home accessories, finechina, crystal and silver, children’s apparel and gift items. We locate ourNeiman Marcus stores at carefully selected venues that cater to our targetcustomers in major metropolitan markets across the United States, and designour stores to provide a feeling of residential luxury by blending art andarchitectural details from the communities in which they are located. Duringfiscal years 2006, 2005 and 2004 our full-line Neiman Marcus stores andclearance centers accounted for 70.9%, 71.3% and 71.4%, respectively, of ourtotal revenues and 86.3%, 86.8% and 87.2%, respectively, of Specialty Retailrevenues.

·                  BergdorfGoodman Stores. Bergdorf Goodman is a premier luxury retailer in New York City wellknown for its couture merchandise, opulent shopping environment and landmarkFifth Avenue locations. Bergdorf Goodman features high-end apparel, fashionaccessories, shoes, decorative home accessories, precious and designer jewelry,cosmetics and gift items. During fiscal years 2006, 2005 and 2004, our BergdorfGoodman stores accounted for 11.3%, 10.9% and 10.4%, respectively, of our totalrevenues and 13.7%, 13.2% and 12.8%, respectively, of Specialty Retailrevenues.

***DirectMarketing.***  Ourupscale direct-to-consumer operation (Direct Marketing) conducts online andcatalog sales of fashion apparel, accessories and home furnishings through theNeiman Marcus brand, online and catalog sales of home furnishings andaccessories through the Horchow brand, and online sales of fashion apparel andaccessories through the Bergdorf Goodman brand. In addition, Direct Marketing currently operates 9 designer websites (3of which were launched at the beginning of fiscal year 2007).  In connection with the designer websites,Direct Marketing creates and maintains separate e-commerce sites bearing thedesigners’ brand names.  Direct Marketingprocures inventory from each designer to be showcased on that designer’swebsite and bears all the responsibilities related to the fulfillment of goodspurchased on the designer website.

Direct Marketing generated revenues of $655.3 million, or 16.0% ofour total revenues, in fiscal year 2006, $592.1 million, or 15.7% of ourtotal revenues, in fiscal year 2005 and $570.6 million, or 16.4% of our totalrevenues in 2004. Over one million customers made a purchase through one of ourcatalogs or websites in fiscal year 2006. Our catalog business circulated over100 million catalogs in fiscal year 2006. We regularly send e-mails toover 2.3 million e-mail addresses, alerting our customers to our newestmerchandise and the latest fashion trends. Over the last five fiscal years,Direct Marketing has achieved a CAGR in revenues (excluding revenues of ourChef’s Catalog brand sold in November 2004) of 12.9%.

For more information about our reportable segments, seeItem 7, “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and Note 16 of the Notes to Consolidated FinancialStatements in Item 15.

2

----

Our fiscal year ends on the Saturday closest toJuly 31. All references to fiscal year 2006 relate to the combined 52weeks ended July 29, 2006 (calculated as described in “The Transactions”);all references to fiscal year 2005 relate to the 52 weeks ended July 30,2005; and all references to fiscal year 2004 relate to the 52 weeks endedJuly 31, 2004.  References to fiscalyears 2007 and years thereafter relate to our fiscal years for such periods.

We make our annual reports onForm 10-K, quarterly reports on Form 10-Q and current reports onForm 8-K, and related amendments, available free of charge through ourwebsite at www.neimanmarcusgroup.com as soon as reasonably practicable after weelectronically file such material with (or furnish such material to) the Securitiesand Exchange Commission. The information contained on our website is notincorporated by reference into this Form 10-K and should not be considered tobe part of this Form 10-K.

**The Transactions**

On April 22, 2005, Neiman Marcus, Inc.,formerly Newton Acquisition, Inc. (the Company), and its wholly-ownedsubsidiary, Newton Acquisition Merger Sub, Inc. (Merger Sub), were formedand incorporated in the state of Delaware. On April 29, 2005, the Companyreceived subscriptions for 900 shares of its common stock from NewtonHolding, LLC (Holding) in exchange for a capital contribution of $900 andMerger Sub issued 900 shares of its common stock to the Company in exchange fora capital contribution of $900. Holding, the Company and Merger Sub were formedby investment funds affiliated with Texas Pacific Group and Warburg Pincus LLC(the Sponsors) for the purpose of acquiring The Neiman Marcus Group, Inc.(NMG).

In connection with the acquisition of NMG, Holding madean aggregate cash equity contribution of $1,420.0 million and a noncashequity contribution of $25.0 million to the Company in exchange for theCompany issuing 999,100 shares of its common stock to Holding. In addition,certain members of executive management of the Company made cash equity contributionsaggregating $7.7 million and noncash equity contributions, consisting ofshares of common stock and common stock options in NMG, aggregating$17.9 million in exchange for 12,264 shares of common stock in theCompany.

The acquisition of NMG was completed on October 6,2005 through the merger of Merger Sub with and into NMG, with NMG being thesurviving entity (the Acquisition). Subsequent to the Acquisition, NMG is asubsidiary of the Company, which is controlled by Holding.

The Sponsors financed the purchase of NMG and theconcurrent redemption of the 6.65% senior notes due 2008 (2008 Notes) through:

·                  applicationof the proceeds from the offering of senior notes and senior subordinatednotes;

·                  initialborrowings under a senior secured asset-based revolving credit facilityand a senior secured term loan facility;

·                  equityinvestments funded by direct and indirect equity investments from the Sponsorsand other investors; and

·                  cashon hand at NMG.

The Acquisition was completed on October 6, 2005 andoccurred simultaneously with:

·                  theclosing of the offering of our senior notes (Senior Notes) and our seniorsubordinated notes (Senior Subordinated Notes);

·                  theclosing of our new senior secured asset-based revolving credit facility(Asset-Based Revolving Credit Facility);

·                  theclosing of our new senior secured term loan facility (Senior Secured Term LoanFacility);

·                  thecall for redemption of, the deposit into a segregated account of the estimatedamount of the redemption payment related to, and the ratable provision ofsecurity pursuant to the terms thereof for, the 2008 Notes;

·                  theratable provision of security for the 2028 debentures (2028 Debentures)pursuant to the terms thereof;

·                  thetermination of our existing $350 million unsecured revolving creditfacility; and

·                  theequity investments described above.

3

----

We refer to these transactions, including the merger andour payment of any costs related to these transactions and certain relatedtransactions as the “Transactions.” See “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Liquidity and CapitalResources” for a description of our senior secured credit facilities and seniorand senior subordinated notes.

Priorto the Acquisition, the Company had no independent assets or operations.  After the Acquisition, the Company representsthe Successor to NMG since the Company’s sole asset is its investment in NMGand its operations consist solely of the operating activities of NMG as well ascosts incurred by the Company related to its investment in NMG.  For periods prior to the Acquisition, NMG isdeemed to be the predecessor to the Company. As a result, for periods prior to the Transactions, the financialstatements of the Company consist of the financial statements of NMG for suchperiods.  All references to “we” and “our”relate to the Company for periods subsequent to the Transactions and to NMG forperiods prior to the Transactions.  Theaccompanying consolidated statements of earnings and cash flows present our resultsof operations and cash flows for the periods preceding the Acquisition(Predecessor) and the periods succeeding the Acquisition (Successor),respectively.

We have prepared our discussionof the results of operations for the fiscal year ended July 29, 2006 bycomparing the results of operations of the Predecessor for the fiscal yearended July 30, 2005 to the combined amounts obtained by adding the earnings andcash flows for the Predecessor nine-week period ended October 1, 2005 and theSuccessor forty-three week period ended July 29, 2006. Although this combined presentation does not comply with generallyaccepted accounting principles (GAAP), we believe that it provides a meaningfulmethod of comparison. The combined operating results have not been prepared ona pro forma basis under applicable regulations and may not reflect the actualresults we would have achieved absent the Transactions and may not bepredictive of future results of operations.

In connection with the Transactions, we incurred significantindebtedness and became highly leveraged. See “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Liquidity and CapitalResources.” In addition, the purchase price paid in connection with theAcquisition has been allocated to state the acquired assets and liabilities atfair value. The purchase accounting adjustments increased the carrying value ofour property and equipment and inventory, established intangible assets for ourtradenames, customer lists and favorable lease commitments and revalued ourlong-term benefit plan obligations, among other things. Subsequent to theTransactions, interest expense and non-cash depreciation and amortizationcharges have significantly increased. As a result, our successor financialstatements subsequent to the Transactions are not comparable to our predecessorfinancial statements.

**Disposition of Gurwitch Products,L.L.C.**

On July 27, 2006, we soldour former majority interest in Gurwitch Products, L.L.C. to Alticor Inc.,for pretax net cash proceeds of approximately $40.8 million (GurwitchDisposition).  Gurwitch Products, L.L.C.designs and markets the Laura Mercier® cosmetics line and had annual revenuesof approximately $71.6 million in fiscal year 2006.  The net assets of GurwitchProducts, L.L.C. were sold for their net carrying value (after purchaseaccounting adjustments made in connection with the Transactions to state suchassets at fair value).  In addition, werecorded tax expense of $13.3 million, payable by the Company on the excess ofthe tax over book gain realized in connection with the Gurwitch Disposition.

The Company’s financialstatements, accompanying notes and other information provided in this AnnualReport onForm 10-K reflect Gurwitch Products, L.L.C. as a discontinued operationfor all periods presented.

**Recent Developments**

On August 31, 2006, we announced preliminary totalrevenues and comparable revenues of approximately $270 million and$262 million, respectively, for the four-week August period of fiscal year2007, representing increases of 7.4% and 4.4%, respectively, compared to thefour-week August period of fiscal year 2006. For the four-week August period offiscal year 2007, comparable revenues increased 2.1% in the Specialty Retailstores segment and 19.3% in the Direct Marketing Segment.

All the financial data set forth above for the four-weekAugust period of fiscal year 2007 are preliminary and unaudited and subject torevision based upon our review and a review by our independent registeredpublic accounting firm of our financial condition and results of operations forthe quarter ending October 28, 2006. Once we and our independent registeredpublic accounting firm have completed our respective reviews of our financialinformation for the quarter ending October 28, 2006, we may report financialresults that are materially different from those set forth above.

4

----

**Industry Overview**

We operate in the luxury apparel and accessories segmentof the U.S. retail industry and have arrangements with luxury-brandedfashion vendors, including Chanel, Prada, St. John, Gucci, David Yurman,Theory, Ermenegildo Zegna, Manolo Blahnik and Giorgio Armani, to market andsell their merchandise. Luxury-branded fashion vendors typically managethe distribution and marketing of their merchandise to maximize the perceptionof brand exclusivity and to facilitate the sale of their goods at premiumprices, including limitations on the number of retail locations through whichthey distribute their merchandise. These retail locations typically consist ofa limited number of specialty stores, high-end department stores and, in someinstances, vendor-owned proprietary boutiques. Retailers that competewith us for the distribution of luxury fashion brands include Saks Fifth Avenue,Nordstrom, Barney’s New York and other national, regional and local retailers.

We believe that the following factors benefitwell-positioned luxury retailers:

·                  attractivedemographic trends, including increasing wealth concentration and an aging babyboomer population;

·                  growingconsumer demand for prestige brands and exclusive products;

·                  retailconsumption patterns of affluent consumers that are generally less influencedby economic cycles than middle or lower income consumers;

·                  higherprice points and limited distribution of luxury merchandise, which havegenerally protected high-end specialty retailing from the growth of discountersand mass merchandisers;

·                  aggressivemarketing by luxury brands; and

·                  consumertrends towards aspirational lifestyles.

**Customer Service and Marketing**

We are committed to providing our customers with apremier shopping experience through our relationship-based customerservice model, with superior merchandise selection and elegant store settingsof our stores. Critical elements to our customer service approach are:

·                  knowledgeable,professional and well-trained sales associates;

·                  marketingprograms designed to promote customer awareness of our offerings of the latestfashion trends;

·                  loyaltyprograms designed to cultivate long-term relationships with our customers; and

·                  facilitatingthe extension of credit to our customers through our proprietary credit cardprogram.

***SalesAssociates.***  We seek to maintain a sales force ofknowledgeable, professional and well-trained sales associates to deliverpersonal attention and service to our customers through our relationship-basedcustomer service model. We compensate our sales associates primarily on acommission basis and provide them with training in the areas of customer service,selling skills and product knowledge. Our sales associates participate inactive clienteling programs designed to maintain contact with our customersbetween store visits and to ensure that our customers are aware of the latestmerchandise offerings and fashion trends that we present in our stores. Weempower our sales associates to act as personal shoppers and in many cases, asthe personal style advisor to our customers.

***Marketing Programs.***  We conducta wide variety of marketing programs to support our sales associates in thecommunication of fashion trends to our customers in order to create fashionexcitement and enhance our customer relationships. The programs include bothin-store events and targeted, brand-consistent print mediacommunications.

5

----

We maintain an active calendar of in-store events topromote our sales efforts. The activities include in-store visits and trunkshows by leading designers featuring the newest fashions from the designer,in-store promotions of the merchandise of selected designers or merchandisecategories, often through events conducted in connection with our loyaltyprograms, and participation in charitable functions in each of our markets.Past trunk shows and in-store promotions at our Neiman Marcus and Bergdorf Goodmanstores have featured designers such as Chanel, Giorgio Armani and Oscar de laRenta.

Through our print media programs, we mail variouspublications to our customers communicating upcoming in-store events, newmerchandise offerings and fashion trends. In connection with these programs,Neiman Marcus produces The Book® approximately eight to nine times each year.The Book is a high-quality publication featuring the latest fashion trends thatis mailed on a targeted basis to our customers and has a yearly printing inexcess of 3.4 million. Our other print publications include The Book forMen, the Bergdorf Goodman Magazine and specific designer mailers. Recently, weadded The Addition®, which identifies for our younger, aspirational customers,as well as our core customers, “must have items” for the current season.

We also believe that the online and print catalogoperations of Direct Marketing promote brand awareness, which benefits theoperations of our retail stores.

***Loyalty Programs.***  Wemaintain a loyalty program under the InCircle® brand name designed to cultivatelong-term relationships with our customers. Our loyalty program focuses on ourmost active customers. This program includes marketing features, includingprivate in-store events, special magazine issues, as well as the ability toaccumulate points for qualifying purchases. Increased points are periodicallyoffered in connection with in-store promotional and other events. Uponattaining specified point levels, customers may redeem their points for a widevariety of gifts ranging from gift cards to designer merchandise and trips toexotic locations. Approximately 46% of revenues at Neiman Marcus stores incalendar years 2005 and 2004 were generated by our InCircle members. Beginningin calendar 2006, we transitioned customers in our previous Bergdorf Goodmanloyalty program to our InCircle loyalty program.

***Proprietary CreditCard Program.***  We maintain a proprietary credit card programthrough which we facilitate the extension of credit to customers under the “NeimanMarcus” and “Bergdorf Goodman” names.

On July 7, 2005, HSBC purchased our approximatelythree million private label Neiman Marcus and Bergdorf Goodman credit cardaccounts and related assets, as well as the outstanding balances associated withsuch accounts. The total purchase price was approximately $647 million,consisting of approximately $534 million in net cash proceeds and theassumption of approximately $113 million of outstanding debt under ourCredit Card Facility.

As a part of the Credit Card Sale, we entered into along-term marketing and servicing alliance with HSBC. Under the terms of thisalliance, HSBC offers credit cards and non-card payment plans bearing ourbrands and we receive from HSBC ongoing payments related to credit card salesand compensation for marketing and servicing activities (HSBC Program Income).During fiscal year 2006, we outsourced various administrative elements of theproprietary credit card program, including the processing of data with respectto our proprietary credit card program to HSBC as provided for in the programagreement with HSBC.  We continue tohandle key customer service functions, primarily customer inquiries.

Subsequent to the Credit Card Sale, we have changed andmay continue to change, the terms of credit offered to our customers.  In addition, HSBC will have discretion overcertain policies and arrangements with credit card customers and may changethese policies 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.

Historically, our customers holding a proprietary creditcard have tended to shop more frequently and have a higher level of spendingthan customers paying with cash or third-party credit cards. In fiscalyears 2006 and 2005, approximately 54% of our revenues were transacted throughour proprietary credit cards.

We utilize data captured through our proprietary creditcard program in connection with promotional events and customer relationshipprograms targeting specific customers based upon their past spending patternsfor certain brands, merchandise categories and store locations.

***IntegratedMulti-Channel Model.***  We offer products through ourcomplementary Direct Marketing and Specialty Retail businesses, which enablesus to maximize our brand recognition and strengthen our customer relationshipsacross all channels. Our well-established catalog and online operation expandsour reach beyond the trading area of our retail stores, as approximately 46%and 50%, respectively, of our Direct Marketing customers in fiscal years 2006and 2005 were located outside of the trade areas of our existing retaillocations. We also use our catalogs and e-commerce websites as selling andmarketing tools to increase the visibility and exposure of our brand andgenerate customer traffic within our retail stores. We believe the combinationof our retail stores and direct selling efforts is the main reason that ourmulti-channel customers spend more on average than our single-channelcustomers (approximately 3.6 times more in fiscal year 2006 and 3.5 times morein fiscal year 2005).

6

----

**Merchandise**

Our percentages of revenues(exclusive of revenues generated by leased departments) by major merchandisecategory are as follows:

|                                               | ** ** | **Years Ended**    | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **July 29,  2006** | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| Women’s Apparel                          |       | 35                      | %          | 35 | % | 35 | % |
| Women’s Shoes,  Handbags and Accessories |       | 19                      | %          | 19 | % | 19 | % |
| Cosmetics and  Fragrances                     |       | 11                      | %          | 11 | % | 10 | % |
| Men’s Apparel  and Shoes                 |       | 12                      | %          | 12 | % | 11 | % |
| Designer and  Precious Jewelry                |       | 10                      | %          | 10 | % | 10 | % |
| Home Furnishings  and Décor              |       | 8                       | %          | 9 | % | 10 | % |
| Other                                         |       | 5                       | %          | 4 | % | 5 | % |
|                                          |       | 100                     | %          | 100 | % | 100 | % |

 

Substantially all of our merchandise is delivered to usby our vendors as finished goods and is manufactured in numerous locations,including Europe and the United States and, to a lesser extent, China, Mexicoand South America.

We lease certain departments in our stores to independentcompanies. Our management regularly evaluates the performance of the leaseddepartments and requires compliance with established guidelines. The companiesto which we lease store space are generally responsible for paying their ownemployees. We receive commissions from these leased departments on a percent ofsales basis.

Our merchandise consists primarily of apparel andaccessories from luxury-branded designers. Our major merchandisecategories are as follows:

*Women’s Apparel:* Women’s apparel consists of dresses,eveningwear, suits, coats, and sportswear separates—skirts, pants, blouses,jackets, and sweaters. Women’s apparel occupies the largest amount of squarefootage within our stores. We work with women’s apparel vendors to present themerchandise and highlight the best of the vendor’s product. Our primary women’sapparel vendors include Chanel, Prada, St. John, Gucci, Theory, Giorgio Armani,Escada and Ellen Tracy.

*Women’s Shoes, Handbags and Accessories:*  Women’saccessories include belts, gloves, scarves, hats and sunglasses. Our primaryvendors in this category include Manolo Blahnik, Prada, Gucci, Chanel, Dior andFerragamo in ladies shoes, and handbags from Chanel, Prada, Gucci, Marc Jacobsand Judith Leiber.

*Cosmetics and Fragrances:*  Cosmetics and fragrances includefacial and skin cosmetics, skin therapy and lotions, soaps, fragrance, candlesand beauty accessories. Our primary vendors of cosmetics and beauty productsinclude La Mer, Bobbie Brown, Sisley, La Prairie, Chanel and Laura Mercier.

*Men’s Apparel and Shoes:*  Men’s apparel and shoes includesuits, dress shirts and ties, sport coats, jackets, trousers, casual wear andeveningwear as well as business and casual footwear.  In recent years, this category has been anarea of increased focus.  BergdorfGoodman has a fully dedicated men’s store in New York. Our primary vendors inthis category include Ermenegildo Zegna, Brioni, Giorgio Armani, and Prada inmen’s clothing and sportswear; and Ermenegildo Zegna, Prada, Ferragamo andGucci in men’s furnishings and shoes.

*Designer and Precious Jewelry:*  Our designer and preciousjewelry offering includes women’s accessories, necklaces, bracelets, rings,brooches and watches that are selected to complement our apparel merchandiseoffering. Our primary vendors in this category include David Yurman, StephenDweck and John Hardy in Designer Jewelry, and Henry Dunay and Roberto Coin inPrecious Jewelry. We often sell precious jewelry on a consignment basis.

*Home Furnishings and Décor:*  Home furnishings and décorinclude linens, tabletop, kitchen accessories, furniture, rugs, decoratives(frames, candlesticks, vases and sculptures) as well as collectables.Merchandise for the home complements our apparel offering in terms of qualityand design. Our primary vendors in this category include Jay Strongwater, Daum,Waterford, Steuben and Baccarat.

7

----

**Vendor Relationships**

Our merchandise assortment consists of a wide selectionof luxury goods purchased from both well-known luxury-branded fashionvendors as well as new and emerging designers. We communicate with our vendorsfrequently, providing feedback on current demand for their products,suggesting, at times, changes to specific product categories or items andgaining insight into their future fashion direction. Certain designers sell theirmerchandise, or certain of their design collections, exclusively to us andother designers sell to us pursuant to their limited distribution policies. Wecompete for quality merchandise and assortment principally based onrelationships and purchasing power with designer resources. Our women’s and men’sapparel and fashion accessories businesses are especially dependent upon ourrelationships with these designer resources. We monitor and evaluate the salesand profitability performance of each vendor and adjust our future purchasingdecisions from time to time based upon the results of this analysis. We have noguaranteed supply arrangements with our principal merchandising sources and,accordingly, there can be no assurance that such sources will continue to meetour needs for quality, style and volume. In addition, our vendor base isdiverse, with no single vendor representing more than 5% of the cost of ourtotal purchases in fiscal years 2006 or 2005. The breadth of our sourcing helpsmitigate risks associated with a single brand or designer.

Consistent with industry business practice, we receiveallowances from certain of our vendors in support of the merchandise wepurchase for resale. We receive certain allowances to reimburse us formarkdowns taken or to support the gross margins that we earn in connection withthe sales of the vendor’s merchandise. Other allowances we receive representreductions to the amounts we pay to acquire the merchandise. We also receiveadvertising allowances from certain of our merchandise vendors, substantiallyall of which represent reimbursements of direct, specified and incrementalcosts we incurred to promote the vendors’ merchandise. These allowances arerecorded as a reduction of our advertising costs when incurred. We also receiveallowances from certain merchandise vendors in conjunction with compensationallowances for employees who sell the vendors’ merchandise, which allowancesare netted against the related compensation expenses that we incur.  For more information related to allowancesreceived from vendors, see Note 1 to our audited consolidated financialstatements included herein.

We offer certain merchandise, primarily precious jewelry,on a consignment basis in order to expand our product assortment. As ofJuly 29, 2006 and July 30, 2005, we held consigned inventories with a costbasis of approximately $251.3 million and $226.8 million, respectively,(consigned inventories are not reflected in our consolidated balance sheet aswe do not take title to consigned merchandise). From time to time, we make advances to certain of our vendors. Theseadvances are typically deducted from amounts paid to vendors at the time wereceive the merchandise or, in the case of advances made for consigned goods,at the time we sell the goods. We had net outstanding advances to vendors ofapproximately $25.0 million at July 29, 2006 and $24.6 million at July 30,2005.

**Inventory Management**

Our merchandising function is decentralized with separatemerchandising functions for Neiman Marcus stores, Bergdorf Goodman and DirectMarketing. Each merchandising function is responsible for the determination ofthe merchandise assortment and quantities to be purchased and, in the case ofNeiman Marcus stores, for the allocation of merchandise to each store. Wecurrently have over 300 merchandise buyers and merchandise planners.

The majority of the merchandise we purchase is initiallyreceived at one of our centralized distribution facilities. To support ourSpecialty Retail stores, we utilize a primary distribution facility inLongview, Texas, a regional distribution facility in Totowa, New Jersey andfive regional service centers. We also operate two distribution facilities inthe Dallas-Fort Worth area to support our Direct Marketing operation.

Our distribution facilities are linked electronically toour various merchandising staffs to facilitate the distribution of goods to ourstores. We utilize electronic data interchange (EDI) technology with certain ofour vendors, which is designed to move merchandise onto the selling floorquickly and cost-effectively by allowing vendors to deliver floor-readymerchandise to the distribution facilities. In addition, we utilize high-speedautomated conveyor systems capable of scanning the bar coded labels on incomingcartons of merchandise and directing the cartons to the proper processingareas. Many types of merchandise are processed in the receiving area andimmediately “cross docked” to the shipping dock for delivery to the stores.Certain processing areas are staffed with personnel equipped with hand-heldradio frequency terminals that can scan a vendor’s bar code and transmit thenecessary information to a computer to record merchandise on hand. We utilizethird-party carriers to distribute our merchandise to individual stores.

8

----

With respect to the Specialty Retail stores, the majorityof the merchandise is held in our retail stores.  We primarily operate on a pre-distributionmodel through which we allocate merchandise on our initial purchase orders toeach store. This merchandise is shipped from our vendors to our distributionfacilities for delivery to designated stores. We closely monitor the inventorylevels and assortments in our retail stores to facilitate reorder andreplenishment decisions, satisfy customer demand and maximize sales. Transfersof goods between stores are made primarily at the direction of merchandisingpersonnel and, to a lesser extent, by store management primarily to fulfillcustomer requests.

We also maintain certain inventories at the Longviewdistribution facility. The goods held at the Longview distribution facilityconsist primarily of goods held in limited assortment or quantity by our storesand replenishment goods available to stores achieving high initial sales levels.  During fiscal year 2004, we expanded ourdistribution center in Longview, Texas by 25% to over 600,000 square feet.  As part of this expansion, we realigned thewarehouse space, enabling us to strengthen our “locker stock” inventorymanagement program.  With this program,we maintain a portion of our most in-demand and high fashion merchandise at ourdistribution facilities.  For productsstored in locker stock, we can ship replenishment merchandise to the storesthat demonstrate the highest customer demand. In addition, our sales associates can use the program to ship itemsdirectly to our customers, thereby improving customer service and increasingproductivity.  This program also helps usto restock inventory at individual stores more efficiently, to maximize theopportunity for full-price selling and to minimize the potential risks relatedto excess inventories.  We plan tocontinue to expand this program to deliver goods to our customers more quicklyand to enhance the allocation of goods to our stores.

**Capital Investments**

We make capital investments annually to support ourlong-term business goals and objectives. We invest capital in new and existingstores, distribution and support facilities as well as information technology.We have gradually increased the number of our stores over the past ten years,growing our full-line Neiman Marcus and Bergdorf Goodman store base from 27stores at the beginning of fiscal year 1996 to our current 39 stores.

We invest capital in the development and construction ofnew stores in both existing and new markets. We conduct extensive demographic,marketing and lifestyle research to identify attractive retail markets with ahigh concentration of our target customers prior to our decision to construct anew store. We compete with other retailers for real estate opportunitiesprincipally on the basis of our ability to attract customers. In addition tothe construction of new stores, we also invest in the on-going maintenance ofour stores to ensure an elegant shopping experience for our customers. Capitalexpenditures for existing stores range from minor renovations of certain areaswithin the store to major remodels and renovations and store expansions. We arefocused on operating only in attractive markets that can profitably support ourstores and are focused on maintaining the quality of our stores and,consequently, our brand. With respect to our major remodels, we only expandafter extensive analysis of our projected returns on capital. We generallyexperience an increase in both total sales and sales per square foot at storesthat undergo a remodel or expansion.

We also believe capital investments for informationtechnology in our stores, distribution facilities and support functions arenecessary to support our business strategies. As a result, we are continuallyupgrading our information systems to improve efficiency and productivity.

In the past three fiscal years, we have made capitalexpenditures aggregating $486 million related primarily to:

·                  theconstruction of new stores in San Antonio, Boca Raton and Charlotte, as well asa store in Austin to be opened in fiscal year 2007;

·                  therenovation and expansion of our main Bergdorf Goodman store in New York Cityand Neiman Marcus stores in San Francisco, Newport Beach, Las Vegas, Houston,and Beverly Hills;

·                  theexpansion of our distribution facilities;

·                  thedevelopment and installation of a new point-of-sale system in our retailstores;

·                  theinstallation of new warehousing and distribution systems for both Direct Marketingand Specialty Retail stores; and

·                  anew human capital management system (including the outsourcing of payroll andbenefits administration).

9

----

In fiscal year 2007, we anticipate capital expendituresfor planned new stores in Charlotte, Austin, suburban Boston, Long Island, thegreater Los Angeles area and suburban Seattle and for renovations of ourAtlanta store and San Diego stores, as well as the main Bergdorf Goodman store.We also expect to make technology related expenditures to enhance existingsystems and reporting capabilities in a number of areas, including ourwarehousing systems at Direct Marketing.

We receive allowances from developers related to theconstruction of our stores thereby reducing our cash investment in thesestores. We record these allowances as deferred real estate credits which arerecognized as a reduction of rent expense on a straight-line basis over thelease term. We received construction allowances aggregating $32.0 millionin fiscal year 2006 and $25.6 million in fiscal year 2005.

**Competition**

The specialty retail industry is highly competitive andfragmented. We compete for customers with specialty retailers, traditional andhigh-end department stores, national apparel chains, vendor-ownedproprietary boutiques, individual specialty apparel stores and direct marketingfirms. We compete for customers principally on the basis of quality andfashion, customer service, value, assortment and presentation of merchandise,marketing and customer loyalty programs and, in the case of Neiman Marcus andBergdorf Goodman, store ambiance. Retailers that compete with us fordistribution of luxury fashion brands include Saks Fifth Avenue, Nordstrom,Barney’s New York and other national, regional and local retailers. Many ofthese competitors have greater resources than we do. In addition, followingconsummation of the Transactions many of those competitors are significantlyless leveraged than we are, and therefore may have greater flexibility torespond to changes in our industry.

We believe we are differentiated from other nationalretailers by our distinctive merchandise assortment, which we believe is moreupscale than other high-end department stores, excellent customer service,prime real estate locations and elegant shopping environment. We believe wedifferentiate ourselves from regional and local high-end luxury retailersthrough our diverse product selection, strong national brand, loyalty programs,customer service, prime shopping locations and strong vendor relationships thatallow us to offer the top merchandise from each vendor. Vendor-ownedproprietary boutiques and specialty stores carry a much smaller selection ofbrands and merchandise, lack the overall shopping experience we provide andhave a limited number of retail locations.

**Employees**

As of September 1, 2006, wehad approximately 17,200 employees. Neiman Marcus stores had approximately14,200 employees, Bergdorf Goodman stores had approximately 1,200 employees,Direct Marketing had approximately 1,700 employees and Neiman Marcus Group hadapproximately 90 employees. Our staffing requirements fluctuate during the yearas a result of the seasonality of the retail industry. We hire additionaltemporary associates and increase the hours of part-time employees during seasonalpeak selling periods. None of our employees is subject to a collectivebargaining agreement, except for approximately 14% of the Bergdorf Goodmanemployees. We believe that our relations with our employees are good.

**Seasonality**

Our business, like that of mostretailers, is affected by seasonal fluctuations in customer demand, productofferings and working capital expenditures. For additional information onseasonality, see Item 7, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Executive Overview—Seasonality.”

10

----

**Regulation**

Our operations are affected by numerous federal and statelaws that impose disclosure and other requirements upon the origination,servicing and enforcement of credit accounts and limitations on the maximumamount of finance charges that may be charged by a credit provider. In additionto our proprietary credit cards, credit to our customers is also providedprimarily through third parties such as American Express, Visa and MasterCard.Any change in the regulation of credit that would materially limit theavailability of credit to our customer base could adversely affect our resultsof operations or financial condition.

Our practices, as well as our competitors, are subject toreview in the ordinary course of business by the Federal Trade Commission andare subject to numerous federal and state laws. Additionally, we are subject tocertain customs, truth-in-advertising and other laws, including consumerprotection regulations that regulate retailers generally and/or govern theimportation, promotion and sale of merchandise. We undertake to monitor changesin these laws and believe that we are in material compliance with allapplicable state and federal regulations with respect to such practices.

**Investment in Kate Spade LLC**

We currently own a 56% interest in Kate Spade LLC, whichdesigns and markets high-end designer handbags and accessories.  A minority investor owns the remaining 44%interest.  Our investment in andrelationship with Kate Spade LLC is governed by an operating agreementthat provides for an orderly transition process in the event either investorwishes to sell its interest, or purchase the other investor’s interest. Amongother things, this operating agreement contains currently exercisable putoption provisions entitling the minority investor to put its interest to us,and currently exercisable call option provisions entitling us to purchase theminority investor’s interest, at a purchase price mutually agreed to by theparties. The purchase price will be determined by the parties or, in the eventthe parties are unable to agree on a mutually acceptable price, by a mutuallyacceptable nationally recognized investment banking firm, subject to certainconditions. We may elect to defer the consummation of a put option for a periodof six months by cooperating with the minority investor in seeking either asale of Kate Spade LLC to a third party or a public offering of KateSpade LLC’s securities. If a sale to a third party or public offering ofKate Spade LLC’s securities is not consummated within six months after theexercise of the put option (which period may be automatically extended for anadditional two months if a registration statement for Kate Spade LLC isfiled with the Securities and Exchange Commission), we are obligated toconsummate the put option. Under the terms of the Kate Spade LLC operatingagreement, consummation of the put option shall occur within thirty days afterthe determination of the valuation with respect to the exercise of the putoption, unless we have elected to defer the consummation of the put option forthe six-month period referred to above, and should a third party sale or publicoffering of Kate Spade LLC occur within such six-month period, we are requiredto pay the minority investor  the excess,if any, of the put option valuation price for its interest over the amount itrealizes through the third party sale or public offering.

In April 2005, the minority investor in Kate SpadeLLC exercised the put option described above with respect to the full amount ofits stake in such company. We subsequently entered into a standstill agreementto postpone the put process while we engaged in discussions with the minorityinvestor in Kate Spade LLC regarding certain strategic alternatives, includingthe possible sale of such company. The standstill agreement, as extended,expired on March 21, 2006, but the parties are continuing to pursuediscussions regarding a possible sale of such company while the put valuationprocess proceeds. Although such discussions are ongoing, no assurance can begiven that they will ultimately lead to any transaction. It is possible that wemay be required to purchase the shares of the minority investor in Kate SpadeLLC pursuant to the option as early as the second quarter of fiscal year 2007.

11

----

**ITEM 1A. RISK FACTORS**

**Risks Related to Our Structure and NMG’sIndebtedness**

**Because ourownership of NMG accounts for substantially all of our assets and operations,we are subject to all risks applicable to NMG.**

We area holding company.  NMG and its subsidiariesconduct substantially all of our consolidated operations and own substantiallyall of our consolidated assets.  As aresult, we are subject to all risks applicable to NMG.  In addition, NMG’s Asset-Based RevolvingCredit Facility, NMG’s Senior Secured Term Loan Facility and the indenturesgoverning NMG’s senior notes and senior subordinated notes contain provisionslimiting NMG’s ability to distribute earnings to us, in the form of dividendsor otherwise.

**NMG has asubstantial amount of indebtedness, which may adversely affect NMG’s cash flowand its ability to operate the business, to comply with debt covenants and makepayments on its indebtedness.**

As a result of the Transactions,we are highly leveraged.  As of July 29,2006, the principal amount of NMG’s total indebtedness was approximately$3,210.2 million and the unused borrowing availability under the $600 millionAsset-Based Revolving Credit Facility was approximately $570.9 million aftergiving effect to $29.1 million of letters of credit outstandingthereunder.  NMG’s substantialindebtedness, combined with its lease and other financial obligations andcontractual commitments, could have other important consequences. For example,it could:

·                  makeit more difficult for NMG to satisfy its obligations with respect to itsindebtedness and any failure to comply with the obligations of any of its debtinstruments, including restrictive covenants and borrowing conditions, couldresult in an event of default under the agreements governing NMG’s indebtedness;

·                  makeNMG more vulnerable to adverse changes in general economic, industry andcompetitive conditions and adverse changes in government regulation;

·                  requireNMG to dedicate a substantial portion of its cash flow from operations topayments on its indebtedness, thereby reducing the availability of cash flowsto fund working capital, capital expenditures, acquisitions and other generalcorporate purposes;

·                  limitNMG’s flexibility in planning for, or reacting to, changes in NMG’s businessand the industry in which it operates;

·                  placeNMG at a competitive disadvantage compared to its competitors that are lesshighly leveraged and therefore may be able to take advantage of opportunitiesthat its leverage prevents it from exploiting; and

·                  limitNMG’s ability to borrow additional amounts for working capital, capitalexpenditures, acquisitions, debt service requirements, execution of itsbusiness strategy or other purposes.

Any of the above listed factorscould materially adversely affect NMG’s business, financial condition andresults of operations.

In addition, NMG’s interestexpense could increase if interest rates increase because the entire amount ofthe indebtedness under the senior secured credit facilities bears interest atfloating rates.   As of July 29, 2006,NMG had approximately $1,875.0 million principal amount of floating ratedebt, consisting of outstanding borrowings under Senior Secured Term LoanFacility.  NMG also had at that dateapproximately $570.9 million of unused floating rate debt borrowing capacityavailable under the Asset-Based Revolving Credit Facility based on a borrowingbase of over $600.0 million at that date and after giving effect to $29.1million used for letters of credit.  EffectiveDecember 6, 2005, NMG entered into floating to fixed interest rate swapagreements for an aggregate notional amount of $1,000.0 million to limit itsexposure to interest rate increases related to a portion of its floating rateindebtedness.

**To service NMG’s indebtedness, it willrequire a significant amount of cash. NMG’s ability to generate cash depends onmany factors beyond its control, and any failure to meet the its debt serviceobligations could harm its business, financial condition and results ofoperations.**

NMG’s ability to pay interest onand principal of the debt obligations will primarily depend upon NMG’s future

12

----

operating performance. As a result, prevailing economicconditions and financial, business and other factors, many of which are beyondour control, will affect its ability to make these payments.

If NMG does not generatesufficient cash flow from operations to satisfy the debt service obligations,NMG may have to undertake alternative financing plans, such as refinancing orrestructuring its indebtedness, selling assets, reducing or delaying capitalinvestments or seeking to raise additional capital.  Our ability to restructure or refinance itsdebt will depend on the condition of the capital markets and our financialcondition at such time.  Any refinancingof NMG’s debt could be at higher interest rates and may require it to complywith more onerous covenants, which could further restrict its businessoperations.  The terms of existing orfuture debt instruments may restrict NMG from adopting some of thesealternatives.  In addition, any failureto make payments of interest and principal on NMG’s outstanding indebtedness ona timely basis would likely result in a reduction of NMG’s credit rating, whichcould harm its ability to incur additional indebtedness on acceptable terms.

Contractual limitations on NMG’sability to execute any necessary alternative financing plans could exacerbatethe effects of any failure to generate sufficient cash flow to satisfy its debtservice obligations.  The Asset-BasedRevolving Credit Facility permits NMG to borrow up to $600.0 million;however, NMG’s ability to borrow thereunder is limited by a borrowing base,which at any time will equal the lesser of 80% of eligible inventory valued atthe lower of cost or market value and 85% of the net orderly liquidation valueof the eligible inventory, less certain reserves.  In addition, our ability to borrow under thisfacility is limited by a minimum liquidity condition, providing that, if lessthan $60.0 million is available at any time, NMG is not permitted toborrow any additional amounts under the Asset-Based Revolving Credit Facilityunless NMG’s pro forma ratio of consolidated EBITDA to consolidated FixedCharges (as such terms are defined in the credit agreement for the seniorsecured asset-based revolving credit facility) is at least 1.1 to1.0.  Our ability to meet this financialratio may be affected by events beyond our control, and we cannot assure youthat we will meet this ratio.

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

**The terms of NMG’s****Asset-Based Revolving CreditFacility and Senior Secured Term Loan Facility and the indentures governing the SeniorNotes, the Senior Subordinated Notes and the 2028 Debentures may restrict NMG’scurrent and future operations, particularly its ability to respond to changesin its business or to take certain actions.**

The credit agreements governingNMG’s Asset-Based Revolving Credit Facility and Senior Secured Term LoanFacility credit facilities and the indentures governing the Senior Notes, theSenior Subordinated Notes and the 2028 Debentures contain, and any futureindebtedness of NMG would likely contain, a number of restrictive covenantsthat impose significant operating and financial restrictions, includingrestrictions on NMG’s ability to engage in acts that may be in its bestlong-term interests. The indentures governing the Senior Notes, the SeniorSubordinated Notes and the 2028 Debentures and the credit agreements governingthe senior secured credit facilities include covenants that, among other things,restrict NMG’s ability to:

·                  incuradditional indebtedness;

·                  paydividends on NMG’s capital stock or redeem, repurchase or retire its capitalstock or indebtedness;

·                  makeinvestments;

·                  createrestrictions on the payment of dividends or other amounts to NMG from NMG’srestricted subsidiaries;

·                  engagein transactions with its affiliates;

·                  sellassets, including capital stock of NMG’s subsidiaries;

·                  consolidateor merge;

·                  createliens; and

·                  enterinto sale and lease back transactions.

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

Moreover, NMG’s Asset-BasedRevolving Credit Facility provides discretion to the agent bank acting on behalfof the

13

----

lenders to impose additional availability and otherreserves, which could materially impair the amount of borrowings that wouldotherwise be available to us. There can be no assurance that the agent bankwill not impose such reserves or, were it to do so, that the resulting impactof this action would not materially and adversely impair NMG’s liquidity.

A breach of any of therestrictive covenants would result in a default under the Asset-Based RevolvingCredit Facility and Senior Secured Term Loan Facility.  If any such default occurs, the lenders underthe Asset-Based Revolving Credit Facility and Senior Secured Term Loan Facilitymay elect to declare all outstanding borrowings under such facilities, togetherwith accrued interest and other fees, to be immediately due and payable, orenforce their security interest, any of which would result in an event ofdefault under NMG’s Senior Notes and Senior Subordinated 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 financialrestrictions and covenants in these debt agreements and any future financingagreements may adversely affect NMG’s ability to finance future operations orcapital needs or to engage in other business activities.

**Risks Related to Our Business and Industry**

**The specialty retail industry is highly competitive.**

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

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

**We are dependent on our relationshipswith certain designers, vendors and other sources of merchandise.**

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

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

We make decisions regarding thepurchase of our merchandise well in advance of the season in which it will besold. For example, women’s apparel, men’s apparel and shoes are typicallyordered six to nine months in advance of the products being offered for salewhile handbags, jewelry and other categories are typically ordered three to sixmonths in advance.  If our sales duringany season, particularly a peak season, are significantly lower than we expectfor any reason, we may not be able to adjust our expenditures for inventory andother expenses in a timely fashion and may be left with a substantial amount ofunsold inventory. If that occurs, we may be forced to rely on markdowns orpromotional sales to dispose of excess inventory. This could have an adverseeffect on our margins and operating income. At the same time, if we fail topurchase a sufficient quantity of merchandise, we may not have an adequatesupply of products to meet consumer demand. This may cause us to lose sales orharm our customer relationships.

**Our failure to identify changes inconsumer preferences or fashion trends may adversely affect our performance.**

Our success depends in large parton our ability to identify fashion trends as well as to anticipate, gauge andreact to

14

----

changing consumer demands in a timely manner. If we failto adequately match our product mix to prevailing customer tastes, we may berequired to sell our merchandise at higher average markdown levels and loweraverage margins. Furthermore, the products we sell often require long leadtimes to order and must appeal to consumers whose preferences cannot bepredicted with certainty and often change rapidly. Consequently, we must stayabreast of emerging lifestyle and consumer trends and anticipate trends and fashionsthat will appeal to our consumer base. Any failure on our part to anticipate,identify and respond effectively to changing consumer demands and fashiontrends could adversely affect our business.

**Our business and performance may beaffected by our ability to implement our store expansion and remodelingstrategies.**

Based upon our expansionstrategy, we expect that planned new stores will add over 660,000 square feetof new store space over approximately the next four fiscal years, representingan increase of over 12% above the current aggregate square footage of ourfull-line Neiman Marcus and Bergdorf Goodman stores, and that our storeremodeling program will add additional new store space from remodels that arealready underway.  New store openings involvecertain risks, including constructing, furnishing and supplying a store in atimely and cost effective manner, accurately assessing the demographic orretail environment at a given location, hiring and training quality staff,obtaining necessary permits and zoning approvals, obtaining commitments from acore group of vendors to supply the new store, integrating the new store intoour distribution 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 affectour business.**

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

**Deterioration in economic conditionscould adversely affect our business.**

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

**The loss of any of our senior managementteam or attrition among our buyers or key sales associates could adverselyaffect our business.**

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

**Inflation may adversely affect our business operations in thefuture.**

In recent years, we haveexperienced certain inflationary conditions in our cost base due primarily to(1) changes in foreign currency exchange rates that have reduced thepurchasing power of the U.S. dollar and (2) increases in selling, generaland administrative expenses, particularly with regard to employee benefits.Inflation can harm our margins and profitability if we are unable to increaseprices or cut costs enough to offset the effects of inflation in our cost base.If inflation in these or other

15

----

costs worsens, we cannot assure you that our attempts tooffset the effects of inflation and cost increases through control of expenses,passing cost increases on to customers or any other method will be successful.Any future inflation could adversely affect our profitability and our business.

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

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

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

We maintain a proprietary creditcard program through which credit is extended to customers under the “NeimanMarcus” and “Bergdorf Goodman” names. Because a majority of our revenues weretransacted through our proprietary credit cards, changes in our proprietarycredit card arrangement that adversely impact our ability to facilitate theprovision of consumer credit may adversely affect our performance.  In July 2005, we sold our approximately threemillion private label credit card accounts and related assets, as well as theoutstanding balances associated with such accounts.  Initially, we continue to handle key customerservice functions, including new account processing, most transactionauthorization, billing adjustments, collection services and customer inquiries.As part of this transaction, we have changed, 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 changethese policies 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 aresubject to numerous federal and state laws that impose disclosure and otherrequirements upon the origination, servicing and enforcement of credit accountsand limitations on the maximum amount of finance charges that may be charged bya credit provider. The purchaser of our credit card business is subject toregulations to which we were not subject prior to the Credit Card Sale. Anyeffect of these regulations or change in the regulation of credit arrangementsthat would materially limit the availability of credit to our customer basecould adversely affect our business. In addition, changes in credit card use,payment patterns, and default rates may result from a variety of economic,legal, social, and other factors that we cannot control or predict withcertainty.

**Our business can be affected by extremeor unseasonable weather conditions.**

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

**We are subject to numerous regulationsthat could affect our operations.**

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

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

The specialty retail industry isseasonal in nature, with a higher level of sales typically generated in thefall and holiday selling seasons. We have in the past experienced significantfluctuation in our revenues from quarter to quarter with a disproportionateamount of our revenues falling in our second fiscal quarter, which coincideswith the holiday season. In

16

----

addition, we incur significant additional expenses in theperiod leading up to the months of November and December in anticipation ofhigher sales volume in those periods, including for additional inventory,advertising and employees.

**Our business is affected by foreigncurrency fluctuations.**

We purchase a substantial portionof our inventory from foreign suppliers whose cost to us is affected by thefluctuation of their local currency against the dollar or who price theirmerchandise in currencies other than the dollar. Accordingly, changes in thevalue of the dollar relative to foreign currencies may increase our cost of goodssold and, if we are unable to pass such cost increases on to our customers,decrease our gross margins and ultimately our earnings. Fluctuations in theEuro-dollar exchange rate affect us most significantly; however, we sourcegoods from numerous countries and thus are affected by changes in numerouscurrencies and, generally, by fluctuations in the U.S. dollar relative to suchcurrencies. Although we hedge some exposures to changes in foreign currencyexchange rates arising in the ordinary course of business, foreign currencyfluctuations may have a material adverse effect on our business, financialcondition and results of operations.

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

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

**Significant increases in costsassociated with the production of catalogs and other promotional material mayadversely affect our operating income.**

We advertise and promote in-storeevents, new merchandise and fashion trends through print catalogs and otherpromotional materials mailed on a targeted basis to our customers. Significantincreases in paper, printing and postage costs could affect the cost ofproducing these materials and as a result, may adversely affect our operatingincome.

**We areindirectly owned and controlled by the Sponsors, and their interests as equityholders may conflict with those of our creditors.**

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

**If we are unable to enforce ourintellectual property rights, or if we are accused of infringing on a thirdparty’s intellectual property rights, our net income may decline.**

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

Additionally, third parties mayassert claims against us alleging infringement, misappropriation or otherviolations of their trademark or other proprietary rights, whether or not theclaims have merit. Claims like these may be time consuming and expensive todefend and could result in our being required to cease using the trademark orother rights and selling the allegedly

17

----

infringing products. This might have an adverse affect onour sales and cause us to incur significant litigation costs and expenses.

**Failure to successfully maintain andupdate information technology systems and enhance existing systems mayadversely affect our business.**

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

**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 usby our vendors as finished goods and is manufactured in numerous locations,including Europe and the United States and, to a lesser extent, China, Mexicoand South America. Our vendors rely on third party carriers to delivermerchandise to our distribution facilities. In addition, our success depends onour ability efficiently to source and distribute merchandise to our SpecialtyRetail stores and Direct Marketing customers. Events such as U.S. or foreignlabor strikes, 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.

18

----

**ITEM 2. PROPERTIES**

Our corporate headquarters are located at the DowntownNeiman Marcus store location in Dallas, Texas. The operating headquarters forNeiman Marcus, Bergdorf Goodman and Direct Marketing are located in Dallas,Texas; New York, New York; and Irving, Texas, respectively.

Properties that we use in our operations include NeimanMarcus stores, Bergdorf Goodman stores, clearance centers and distributionsupport and office facilities. As of September 20, 2006, the approximateaggregate square footage of the properties used in our operations was asfollows:

|                                              | ** ** | **Owned** | ** ** | **Owned  Subject  to Ground  Lease** | ** ** | **Leased** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|-----------|------------|-------------------------------------------|------------|------------|------------|-----------|------------|
| Neiman Marcus  Stores                        |       | 752,000   |       | 2,075,000                                 |       | 2,261,000  |       | 5,088,000 |       |
| Bergdorf Goodman  Stores                     |       | —    |       | —                                    |       | 316,000    |       | 316,000   |       |
| Clearance  Centers and Other                 |       | —    |       | —                                    |       | 510,000    |       | 510,000   |       |
| Distribution, Support  and Office Facilities |       | 1,317,000 |       | 150,000                                   |       | 987,000    |       | 2,454,000 |       |

 

***Neiman MarcusStores. ***As of September 20, 2006, we operated 37 NeimanMarcus stores, with an aggregate total property size of approximately 5,088,000square feet. The following table sets forth certain details regarding eachNeiman Marcus store:

**Neiman MarcusStores**
| **Locations**                         | ** ** | **Fiscal Year  Operations  Began** | ** ** | **Gross  Store  Sq. Feet** | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|
| Dallas, Texas  (Downtown)(1)          |       | 1908                                    |       | 129,000                         |       |
| Dallas, Texas  (NorthPark)(2)*        |       | 1965                                    |       | 218,000                         |       |
| Houston, Texas  (Galleria)(3)*        |       | 1969                                    |       | 224,000                         |       |
| Bal Harbour,  Florida(2)              |       | 1971                                    |       | 97,000                          |       |
| Atlanta,  Georgia(2)*                 |       | 1973                                    |       | 154,000                         |       |
| St. Louis,  Missouri(2)               |       | 1975                                    |       | 145,000                         |       |
| Northbrook,  Illinois(3)              |       | 1976                                    |       | 144,000                         |       |
| Fort Worth,  Texas(2)                 |       | 1977                                    |       | 119,000                         |       |
| Washington,  D.C.(2)*                 |       | 1978                                    |       | 130,000                         |       |
| Newport Beach,  California(3)*        |       | 1978                                    |       | 154,000                         |       |
| Beverly Hills,  California(1)*        |       | 1979                                    |       | 185,000                         |       |
| Westchester, New  York(2)*            |       | 1981                                    |       | 138,000                         |       |
| Las Vegas,  Nevada(2)                 |       | 1981                                    |       | 174,000                         |       |
| Oak Brook,  Illinois(2)               |       | 1982                                    |       | 119,000                         |       |
| San Diego,  California(2)             |       | 1982                                    |       | 106,000                         |       |
| Fort Lauderdale,  Florida(3)*         |       | 1983                                    |       | 94,000                          |       |
| San Francisco,  California(4)*        |       | 1983                                    |       | 251,000                         |       |
| Chicago,  Illinois (Michigan Ave.)(2) |       | 1984                                    |       | 188,000                         |       |
| Boston,  Massachusetts(2)             |       | 1984                                    |       | 111,000                         |       |
| Palo Alto, California(3)*             |       | 1986                                    |       | 120,000                         |       |
| McLean, Virginia(4)*                  |       | 1990                                    |       | 130,000                         |       |
| Denver, Colorado(3)*                  |       | 1991                                    |       | 90,000                          |       |
| Minneapolis, Minnesota(2)             |       | 1992                                    |       | 119,000                         |       |
| Scottsdale, Arizona(2)*               |       | 1992                                    |       | 118,000                         |       |
| Troy, Michigan(3)**                   |       | 1993                                    |       | 157,000                         |       |
| Short Hills, New Jersey(3)*           |       | 1996                                    |       | 138,000                         |       |
| King of Prussia, Pennsylvania(3)*     |       | 1996                                    |       | 142,000                         |       |
| Paramus, New Jersey(3)*               |       | 1997                                    |       | 141,000                         |       |
| Honolulu, Hawaii(3)                   |       | 1999                                    |       | 181,000                         |       |
| Palm Beach, Florida(2)                |       | 2001                                    |       | 53,000                          |       |
| Plano, Texas (Willow Bend)(4)*        |       | 2002                                    |       | 156,000                         |       |
| Tampa, Florida(3)*                    |       | 2002                                    |       | 96,000                          |       |
| Coral Gables, Florida(2)*             |       | 2003                                    |       | 136,000                         |       |
| Orlando, Florida(4)*                  |       | 2003                                    |       | 95,000                          |       |
| San Antonio, Texas(4)*                |       | 2006                                    |       | 120,000                         |       |
| Boca Raton, Florida(2)**              |       | 2006                                    |       | 136,000                         |       |
| Charlotte, North  Carolina(3)         |       | 2007                                    |       | 80,000                          |       |

 

----

(1)                                  Owned subject to partial ground lease.

(2)                                  Leased.

(3)                                  Owned subject to ground lease.

(4)                                  Owned.

*                                         Mortgaged to secure our senior secured creditfacilities and the 2028 Debentures.

**                                  Expected to be mortgaged to secure our seniorsecured credit facilities and the 2028 Debentures.

19

----

We recently opened new stores in San Antonio (120,000square feet) in September 2005, Boca Raton (136,000 square feet) in November2005 and Charlotte (80,000 square feet) in September 2006 and currently plan toopen new stores in:

·                  Austinin Spring 2007 (80,000 square feet planned),

·                  suburbanBoston in Fall 2007 (100,000 square feet planned),

·                  LongIsland in Fall 2008 (150,000 square feet planned),

·                  thegreater Los Angeles area in Fall 2008 (120,000 square feet planned),

·                  suburbanSeattle in Spring 2009 (120,000 square feet planned), and

·                  Princetonin Spring 2010 (90,000 square feet planned).

***BergdorfGoodman Stores. ***We operate two Bergdorf Goodman stores, both ofwhich are located in Manhattan at 58th Street and Fifth Avenue. The following tablesets forth certain details regarding these stores:

**Bergdorf GoodmanStores**

| Locations                       | ** ** | **Fiscal Year  Operations  Began** | ** ** | **Gross Store  Sq. Feet** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|
| New York City  (Main)(1)        |       | 1901                                    |       | 250,000                             |       |
| New York City  (Men’s)(1)* |       | 1991                                    |       | 66,000                              |       |

 

----

(1)           Leased.

*              Mortgaged to secureour senior secured credit facilities and the 2028 Debentures.

***ClearanceCenters. ***As of September 1, 2006, we operated 18 clearancecenters (16 Last Call and 2 Horchow) that average approximately 27,000 squarefeet each in size.

***Distribution,support and office facilities. ***We own approximately 34 acres of land in Longview,Texas, where our primary distribution facility is located. The Longviewfacility is the principal merchandise processing and distribution facility forNeiman Marcus stores. We currently utilize a regional distribution facility inTotowa, New Jersey and five regional service centers in New York, Florida,Illinois, Texas and California. We also own approximately 50 acres of land inIrving, Texas, where our Direct Marketing operating headquarters anddistribution facility is located.   Inaddition, we currently utilize another regional distribution facility inDallas, Texas to support our Direct Marketing operation.

***Lease Terms.***  The termsof the leases for substantially all of our stores, assuming all outstandingrenewal options are exercised, range from 15 to 99 years. The lease on theBergdorf Goodman Main Store expires in 2050 and the lease on the BergdorfGoodman Men’s Store expires in 2010, with two 10-year renewal options. Mostleases provide for monthly fixed rentals or contingent rentals based upon salesin excess of stated amounts and normally require us to pay real estate taxes,insurance, common area maintenance costs and other occupancy costs.

For further information on ourproperties and lease obligations, see Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and Note 14 ofthe Notes to Consolidated Financial Statements in Item 15.

20

----

**ITEM 3. LEGAL PROCEEDINGS**

We are currently involved in various legal actions andproceedings that arose in the ordinary course of our business. We believe thatany liability arising as a result of these actions and proceedings will nothave a material adverse effect on our financial position, results of operationsor cash flows.

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

No matters were submitted to avote of our security holders during the quarter ended July 29, 2006.

21

----

**PART II**

**ITEM 6. SELECTED FINANCIAL DATA**

The following selected financialdata is qualified in entirety by our consolidated financial statements (and therelated Notes thereto) contained in Item 15 and should be read inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” in Item 7. We derived the selected financialdata as of July 29, 2006 and July 30, 2005 and for the forty-three weeksended July 29, 2006, nine weeks ended October 1, 2005, fiscal years endedJuly 30, 2005 and July 31, 2004 from our audited consolidatedfinancial statements and related notes. The selected financial data as of July 31, 2004, August 2, 2003 andAugust 3, 2002 and for the fiscal years ended August 2, 2003 and August 3,2002 reflect adjustments to the Predecessor’s audited consolidated financialstatements to reclassify the operations of Gurwitch Products, L.L.C. as adiscontinued operation.  The selectedfinancial data as of fiscal year ended August 3, 2002 also reflect adjustmentsto the Predecessor’s audited consolidated financial statements to reclassifycertain amounts related to the presentation of 1) construction allowances, 2)depreciation expense and 3) income from credit card operations in order toconform such amounts to our current basis of presentation.  Additionally, 2002 included 53 weeks ofoperations while the other years presented consist of 52 weeks of operations.
| ** **                                                                                                      | ** ** | **(Successor)**                                    | ** ** | ** ** | **(Predecessor)**                             | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|------------|-----------------------------------------------|------------|
| **(in thousands)**                                                                                         | ** ** | **Forty-three  weeks  ended  July 29,  2006** | ** ** | ** ** | **Nine  weeks  ended  October 1,  2005** | ** ** | **Fiscal  year  ended  July 30,  2005** | ** ** | **Fiscal  year  ended  July 31,  2004** | ** ** | **Fiscal  year  ended  August 2,  2003** | ** ** | **Fiscal  year  ended  August 3,  2002** | ** ** |
| **OPERATING RESULTS**                                                                                           |       |                                               |       |       |                                          |       |   |   |   |   |   |   |   |   |
| Revenues                                                                                                        |       | $                                                  | 3,462.2    |       |                                          | $          | 643.4 |   | $ | 3,774.8 |   | $ | 3,484.0 |   | $ | 3,045.8 |   | $ | 2,905.1 |   |
| Cost of goods sold  including buying and occupancy costs (excluding depreciation)                               |       | 2,259.1                                            |       |       | 378.2                                         |       | 2,390.3 |   | 2,231.2 |   | 1,997.8 |   | 1,928.4 |   |
| Selling, general and  administrative expenses (excluding depreciation)                                          |       | 822.1                                              |       |       | 160.7                                         |       | 931.6 |   | 863.4 |   | 799.2 |   | 771.4 |   |
| Income from credit card  operations                                                                             |       | (49.4                                              | )          |       | (7.8                                          | )          | (71.6 | ) | (55.8 | ) | (53.3 | ) | (49.5 | ) |
| Depreciation and  amortization                                                                                  |       | 171.3                                              |       |       | 19.7                                          |       | 106.3 |   | 98.1 |   | 82.1 |   | 82.4 |   |
| Operating earnings                                                                                              |       | 259.1                                              |       |       | 69.0                                          | (2)        | 409.0 | (3) | 343.2 | (5) | 219.9 |   | 175.7 | (8) |
| Earnings from continuing  operations before income taxes, minority interest and change in accounting  principle |       | 41.2                                               |       |       | 69.9                                          |       | 396.7 |   | 327.3 |   | 203.7 |   | 160.3 |   |
| Net earnings                                                                                                    |       | $                                                  | 12.5       | (1)        |                                          | $          | 44.2 |   | $ | 248.8 | (4) | $ | 204.8 | (6) | $ | 109.3 | (7) | $ | 99.6 |   |

 
| ** **                   | ** ** | **(Successor)**    | ** ** | ** ** | **(Predecessor)** | ** ** |
|------------------------------|------------|--------------------|------------|------------|-------------------|------------|
| ** **                   | ** ** | **July 29,  2006** | ** ** | ** ** | ** **        | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** | **August 2,  2003** | ** ** | **August 3,  2002** | ** ** |
| ** **                   | ** ** | ** **         | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **FINANCIAL POSITION**       |       |               |       |       |              |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents   |       | $                  | 224.8      |       |              |       |   | $ | 853.4 |   | $ | 368.4 |   | $ | 207.0 |   | $ | 177.7 |   |
| Merchandise inventories      |       | 804.2              |       |       |              |       | 742.9 |   | 713.8 |   | 682.2 |   | 652.4 |   |
| Total current assets         |       | 1,135.9            |       |       |              |       | 1,708.5 |   | 1,706.2 |   | 1,246.1 |   | 1,127.6 |   |
| Property and equipment,  net |       | 1,043.8            |       |       |              |       | 851.4 |   | 748.4 |   | 732.1 |   | 685.8 |   |
| Total assets                 |       | 6,608.0            |       |       |              |       | 2,660.7 |   | 2,617.6 |   | 2,104.5 |   | 1,941.5 |   |
| Current liabilities          |       | 699.1              |       |       |              |       | 617.3 |   | 727.7 |   | 530.4 |   | 518.5 |   |
| Long-term liabilities        |       | $                  | 4,474.9    |       |              |       |   | $ | 457.3 |   | $ | 509.1 |   | $ | 428.0 |   | $ | 361.1 |   |

 

 

22

----

 
| ** **                           | ** ** | **(Successor)**                                    | ** ** | ** ** | **(Predecessor)**                                   | ** ** |
|--------------------------------------|------------|----------------------------------------------------|------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **Forty-three  weeks  ended  July 29,  2006** | ** ** | ** ** | **Nine  weeks  ended  October 1,   2005** | ** ** | **Fiscal  year  ended  July 30,  2005** | ** ** | **Fiscal  year  ended  July 31,  2004** | ** ** | **Fiscal  year  ended  August 2,  2003** | ** ** | **Fiscal  year  ended  August 3,  2002** | ** ** |
| **OTHER  OPERATING DATA:**           |       |                                               |       |       |                                                |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                |       | $                                                  | 141.0      |       |                                                | $          | 26.2 |   | $ | 199.7 |   | $ | 119.1 |   | $ | 128.4 |   | $ | 171.1 |   |
| Depreciation  expense                |       | $                                                  | 111.1      |       |                                                | $          | 19.7 |   | $ | 106.3 |   | $ | 98.1 |   | $ | 82.1 |   | $ | 77.3 |   |
| Rent expense                         |       | $                                                  | 59.6       |       |                                                | $          | 11.5 |   | $ | 65.9 |   | $ | 57.7 |   | $ | 53.6 |   | $ | 53.3 |   |
| Change in  comparable revenues(9)    |       | 6.4                                                | %          |       | 9.2                                                 | %          | 9.8 | % | 14.4 | % | 3.8 | % | (4.8 | )% |
| Number of stores open  at period end |       | 38                                                 |       |       | 37                                                  |       | 36 |   | 37 |   | 37 |   | 35 |   |

 

----

(1)           For the forty-three weeks ended July 29, 2006, net earnings include aloss from discontinued operation of $13.9 million, which includes $13.3 millionof income tax expense related to the excess of the tax over book gain realizedin connection with the Gurwitch Disposition.

(2)           For the nine weeks ended October 1, 2005, operating earningsincludes $23.5 million of transaction and other costs incurred inconnection with the Transactions. These costs consist primarily of$4.5 million of accounting, investment banking, legal and other costs associatedwith the Transactions and a $19.0 million non-cash charge for stockcompensation resulting from the accelerated vesting of Predecessor stockoptions and restricted stock in connection with the Acquisition.

(3)           For fiscal year 2005, operating earnings include a $15.3 millionpretax loss related to the disposition of Chef’s Catalog and a$6.2 million pretax gain related to the sale of our credit card portfolio.

(4)           For fiscal year 2005, net earnings reflect taxbenefits aggregating $7.6 million resulting from favorable settlementsassociated with previous state tax filings and reductions in previouslyrecorded deferred tax liabilities.

(5)           For fiscal year 2004, operating earnings include a$3.9 million pretax impairment charge related to the writedown to fairvalue in the net carrying value of the Chef’s Catalog tradename intangibleasset.

(6)           For fiscal year 2004, net income reflects a$7.5 million tax benefit related to favorable settlements associated withprevious state tax filings.

(7)           For fiscal year 2003, net earnings reflect anafter-tax charge of $14.8 million for the writedown of certain intangibleassets related to prior purchase business combinations as a result of theimplementation of a new accounting principle.

(8)           For fiscal year 2002, operating earnings reflect1) a $16.6 million gain from the change in vacation policy made bythe Company and 2) $13.2 million of impairment and other charges,related primarily to the impairment of certain long-lived assets.

(9)           Comparable revenues include 1) revenuesderived from our retail stores open for more than 52 weeks, includingstores that have been relocated or expanded, 2) revenues from our DirectMarketing operation and 3) revenues from Kate Spade LLC. Comparablerevenues exclude 1) revenues of closed stores, 2) revenues of GurwitchProducts, L.L.C. (sold in July 2006) and 3) revenues of our previous Chef’sCatalog operations (sold in November 2004).  The calculation of the change in comparablerevenues for 2003 is based on revenues for the 52 weeks endedAugust 2, 2003 compared to revenues for the 52 weeks endedJuly 27, 2002.

23

----

**ITEM 7. ****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**EXECUTIVEOVERVIEW**

The following discussion andanalysis of our financial condition and results of operations should be readtogether with our audited consolidated financial statements and related notes.Unless otherwise specified, the meanings of all defined terms in Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A) are consistent with the meanings of such terms as defined in theNotes to Consolidated Financial Statements. This discussion contains forward-lookingstatements. Please see “Forward-Looking Statements” for a discussion ofthe risks, uncertainties and assumptions relating to these statements.

**Overview**

Neiman Marcus, Inc., (the Company) together with ouroperating segments and subsidiaries, is a high-end specialty retailer. Ouroperations include the Specialty Retail stores segment and the Direct Marketingsegment. The Specialty Retail stores segment consists primarily of NeimanMarcus and Bergdorf Goodman stores. The Direct Marketing segment conducts bothonline operations and print catalog under the brand names of Neiman Marcus, BergdorfGoodman, Horchow and Chef’s Catalog (prior to its disposition inNovember 2004).  We also own a 56%interest in Kate Spade LLC, which designs and markets high-end designerhandbags and accessories.

Neiman Marcus, Inc. (formerly Newton Acquisition, Inc.)acquired The Neiman Marcus Group, Inc. (NMG) on October 6, 2005through a merger transaction with Newton Acquisition Merger Sub, Inc., awholly-owned subsidiary of Neiman Marcus, Inc.  The acquisition was accomplished through themerger of the Newton Acquisition Merger Sub, Inc. with and into NMG, withNMG being the surviving entity (the Acquisition).  Subsequent to the Acquisition, NMG is asubsidiary of the Company, which is controlled by Newton Holding, LLC(Holding). Both the Company and Holding were formed by investment fundsaffiliated with Texas Pacific Group and Warburg Pincus LLC (the Sponsors).

Prior to the Acquisition, the Company had no independentassets or operations.  After theAcquisition, the Company represents the Successor to NMG since the Company’ssole asset is its investment in NMG and its operations consist solely of theoperating activities of NMG as well as costs incurred by the Company related toits investment in NMG.  For periods priorto the Acquisition, NMG is deemed to be the predecessor to the Company.  As a result, for periods prior to theTransactions, the financial statements of the Company consist of the financialstatements of NMG for such periods.  Allreferences to “we” and “our” relate to the Company for periods subsequent tothe Transactions and to NMG for periods prior to the Transactions.  The accompanying condensed consolidatedstatements of earnings and cash flows present our results of operations andcash flows for the periods preceding the Acquisition (Predecessor) and theperiods succeeding the Acquisition (Successor), respectively.

We have prepared our discussion of the results ofoperations for the fiscal year ended July 29, 2006 by comparing theresults of operations of the Predecessor for the fiscal year ended July 30,2005 to the combined amounts obtained by adding the earnings and cash flows forthe Predecessor nine-week period ended October 1, 2005 and the Successorforty-three week period ended July 29, 2006. Although this combinedpresentation does not comply with generally accepted accounting principles(GAAP), we believe that it provides a meaningful method of comparison. Thecombined operating results have not been prepared on a pro forma basis underapplicable regulations and may not reflect the actual results we would haveachieved absent the Transactions and may not be predictive of future results ofoperations.

In connection with the Transactions, we incurredsignificant indebtedness and became highly leveraged. See “Liquidity andCapital Resources.” In addition, the purchase price paid in connection with theAcquisition has been allocated to state the acquired assets and liabilities atfair value. The purchase accounting adjustments increased the carrying value ofour property and equipment and inventory, established intangible assets for ourtradenames, customer lists and favorable lease commitments and revalued ourlong-term benefit plan obligations, among other things. Subsequent to theTransactions, interest expense and non-cash depreciation and amortizationcharges have significantly increased. As a result, our successor financialstatements subsequent to the Transactions are not comparable to our predecessorfinancial statements.

Our fiscal year ends on the Saturday closest toJuly 31. All references to fiscal year 2006 relate to the combined 52weeks ended July 29, 2006 (calculated as described above); all referencesto fiscal year 2005 relate to the 52 weeks ended July 30, 2005 andall references to fiscal year 2004 relate to the 52 weeks endedJuly 31, 2004.

24

----

On July 27, 2006, we sold our former majorityinterest in Gurwitch Products, L.L.C. to Alticor Inc., for pretax net cashproceeds of approximately $40.8 million (Gurwitch Disposition).  Gurwitch Products, L.L.C. designs and marketsthe Laura Mercier cosmetics line and had annual revenues of approximately $71.6million in fiscal year 2006.  Thenet assets of Gurwitch Products, L.L.C. were sold for their net carryingvalue (after purchase accounting adjustments made in connection with theTransactions to state such assets at fair value).  In addition, we recorded tax expense of $13.3million, payable by the Company, on the excess of the tax over book gainrealized in connection with the Gurwitch Disposition.  TheCompany’s financial statements, accompanying notes and other informationprovided in this Annual Report on Form 10-K reflect Gurwitch Products, L.L.C.as a discontinued operation for all periods presented.

**Recent Developments**

On August 31, 2006, we announced preliminary total revenuesand comparable revenues of approximately $270 million and$262 million, respectively, for the four-week August period of fiscal year2007, representing increases of 7.4% and 4.4%, respectively, compared to thefour-week August period of fiscal year 2006. For the four-week August period offiscal year 2007, comparable revenues increased 2.1% in the Specialty Retailstores segment and 19.3% in the Direct Marketing Segment.

All the financial data for the four-week August period offiscal year 2007 set forth above are preliminary and unaudited and subject torevision based upon our review and the review by our independent registeredpublic accounting firm of our financial condition and results of operations forthe quarter ending October 28, 2006. Once we and our independent registeredpublic accounting firm have completed our respective reviews of our financialinformation for the quarter ending October 28, 2006, we may report financialresults that are materially different from those set forth above.

**Factors Affecting Our Results**

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

·                  Salesof merchandise—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.

·                  Commissionsfrom leased departments—A small portion of the sales of our Specialty Retailstores consist of commissions from certain departments in our stores that welease to independent companies.

·                  Deliveryand processing—We generate revenues from delivery and processing chargesrelated to merchandise delivered to our customers from our retail and directmarketing operations.

Our revenues can be affected by the following factors:

·                  changesin the level of consumer spending generally and, specifically, on luxury goods;

·                  changesin the level of full-price sales;

·                  changesin the level of promotional events conducted by our Specialty Retail stores;

·                  ourability to successfully implement our store expansion and remodelingstrategies;

·                  therate of growth in internet sales by our Direct Marketing operation; and

·                  generaleconomic conditions.

In addition, our revenues are seasonal. For a descriptionof the seasonality of our business, see “Seasonality.”

25

----

***Cost of goods sold including buying and occupancy costs (excludingdepreciation) (COGS).*** COGS consists of the followingcomponents:

·                  Inventorycosts—We utilize the retail method of accounting, which is widely used in theretail industry due to its practicality, for substantially all of ourmerchandise inventories. Merchandise inventories are stated at the lower ofcost or market. Under the retail inventory method, the valuation of inventoriesat cost and the resulting gross margins are determined by applying a calculatedcost-to-retail ratio, for various groupings of similar items, to the retailvalue of inventories. The cost of the inventory reflected on the consolidatedbalance sheet is decreased by charges to cost of goods sold at the time theretail value of the inventory is lowered through the use of markdowns. Hence,earnings are negatively impacted when merchandise is marked down.

·                  Buyingcosts—Buying costs consist primarily of salaries and expenses incurred by ourmerchandising and buying operations.

·                  Occupancycosts—Occupancy costs consist primarily of rent, property taxes and operatingcosts of our retail, distribution and support facilities. A significant portionof our buying and occupancy costs are fixed.

·                  Deliveryand processing costs—Delivery and processing costs consist primarily ofdelivery charges we pay to third-party carriers and other costs relatedto the fulfillment of customer orders not delivered at the point-of-sale.

With the introduction of new fashions in the first andthird fiscal quarters and our emphasis on full-price selling in these quarters,a lower level of markdowns and higher margins are characteristic of thesequarters.

Consistent with industry business practice, we receiveallowances from certain of our vendors in support of the merchandise wepurchase for resale. Certain allowances are received to reimburse us formarkdowns taken or to support the gross margins that we earn in connection withthe sales of the vendor’s merchandise. These allowances result in an increaseto gross margin when we earn the allowances and they are approved by thevendor. Other allowances we receive represent reductions to the amounts we payto acquire the merchandise. These allowances reduce the cost of the acquiredmerchandise and are recognized at the time the goods are sold.

Changes in our COGS as a percentage of revenues areaffected primarily by the following factors:

·                  customeracceptance of and demand for the merchandise we offer in a given season and therelated impact of such factors on the level of full-price sales;

·                  ourability to order an appropriate amount of merchandise to match customer demandand the related impact on the level of net markdowns incurred;

·                  factorsaffecting revenues generally;

·                  changesin occupancy costs primarily associated with the opening of new stores ordistribution facilities; and

·                  theamount of vendor reimbursements we receive during the fiscal year.

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

Advertising costs incurred by our Specialty Retailsegment consist primarily of print media costs related to promotional materialsmailed to our customers, while advertising costs incurred by our DirectMarketing operation relate to the production, printing and distribution of ourprint catalogs and the production of the photographic content on our websites,as well as online marketing costs. We receive advertising allowances fromcertain of our merchandise vendors. Substantially all the advertisingallowances we receive represent reimbursements of direct, specific andincremental costs that we incur to promote the vendor’s merchandise in connectionwith our various advertising programs, primarily catalogs and other printmedia. As a result, these allowances are recorded as a reduction of ouradvertising costs when earned. Vendor allowances earned and recorded as areduction to selling, general and administrative expenses aggregatedapproximately $61.7 million in fiscal year 2006 (including $18.6 million forthe Predecessor prior to the Acquisition), $57.5 million in fiscal year2005 and $55.3 million in fiscal year 2004.

26

----

We also receive allowances from certain merchandisevendors in conjunction with compensation programs for employees who sell thevendor’s merchandise. These allowances are netted against the relatedcompensation expense that we incur. Amounts received from vendors related to compensationprograms were $59.5 million in fiscal year 2006 (including $10.1 millionfor the Predecessor prior to the Acquisition), $53.2 million in fiscalyear 2005 and $46.3 million in fiscal year 2004.

Changes in our selling, general and administrative expensesare affected primarily by the following factors:

·                  changesin the number of sales associates primarily due to expansion of existing storesand new store openings, including increased health care and related benefitsexpenses;

·                  changesin expenses incurred in connection with our advertising and marketing programs;and

·                  changesin expenses related to insurance and long-term benefits due to general economicconditions such as rising health care costs.

***Income from credit card operations***.  Prior tothe Credit Card Sale on July 7, 2005, our credit card operations generatedfinance charge income, net of credit losses, which we recognized as income whenearned. 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 based on net credit card sales andcompensation for marketing and servicing activities (HSBC Program Income). Werecognize HSBC Program Income when earned. Prior to fiscal year 2006, wepresented income from credit card operations as a reduction of selling, generaland administrative expenses. We now present this income as a separate line itemon our statements of earnings and have reclassified prior periods to conform tothis presentation.

As a percentage of revenues, the HSBC Program Income islower than the net finance charge income we earned prior to the Credit CardSale. However, the resulting decrease in income from credit card operations ismitigated, in part, by 1) decreases in SG&A expenses we incur due tothe transfer of certain servicing functions to HSBC after the sale,2) decreases in our capital investments related to the servicing of the creditcard portfolio and 3) decreases in carrying costs related to our previousfunding of the seasonal working capital requirements of the credit cardportfolio. In tandem with HSBC, we have initiated various changes in our creditcard program to alter the credit terms available to our cardholders and toenhance the earnings of the portfolio. These changes have increased the levelof HSBC Program Income earned by the Company.

In the future, the HSBC Program Income may be:

·                  decreasedbased upon the level of future services we provide to HSBC; and

·                  increasedbased upon other changes to our historical credit card program related to,among other things, the interest rates applied to unpaid balances and theassessment of late fees.

27

----

**Fiscal Year 2006 Highlights**

We believe that our product assortment of luxury,designer and fashion merchandise, coupled with our sales promotion activitiesand our commitment to superior customer service, have been critical to oursuccess in the past. In addition, we believe these factors are critical to ourfuture growth and success. Highlights from fiscal year 2006 include:

·                  Revenues—Ourrevenues for fiscal year 2006 were $4,105.6 million, the highest in ourhistory. Revenues increased 8.8% in fiscal year 2006 as compared to fiscal year2005, with increases in comparable store sales in all four fiscal quarterscompared to the same periods in fiscal year 2005. Comparable revenuespercentage increases by fiscal quarter for fiscal year 2006 as compared to thesame periods in fiscal year 2005 were:
| First fiscal quarter   |   | 8.3 | % |
|------------------------|--------|-----|---|
| Second fiscal  quarter |   | 6.3 | % |
| Third fiscal  quarter  |   | 6.3 | % |
| Fourth fiscal quarter  |   | 6.6 | % |

 

For Specialty Retail stores, oursales per square foot increased by 5.9% to $611 in fiscal year 2006 compared to$577 in fiscal year 2005.

·                  Costof goods sold including buying and occupancy costs (excludingdepreciation)—COGS represented 64.2% of our revenues in fiscal year 2006 ascompared to 63.3% for fiscal year 2005. This increase was primarily due to purchase accounting adjustments infiscal year 2006 of $43.8 million, or 1.1% of revenues.

·                  Selling,general and administrative expenses (excluding depreciation)—Selling, generaland administrative expenses were 23.9% of our revenues in fiscal year 2006 and24.7% of our revenues in fiscal year 2005.

·                  Operatingearnings— For fiscal year 2006, our operating earnings were$328.1 million, or 8.0% of revenues, compared to $409.0 million, or10.8% of revenues for fiscal year 2005. Fiscal year 2006 operating earnings include charges aggregating $121.9million, or 3.0% of revenues, consisting of 1) $60.2 million of amortizationexpense related to intangible assets recorded in connection with theTransactions, 2) $38.2 million of non-cash charges related to other valuationadjustments recorded in connection with the Transactions and 3) $23.5 millionof costs incurred in connection with the Transactions.  In addition, fiscal year 2006 operatingearnings were negatively impacted by 1) lower income from credit cardoperations of $14.5 million, or 0.5% of revenues, as a result of the CreditCard Sale and 2) higher depreciation charges of 0.4% of revenues as a result ofhigher levels of capital expenditures for new stores and remodels in recentyears.

**Seasonality**

We conduct our selling activities in two primary sellingseasons—Fall and Spring. The Fall season is comprised of our first and secondfiscal quarters and the Spring season is comprised of our third and fourthfiscal quarters.

Our first fiscal quarter is generally characterized by ahigher level of full-price selling with a focus on the initial introduction ofFall season fashions. Aggressive in-store marketing activities designed tostimulate customer buying, a lower level of markdowns and higher margins are characteristicof this quarter. The second fiscal quarter is more focused on promotionalactivities related to the December holiday season, the early introduction ofresort season collections from certain designers and the sale of Fall seasongoods on a marked down basis. As a result, margins are typically lower in thesecond fiscal quarter. However, due to the seasonal increase in sales thatoccurs during the holiday season, the second fiscal 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 fiscal quarters as a result of higherseasonal requirements.

Similarly, the third fiscal quarter is generallycharacterized by a higher level of full-price selling with a focus on theinitial introduction of Spring season fashions. Aggressive in-store marketingactivities designed to stimulate customer buying, a lower level of markdownsand higher margins are again characteristic of this quarter. Revenues aregenerally the lowest in the fourth fiscal quarter with a focus on promotionalactivities offering Spring season goods to the customer on a marked down basis,resulting in lower margins during the quarter. Our working capital requirementsare typically lower in the third and fourth fiscal quarters than in the otherquarters.

28

----

A large percentage of our merchandise assortment,particularly in the apparel, fashion accessories and shoe categories, isordered months in advance of the introduction of such goods. For example, women’sapparel, men’s apparel and shoes are typically ordered six to nine months inadvance of the products being offered for sale while handbags, jewelry andother categories are typically ordered three to six months in advance. As aresult, inherent in the successful execution of our business plans is ourability both to predict the fashion trends that will be of interest to ourcustomers and to anticipate future spending patterns of our customer base.

We monitor the sales performance of our inventoriesthroughout each season. We seek to order additional goods to supplement ouroriginal purchasing decisions when the level of customer demand is higher thanoriginally anticipated. However, in certain merchandise categories,particularly fashion apparel, our ability to purchase additional goods can belimited. This can result in lost sales in the event of higher than anticipateddemand of the fashion goods we offer or a higher than anticipated level ofconsumer spending. Conversely, in the event we buy fashion goods that are notaccepted by the customer or the level of consumer spending is less than weanticipated, we typically incur a higher than anticipated level of markdowns,net of vendor allowances, to sell the goods that remain at the end of theseason, resulting in lower operating profits. We believe that the experience ofour merchandising and selling organizations helps to minimize the inherent riskin predicting fashion trends.

**OPERATING RESULTS**

**Performance Summary**

The following table sets forth certain items expressed aspercentages of net revenues for the periods indicated.
| ** **                                                                        | ** ** | **Forty-three  weeks  ended  July 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 29,  2006** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                        | ** ** | **(Successor)**                                    | ** ** | **(Predecessor)**                                 | ** ** | **(Combined)**                                   | ** ** | **(Predecessor)**                                | ** ** | **(Predecessor)**                                | ** ** |
| Revenues                                                                          |       | 100.0                                              | %          | 100.0                                             | %          | 100.0                                            | %          | 100.0                                            | %          | 100.0                                            | %          |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation) |       | 65.3                                               |       | 58.8                                              |       | 64.2                                             |       | 63.3                                             |       | 64.0                                             |       |
| Selling, general  and administrative expenses (excluding depreciation)            |       | 23.7                                               |       | 25.0                                              |       | 23.9                                             |       | 24.7                                             |       | 24.8                                             |       |
| Income from  credit card operations                                               |       | (1.4                                               | )          | (1.2                                              | )          | (1.4                                             | )          | (1.9                                             | )          | (1.6                                             | )          |
| Depreciation  expense                                                             |       | 3.2                                                |       | 3.1                                               |       | 3.2                                              |       | 2.8                                              |       | 2.8                                              |       |
| Amortization of  customer lists                                                   |       | 1.3                                                |       | —                                            |       | 1.1                                              |       | —                                           |       | —                                           |       |
| Amortization of  favorable lease commitments                                      |       | 0.4                                                |       | —                                            |       | 0.4                                              |       | —                                           |       | —                                           |       |
| Transaction and  other costs                                                      |       | —                                             |       | 3.7                                               |       | 0.6                                              |       | —                                           |       | 0.1                                              |       |
| Loss on  disposition of Chef’s Catalog                                       |       | —                                             |       | —                                            |       | —                                           |       | 0.4                                              |       | —                                           |       |
| Gain on credit  card sale                                                         |       | —                                             |       | —                                            |       | —                                           |       | (0.2                                             | )          | —                                           |       |
| Operating  earnings                                                               |       | 7.5                                                |       | 10.7                                              |       | 8.0                                              |       | 10.8                                             |       | 9.9                                              |       |
| Interest expense  (income), net                                                   |       | 6.3                                                |       | (0.1                                              | )          | 5.3                                              |       | 0.3                                              |       | 0.5                                              |       |
| Earnings from  continuing operations before income taxes and minority interest    |       | 1.2                                                |       | 10.9                                              |       | 2.7                                              |       | 10.5                                             |       | 9.4                                              |       |
| Income taxes                                                                      |       | 0.4                                                |       | 4.0                                               |       | 1.0                                              |       | 3.9                                              |       | 3.4                                              |       |
| Earnings from  continuing operations before minority interest                     |       | 0.8                                                |       | 6.9                                               |       | 1.7                                              |       | 6.7                                              |       | 5.9                                              |       |
| Minority  interest in net (earnings) loss of subsidiaries                         |       | (0.0                                               | )          | 0.1                                               |       | 0.0                                              |       | (0.1                                             | )          | (0.1                                             | )          |
| Earnings from  continuing operations                                              |       | 0.8                                                |       | 6.9                                               |       | 1.7                                              |       | 6.6                                              |       | 5.9                                              |       |
| (Loss) earnings  from discontinued operation                                      |       | (0.4                                               | )          | 0.0                                               |       | (0.3                                             | )          | 0.0                                              |       | 0.0                                              |       |
| Net earnings                                                                      |       | 0.4                                                | %          | 6.9                                               | %          | 1.4                                              | %          | 6.6                                              | %          | 5.9                                              | %          |

 

29

----

In connection with the Transactions, the Company incurredsignificant indebtedness and became highly leveraged. See “Liquidity andCapital Resources.” In addition, the purchase price paid in connection with theAcquisition has been allocated to state the acquired assets and liabilities atfair value. The purchase accounting adjustments increased the carrying value ofour property and equipment and inventory, established intangible assets for ourtradenames, customer lists and favorable lease commitments and revalued ourlong-term benefit plan obligations, among other things. Subsequent to theTransactions, interest expense and non-cash depreciation and amortizationcharges have significantly increased. As a result, our Successor financialstatements subsequent to the Transactions are not comparable to our Predecessorfinancial statements.

Set forth in the following table is certain summary information withrespect to our operations for the periods indicated.
| **(dollars in millions)**                                                               | ** ** | **Forty-three  weeks  ended  July 29,  2006** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 29,  2006** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **(Successor)**                                    | ** ** | **(Predecessor)**                                 | ** ** | **(Combined)**                                   | ** ** | **(Predecessor)**                                | ** ** | **(Predecessor)**                                | ** ** |
| REVENUES                                                                                          |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Specialty Retail  stores                                                                          |       | $                                                  | 2,829.9    |                                              | $          | 544.9                                            |       | $                                                | 3,374.8    |                                             | $          | 3,103.0 |   | $ | 2,850.1 |   |
| Direct Marketing                                                                                  |       | 567.8                                              |       | 87.5                                              |       | 655.3                                            |       | 592.1                                            |       | 570.6                                            |       |
| Other(1)                                                                                          |       | 64.5                                               |       | 11.0                                              |       | 75.5                                             |       | 79.7                                             |       | 63.3                                             |       |
| Total                                                                                             |       | $                                                  | 3,462.2    |                                              | $          | 643.4                                            |       | $                                                | 4,105.6    |                                             | $          | 3,774.8 |   | $ | 3,484.0 |   |
| OPERATING EARNINGS                                                                                |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Specialty Retail  stores                                                                          |       | $                                                  | 312.3      |                                              | $          | 91.4                                             |       | $                                                | 403.7      |                                             | $          | 377.8 |   | $ | 310.6 |   |
| Direct Marketing                                                                                  |       | 90.0                                               |       | 8.2                                               |       | 98.2                                             |       | 75.2                                             |       | 61.3                                             |       |
| Other(1)                                                                                          |       | 1.0                                                |       | (1.3                                              | )          | (0.2                                             | )          | 11.5                                             |       | 11.0                                             |       |
| Subtotal                                                                                          |       | 403.3                                              |       | 98.3                                              |       | 501.7                                            |       | 464.5                                            |       | 382.9                                            |       |
| Corporate  expenses                                                                               |       | (45.8                                              | )          | (5.8                                              | )          | (51.7                                            | )          | (46.4                                            | )          | (35.8                                            | )          |
| Amortization of  customer lists and favorable lease commitments                                   |       | (60.2                                              | )          | —                                            |       | (60.2                                            | )          | —                                           |       | —                                           |       |
| Non-cash  charges related to other valuation adjustments made in connection with the  Acquisition |       | (38.2                                              | )          | —                                            |       | (38.2                                            | )          | —                                           |       | —                                           |       |
| Transaction and  other costs                                                                      |       | —                                             |       | (23.5                                             | )          | (23.5                                            | )          | —                                           |       | —                                           |       |
| Loss on  disposition of Chef’s Catalog                                                       |       | —                                             |       | —                                            |       | —                                           |       | (15.3                                            | )          | —                                           |       |
| Gain on Credit  Card Sale                                                                         |       | —                                             |       | —                                            |       | —                                           |       | 6.2                                              |       | —                                           |       |
| Impairment and  other charges                                                                     |       | —                                             |       | —                                            |       | —                                           |       | —                                           |       | (3.9                                             | )          |
| Total                                                                                             |       | $                                                  | 259.1      |                                              | $          | 69.0                                             |       | $                                                | 328.1      |                                             | $          | 409.0 |   | $ | 343.2 |   |
| OPERATING PROFIT MARGIN                                                                           |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Specialty Retail  stores                                                                          |       | 11.0                                               | %          | 16.8                                              | %          | 12.0                                             | %          | 12.2                                             | %          | 10.9                                             | %          |
| Direct Marketing                                                                                  |       | 15.8                                               | %          | 9.4                                               | %          | 15.0                                             | %          | 12.7                                             | %          | 10.7                                             | %          |
| Total                                                                                             |       | 7.5                                                | %          | 10.7                                              | %          | 8.0                                              | %          | 10.8                                             | %          | 9.9                                              | %          |
| CHANGE IN COMPARABLE  REVENUES(2)                                                                 |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Specialty Retail  stores                                                                          |       | 5.4                                                | %          | 9.8                                               | %          | 6.1                                              | %          | 8.7                                              | %          | 13.1                                             | %          |
| Direct Marketing                                                                                  |       | 13.9                                               | %          | 9.6                                               | %          | 13.3                                             | %          | 16.3                                             | %          | 19.2                                             | %          |
| Total                                                                                             |       | 6.4                                                | %          | 9.2                                               | %          | 6.8                                              | %          | 9.8                                              | %          | 14.4                                             | %          |
| SALES PER SQUARE FOOT                                                                             |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Specialty Retail  stores                                                                          |       | $                                                  | 508        |                                              | $          | 103                                              |       | $                                                | 611        |                                             | $          | 577 |   | $ | 528 |   |
| STORE COUNT                                                                                       |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Neiman Marcus and  Bergdorf Goodman stores:                                                       |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Open at  beginning of period                                                                      |       | 37                                                 |       | 36                                                |       | 36                                               |       | 37                                               |       | 37                                               |       |
| Opened during  the period                                                                         |       | 1                                                  |       | 1                                                 |       | 2                                                |       | (1                                               | )          | —                                           |       |
| Open at end of  period                                                                            |       | 38                                                 |       | 37                                                |       | 38                                               |       | 36                                               |       | 37                                               |       |
| Clearance centers:                                                                                |       |                                               |       |                                              |       |                                             |       |                                             |       |                                             |       |
| Open at  beginning of period                                                                      |       | 17                                                 |       | 16                                                |       | 16                                               |       | 14                                               |       | 14                                               |       |
| Opened during  the period                                                                         |       | 1                                                  |       | 1                                                 |       | 2                                                |       | 2                                                |       | —                                           |       |
| Open at end of period                                                                             |       | 18                                                 |       | 17                                                |       | 18                                               |       | 16                                               |       | 14                                               |       |

 

----

30

----

(1)           Other includes theoperations of Kate Spade, LLC.

(2)           Comparable revenuesinclude 1) revenues derived from our retail stores open for more than52 weeks, including stores that have been relocated or expanded,2) revenues from our Direct Marketing operation and 3) revenues fromKate Spade LLC. Comparable revenues exclude 1) revenues of closed stores, 2)revenues of Gurwitch Products, L.L.C. (sold in July 2006) and 3) revenues of ourprevious Chef’s Catalog operations (sold in November 2004).

**Fiscal Year Ended July 29, 2006 Compared to FiscalYear Ended July 30, 2005**

***Revenues*.**  Revenues for fiscal year 2006 of$4,105.6 million increased $330.8 million, or 8.8%, from$3,774.8 million in fiscal year 2005, reflecting increases in comparablerevenues, revenues from new stores and higher internet sales.  Revenues increased in fiscal year 2006compared to fiscal year 2005 at all our operating companies, except for KateSpade.

Comparable revenues for fiscal year 2006 were$3,992.2 million compared to $3,740.6 million in fiscal year 2005,representing an increase of 6.8%. Comparable revenues increased in fiscal year2006 by 6.1% for Specialty Retail stores, 13.3% for Direct Marketing and decreased13.1% for Kate Spade compared to fiscal year 2005.

Comparable revenues in fiscal year 2005 increased by 9.8% as compared tofiscal year 2004. Changes in comparable revenues by fiscal quarter are asfollows:
|                          | ** ** | **Fiscal Year 2006** | ** ** | **Fiscal Year 2005** | ** ** |
|--------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **Fourth  Quarter**            | ** ** | **Third  Quarter**             | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
| Specialty Retail  stores |       | 5.8                            | %          | 5.7                            | %          | 4.5 | % | 8.8 | % | 7.4 | % | 6.5 | % | 9.6 | % | 11.1 | % |
| Direct Marketing         |       | 13.2                           | %          | 16.5                           | %          | 13.2 | % | 10.4 | % | 19.5 | % | 16.8 | % | 15.8 | % | 13.1 | % |
| Total                    |       | 6.6                            | %          | 6.3                            | %          | 6.3 | % | 8.3 | % | 9.4 | % | 7.9 | % | 10.4 | % | 11.4 | % |

 

In fiscal year 2006, internet sales by Direct Marketingwere $405.7 million, an increase of 33.0% from fiscal year 2005, excludingChef’s Catalog. Total revenues of Chef’s Catalog (prior to its sale inNovember 2004) of $13.9 million are included in consolidated revenuesfor fiscal year 2005.

***Cost of goodssold including buying and occupancy costs (excluding depreciation).***  COGS forfiscal year 2006 and fiscal year 2005 were:
|                                                                                                                            | ** ** | **Fiscal year ended  July 29, 2006** | ** ** | **Fiscal year ended  July 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **(Combined)**                                           | ** ** | **(Predecessor)**                                        | ** ** |
| **(in millions, except percentages)**                                                                       | ** ** | **$**                                                    | ** ** | **% of  revenues**                                  | ** ** | **$** | ** ** | **% of  revenues** | ** ** |
| ** **                                                                                                                 | ** ** | ** **                                               | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| COGS, before  purchase accounting adjustments                                                                              |       | $                                                        | 2,593.6    |                                                     | 63.1       | % | $ | 2,390.3 |   | 63.3 | % |
| Purchase  accounting adjustments, primarily non-cash charges related to step-up  in carrying value of acquired inventories |       | 43.8                                                     |       | 1.1                                                      |       | — |   | — |   |
| COGS, as reported                                                                                                          |       | $                                                        | 2,637.4    |                                                     | 64.2       | % | $ | 2,390.3 |   | 63.3 | % |

 

We present the non-GAAP financial measure COGS, beforepurchase accounting adjustments because we use this measure to monitor andevaluate the performance of our business and believe the presentation of thismeasure will enhance investors’ ability to analyze trends in our business andevaluate our performance relative to other companies in our industry.

The increase in COGS as reported under GAAP to 64.2% ofrevenues from 63.3% of revenues in the prior fiscal year primarily reflects$43.8 million of purchase accounting adjustments to increase the carryingvalue of the acquired inventories recorded in connection with the Transactions.COGS before purchase accounting adjustments was 63.1% of revenues compared to63.3% of revenues in the prior year reflecting:

·                  adecrease in product costs by approximately 0.1% of revenues primarily due tolower net markdowns; and

·                  adecrease in buying and occupancy costs of approximately 0.1% of revenuesprimarily due to leveraging payroll and rent expense on a higher level ofrevenues in fiscal year 2006.

31

----

We incurred a lower level of net markdowns in our Specialty Retailstores in fiscal year 2006 primarily due to:

·                    higher levelsof full-price selling; and

·                  markdownsavings, primarily in the Spring season, related to lower markdown percentages takenin connection with the end-of-season clearance activities in our full-linestores.

Consistent with industry business practice, we receiveallowances from certain of our vendors in support of the merchandise wepurchase for resale. We receive certain allowances to reimburse us formarkdowns taken and/or to support the gross margins realized in connection withthe sales of the vendor’s merchandise. We recognize these allowances as adecrease in COGS when the allowances are earned and approved by the vendor.Other allowances we receive represent reductions to the amounts initially paidto acquire the merchandise. We recognize these allowances as a reduction in thecost of the acquired merchandise resulting in a decrease in COGS at the timethe goods are sold. We received vendor allowances of $88.9 million, or 2.2% ofrevenues, in fiscal year 2006 and $82.8 million, or 2.2% of revenues, infiscal year 2005.

***Selling, general and administrative expenses(excluding depreciation).***  SG&A expenses were 23.9% ofrevenues in fiscal year 2006 compared to 24.7% of revenues in the prior fiscalyear period.

The net decrease in SG&A expenses as a percentage ofrevenues in fiscal year 2006 was primarily due to:

·                  adecrease in marketing and advertising costs of approximately 0.3% of revenuesprimarily due to higher internet sales by our Direct Marketing segment, whichhave a lower expense to revenue ratio than catalog sales;

·                  adecrease of approximately 0.3% of revenues in our payroll and employee benefitcosts primarily due to the leveraging of these expenses on a higher level ofrevenues in fiscal year 2006 period and favorable insurance claims experience;

·                  lowerannual incentive compensation costs of approximately 0.1% of revenues;

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

·                  adecrease of approximately 0.1% of revenues in professional and legal feesincurred primarily due to a higher level of costs incurred in the fourthquarter of fiscal year 2005 related to the Transactions.

These decreases in SG&A expenses, as a percentage ofrevenues, were partially offset by:

·                  managementservices fees of $8.7 million, or 0.2% of revenues, payable to theSponsors as a result of the Acquisition; and

·                  anincrease in preopening expenses and store remodeling expenses primarilyincurred in connection with the opening of our San Antonio store inSeptember 2005 and our Boca Raton store in November 2005 byapproximately 0.1% of revenues.

***Income from credit card operations.***  Wereceived HSBC Program Income of $57.2 million, or 1.4% of revenues, infiscal year 2006 compared to net finance charge income of $71.6 million,or 1.9% of revenues, in fiscal year 2005.

***Depreciation expense.***  Depreciationexpense was $130.8 million, or 3.2% of revenues, in fiscal year 2006compared to $106.3 million, or 2.8% of revenues, in the prior fiscal year.The increase in depreciation was primarily due to 1) a higher level ofcapital spending in recent years and 2) additional depreciation expenseresulting from the revaluation of our property and equipment at fair value inconnection with the Acquisition.

***Amortization expense.*** Amortization of acquisition related intangibles (customer lists andfavorable lease commitments) recorded as a result of the application ofpurchase accounting in connection with the Acquisition aggregated$60.2 million, or 1.5% of revenues, for fiscal year 2006. We had noamortization expense in the prior year period.

32

----

***Transaction and other costs.***  During theperiod July 30, 2005 to October 1, 2005, we expensed$23.5 million in connection with the Transactions. These costs consistedof $4.5 million of accounting, investment banking, legal and other costsassociated with the Transactions and a $19.0 million non-cash charge forstock compensation resulting from the accelerated vesting of Predecessor stockoptions and restricted stock.

***Segment operating earnings.***  Segmentoperating earnings for our Specialty Retail stores and Direct Marketing segmentsdo not reflect the impact of adjustments to revalue our assets and liabilitiesto estimated fair value at the Acquisition date. See Note 16 to ourconsolidated financial statements.

Operating earnings for our Specialty Retail storessegment were $403.7 million, or 12.0% of Specialty Retail stores revenues,for fiscal year 2006 compared to $377.8 million, or 12.2% of SpecialtyRetail stores revenues, for the prior year period. Operating margin forSpecialty Retail stores was positively impacted by 1) higher productmargins, 2) lower SG&A expenses for compensation and related benefits,as a percentage of revenues, as a result of leveraging these expenses on ahigher level of revenues in fiscal year 2006 and 3) the leveraging ofbuying and occupancy costs on a higher level of revenues. These effects wereoffset, in part, by 1) a lower level of income from our credit cardoperations due to the sale of our credit card operations to HSBC inJuly 2005, 2) higher preopening costs and 3) higher depreciationcharges as a result of higher levels of capital expenditures for new stores andstore remodels in recent years.

Operating earnings for Direct Marketing increased to$98.2 million, or 15.0% of Direct Marketing revenues, in fiscal year 2006from $75.2 million, or 12.7% of Direct Marketing revenues, for the prioryear period. The increase in operating earnings and operating margin for DirectMarketing was primarily the result of 1) higher product margins and2) the decrease in advertising and marketing costs, as a percentage ofrevenues, incurred to support internet sales.

***Interest expense, net.***  Netinterest expense was $217.0 million in fiscal year 2006 and$12.3 million for the prior year period. The significant components ofinterest expense are as follows:
| (in thousands)                         | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | **Nine weeks  Ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 29,  2006** | ** ** | **Fiscal year   ended  July 30,  2005** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                  | ** ** | **(Successor)**                                        | ** ** | **(Predecessor)**                                 | ** ** | **(Combined)**                                   | ** ** | **(Predecessor)**                                      | ** ** |
|                                        |       |                                                   |       |                                              |       |                                             |       |                                                   |       |
| Asset-Based  Revolving Credit Facility      |       | $                                                      | 1,332      |                                              | $          | —                                           |       | $                                                      | 1,332      |   | $ | — |   |
| Senior Secured  Term Loan Facility          |       | 111,662                                                |       | —                                            |       | 111,662                                          |       | —                                                 |       |
| 2028 Debentures                             |       | 7,266                                                  |       | 1,542                                             |       | 8,808                                            |       | 8,904                                                  |       |
| Senior Notes                                |       | 51,421                                                 |       | —                                            |       | 51,421                                           |       | —                                                 |       |
| Senior  Subordinated Notes                  |       | 42,339                                                 |       | —                                            |       | 42,339                                           |       | —                                                 |       |
| Credit Agreement                            |       | —                                                 |       | —                                            |       | —                                           |       | 5,803                                                  |       |
| 2008 Notes                                  |       | 638                                                    |       | 1,439                                             |       | 2,077                                            |       | 8,308                                                  |       |
| Amortization of  debt issue costs and other |       | 12,275                                                 |       | 322                                               |       | 12,597                                           |       | 1,193                                                  |       |
| Total interest expense                      |       | 226,933                                                |       | 3,303                                             |       | 230,236                                          |       | 24,208                                                 |       |
| Less:                                       |       |                                                   |       |                                              |       |                                             |       |                                                   |       |
| Interest income                             |       | 5,557                                                  |       | 3,046                                             |       | 8,603                                            |       | 6,556                                                  |       |
| Capitalized interest                        |       | 3,446                                                  |       | 1,146                                             |       | 4,592                                            |       | 5,350                                                  |       |
| Interest expense, net                       |       | $                                                      | 217,930    |                                              | $          | (889                                             | )          | $                                                      | 217,041    |   | $ | 12,302 |   |

 

The increase in interest expense is due to the$3.3 billion increase in debt incurred in connection with theTransactions. The increase in interest income was due primarily to interestearned on higher average invested balances after the Credit Card Sale inJuly 2005 and prior to the Transactions.

***Income taxes.***  Oureffective income tax rate was 35.6% for the forty-three weeks ended July 29,2006 and 36.8% for the nine weeks ended October 1, 2005, resulting in aneffective tax rate of 36.4% for the combined fiscal year 2006 period.  Our combined effective tax rate for fiscalyear 2006 was favorably impacted by a higher level of tax-exempt interestincome earned.  Our effective income taxrate was 36.7% for the fiscal year ended July 30, 2005 and was favorablyimpacted by tax-exempt interest income, offset by non-deductible transactioncosts.  In the fourth fiscal quarter offiscal year 2005, we recognized tax benefits aggregating $7.6 millionrelated to a favorable settlement associated with previous state tax filingsand reductions in previously recorded deferred tax liabilities. Excluding thesebenefits, our effective tax rate was 38.6% for fiscal year 2005.

33

----

The Company’s federal tax returns for fiscal years 2004and 2003 are currently under examination by the Internal Revenue Service (IRS).We believe our recorded tax liabilities as of July 29, 2006 are sufficientto cover any potential assessments to be made by the IRS upon the completion oftheir examinations. We will continue to monitor the progress of the IRSexaminations and review our recorded tax liabilities for potential auditassessments.  Adjustments to increase ordecrease the recorded tax liabilities may be required in the future asadditional facts become known.

**Fiscal Year Ended July 30, 2005 Compared to FiscalYear Ended July 31, 2004**

***Revenues.***  Revenuesfor fiscal year 2005 of $3,774.8 million increased $290.8 million, or8.3%, from $3,484.0 million in fiscal year 2004.

Comparable revenues for fiscal year 2005 were$3,740.6 million compared to $3,390.5 million in fiscal year 2004,representing an increase of 9.8%. Comparable revenues increased in fiscal year2005 by 8.7% for Specialty Retail stores, 16.3% for Direct Marketing and 8.6%for Kate Spade LLC compared to fiscal year 2004. Comparable revenues in fiscalyear 2004 increased by 14.4% as compared to fiscal year 2003. Changes incomparable revenues by fiscal quarter are as follows:
|                          | ** ** | **Fiscal Year 2005** | ** ** | **Fiscal Year 2004** | ** ** |
|--------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **Fourth  Quarter**            | ** ** | **Third  Quarter**             | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
| Specialty Retail  stores |       | 7.4                            | %          | 6.5                            | %          | 9.6 | % | 11.1 | % | 11.3 | % | 22.2 | % | 10.2 | % | 9.6 | % |
| Direct Marketing         |       | 19.5                           | %          | 16.8                           | %          | 15.8 | % | 13.1 | % | 21.7 | % | 14.4 | % | 25.7 | % | 13.2 | % |
| Total                    |       | 9.4                            | %          | 7.9                            | %          | 10.4 | % | 11.4 | % | 12.8 | % | 22.0 | % | 12.6 | % | 10.7 | % |

 

We believe the increases in our comparable revenues infiscal year 2005 were primarily the result of a higher level of consumerspending, in general, with a higher increase coming from the affluent luxurycustomers we serve. In addition, we believe the increases in our comparablerevenues were driven by sales events conducted by our Specialty Retail storesand by the growth of internet sales for Direct Marketing. In fiscal year 2005,internet sales by Direct Marketing, excluding Chef’s Catalog, were$305.9 million, representing 51.7% of Direct Marketing revenues and anincrease of 46.0% from fiscal year 2004.

***Costs of goods sold including buying andoccupancy costs (excluding depreciation).***  COGS was63.3% of revenues in fiscal year 2005 compared to 64.0% of revenues in fiscalyear 2004. The decrease in COGS as percentage of revenues was primarily due to:

·                  thedecrease in product costs by approximately 0.6% as a percentage of revenues;and

·                  adecrease in buying and occupancy costs by approximately 0.1% as a percentage ofrevenues.

We had lower product costs as a percentage of revenues atboth our Specialty Retail stores and our Direct Marketing operations duringfiscal year 2005. We believe the decrease in product costs as a percentage ofrevenues at our Specialty Retail stores was due primarily to the higher portionof full-price sales generated in fiscal year 2005 and our continued emphasis oninventory management. Net markdowns for Specialty Retail stores wereconsistent, as a percentage of revenues, in fiscal year 2005 and fiscal year2004. We also had lower product costs as a percentage of revenues at our DirectMarketing operation in fiscal year 2005 subsequent to our disposition of Chef’sCatalog in November 2004. Chef’s Catalog had higher product costs as apercentage of revenues than our other Direct Marketing brands. However, weincurred a higher level of net markdowns in fiscal year 2005 for DirectMarketing as compared to fiscal year 2004 primarily due to lower thananticipated sales in our catalog operations during the December holiday season.We received vendor allowances to reimburse us for markdowns taken or to supportthe gross margins we earned in connection with the sales of the vendors’merchandise of $82.8 million, or 2.2% of revenues, in fiscal year 2005 and$79.3 million, or 2.3% of revenues, in fiscal year 2004.

Buying and occupancy costs decreased by approximately0.1% as a percentage of revenues during fiscal year 2005 compared to fiscalyear 2004 primarily due to the leveraging of fixed expenses over the higherlevel of revenues we generated during fiscal year 2005.

34

----

***Selling, general and administrative expenses(excluding depreciation).***  SG&A expenses were 24.7% ofrevenues in fiscal year 2005 compared to 24.8% of revenues in fiscal year 2004.

The net decrease in selling, general and administrativeexpenses as a percentage of revenues in fiscal year 2005 as compared to fiscalyear 2004 was primarily due to:

·                  adecrease in marketing and advertising costs by approximately 0.3% as apercentage of revenues, primarily due to the elimination of expenditures forChef’s Catalog which were higher as a percentage of revenues than the marketingand advertising costs for our other Direct Marketing brands; and

·                  adecrease in incentive compensation by approximately 0.1% as a percentage ofrevenues.

These decreases in selling, general and administrativeexpenses as a percentage of revenues were partially offset by:

·                  costs,consisting primarily of legal and consulting fees, aggregating$6.7 million, or approximately 0.2% as a percentage of revenues, incurredin connection with the Transactions;

·                  anincrease in costs, primarily payroll, by approximately 0.1% as a percentage ofrevenues incurred by Direct Marketing and Kate Spade LLC in support of newbusiness initiatives and the expansion of Kate Spade operations; and

·                  anincrease in employee benefit expenses, including medical and pension expenses,by approximately 0.1% as a percentage of revenues.

In addition, selling, general and administrative expensesincreased as a percentage of revenues in fiscal year 2005 due to a$3.7 million reduction in selling, general and administrative expensesrecorded in the second fiscal quarter of fiscal year 2004 for the favorableimpact of conclusions of certain sales tax and unclaimed property examinationsfor which the agreed-on settlements were less than the amounts we previouslyestimated. We recorded no corresponding reduction in selling, general andadministrative expenses in fiscal year 2005.

***Income from credit card operations.***  Incomefrom credit card operations, net was $71.6 million, or 1.9% of revenues,in fiscal year 2005 compared to $55.7 million, or 1.6% of revenues, infiscal year 2004. An increase in net income generated by our credit cardportfolio by approximately 0.1% as a percentage of revenues is consistent withthe increase in sales made pursuant to our proprietary credit card program. Inaddition, income from credit card operations, net was higher in fiscal year2005 as compared to fiscal year 2004 by approximately 0.2% due to a$7.6 million reduction in the income generated by our credit cardportfolio in fiscal year 2004 related to the required amortization of thepremium associated with the carrying value of the Retained Interests and SoldInterests during the transition from Off-Balance Sheet Accounting to financingaccounting in fiscal year 2004, as more fully described in Note 6 of thenotes to our audited consolidated financial statements. We recorded nocorresponding decrease in fiscal year 2005.

***Depreciation expense.*** Depreciation expense was $106.3 million, or 2.8% of revenues, in fiscalyear 2005 compared to $98.1 million, or 2.8% of revenues, in fiscal year2004. Included in depreciation expense in fiscal year 2005 are unfavorable netadjustments to depreciation aggregating approximately $5.8 million, or0.2% of revenues, made primarily in the second and third fiscal quarters offiscal year 2005 in connection with our review of the amortization periodsassigned to our leased property and equipment and deferred real estate credits.

***Loss on disposition of Chef’s Catalog.***  InNovember 2004, we completed the Chef’s Catalog Disposition. Chef’s Catalogis a multi-channel retailer of professional-quality kitchenwarewith revenues of approximately $73 million in fiscal year 2004. AtOctober 30, 2004, Chef’s Catalog had net tangible assets, primarilyinventory, of $12.5 million and net intangible assets of$17.2 million. We received proceeds, net of selling costs, of$14.4 million from the sale. As the carrying value of the Chef’s Catalogassets exceeded the net proceeds from the sale, we incurred a pretax loss of$15.3 million in the first fiscal quarter of fiscal year 2005 related tothe Chef’s Catalog Disposition.

***Gain on Credit Card Sale.***  OnJuly 7, 2005, 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 in connectionwith the Credit Card Sale. The total purchase price was approximately$647 million, consisting of approximately $534 million in net cashproceeds and the assumption of approximately $113 million of outstandingdebt under our Credit Card Facility. We recognized a gain of $6.2 millionin connection with the Credit Card Sale. Our proprietary credit card portfoliogenerated income, representing primarily the excess of finance charge income,net of credit losses, of

35

----

approximately $75.4 million in fiscal year 2005. If the Credit CardSale had been consummated as of the first day of fiscal year 2005, we believethe HSBC Program Income for fiscal year 2005 would have been at least$42 million. HSBC and the Company are currently in the process ofimplementing changes to the proprietary credit card program that we expect willbe fully implemented during the fourth quarter of fiscal year 2006. Had suchchanges been fully implemented on the first day of fiscal year 2005, we believethe HSBC Program Income for fiscal year 2005 would have been approximately$56 million.

***Segment operating earnings.***  Operatingearnings for our Specialty Retail stores segment were $377.8 million forfiscal year 2005 compared to $310.6 million for fiscal year 2004. This21.6% increase was primarily the result of increased revenues and margins andnet decreases in both buying and occupancy expenses and selling, general andadministrative expenses as a percentage of revenues.

Operating earnings for Direct Marketing increased to$75.2 million in fiscal year 2005 from $61.3 million for fiscal year2004. This 22.6% increase was primarily the result of increased revenues andmargins and net decreases in both buying and occupancy expenses and selling,general and administrative expenses as a percentage of revenues, partly offsetby a higher level of net markdowns.

***Interest expense, net.***  Netinterest expense was $12.3 million in fiscal year 2005 and$15.9 million in fiscal year 2004.

The net decrease in net interest expense was due to:

·                  increasesin interest income of $4.4 million generated by higher cash balances; and

·                  increasesin capitalized interest charges of $2.3 million associated with storeconstruction and remodeling activities.

The net decrease in interest expense was offset by a$3.5 million increase in the interest expense attributable to the monthlydistributions to the holders of certain interests issued by a trust inconnection with our revolving credit securitization program (the obligationsunder which have been transferred as part of the Credit Card Sale). We begancharging those distributions to interest expense in December 2003 as aresult of the discontinuance of Off-Balance Sheet Accounting (as defined belowunder “ —Critical Accounting Policies—Accounts Receivable—Prior to the CreditCard Sale”).

***Income taxes.***  Oureffective income tax rate was 36.7% for fiscal year 2005 and 36.7% for fiscalyear 2004. The income tax rate for fiscal year 2005 was favorably impacted bytax-exempt interest income, offset by non-deductible transaction costs.  In the fourth fiscal quarter of fiscal year2005, we recognized tax benefits aggregating $7.6 million related to a favorablesettlement associated with previous state tax filings and reductions inpreviously recorded deferred tax liabilities. Excluding these benefits, oureffective tax rate was 38.6% for fiscal year 2005. In the second fiscal quarterof fiscal year 2004, we also recognized a tax benefit of $7.5 millionrelated to favorable settlements associated with previous state tax filings.Excluding this benefit, our effective tax rate was 39.0% for fiscal year 2004.

**Inflation and Deflation**

We believe changes in revenues and net earnings that haveresulted from inflation or deflation have not been material during the periodspresented. In recent years, we have experienced certain inflationary conditionsrelated to 1) increases in product costs due primarily to changes inforeign currency exchange rates that have reduced the purchasing power of theU.S. dollar and 2) increases in SG&A. We purchase a substantialportion of our inventory from foreign suppliers whose costs are affected by thefluctuation of their local currency against the dollar or who price theirmerchandise in currencies other than the dollar. Accordingly, changes in thevalue of the dollar relative to foreign currencies may increase our cost ofgoods sold and if we are unable to pass such cost increases to our customers,our gross margins, and ultimately our earnings, would decrease. Fluctuations inthe euro-U.S. dollar exchange rate affect us most significantly; however, wesource goods from numerous countries and thus are affected by changes in numerouscurrencies and, generally, by fluctuations in the U.S. dollar relative to suchcurrencies. Although we hedge some exposures to changes in foreign currencyexchange rates arising in the ordinary course of business, foreign currencyfluctuations could have a material adverse effect on our business, financialcondition and results of operations in the future. We attempt to offset theeffects of inflation through price increases and control of expenses, althoughour ability to increase prices may be limited by competitive factors. Weattempt to offset the effects of merchandise deflation, which has occurred on alimited basis in recent years, through control of expenses. There is noassurance, however, that inflation or deflation will not materially affect ouroperations in the future.

36

----

**LIQUIDITY ANDCAPITAL RESOURCES**

Our cash requirements consist principally of:

·                  thefunding of our merchandise purchases;

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

·                  debtservice requirements;

·                  incometax payments; and

·                  obligationsrelated to our Pension Plan.

Our primary sources of short-term liquidity are comprisedof cash on hand and availability under our Asset-Based Revolving CreditFacility. The amounts of cash on hand and borrowings under the Asset-BasedRevolving Credit Facility are influenced by a number of factors, includingrevenues, working capital levels, vendor terms, the level of capitalexpenditures, cash requirements related to financing instruments and debtservice obligations following the Transactions, Pension Plan fundingobligations and our tax payment obligations, among others.

Our working capital requirements fluctuate during thefiscal year, increasing substantially during the first and second quarters ofeach fiscal year as a result of higher seasonal levels of inventories.  We have typically financed the increases inworking capital needs during the first and second fiscal quarters with cashflows from operations and, to a lesser extent, with cash provided fromborrowings under our credit facilities. During fiscal year 2006, we financedour seasonal increases in working capital with cash flows from operations andborrowings under our Asset-Based Revolving Credit Facility. During thefirst quarter of fiscal year 2006, we borrowed $150 million under ourAsset-Based Revolving Credit Facility. We repaid these borrowings in thesecond quarter of fiscal year 2006.

We believe that operating cash flows, available vendorfinancing and amounts available pursuant to our senior secured Asset-BasedRevolving Credit Facility will be sufficient to fund our operations,anticipated capital expenditure requirements, debt service obligations,contractual obligations and commitments and Pension Plan funding requirementsthrough the end of fiscal year 2007.

At July 29, 2006, cash and equivalents were$224.8 million compared to $853.4 million at July 30, 2005. This$628.6 million decrease in cash is primarily due to:

·                  higher cash balance at July 30, 2005 as a resultof the net cash proceeds of $533.7 million received from the Credit Card Salein July 2005;

·                  the use of available cash of approximately $666.1million in connection with the consummation of the Transactions in October2005;

·                  higher debt and interest requirements in fiscalyear 2006, including a $100 million voluntary principal repayment on the SeniorSecured Term Loan Facility made in the second quarter; offset, in part by,

·                  pretax net cash proceeds of $40.8 million receivedfor the Gurwitch Disposition in July 2006.

Net cash provided by operating activities was$400.2 million in fiscal year 2006 compared to $845.4 million infiscal year 2005. Cash flows related to operating activities in fiscal year2005 were favorably impacted by 1) the $533.7 million net cash proceedsreceived by the Predecessor in connection with the Credit Card Sale, partiallyoffset by 2) the funding of a $68.8 million increase in accounts receivableprior to the Credit Card Sale.

Net cash used for investing activities was$5,286.1 million fiscal year 2006 which consisted of cash outflows of$5,156.4 million paid to effect the Acquisition and $167.2 million ofcapital expenditures, partially offset by $40.8 million pretax net cashproceeds received in connection with the Gurwitch Disposition. Net cash used ininvesting activities was $228.8 million in fiscal year 2005 primarily for$199.7 million of capital expenditures and $40.7 million cashrestricted for the repayment of the outstanding indebtedness on our Credit CardFacility, offset by $14.4 million in cash proceeds from the sale of

37

----

Chef’s Catalog. We incurred capital expenditures in fiscal year 2006related to the construction of new stores in San Antonio, Boca Raton, Charlotteand Austin and the remodels of our San Francisco, Houston, Beverly Hills andBergdorf Goodman stores. We opened our San Antonio store inSeptember 2005, our Boca Raton store in November 2005 and ourCharlotte store in September 2006.  We planto open the Austin store in March 2007. We currently project capital expenditures for fiscal year 2007 to beapproximately $160 to $170 million.

Net cash provided by financing activities was$4,257.6 million in fiscal year 2006 as compared to net cash used forfinancing activities of $131.5 million in fiscal year 2005. Proceeds fromdebt incurred in connection with the Transactions, net of issuance costs,aggregated $3,222.1 million and cash equity contributions received inconnection with the Transactions aggregated $1,427.7 million. In fiscalyear 2006, we also repaid our $150.0 million of seasonal borrowings underour Asset-Based Revolving Credit Facility, paid $134.7 million forthe redemption of our 2008 Notes pursuant to our call of such notes forredemption in connection with the Transactions and repaid $100.0 millionprincipal amount of borrowings on the Senior Term Loan Facility. In fiscal year2005, we repaid $112.5 million of borrowings under our revolving creditsecuritization program and paid dividends of $27.4 million.

**Financing Structure at July 29, 2006**

Our major sources of funds are comprised of vendorfinancing, a $600.0 million Asset-Based Revolving Credit Facility,$1,875.0 million Senior Secured Term Loan Facility, $700.0 millionSenior Notes, $500.0 million Senior Subordinated Notes,$125.0 million 2028 Debentures and operating leases.

***Senior Secured Asset-Based RevolvingCredit Facility.***  On October 6, 2005, in connection withthe Transactions, NMG entered into a credit agreement and related security andother agreements for a senior secured Asset-Based Revolving CreditFacility with Deutsche Bank Trust Company Americas as administrative agent andcollateral agent. The Asset-Based Revolving Credit Facility providesfinancing of up to $600.0 million, subject to a borrowing base equal to atany time the lesser of 80% of eligible inventory (valued at the lower of costor market value) and 85% of net orderly liquidation value of the eligibleinventory, less certain reserves. The Asset-Based Revolving CreditFacility includes borrowing capacity available for letters of credit and forborrowings on same-day notice. At the closing of the Transactions, NMG utilized$150.0 million of the Asset-Based Revolving Credit Facility forloans and approximately $16.5 million for letters of credit. In the secondquarter of fiscal year 2006, NMG repaid all loans under the Asset-BasedRevolving Credit Facility. As of July 29, 2006, NMG had$570.9 million of unused borrowing availability under the Asset-BasedRevolving Credit Facility based on a borrowing base of over $600.0 millionand after giving effect to $29.1 million used for letters of credit.

The Asset-Based Revolving Credit Facility providesthat NMG has 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 NMG 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 NMG’s 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 NMG’s option, either(a) a base rate determined by reference to the higher of (1) theprime rate of Deutsche Bank Trust Company Americas and (2) the federalfunds effective rate plus 1¤2 of 1% or(b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin. The initial applicable margin is 0% with respect to baserate borrowings and 1.75% with respect to LIBOR borrowings. The applicablemargin is subject to adjustment based on the historical availability under theAsset-Based Revolving Credit Facility. In addition, NMG is required topay a commitment fee of 0.375% per annum in respect of the unutilizedcommitments. If the average revolving loan utilization is 50% or more for anyapplicable period, the commitment fee will be reduced to 0.250% for suchperiod. NMG must also pay customary letter of credit fees and agency fees.

If at any time the aggregate amount of outstanding loans,unreimbursed letter of credit drawings and undrawn letters of credit under theAsset-Based Revolving Credit Facility exceeds the lesser of (i) thecommitment amount and (ii) the borrowing base, NMG 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 theamount available under the Asset-Based Revolving Credit Facility is lessthan $60 million or an event of default has occurred, NMG will be requiredto repay outstanding loans and cash collateralize letters of credit with thecash NMG would then be required to deposit daily in a collection accountmaintained with the agent under the Asset-Based Revolving CreditFacility. NMG may voluntarily reduce the unutilized portion of the commitmentamount and repay outstanding loans at any time without premium or penalty otherthan customary “breakage” costs with respect

38

----

to LIBOR loans. There is no scheduled amortization under the Asset-BasedRevolving Credit Facility; the principal amount of the loans outstanding is dueand payable in full on October 6, 2010.

All obligations under the Asset-Based RevolvingCredit Facility are guaranteed by the Company and certain of NMG’s existing andfuture domestic subsidiaries (excluding, among others, Kate Spade LLC). As ofJuly 29, 2006, the liabilities of NMG’s non-guarantor subsidiaries totaledapproximately $21.0 million, or 0.4% of consolidated liabilities, and theassets of NMG’s non-guarantor subsidiaries aggregated approximately$143.3 million, or 2.2% of consolidated total assets. All obligationsunder NMG’s Asset-Based Revolving Credit Facility, and the guarantees ofthose obligations, are secured, subject to certain significant exceptions, bysubstantially all of the assets of the Company and NMG and NMG’s subsidiariesthat have guaranteed the Asset-Based Revolving Credit Facility(subsidiary guarantors), including:

·                  afirst-priority security interest in personal property consisting ofinventory and related accounts, cash, deposit accounts, all payments receivedby NMG or the subsidiary guarantors from credit card clearinghouses andprocessors or otherwise in respect of all credit card charges for sales ofinventory by NMG and the subsidiary guarantors, certain related assets andproceeds of the foregoing; and

·                  asecond-priority pledge of 100% of NMG’s capital stock and certain of thecapital stock held by NMG, the Company or any subsidiary guarantor (whichpledge, in the case of any foreign subsidiary is limited to 100% of thenon-voting stock (if any) and 65% of the voting stock of such foreignsubsidiary); and

·                  asecond-priority security interest in, and mortgages on, substantially allother tangible and intangible assets of NMG, the Company and each subsidiaryguarantor, including a significant portion of NMG’s material owned and leasedreal property (which currently consists of approximately half of NMG’sfull-line retail stores) and equipment.

Capital stock and other securities of a subsidiary of NMGthat are owned by NMG or any subsidiary guarantor will not constitutecollateral under NMG’s Asset-Based Revolving Credit Facility to theextent that such securities cannot secure NMG’s 2028 Debentures or othersecured public debt obligations without requiring the preparation and filing ofseparate financial statements of such subsidiary in accordance with applicableSEC rules. As a result, the collateral under NMG’s Asset-Based RevolvingCredit Facility will include shares of capital stock or other securities ofsubsidiaries of NMG or any subsidiary guarantor only to the extent that theapplicable value of such securities (on a subsidiary-by-subsidiary basis) isless than 20% of the aggregate principal amount of the 2028 Debentures or othersecured public debt obligations of NMG. Stock of Kate Spade LLC and its assetsalso will not constitute collateral under NMG’s Asset-Based RevolvingCredit Facility.

NMG’s Asset-Based Revolving Credit Facilitycontains a number of covenants that, among other things and subject to certainsignificant exceptions, restrict its ability and the ability of itssubsidiaries to:

·                  incuradditional indebtedness;

·                  paydividends on NMG’s capital stock or redeem, repurchase or retire NMG’s capitalstock or indebtedness;

·                  makeinvestments, loans, advances and acquisitions;

·                  createrestrictions on the payment of dividends or other amounts to NMG from itssubsidiaries that are not guarantors;

·                  engagein transactions with NMG’s affiliates;

·                  sellassets, including capital stock of NMG’s subsidiaries;

·                  consolidateor merge;

·                  createliens; and

·                  enterinto sale and lease back transactions.

The covenants limiting dividends and other restrictedpayments; investments, loans, advances and acquisitions; and prepayments orredemptions of other indebtedness, each permit the restricted actions in anunlimited amount, subject to the

39

----

satisfaction of certain payment conditions, principally that NMG musthave at least $75.0 million of pro forma excess availability under theAsset-Based Revolving Credit Facility and that NMG must be in pro formacompliance with the fixed charge coverage ratio described below.

Although the credit agreement governing the Asset-BasedRevolving Credit Facility does not require NMG to comply with any financialratio maintenance covenants, if less than $60.0 million were available tobe borrowed under the Asset-Based Revolving Credit Facility at any time,NMG would not be permitted to borrow any additional amounts unless its 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 creditagreement also contains customary affirmative covenants and events of default.

***Senior Secured Term Loan Facility.***  OnOctober 6, 2005, in connection with the Transactions, NMG entered into acredit agreement and related security and other agreements for a$1,975.0 million Senior Secured Term Loan Facility with Credit Suisse asadministrative agent and collateral agent. The full amount of the SeniorSecured Term Loan Facility was borrowed on October 6, 2005. In the secondquarter of fiscal year 2006, NMG repaid $100.0 million principal amount ofthe loans under the Senior Secured Term Loan Facility.

Borrowings under the Senior Secured Term Loan Facilitybear interest at a rate per annum equal to, at NMG’s 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¤2 of 1% or(b) a LIBOR rate, subject to certain adjustments, in each case plus an applicablemargin. The applicable margin is 1.5% with respect to base rate borrowings and2.5% with respect to LIBOR borrowings. The interest rate on the outstandingborrowings pursuant to the Senior Secured Term Loan Facility was 7.77% atJuly 29, 2006.

The credit agreement governing the Senior Secured TermLoan Facility requires NMG to prepay outstanding term loans with 50% (whichpercentage will be reduced to 25% if NMG’s total leverage ratio is less than aspecified ratio and will be reduced to 0% if NMG’s total leverage ratio is lessthan a specified ratio) of its annual excess cash flow (as defined in thecredit agreement).  For fiscal year 2006,NMG was not required to prepay any outstanding term loans pursuant to theannual excess cash flow requirements.  Ifa change of control (as defined in the credit agreement) occurs, NMG will berequired to offer to prepay all outstanding term loans, at a prepayment priceequal to 101% of the principal amount to be prepaid, plus accrued and unpaidinterest to the date of prepayment. NMG also must offer to prepay outstandingterm loans at 100% of the principal amount to be prepaid, plus accrued andunpaid interest, with the proceeds of certain asset sales under certaincircumstances.

NMG may voluntarily prepay outstanding loans under theSenior Secured Term Loan Facility at any time without premium or penalty otherthan customary “breakage” costs with respect to LIBOR loans. If NMG repays allor any portion of the Senior Secured Term Loan Facility prior toOctober 6, 2006 (other than a prepayment that is made with certaindesignated asset sale proceeds), NMG must pay 101% of the principal amount tobe repaid. There is no scheduled amortization under the Senior Secured TermLoan Facility. The principal amount of the loans outstanding is due and payablein full on April 6, 2013.

All obligations under the Senior Secured Term LoanFacility are unconditionally guaranteed by the Company and each direct andindirect domestic subsidiary of NMG that guarantees the obligations of NMGunder its Asset-Based Revolving Credit Facility. All obligations underthe Senior Secured Term Loan Facility, and the guarantees of those obligations,are secured, subject to certain significant exceptions, by substantially all ofthe assets of the Company, NMG and the subsidiary guarantors, including:

·                  afirst-priority pledge of 100% of NMG’s capital stock and certain of thecapital stock held by NMG, the Company or any subsidiary guarantor (whichpledge, in the case of any foreign subsidiary is limited to 100% of thenon-voting stock (if any) and 65% of the voting stock of such foreignsubsidiary); and

·                  afirst-priority security interest in, and mortgages on, substantially allother tangible and intangible assets of NMG, the Company and each subsidiaryguarantor, including a significant portion of NMG’s material owned and leasedreal property (which currently consists of approximately half of NMG’sfull-line retail stores) and equipment, but excluding, among other things, thecollateral described in the following bullet point; and

·                  asecond-priority security interest in personal property consisting ofinventory and related accounts, cash, deposit accounts, all payments receivedby NMG or the subsidiary guarantors from credit card clearinghouses and processorsor otherwise in respect of all credit card charges for sales of inventory byNMG and the subsidiary guarantors, certain related assets and proceeds of theforegoing.

Capital stock and other securities of a subsidiary of NMGthat are owned by NMG or any subsidiary guarantor will not constitutecollateral under NMG’s Senior Secured Term Loan Facility to the extent thatsuch securities cannot secure the 2028

40

----

Debentures or other secured public debt obligations without requiringthe preparation and filing of separate financial statements of such subsidiaryin accordance with applicable SEC rules. As a result, the collateral under NMG’sSenior Secured Term Loan Facility will include shares of capital stock or othersecurities of subsidiaries of NMG or any subsidiary guarantor only to theextent that the applicable value of such securities (on asubsidiary-by-subsidiary basis) is less than 20% of the aggregate principalamount of the 2028 Debentures or other secured public debt obligations of NMG.Stock of Kate Spade LLC and its assets also will not constitute collateralunder NMG’s Senior Secured Term Loan Facility.

The credit agreement governing the Senior Secured TermLoan Facility contains a number of negative covenants that are substantiallysimilar to those governing the Senior Notes and additional covenants related tothe security arrangements for the Senior Secured Term Loan Facility. The creditagreement also contains customary affirmative covenants and events of default.

***2028 Debentures.***  InMay 1998, NMG issued $125.0 million aggregate principal amount of its7.125% 2028 Debentures. In connection with the Transactions, NMG equally andratably secured the 2028 Debentures by a first lien security interest oncertain collateral subject to liens granted under NMG’s Senior Secured CreditFacilities constituting (a) (i) 100% of the capital stock of certain ofNMG’s existing and future domestic subsidiaries, and (ii) 100% of thenon-voting stock and 65% of the voting stock of certain of NMG’s existing andfuture foreign subsidiaries and (b) certain of NMG’s principal propertiesthat include approximately half of NMG’s full-line stores, in each case, to theextent required by the terms of the indenture governing the 2028 Debentures.The 2028 Debentures contain covenants that restrict NMG’s ability to createliens and enter into sale and lease back transactions. The collateral securingthe 2028 Debentures will be released upon the release of liens on suchcollateral under NMG’s Senior Secured Credit Facilities and any other debt(other than the 2028 Debentures) secured by such collateral. Capital stock andother securities of a subsidiary of NMG that are owned by NMG or any subsidiarywill not constitute collateral under the 2028 Debentures to the extent suchproperty does not constitute collateral under NMG’s Senior Secured CreditFacilities, as described above. The 2028 Debentures are guaranteed on anunsecured, senior basis by the Company.

***Senior Notes.**** *On October 6, 2005,Newton Acquisition Merger Sub, Inc. issued $700.0 million aggregateoriginal principal amount of 9.0% / 9.75% Senior Notes under a senior indenture(Senior Indenture) with Wells Fargo Bank, National Association, as trustee. Atthe closing of the Transactions, as the surviving corporation in theAcquisition, NMG assumed all the obligations of Newton Acquisition MergerSub, Inc. under the Senior Indenture. The Senior Notes mature onOctober 15, 2015.

For any interest payment period through October 15,2010, NMG 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 Senior Notes accrues at the rate of 9% perannum. PIK Interest on the Senior Notes accrues at the rate of 9.75% per annum.After October 15, 2010, NMG will make all interest payments on the SeniorNotes entirely in cash. All Senior Notes mature on October 15, 2015 andhave the same rights and benefits as the senior notes issued on October 6,2005. Interest on the Senior Notes is payable quarterly in arrears on eachJanuary 15, April 15, July 15 and October 15, commencing onJanuary 15, 2006.

The Senior Notes are fully and unconditionally guaranteedon a joint and several unsecured, senior basis, by each of NMG’s wholly-owneddomestic subsidiaries that guarantee NMG’s obligations under its Senior SecuredCredit Facilities and by the Company. The Senior Notes and the guaranteesthereof are NMG’s and the guarantors’ unsecured, senior obligations and rank(i) equal in the right of payment with all of NMG’s and the guarantors’existing and future senior indebtedness, including any borrowings under NMG’sSenior Secured Credit Facilities and the guarantees thereof and NMG’s 2028Debentures; and (ii) senior to all of NMG’s and its guarantors’ existingand future subordinated indebtedness, including the Senior Subordinated Notesdue 2015 and the guarantees thereof. The Senior Notes also are effectively juniorin priority to NMG’s and its guarantors’ obligations under all securedindebtedness, including NMG’s Senior Secured Credit Facilities, the 2028Debentures, and any other secured obligations of NMG, in each case, to theextent of the value of the assets securing such obligations. In addition, theSenior Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of NMG’s subsidiaries that are notproviding guarantees.

NMG is not required to make any mandatory redemption orsinking fund payments with respect to the Senior Notes, but under certaincircumstances, NMG may be required to offer to purchase Senior Notes asdescribed below. NMG may from time to time acquire Senior Notes by means otherthan a redemption, whether by tender offer, in open market purchases, throughnegotiated transactions or otherwise, in accordance with applicable securitieslaws.

Except as described below, the Senior Notes are notredeemable at NMG’s option prior to October 15, 2010. From and afterOctober 15, 2010, NMG may redeem the Senior Notes, in whole or in part, ata redemption price equal to 104.5% of

41

----

principal amount, declining annually to 100% of the principal amount onOctober 15, 2013, plus accrued and unpaid interest, and AdditionalInterest (as defined in the Senior Indenture), if any, thereon to theapplicable redemption date.

Prior to October 15, 2008, NMG may, at its option,subject to certain conditions, redeem up to 35% of the original aggregateprincipal amount of Senior Notes at a redemption price equal to 109% of theaggregate 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 NMG or any direct or indirectparent of NMG to the extent such net proceeds are contributed to NMG. At anytime prior to October 15, 2010, NMG also may redeem all or a part of theSenior Notes at a redemption price equal to 100% of the principal amount of SeniorNotes redeemed plus an applicable premium, as provided in the Senior Indenture,as of, and accrued and unpaid interest and Additional Interest, if any, to theredemption date.

Upon the occurrence of a change of control (as defined inthe Senior Indenture), each holder of the Senior Notes has the right to requireNMG to repurchase some or all of such holder’s Senior Notes at a price in cashequal to 101% 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 Notes containscovenants that limit NMG’s ability and certain of its subsidiaries’ ability to:

·                  incuradditional indebtedness;

·                  paydividends on NMG’s capital stock or redeem, repurchase or retire NMG’s capitalstock or subordinated indebtedness;

·                  makeinvestments;

·                  createrestrictions on the payment of dividends or other amounts to NMG from itsrestricted subsidiaries that are not guarantors of the notes;

·                  engagein transactions with NMG’s affiliates;

·                  sellassets, including capital stock of NMG’s subsidiaries;

·                  consolidateor merge;

·                  createliens; and

·                  enterinto sale and lease back transactions.

NMG’s majority interest in Kate Spade LLC is not subjectto the covenants contained in the Senior Indenture. The Senior Indenture alsoprovides for events of default, which, if any of them occurs, would permit orrequire the principal, premium, if any, interest and any other monetaryobligations on all outstanding Senior Notes to be due and payable immediately.

***Senior Subordinated Notes.**** *On October 6, 2005,Newton Acquisition Merger Sub, Inc. issued $500.0 million aggregateprincipal amount of 10.375% Senior Subordinated Notes under a seniorsubordinated indenture (Senior Subordinated Indenture) with Wells Fargo Bank,National Association, as trustee. At the closing of the Transactions, as thesurviving corporation in the Acquisition, NMG assumed all the obligations ofNewton Acquisition Merger Sub, Inc. under the Senior Subordinated Indenture.The Senior Subordinated Notes mature on October 15, 2015. Interest on theSenior Subordinated Notes is payable in cash semi-annually in arrears on eachApril 15 and October 15, commencing April 15, 2006.

The Senior Subordinated Notes are fully and unconditionallyguaranteed, on a joint and several unsecured, senior subordinated basis, byeach of NMG’s wholly-owned domestic subsidiaries that guarantee NMG’sobligations under its Senior Secured Credit Facilities and by the Company. TheSenior Subordinated Notes and the guarantees thereof are NMG’s and theguarantors’ unsecured, senior subordinated obligations and rank (i) juniorto all of NMG’s and the guarantors’ existing and future senior indebtedness,including the Senior Notes and any borrowings under NMG’s Senior Secured CreditFacilities, and the guarantees thereof and NMG’s 2028 Debentures;(ii) equally with any of NMG’s and the guarantors’ future seniorsubordinated indebtedness; and (iii) senior to any of NMG’s and theguarantors’ future subordinated indebtedness. In addition, the SeniorSubordinated Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of NMG’s subsidiaries that are notproviding guarantees.

42

----

NMG is not required to make any mandatory redemption orsinking fund payments with respect to the Senior Subordinated Notes, but, undercertain circumstances, NMG may be required to offer to purchase SeniorSubordinated Notes as described below. NMG may from time to time acquire SeniorSubordinated Notes by means other than a redemption, whether by tender offer,in open market purchases, through negotiated transactions or otherwise, inaccordance with applicable securities laws.

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

Prior to October 15, 2008, NMG may, at its option,subject to certain conditions, redeem up to 35% of the original aggregateprincipal amount of Senior Subordinated Notes at a redemption price equal to110.375% of the aggregate principal amount thereof, plus accrued and unpaidinterest, and Additional Interest, if any, thereon to the redemption date, withthe net cash proceeds of one or more equity offerings of NMG or any direct orindirect parent of NMG to the extent such net proceeds are contributed to NMG.

At any time prior to October 15, 2010, NMG also mayredeem all or a part of the Senior Subordinated Notes at a redemption priceequal to 100% of the principal amount of Senior Subordinated Notes redeemedplus an applicable premium, as provided in the Senior Subordinated Indenture,as of, and accrued and unpaid interest and Additional Interest, if any, to theredemption date.

Upon the occurrence of a change of control (as defined inthe Senior Subordinated Indenture), NMG will make an offer to purchase all ofthe Senior Subordinated Notes at a price in cash equal to 101% of the aggregateprincipal amount thereof plus accrued and unpaid interest, and AdditionalInterest, if any, to the date of purchase.

The indenture governing the Senior Subordinated Notescontains covenants substantially similar to those applicable to NMG’s SeniorNotes described above. The Senior Subordinated Indenture also provides forevents of default, which, if any of them occurs, would permit or require theprincipal, premium, if any, interest and any other monetary obligations on alloutstanding Senior Notes to be due and payable immediately, subject to certainexceptions.

***Redemption of 2008 Notes.***  InMay 1998, NMG issued $125.0 million aggregate principal amount of its2008 Notes. Upon closing of the Transactions, NMG called its 2008 Notes forredemption pursuant to their terms. On November 7, 2005, NMG used$134.7 million of reserved cash to redeem its 2008 Notes, which included acall premium of $6.2 million plus accrued interest of $3.5 millionthrough the redemption date.

***Interest Rate Swaps.***  NMG usesderivative financial instruments to help manage its interest rate risk.Effective December 6, 2005, NMG entered into floating to fixed interestrate swap agreements for an aggregate notional amount of $1,000.0 millionto limit its exposure to interest rate increases related to a portion of itsfloating rate indebtedness. The interest rate swap agreements terminate afterfive years. As of the effective date, NMG designated the interest rate swaps ascash flow hedges. As a result, changes in the fair value of NMG’s swaps arerecorded subsequent to the effective date as a component of other comprehensiveincome.

At July 29, 2006, the fair value of NMG’s interestrate swap agreements was a gain of approximately $20.2 million, whichamount is included in other assets. As a result of the swap agreements, NMG’seffective fixed interest rates as to the $1,000.0 million in floating rateindebtedness will range from 6.931% to 7.499% per quarter and result in anaverage fixed rate of 7.285%.

43

----

**Contractual Obligations and Commitments**

The following table summarizes our estimated significantcontractual cash obligations at July 29, 2006:
|                                         | ** ** | **Payments Due By Period** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|
| **(in thousands)**                 | ** ** | **Total**                                 | ** ** | **Fiscal Year  2007** | ** ** | **Fiscal  Years  2008-2009** | ** ** | **Fiscal  Years  2010-2011** | ** ** | **Fiscal Year  2012 and  Beyond** | ** ** |
| Contractual  obligations:               |       |                                      |       |   |   |   |   |   |   |   |   |
| Senior Secured  Term Loan Facility (1)  |       | $                                         | 1,875,000  |   | $ | — |   | $ | — |   | $ | — |   | $ | 1,875,000 |   |
| Senior Notes                            |       | 700,000                                   |       | — |   | — |   | — |   | 700,000 |   |
| Senior  Subordinated Notes              |       | 500,000                                   |       | — |   | — |   | — |   | 500,000 |   |
| 2028 Debentures                         |       | 125,000                                   |       | — |   | — |   | — |   | 125,000 |   |
| Interest  requirements (2)              |       | 2,124,000                                 |       | 267,000 |   | 534,000 |   | 540,000 |   | 783,000 |   |
| Operating lease  obligations            |       | 808,900                                   |       | 47,800 |   | 99,400 |   | 93,500 |   | 568,200 |   |
| Minimum pension  funding obligation (3) |       | —                                    |       | — |   | — |   | — |   | — |   |
| Other long-term  liabilities (4)        |       | 68,500                                    |       | 8,100 |   | 13,500 |   | 11,400 |   | 35,500 |   |
| Construction  commitments               |       | 235,000                                   |       | 97,800 |   | 137,200 |   | — |   | — |   |
| Inventory  purchase commitments (5)     |       | 953,900                                   |       | 953,900 |   | — |   | — |   | — |   |
|                                    |       | $                                         | 7,390,300  |   | $ | 1,374,600 |   | $ | 784,100 |   | $ | 644,900 |   | $ | 4,586,700 |   |

 

----

(1)           $100.0 millionof term loans under this facility were repaid in the second quarter of fiscalyear 2006.  The above table does notreflect future excess cash flow prepayments, if any, that may be required underthe term loan facility.

(2)           The cash obligations forinterest requirements reflect 1) interest requirements on our fixed-rate debtobligations at their contractual rates, 2) interest requirements on floatingrate debt obligations not subject to interest rate swaps at rates in effect atJuly 29, 2006 and 3) interest requirements on floating rate debt obligationssubject to interest rate swaps at the fixed rates provided through the swapagreements.  A 1% increase in thefloating rates related to floating rate debt outstanding at July 29, 2006 notsubject to interest rate swaps would increase annual interest rate requirementsby approximately $8.8 million.

(3)           Minimum pensionfunding requirements are not included above as such amounts are not currentlyquantifiable for all periods presented. In fiscal year 2007, we do not believe we will be required to make anycontributions to our Pension Plan for the plan year ended July 31, 2006.

(4)           Other long-termliabilities of $192.2 million reflected on our balance sheet atJuly 29, 2006 include our obligations related to our supplementalretirement and postretirement health care benefit plans. The other long-termliabilities payments primarily include the expected benefit payments for theseobligations (through 2015), as currently estimated by our actuaries. The timingof the expected payments for our remaining long-term liabilities, primarily forother employee benefit plans and arrangements, are not currently estimable.

(5)           In the normal courseof our business, we issue purchase orders to vendors/suppliers for merchandise.Our purchase orders are not unconditional commitments but, rather representexecutory contracts requiring performance by the vendors/suppliers, includingthe delivery of the merchandise prior to a specified cancellation date and thecompliance with product specifications, quality standards and otherrequirements. In the event of the vendor’s failure to meet the agreed uponterms and conditions, we may cancel the order.

44

----

The following table summarizes the expiration of oursignificant commercial commitments outstanding at July 29, 2006:
|                                                           | ** ** | **Amount of Commitment by Expiration Period** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **(in thousands)**                                   | ** ** | **Total**                                                              | ** ** | **Fiscal Year  2007** | ** ** | **Fiscal  Years  2008-2009** | ** ** | **Fiscal  Years  2010-2011** | ** ** | **Fiscal Year  2012 and  Beyond** | ** ** |
| Other commercial  commitments:                            |       |                                                                   |       |   |   |   |   |   |   |   |   |
| Senior secured  asset-based revolving credit  facility(1) |       | $                                                                      | 600,000    |   | $ | — |   | $ | — |   | $ | — |   | $ | 600,000 |   |
| Other lending  facilities                                 |       | 7,600                                                                  |       | 7,600 |   | — |   | — |   | — |   |
| Surety bonds                                              |       | 4,000                                                                  |       | 4,000 |   | — |   | — |   | — |   |
|                                                      |       | $                                                                      | 611,600    |   | $ | 11,600 |   | $ | — |   | $ | — |   | $ | 600,000 |   |

----

(1)           As of July 29,2006, we had no borrowings outstanding under our new senior secured asset-basedrevolving credit facility and had $570.9 million of unused borrowingavailability, after giving effect to $29.1 million of outstanding letters ofcredit. Our working capital requirements are greatest in the first and secondfiscal quarters as a result of higher seasonal requirements. See “Descriptionof Other Indebtedness—Senior Secured Asset-Based Revolving Credit Facility”and “Management’s Discussion and Analysis of Financial Conditions and Resultsof Operations—Seasonality.”

In addition to the items presented above, our otherprincipal commercial commitments are comprised of common area maintenancecosts, tax and insurance obligations and contingent rent payments.

At August 1, 2006 (the most recent measurementdate), our actuarially calculated projected benefit obligation for our PensionPlan was $364.7 million and the fair value of the assets was$293.7 million. Our policy is to fund the Pension Plan at or above theminimum amount required by law. In fiscal year 2006, we did not make anyvoluntary contributions to the Pension Plan. In fiscal year 2005, we made avoluntary contribution of $20.0 million in the third fiscal quarter forthe plan year ended July 31, 2004. Based upon currently available information, we will not be required tomake contributions in fiscal year 2007 to the Pension Plan for the plan yearended July 31, 2006.

***Investment in KateSpade LLC.***  We currently own a 56% interest in Kate SpadeLLC, which designs and markets high-end designer handbags and accessories.  A minority investor owns the remaining 44%interest.  Our investment in andrelationship with Kate Spade LLC are governed by an operating agreementthat provides for an orderly transition process in the event either investorwishes to sell its interest, or purchase the other investor’s interest. Amongother things, this operating agreement contains currently exercisable putoption provisions entitling the minority investor to put its interest to us,and currently exercisable call option provisions entitling us to purchase theminority investor’s interest, at a purchase price mutually agreed to by theparties. The purchase price will be determined by the parties or, in the eventthe parties are unable to agree on a mutually acceptable price, by a mutuallyacceptable nationally recognized investment banking firm, subject to certainconditions. We may elect to defer the consummation of a put option for a periodof six months by cooperating with the minority investor in seeking either asale of Kate Spade LLC to a third party or a public offering of KateSpade LLC’s securities. If a sale to a third party or public offering ofKate Spade LLC’s securities is not consummated within six months after theexercise of the put option (which period may be automatically extended for anadditional two months if a registration statement for Kate Spade LLC isfiled with the SEC), we are obligated to consummate the put option. Under theterms of the Kate Spade LLC operating agreement, consummation of the putoption shall occur within thirty days after the determination of the valuationwith respect to the exercise of the put option, unless we have elected to deferthe consummation of the put option for the six-month period referred to above,and should a third party sale or public offering of Kate Spade LLC occurwithin such six-month period, we are required to pay the minority investor theexcess, if any, of the put option valuation price for its interest over theamount it realizes through the third party sale or public offering.

In April 2005, the minority investor in Kate SpadeLLC exercised the put option described above with respect to the full amount ofits stake in such company. We subsequently entered into a standstill agreementto postpone the put process while we engaged in discussions with the minorityinvestor in Kate Spade LLC regarding certain strategic alternatives, includingthe possible sale of such company. The standstill agreement, as extended,expired on March 21, 2006, but the parties are continuing to pursuediscussions regarding a possible sale of such company while the put valuationprocess proceeds. Although such discussions are ongoing, no assurance can begiven that they will ultimately lead to any transaction. It is possible that wemay be required to purchase the shares of the minority investor in Kate SpadeLLC pursuant to the option as early as the second quarter of fiscal year 2007.

45

----

**OTHER MATTERS**

**Factors That May Affect Future Results**

Matters discussed in MD&Ainclude forward-looking statements. Forward-looking statementsgenerally can be identified by the use of forward-looking terminologysuch as “may,” “plan,” “predict,” “expect,” “estimate,” “intend,” “would,” “could,”“should,” “anticipate,” “believe,” “project” or “continue.” We make theseforward-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 futureperformance include, but are not limited, to:

*Political and General EconomicConditions*

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

·                  terroristactivities in the United States and elsewhere;

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

*Customer Demographic Issues*

·                  changes in thedemographic or retail environment;

·                  changes inconsumer confidence resulting in a reduction of discretionary spending ongoods;

·                  changes inconsumer preferences or fashion trends;

·                  changes in ourrelationships with key customers;

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

*Merchandise Procurement and SupplyChain Considerations*

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

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

·                  changes inforeign currency exchange or inflation rates;

·                  significantincreases in paper, printing and postage costs;

*Industry and Competitive Factors*

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

·                  seasonality ofthe retail business;

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

·                  delays inanticipated store openings and renovations;

·                  our success inenforcing our intellectual property rights;

46

----

*Employee Considerations*

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

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

*Legal and Regulatory Issues*

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

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

*Leverage Considerations*

·                  the effects ofincurring a substantial amount of indebtedness under our senior secured creditfacilities and our senior notes and senior subordinated notes;

·                  the effects uponus of complying with the covenants contained in our senior secured creditfacilities and the indentures governing our senior notes and seniorsubordinated notes; and

·                  restrictions theterms and conditions of the indebtedness under our senior secured creditfacilities may place on our ability to respond to changes in our business or totake certain actions.

*Other Factors*

·                  impact offunding requirements related to our noncontributory defined benefit pensionplan;

·                  the design andimplementation of new information systems as well as enhancements of existingsystems; and

·                  other risks,uncertainties and factors set forth in this Annual Report on Form 10-K,including those set forth in Item 1A, “Risk Factors”.

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

**Critical Accounting Policies**

Our accounting policies are more fully described inNote 1 of the notes to our audited consolidated financial statementsappearing elsewhere in this prospectus. As disclosed in Note 1 of thenotes to our audited consolidated financial statements, the preparation offinancial statements in conformity with generally accepted accountingprinciples requires us to make estimates and assumptions about future events.These estimates and assumptions affect the amounts of assets, liabilities,revenues and expenses and the disclosure of gain and loss contingencies at thedate of our audited consolidated financial statements appearing elsewhere inthis prospectus.

While we believe that our past estimates and assumptionshave been materially accurate, the amounts we have currently estimated aresubject to change if different assumptions as to the outcome of future eventswere made. We evaluate our estimates and judgments on an ongoing basis andpredicate those estimates and judgments on historical experience and on variousother factors that we believe to be reasonable under the circumstances. We makeadjustments to our assumptions and judgments when facts and circumstancesdictate. Since future events and their effects cannot be determined withabsolute certainty, actual results may differ from the estimates used inpreparing the accompanying audited consolidated financial statements.

We believe the following critical accounting policiesencompass the more significant judgments and estimates used in the preparationof our audited consolidated financial statements.

47

----

***Purchase Accounting*. **Wehave accounted for the Acquisition in accordance with the provisions ofStatement of Financial Accounting Standards No. 141, “Business Combinations,”(SFAS  No. 141) whereby the purchaseprice paid to effect the Acquisition is allocated to state the acquired assetsand liabilities at fair value. The Acquisition and the allocation of thepurchase price have been recorded as of October 1, 2005, the beginning ofour October 2005 accounting period. In connection with the purchase priceallocation, we have made estimates of the fair values of our long-lived andintangible assets based upon assumptions related to future cash flows, discountrates and asset lives utilizing currently available information which resultedin increases in  the carrying value ofour property and equipment and inventory, the recording of intangible assetsfor our tradenames, customer lists and favorable lease commitments and therevaluation of our long-term benefit plan obligations, among other things.

***Revenues.***  Revenuesinclude sales of merchandise and services, net commissions earned from leaseddepartments in our retail stores and delivery and processing revenues relatedto merchandise sold. Revenues from our retail operations are recognized at thelater of the point of sale or the delivery of goods to the customer. Revenuesfrom Direct Marketing are recognized when the merchandise is delivered to thecustomer. We maintain reserves for anticipated sales returns primarily based onour historical trends related to returns by our retail and direct marketingcustomers. Our reserves for anticipated sales returns aggregated$43.7 million at July 29, 2006, $35.2 million at July 30,2005 and $30.8 million at July 31, 2004.

***MerchandiseInventories and Cost of Goods Sold.***  We utilizethe retail method of accounting for substantially all of our merchandiseinventories. Merchandise inventories are stated at the lower of cost or market.The retail inventory method is widely used in the retail industry due to itspracticality.

Under the retail inventory method, the valuation ofinventories at cost and the resulting gross margins are determined by applyinga calculated cost-to-retail ratio, for various groupings of similar items, tothe retail value of inventories. The cost of the inventory reflected on theconsolidated balance sheets is decreased by charges to cost of goods sold atthe time the retail value of the inventory is lowered through the use of markdowns.Hence, earnings are negatively impacted when merchandise is marked down.

The areas requiring significant management judgmentrelated to the valuation of our inventories include (1) setting theoriginal retail value for the merchandise held for sale, (2) recognizingmerchandise for which the customer’s perception of value has declined andappropriately marking the retail value of the merchandise down to the perceivedvalue and (3) estimating the shrinkage that has occurred between physicalinventory counts. These judgments and estimates, coupled with the averagingprocesses within the retail method can, under certain circumstances, producevarying financial results. Factors that can lead to different financial resultsinclude (1) determination of original retail values for merchandise heldfor sale, (2) identification of declines in perceived value of inventoriesand processing the appropriate retail value markdowns and (3) overlyoptimistic or conservative estimation of shrinkage. We believe our merchandisevaluation and pricing controls minimize the risk that our inventory valueswould be materially misstated.

Consistent with industry business practice, we receiveallowances from certain of our vendors in support of the merchandise wepurchase for resale. We receive certain allowances to reimburse us formarkdowns taken and/or to support the gross margins earned in connection withthe sales of the vendor’s merchandise. We recognize these allowances as anincrease to gross margin when the allowances are earned and approved by thevendor. Other allowances we receive represent reductions to the amounts paid toacquire the merchandise. We recognize these allowances as a reduction in thecost of the acquired merchandise resulting in an increase to gross margin atthe time the goods are sold. The amount of vendor reimbursements we receiveddid not have a significant impact on the year-over-year change in gross marginduring fiscal year 2006, fiscal year 2005 or fiscal year 2004. We receivedvendor reimbursements of $88.9 million in fiscal year 2006,$82.8 million in fiscal year 2005 and $79.3 million in fiscal year2004.

***Accounts Receivable and Income from CreditCard Operations.***  We sold our proprietary credit card accountsto HSBC on July 7, 2005 (Credit Card Sale).  As a part of the Credit Card Sale, we enteredinto a long-term marketing and servicing alliance with HSBC. Under the terms ofthis alliance, HSBC offers credit card and non-card payment plans bearing our brandsand we receive ongoing payments from HSBC based on credit card sales andcompensation for marketing and servicing activities (HSBC Program Income).  We recognize HSBC Program Income when earned.

Prior to the Credit Card Sale, we extended credit tocertain of our customers pursuant to our proprietary retail credit cardprogram.  Our credit card operationsgenerated finance charge income, net of credit losses, which was recognized asincome when earned and we maintained reserves for potential credit losses. Weevaluated the collectibility of our accounts receivable based on a combinationof factors, including analysis of historical trends, aging of accountsreceivable, write-off experience and expectations of future performance.

48

----

In connection witha revolving Credit Card Facility (Credit Card Facility) established inSeptember 2000, we transferred substantially all of our credit card receivablesto a wholly-owned subsidiary which in turn sold such receivables to the NeimanMarcus Credit Card Master Trust (Trust). In connection with the Credit Card Sale, HSBC assumed our outstandingobligations pursuant to the Credit Card Facility.

At the inception of the Credit Card Facility in September 2000, theTrust issued certificates representing undivided interests in the credit cardreceivables to both third-party investors (Sold Interests) and to NMG(Retained Interests).  We held RetainedInterests represented by the Class B Certificate ($23.8 million facevalue), the Class C Certificate ($68.2 million face value) and theSeller’s Certificate (representing the excess of the total receivables sold tothe Trust over the Sold Interests and the Class B and Class CCertificates). In addition, we held rights to certain residual cash flowscomprised of excess finance charge collections (IO Strip).  From the inception of the Credit CardFacility until December 2003, our transfers and sales of credit cardreceivables pursuant to the terms of the Credit Card Facility were accountedfor as sales (Off-Balance Sheet Accounting). During the periods for which themonthly transfers to the Trust qualified for Off-Balance Sheet Accounting, werecognized income on our Retained Interests on the basis of their estimatedyield to maturity and gains on the Sold Interests arising from the monthlytransfers of new credit card receivables to the Trust.

Under the Credit Card Facility, we serviced the credit card receivablesfor a contractually defined servicing fee. We earned servicing fees of$5.4 million in fiscal year 2005 and $6.3 million in fiscal year2004.

***Long-lived Assets.***  Propertyand equipment are stated at historical cost less accumulated depreciation. Forfinancial reporting purposes, we compute depreciation principally using thestraight-line method over the estimated useful lives of the assets. Buildingsand improvements are depreciated over five to 30 years while fixtures andequipment are depreciated over three to 15 years. Leasehold improvementsare amortized over the shorter of the asset life or the lease term. Costsincurred for the development of internal computer software are capitalized andamortized using the straight-line method over three to ten years.

To the extent that we remodel or otherwise replace ordispose of property and equipment prior to the end of the assigned depreciablelives, we could realize a loss or gain on the disposition. To the extent assetscontinue to be used beyond their assigned depreciable lives, no depreciationexpense is incurred. We reassess the depreciable lives of our long-lived assetsin an effort to reduce the risk of significant losses or gains at dispositionand the utilization of assets with no depreciation charges. The reassessment ofdepreciable lives involves utilizing historical remodel and dispositionactivity and forward-looking capital expenditure plans. In fiscal year2005, we made adjustments to rent and depreciation aggregating approximately$5.0 million, or 0.1% of revenues, made in the second and third fiscalquarters of fiscal year 2005 in connection with our review of the amortizationperiods assigned to our leased property and equipment and deferred real estatecredits. Our reassessments of depreciable lives had no material impact on ouroperating results in fiscal year 2004.

We assess the recoverability of the carrying values ofour store assets annually and upon the occurrence of certain events (e.g.,opening a new store near an existing store or announcing plans for a storeclosing). The recoverability assessment requires judgment and estimates forfuture store generated cash flows. The underlying estimates of cash flowsinclude estimates of future revenues, gross margin rates and store expenses andare based upon the stores’ past and expected future performance. New stores mayrequire two to five years to develop a customer base necessary to generate thecash flows of our more mature stores. To the extent our estimates for revenuegrowth and gross margin improvement are not realized, future annual assessmentscould result in impairment charges. No store impairment charges were recordedin either of fiscal years 2006, 2005 or 2004.

***Goodwill and Intangible Assets.***  Goodwilland indefinite-lived intangible assets, such as tradenames, are not subject toamortization. Rather, recoverability of goodwill and indefinite-livedintangible assets is assessed annually and upon the occurrence of certainevents. The recoverability assessment requires us to make judgments andestimates regarding fair values. Fair values are determined using estimatedfuture cash flows, including growth assumptions for future revenues, gross marginrates and other estimates. To the extent that our estimates are not realized,future assessments could result in impairment charges.

Customer lists are amortized using the straight-linemethod over their estimated useful lives, ranging from 5 to 26 years (weightedaverage life of 13 years).  Favorablelease commitments are amortized straight-line over the remaining lives of theleases, ranging from 6 to 49 years (weighted average life of 33 years).  Total estimated amortization of allacquisition-related intangible assets for the next five fiscal years iscurrently estimated as follows (in thousands):
| 2007 |   | $      | 72,889 |   |
|------|--------|--------|--------|--------|
| 2008 |   | 72,889 |   |
| 2009 |   | 72,889 |   |
| 2010 |   | 72,889 |   |
| 2011 |   | 62,178 |   |

 

49

----

***FinancialInstruments.***  Weuse derivative financial instruments to help manage our interest raterisks.  At July 29, 2006, we haveoutstanding floating and fixed interest rate swap agreements for an aggregatenotional amount of $1,000.0 million. These interest rate swap agreements have been designated as cash flowhedges and are recorded at fair value on the consolidated balance sheets.

At July 29, 2006, the fair value of NMG’s interestrate swap agreements was a gain of approximately $20.2 million, whichamount is included in other assets.

***Advertising andCatalog Costs.***  We incur costs to advertise and promote themerchandise assortment offered by both Specialty Retail stores and DirectMarketing. Advertising costs incurred by our Specialty Retail stores consistprimarily of print media costs related to promotional materials mailed to ourcustomers. These costs are expensed at the time of mailing to the customer.Advertising costs incurred by Direct Marketing relate to the production,printing and distribution of our print catalogs and the production of thephotographic content on our websites. We amortize the costs of print catalogsduring the periods we expect to generate revenues from such catalogs, generallythree to six months. We expense the costs incurred to produce the photographiccontent on our websites at the time the images are first loaded onto thewebsite. We expense website design costs as incurred.

***Gift Cards. ***We sell gift cards at our Specialty Retail stores and through DirectMarketing. Unredeemed gift cards aggregated $30.1 million at July 29,2006, $25.6 million at July 30, 2005 and $21.8 million atJuly 31, 2004. The gift cards sold to our customers have no statedexpiration dates and are subject to actual and /or potential escheatment rightsin various of the jurisdictions in which we operate. As a result, we have notreversed any unredeemed gift card balances into income in fiscal years 2006,2005 or 2004 pending a final determination as to the invalidity of current andpotential escheatment claims in any applicable jurisdictions with respect tothe unredeemed balances of gift cards.

***Loyalty Programs.***  Wemaintain customer loyalty programs in which customers accumulate points forqualifying purchases. Upon reaching certain levels, customers may redeem theirpoints for gifts. Generally, points earned in a given year must be redeemed nolater than ninety days subsequent to the end of the annual program period.

The estimates of the costs associated with the loyaltyprograms require us to make assumptions related to customer purchasing levels,redemption rates and costs of awards to be chosen by our customers. Ourcustomers redeem a substantial portion of the points earned in connection withour loyalty programs for gift cards. At the time the qualifying sales givingrise to the loyalty program points are made, we defer the portion of therevenues on the qualifying sales transactions equal to the estimate of theretail value of the gift cards to be issued upon conversion of the points togift cards. We record the deferral of revenues related to gift card awardsunder our loyalty programs as a reduction of revenues. In addition, we chargethe cost of all other awards under our loyalty programs to cost of goods sold.We deferred revenues related to anticipated gift card awards of$28.5 million in fiscal year 2006, $23.8 million in fiscal year 2005and $20.8 million in fiscal year 2004 and charged costs of goods sold forthe anticipated costs of all other awards of $3.7 million in fiscal year2006, $4.9 million in fiscal year 2005 and $6.1 million in fiscalyear 2004.

***Pension Plan.***  We sponsora noncontributory defined benefit pension plan covering substantially allfull-time employees. In calculating our pension obligations and related pensionexpense, we make various assumptions and estimates after consulting withoutside actuaries and advisors. The annual determination of pension expenseinvolves calculating the estimated total benefits ultimately payable to planparticipants and allocating this cost to the periods in which services areexpected to be rendered. We use the projected unit credit method in recognizingpension liabilities. The Pension Plan is valued annually as of the beginning ofeach fiscal year.

Significant assumptions related to the calculation of ourpension obligation include the discount rate used to calculate the actuarialpresent value of benefit obligations to be paid in the future, the expectedlong-term rate of return on assets held by the Pension Plan and the averagerate of compensation increase by plan participants. We review these actuarialassumptions annually based upon currently available information.

The assumed discount rate utilized is based on a broadsample of Moody’s high quality corporate bond yields as of the measurementdate. The projected benefit payments are matched with the yields on these bondsto determine an appropriate discount rate for the plan. The discount rate isutilized principally in calculating the actuarial present value of our pensionobligation and net pension expense. At July 29, 2006, the discount ratewas 6.25%. To the extent the discount rate increases or decreases, our pensionobligation is decreased or increased, accordingly. The estimated effect of a0.25% decrease in the discount rate would increase the pension obligation by$15.7 million and increase annual pension expense by $0.9 million.

50

----

The assumed expected long-term rate of return on assetsis the weighted average rate of earnings expected on the funds invested or tobe invested to provide for the pension obligation. In fiscal year 2006, thetarget allocation of our Pension Plan assets was equity securities(approximately 80%) and fixed income securities (approximately 20%). Weperiodically evaluate the allocation between investment categories of theassets held by the Pension Plan. The expected average long-term rate of returnon assets is based principally on the counsel of our outside actuaries andadvisors. We utilize this rate primarily in calculating the expected return onplan assets component of the annual pension expense. To the extent the actualrate of return on assets realized over the course of a year is greater than theassumed rate, that year’s annual pension expense is not affected. Rather, thisgain reduces future pension expense over a period of approximately 12 to18 years. To the extent the actual rate of return on assets is less thanthe assumed rate, that year’s annual pension expense is likewise not affected.Rather, this loss increases pension expense over approximately 12 to18 years. During fiscal year 2006, we utilized 8.0% as the expectedlong-term rate of return on plan assets.

The assumed average rate of compensation increase is theaverage annual compensation increase expected over the remaining employmentperiods for the participating employees. We utilized a rate of 4.5% for the periodsbeginning August 1, 2006. This rate is utilized principally in calculatingthe pension obligation and annual pension expense. A 0.25% increase in theassumed rate of compensation increase is estimated to increase the pensionobligation by $2.3 million and increase annual pension expense by$0.3 million.

***Self-insurance andOther Employee Benefit Reserves.***  We use estimates in thedetermination of the required accruals for general liability, workers’compensation and health insurance as well as short-term disability,supplemental executive retirement benefits and postretirement health carebenefits. We base these estimates upon an examination of historical trends,industry claims experience and, in certain cases, calculations performed bythird-party actuaries. Projected claims information may change in thefuture and may require us to revise these accruals. Self-insurance reservesincluding general liability, workers’ compensation and health insuranceaggregated $45.5 million at July 29, 2006 and $43.2 million atJuly 30, 2005. Other employee benefit reserves including short-termdisability, supplemental executive retirement benefits and postretirementhealth care benefits aggregated $107.6 million at July 29, 2006 and$94.4 million at July 30, 2005.

***Income Taxes.***  We areroutinely under audit by federal, state or local authorities in the areas ofincome taxes. These audits include questioning the timing and amount ofdeductions and the allocation of income among various tax jurisdictions. Inevaluating the exposure associated with various tax filing positions, we accruecharges for probable exposures. Based on our annual evaluations of taxpositions, we believe we have appropriately accrued for probable exposures. Tothe extent we were to prevail in matters for which accruals have beenestablished or be required to pay amounts in excess of recorded reserves, oureffective tax rate in a given financial statement period could be materiallyimpacted.

***Litigation.***  We areperiodically involved in various legal actions arising in the normal course ofbusiness. We are required to assess the probability of any adverse judgments aswell as the potential range of any losses. We determine the required accrualsafter a careful review of the facts of each significant legal action. Ouraccruals may change in the future due to new developments in these matters.

**Recent Accounting Pronouncements**

In March 2005, the FASB issued FASB InterpretationNo. 47, “Accounting for Conditional Asset Retirement Obligations, aninterpretation of FASB Statement No. 143” (FIN 47). FIN 47 clarifies thatconditional asset retirement obligations meet the definition of liabilities andshould be recognized when incurred if their fair values can be reasonablyestimated. We adopted FIN 47 as of the beginning of fiscal year 2006 with nomaterial impact on our consolidated financial statements.

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes – an interpretation of FASB Statement No. 109” (FIN 48), which clarifiesthe accounting for uncertainty in tax positions.  This Interpretation requires that werecognize in our consolidated financial statements the impact of a taxposition, if that position is more likely than not of being sustained uponexamination, based on the technical merits of the position.  FIN 48 will be effective for the first fiscalyear beginning after December 15, 2006, or our fiscal year ending August 2,2008.  We have not yet evaluated theimpact, if any, of adopting FIN 48 on our consolidated financial statements.

51

----

In September 2006,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108(SAB 108).  SAB 108 addresses the processand diversity in practice of quantifying financial statement misstatements resultingin the potential build up of improper amounts on the balance sheet.  We will be required to adopt the provisionsof SAB 108 in fiscal year 2007.  Wecurrently do not believe that the adoption of SAB 108 will have a materialimpact on our consolidated financial statements.

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The market risk inherent in the Company’s financialinstruments represents the potential loss arising from adverse changes ininterest rates and foreign currency exchange rates. The Company does not enterinto derivative financial instruments for trading purposes. The Company seeksto manage exposure to adverse interest rate changes through its normaloperating and financing activities. The Company is exposed to interest raterisk through its borrowing activities, which are described in Note 9 toour consolidated financial statements.

As of July 29, 2006, NMG had no borrowings outstandingunder its Asset-Based Revolving Credit Facility that bears interest atfloating rates. Future borrowings under NMG’s Asset-Based RevolvingFacility, to the extent of outstanding borrowings, would be affected byinterest rate changes.

At July 29, 2006, NMG had $1,875.0 million ofdebt under its Senior Secured Term Loan Facility issued in connection with theTransactions that bears interest at floating rates. A 1% increase in thesefloating rates would increase annual interest expense by approximately$18.7 million.

NMG uses derivative financial instruments to help manageits interest rate risk.  EffectiveDecember 6, 2005, NMG  entered intofloating to fixed interest rate swap agreements for an aggregate notionalamount of $1,000.0 million to limit its exposure to interest rateincreases related to a portion of its floating rate indebtedness. The interestrate swap agreements terminate after five years. As of the effective date, NMGdesignated the interest rate swaps as cash flow hedges. As a result, changes inthe fair value of the swaps are recorded subsequent to the effective date as a componentof other comprehensive income.

At July 29, 2006, the fair value of NMG’s interest rateswap agreements was a gain of approximately $20.2 million, which amount isincluded in other assets. As a result of the swap agreements, NMG’s effectivefixed interest rates as to the $1,000.0 million in floating rateindebtedness will range from 6.931% to 7.499% per quarter and result in anaverage fixed rate of 7.285%.

NMG uses derivative financial instruments to manageforeign currency risk related to the procurement of merchandise inventoriesfrom foreign sources. NMG enters into foreign currency contracts denominated inthe euro and British pound. NMG had foreign currency contracts in the form offorward exchange contracts in the notional amounts of approximately$54.9 million as of July 29, 2006 and approximately$44.9 million as of July 30, 2005. The market risk inherent in theseinstruments was not material to NMG’s consolidated financial position, resultsof operations or cash flows in fiscal year 2006.

The effects of changes in theU.S. equity and bond markets serve to increase or decrease the value of pensionplan assets, resulting in increased or decreased cash funding by the Company.The Company seeks to manage exposure to adverse equity and bond returns bymaintaining diversified investment portfolios and utilizing professionalinvestment managers.

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

The following consolidatedfinancial statements of the Company and supplementary data are included as pagesF-1 through F-57 at the end of this Annual Report on Form 10-K:

| Index                                                                  | ** ** | **Page  Number** |
|------------------------------------------------------------------------|------------|------------------|
| Management’s  Report on Internal Control over Financial Reporting |       | F-2              |
| Report of  Independent Registered Public Accounting Firm               |       | F-3              |
| Consolidated  Balance Sheets                                           |       | F-4              |
| Consolidated  Statements of Earnings                                   |       | F-5              |
| Consolidated  Statements of Cash Flows                                 |       | F-6              |
| Consolidated  Statements of Shareholders’ Equity                  |       | F-8              |
| Notes to  Consolidated Financial Statements                            |       | F-10             |

 

52

----

**ITEM 9.   CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

None.

**ITEM 9A. CONTROLS AND PROCEDURES**

**a.****                                       Disclosure Controls and Procedures.**

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

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

Our management is responsible forestablishing and maintaining adequate internal control over financial reportingas defined in Exchange Act Rule 13a-15(f). Our management conducted anevaluation of the effectiveness of our internal control over financialreporting based on the framework and criteria established in *Internal Control—Integrated Framework*,issued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on this evaluation, our management concluded that our internal controlover financial reporting was effective as of July 29, 2006. During itsassessment, management did not identify any material weaknesses in our internalcontrol over financial reporting. Our independent registered public accountingfirm, Deloitte & Touche LLP, has audited our consolidated financialstatements and has issued an attestation report on management’s assessment ofour internal control over financial reporting, as stated in their reportincluded herein.

**c.****                                       Changes in Internal Control over FinancialReporting**

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

**ITEM 9B. OTHER INFORMATION**

None.

53

----

**PART III**

**ITEM10.  DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT**

Thefollowing table sets forth the name, age and position of individuals whocurrently serve as our directors and executive officers.
| **Name**           | ** ** | **Age** | ** ** | **Position**                                                                       |
|--------------------|------------|---------|------------|------------------------------------------------------------------------------------|
| David A. Barr      |       | 43      |       | Director                                                                           |
| Ron Beegle         |       | 43      |       | Director                                                                           |
| Jonathan Coslet    |       | 41      |       | Director                                                                           |
| James Coulter      |       | 46      |       | Director                                                                           |
| John G. Danhakl    |       | 50      |       | Director                                                                           |
| Sidney Lapidus     |       | 68      |       | Director                                                                           |
| Kewsong Lee        |       | 41      |       | Director                                                                           |
| Carrie Wheeler     |       | 34      |       | Director                                                                           |
| Burton M. Tansky   |       | 68      |       | President and  Chief Executive Officer, Director                                   |
| James E. Skinner   |       | 53      |       | Senior Vice  President and Chief Financial Officer                                 |
| Nelson A. Bangs    |       | 53      |       | Senior Vice  President and General Counsel                                         |
| Marita O’Dea  |       | 57      |       | Senior Vice  President, Human Resources                                            |
| Steven P. Dennis   |       | 46      |       | Senior Vice  President, Strategy, Business Development and Multi-Channel Marketing |
| Karen W. Katz      |       | 49      |       | President and  Chief Executive Officer of Neiman Marcus Stores                     |
| Brendan L. Hoffman |       | 38      |       | President and  Chief Executive Officer of Neiman Marcus Direct                     |
| James J. Gold      |       | 42      |       | President and  Chief Executive Officer of Bergdorf Goodman                         |

 

Thefollowing biographies describe the business experience of our directors andexecutive officers.

**David A.Barr** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Barr has been managing director of Warburg Pincus LLC and a general partner ofWarburg Pincus & Co. since January 2001. Prior to joining Warburg Pincus in 2000, Mr. Barr served as a managingdirector at Butler Capital where he focused on consumer and industrialleveraged buyout transactions for more than ten years.  Mr. Barr also serves on the board ofdirectors of Builders First Source, Inc., Eagle Family Foods, Inc., PolyporeInc., TransDigm Inc., and Wellman, Inc.

**RonBeegle** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Beegle is a partner of Goode Partners and serves as an advisor to DLJMBMerchant Banking Partners (“DLJMB”). Prior to joining Goode Partners, Mr. Beegle served as an OperatingPartner and Chairman of Global Consumer Retail Investors for DLJMB.  From 1996 to 2003, Mr. Beegle spent sevenyears at Gap Inc., serving as Senior Vice President of Finance and Operationsof Banana Republic, Executive Vice President and General Manager of Gap Inc.Direct, and Chief Operating Officer of the company’s flagship Gapdivision.  Mr. Beegle also serves on theboard of directors of Aeropostale, Inc.

**JonathanCoslet** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Coslet has been a partner of Texas Pacific Group since 1993 and is currently asenior partner and member of the firm’s Executive, Management and InvestmentCommittees.  Prior to joining TexasPacific Group, Mr. Coslet worked at Donaldson, Lufkin & Jenrette, specializingin leveraged acquisitions and high yield finance from 1991 to 1993.  Mr. Coslet also serves on the board ofdirectors of Quintiles Transnational Corp., IASIS Healthcare Corp., and J. CrewGroup, Inc.

**JamesCoulter** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Coulter co-founded Texas Pacific Group in 1992 and has been Managing GeneralPartner of Texas Pacific Group for more than eight years.  From 1986 to 1992, Mr. Coulter was a VicePresident of Keystone, Inc.  From 1986 to1988, Mr. Coulter was also associated with SPO Partners, an investment firmthat focuses on public market and private minority investments.  Mr. Coulter also serves on the board ofdirectors of Lenovo Group Limited, Seagate Technology, and Zhone Technologies,Inc.

**John G.Danhakl** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Danhakl is a Managing Partner of Leonard Green & Partners, L.P. with whomhe has been a partner since 1995.  Priorto

54

----

joining LeonardGreen & Partners, L.P., he served as a Managing Director in the Los Angelesoffice of Donaldson, Lufkin & Jenrette, which he joined in 1990.  From 1985 to 1990, Mr. Danhakl was a VicePresident in corporate finance at Drexel Burnham Lambert.  He also serves on the board of directors ofArden Group, Inc., Horseshows In the Sun, Inc., Leslie’s Poolmart, Inc., PetcoAnimal Supplies, Inc., Rite Aid Corporation, The Tire Rack, Inc., andSagittarius Brands, Inc.

**SidneyLapidus** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Lapidus is a Managing Director and Senior Advisor of Warburg Pincus LLC.  He has been employed at Warburg Pincus since1967.  Prior to that time, he was anattorney with the SEC.  He presentlyserves as a director of Lennar Corporation and Knoll, Inc.  He is also a director of many nonprofitorganizations including New York University School of Medicine, and ispresident of the American Jewish Historical Society.

**KewsongLee** was appointed to serve as a director following theconsummation of the Transactions.  Mr.Lee has been a member and managing director of Warburg Pincus LLC and a generalpartner of Warburg Pincus & Co. since January 1997 and is currently amember of Warburg Pincus LLC’s Executive Management Group.  He has been employed at Warburg Pincus since1992.  Prior to joining Warburg Pincus,Mr. Lee served as a consultant at McKinsey & Company, Inc. from 1990 to1992.  Mr. Lee also serves on the boardof directors of Arch Capital Group, Ltd., Knoll, Inc., TransDigm Inc., andseveral privately held companies.

**CarrieWheeler** was appointed to serve as a director following theconsummation of the Transactions.  Ms.Wheeler is a partner of Texas Pacific Group. Prior to joining Texas Pacific Group in 1996, she was with Goldman,Sachs & Co. from 1993 to 1996.  Ms.Wheeler also serves on the board of directors of Metro-Goldwyn-Mayer Inc.

**Burton M.Tansky**has served as a director on the Board of Directors andas President and Chief Executive Officer since the consummation of theTransactions on October 6, 2005.  He hasserved as a director and President and Chief Executive Officer of The NeimanMarcus Group, Inc. since May 2001 and as President and Chief Operating Officerfrom December 1998 until May 2001.  Heserved as Executive Vice President of The Neiman Marcus Group, Inc. fromFebruary 1998 until December 1998 and as Chairman and Chief Executive Officerof Neiman Marcus Stores from May 1994 until February 1998.  He served as Chairman and Chief ExecutiveOfficer of Bergdorf Goodman from 1990 until 1994.  Mr. Tansky also serves on the board ofdirectors of International Flavors and Fragrances Inc.

**James E.Skinner** has been Senior Vice President and Chief FinancialOfficer since the consummation of the Transactions.  Since June 2001, he has also served as SeniorVice President and Chief Financial Officer of The Neiman Marcus Group,Inc.  From August 2000 through December2000, Mr. Skinner served as Senior Vice President and Chief Financial Officerof Caprock Communications Corp. and from 1994 until 2000, served as ExecutiveVice President, Chief Financial Officer and Treasurer for CompUSA Inc.

**Nelson A.Bangs** has been Senior Vice President and General Counselsince the consummation of the Transactions and has served in that capacity forThe Neiman Marcus Group, Inc. since April 2001. From January 1999 to April 2001, Mr. Bangs engaged in a privateconsulting and law practice; from April 1998 until January 1999, he served asSenior Vice President and General Counsel of Pillowtex Corporation; and heserved as Senior Vice President, General Counsel and Secretary of DrPepper/Seven Up, Inc. (and predecessors) prior thereto.

**Marita O’Dea**has been Senior Vice President, Human Resources since the consummation of theTransactions and has also served in that capacity for The Neiman Marcus Group,Inc. since September 2002.  She served asVice President, Human Resources of The Neiman Marcus Group, Inc. from June 2001until September 2002.  Also, Ms. O’Deahas served as Senior Vice President of Human Resources of Neiman Marcus Storessince 1995.

**Steven P.Dennis** has been Senior Vice President of Strategy, BusinessDevelopment and Multi-Channel Marketing since the consummation of theTransactions and has also served in that capacity for The Neiman Marcus Group,Inc. since September 2004.  Prior tojoining us, Mr. Dennis served as Vice President, Corporate Strategy of Sears,Roebuck and Co. from 2001 until 2003.  In2002, he assumed the additional responsibility for Lands’ End post-acquisitioninitiatives.  From September 1999 toFebruary 2001, he served as Sears’ Vice President, Multichannel Integration.

**Karen W.Katz** has been President and Chief Executive Officer of NeimanMarcus Stores since December 2002.  Ms. Katzserved as President and Chief Executive Officer of Neiman Marcus Direct fromMay 2000 to December 2002 and as Executive Vice President of Neiman MarcusStores from February 1998 until May 2000. Ms. Katz serves on the board of directors of Pier 1 Imports, Inc.

55

----

**BrendanL. Hoffman** has been President and Chief Executive Officer ofNeiman Marcus Direct since December 2002. Mr. Hoffman served as Vice President of the Neiman Marcus Last CallClearance Division from August 2000 to December 2002, and as a DivisionalMerchandise Manager of Bergdorf Goodman from October 1998 to August 2000.

**James J.Gold** has been President and Chief Executive Officer ofBergdorf Goodman since May 2004.  Mr.Gold served as Senior Vice President, General Merchandise Manager of NeimanMarcus Stores from December 2002 to May 2004, as Division Merchandise Managerfrom June 2000 to December 2002 and as Vice President of the Neiman Marcus LastCall Clearance Division from March 1997 to June 2000.

**Code ofEthics**

TheBoard has adopted The Neiman Marcus Group, Inc. Code of Ethics and Conductwhich is applicable to all our directors, officers and employees, as well as aseparate Code of Ethics for Financial Professionals that applies to allfinancial employees including the Chief Executive Officer, the Chief FinancialOfficer and the Principal Accounting Officer. Both the Code of Ethics and Conduct and the Code of Ethics for FinancialProfessionals may be accessed through our website at www.neimanmarcusgroup.comunder the “Investor Information – Corporate Governance” section.  Requests for printed copies may be made inwriting to The Neiman Marcus Group, Inc., Attn. Investor Relations, One MarcusSquare, 1618 Main Street, Dallas, Texas 75201.

**BoardCommittees**

OurBoard of Directors has established an audit committee, an executive committeeand a compensation committee.  Themembers of our audit committee are David A. Barr, Carrie Wheeler, Ron Beegleand Sidney Lapidus.  The audit committeerecommends the annual appointment of auditors with whom the audit committeereviews the scope of audit and non-audit assignments and related fees,accounting principles we use in financial reporting, internal auditingprocedures and the adequacy of our internal control procedures.  The members of our executive committee areJonathan Coslet, Kewsong Lee, and Burton M. Tansky.  The executive committee manages the affairsof the Company as necessary between meetings of our Board of Directors and actson matters that must be dealt with prior to the next scheduled Boardmeeting.  The members of our compensationcommittee are Jonathan Coslet, Kewsong Lee, and John G. Danhakl.  The compensation committee reviews andapproves the compensation and benefits of our employees, directors andconsultants, administers our employee benefit plans, authorizes and ratifiesstock option and/or restricted stock grants and other incentive arrangements,and authorizes employment and related agreements.

Eachof the Sponsors has the right to have at least one of its directors sit on eachcommittee of the Board of Directors, to the extent permitted by applicable lawsand regulations.

**AuditCommittee Financial Expert**

TheBoard of Directors has determined that David A. Barr, Chairman of the AuditCommittee, meets the criteria set forth in the rules and regulations of the SECfor an “audit committee financial expert.”

**Director Compensation**

Infiscal year 2006 prior to the completion of the Transactions, each independentdirector of NMG was paid an annual retainer fee of $60,000.  The chairman of the Audit Committee receivedan additional $20,000 per year, and other committee chairs each received anadditional $15,000 per year.  Boardmembers did not receive per-meeting fees. Upon the consummation of the Transactions, each individual serving as adirector prior to the Transactions became entitled to a lifetime discount atthe Company’s stores on the same terms applicable to the individual immediatelyprior to the Transactions.  Eachindependent director was also entitled to receive additional compensation inthe form of stock-based units in an amount equal to the value of the annualcash retainer.  The number of stock-basedunits was calculated quarterly by dividing $15,000 (the amount of the quarterlycash retainer) by the trailing five-day average of the high and low price ofthe Class A Common Stock at the end of each fiscal quarter.  Dividend equivalents in the form ofadditional units representing Class A Common Stock were credited to eachindependent director’s account on each dividend payment date equal to (i) theper-share cash dividend divided by the average of the high and low price of ourClass A Common Stock on the dividend payment date, multiplied by (ii) thenumber of units reflected in the independent director’s account on the day beforethe dividend payment date.  The value ofeach of the independent director’s stock-based units was paid in cash on thecompletion of the merger.  Thestock-based units were valued for payment by multiplying the applicable numberof units by the merger consideration. These stock-based units did not carry voting or dispositive rights.

56

----

Pursuantto the Deferred Compensation Plan for Non-Employee Directors, independentdirectors were offered the right to elect to receive all or a part of the cashportion of their fees on a deferred basis. The deferred compensation plan for non-employee directors was terminatedon the closing date of the Transactions and amounts accrued under the plan werepaid out to the then participating directors.

Followingthe completion of the Transactions, the policies with respect to directorcompensation were amended to take into account our new ownership and corporatestructure.  Currently, none of ourdirectors receive compensation for their service as a member of our board.  They are reimbursed for any expenses incurredas a result of their service.  As anemployee director, Mr. Tansky receives no compensation for his service as aBoard member.  We offer to each of ourdirectors a discount at our stores at the same rate that is available toemployees.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section16(a) of the Securities Exchange Act of 1934, as amended, required, for periodsprior to the completion of the Acquisition in October 2005, our directors,executive officers and persons who owned more than 10% of a registered class ofour equity securities, to file reports of ownership and changes in ownershipwith the SEC.  Based on our records andother information, we believe that all required Section 16(a) reports for ourdirectors, executive officers and persons who owned more than 10% of aregistered class of our equity securities for fiscal year 2006 prior to thecompletion of the Acquisition were timely filed.

**ITEM11.  EXECUTIVE COMPENSATION**

Thefollowing table sets forth the annual compensation for the Chief ExecutiveOfficer and the four other most highly compensated executive officers (the “NamedExecutive Officers”) serving at the end of fiscal year 2006.

**SummaryCompensation Table**
|                                                | ** ** | **Annual Compensation** | ** ** | **Long-Term Compensation Awards** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|---------------------------------------------|------------|
| **Name and Principal Position** | ** ** | **Fiscal  Year**             | ** ** | **Salary ($)**                         | ** ** | **Bonus  ($)(1) ** | ** ** | **Other Annual  Compensation  ($)** | ** ** | **Restricted  Stock  Awards  ($)** | ** ** | **Securities  Underlying  Options (#)** | ** ** | **All Other  Compensation  ($)(7)** | ** ** |
| Burton M. Tansky                               |       | 2006                         |       | 1,350,000                                   |       | 1,810,928 |   | 12,000 | (2) |   |   | 16,349.18 | (6) | 82,564 |   |
| President and Chief                            |       | 2005                         |       | 1,300,000                                   |       | 1,690,000 |   | 12,000 | (2) | 2,699,940 | (5) |   |   | 103,921 |   |
| Executive Officer                              |       | 2004                         |       | 1,250,000                                   |       | 1,574,219 |   |   |   | 1,132,830 | (5) | 76,000 |   | 76,665 |   |
|                                           |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Karen W. Katz                                  |       | 2006                         |       | 760,000                                     |       | 725,760 |   | 25,000 | (3) |   |   | 10,682.08 | (6) | 42,486 |   |
| President and Chief                            |       | 2005                         |       | 715,000                                     |       | 694,086 |   | 25,000 | (3) | 1,403,956 | (5) |   |   | 43,290 |   |
| Executive Officer                              |       | 2004                         |       | 650,000                                     |       | 633,750 |   |   |   | 633,187 | (5) | 35,000 |   | 29,249 |   |
| Neiman Marcus Stores                           |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
|                                           |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| James E. Skinner                               |       | 2006                         |       | 530,000                                     |       | 448,210 |   |   |   |   |   | 5,341.04 | (6) | 27,863 |   |
| Senior Vice President                          |       | 2005                         |       | 510,000                                     |       | 408,000 |   |   |   | 789,756 | (5) |   |   | 32,088 |   |
| and Chief Financial                            |       | 2004                         |       | 485,000                                     |       | 378,300 |   |   |   | 404,112 | (5) | 25,000 |   | 23,061 |   |
| Officer                                        |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
|                                           |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Brendan L. Hoffman                             |       | 2006                         |       | 460,000                                     |       | 439,675 |   |   |   |   |   | 5,341.04 | (6) | 11,347 |   |
| President and Chief                            |       | 2005                         |       | 440,000                                     |       | 279,030 |   |   |   | 105,297 | (5) | 31,042 |   | 22,219 |   |
| Executive Officer                              |       | 2004                         |       | 400,000                                     |       | 306,650 |   |   |   | 187,423 | (5) | 36,900 |   | 6,452 |   |
| Neiman Marcus Direct                           |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
|                                           |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| James J. Gold                                  |       | 2006                         |       | 425,000                                     |       | 406,222 |   | 145,385 | (4) |   |   | 5,341.04 | (6) | 3,437 |   |
| President and Chief                            |       | 2005                         |       | 400,000                                     |       | 320,000 |   | 140,000 | (4) | 789,756 | (5) |   |   | 186,135 |   |
| Executive Officer                              |       | 2004                         |       | 400,000                                     |       | 174,425 |   |   |   | 312,121 | (5) | 21,500 |   | 416 |   |
| Bergdorf Goodman                               |       |                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |

 

----

57

----

(1)                                  Bonuspayments are reported with respect to the year in which the related serviceswere performed and consist of both bonus payments made pursuant to our KeyExecutive Bonus Plan and discretionary bonus payments.

Discretionary bonus payments were made in fiscal year2006 for $86,235 to Burton M. Tansky, $34,555 to Karen W. Katz, $49,915 toJames E. Skinner, $20,937 to Brendan L. Hoffman and $19,344 to James J. Gold.

(2)           The amountshown for Mr. Tansky is for a car allowance.

 

(3)           The amountshown for Karen Katz is for a clothing allowance.

 

(4)           The amountshown for Jim Gold is for a cost of living adjustment due to his relocationfrom Texas to New York.

 

(5)           Restrictedstock and options awarded the Named Executive Officers in fiscal years 2005 and2004 were awarded under The Neiman Marcus Group, Inc. 1997 Incentive Plan (the“1997 Plan”) which terminated on the closing date of the Transactions.  All outstanding awards were cashed out inaccordance with the merger agreement or were rolled over into equity in theCompany.  In particular, members ofsenior management rolled over or invested a mixture of cash and restrictedstock equal to an aggregate of $25.6 million into shares of the Company’sstock.

 

(6)           Optionsawarded the Named Executive Officers in fiscal year 2006 were awarded under theNeiman Marcus, Inc. Management Equity Incentive Plan.

 

(7)                                  Theamounts reported include the cost of matching contributions under the KeyEmployee Deferred Compensation Plan, which was terminated on the closing dateof the Transactions and replaced by The Neiman Marcus Group, Inc. Key EmployeeCompensation Plan effective January 1, 2006 (“Matching Contributions”), grouplife insurance premiums, and financial counseling.  For fiscal year 2006, such amounts for eachof the Named Executive Officers were as follows:

|                     | ** ** | **Matching**      | ** ** | **Group Life**         | ** ** | **Financial**  | ** ** |
|---------------------|------------|-------------------|------------|-----------------------------|------------|----------------|------------|
| **Name**            | ** ** | **Contributions** | ** ** | **Insurance Premiums** | ** ** | **Counseling** | ** ** |
| Burton M. Tansky    |       | $                 | 47,227     |                        | $          | 5,133          |       | $ | 30,204 |   |
| Karen W. Katz       |       | 40,585            |       | 811                         |       | 1,090          |       |
| James E. Skinner    |       | 26,791            |       | 1,072                       |       | —         |       |
| Brendan L.  Hoffman |       | 10,961            |       | 386                         |       | —         |       |
| James J. Gold       |       | —            |       | 437                         |       | 3,000          |       |
|                     |            |                   |            |                             |            |                |            |  |  |  |

 

**OPTION GRANTSIN LAST FISCAL YEAR**
| ** **          | ** ** | **Individual Grants(1)**                                     | ** ** | ** **                                                                                       | ** ** |
|---------------------|------------|-------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| **Name**            | ** ** | **Number of  Securities  Underlying  Options  Granted  (#)** | ** ** | **Percent of  Total Options  Granted to  Employees in  Fiscal Year(2)** | ** ** | **Exercise  or Base  Price  ($/Share)** | ** ** | **Expiration  Date** | ** ** | **Grant Date  Present Value($)(3)** | ** ** |
|                |       |                                                              |       |                                                                                             |       |   |   |   |   |   |   |
| Burton M. Tansky    |       | 16,349.18                                                         |       | 21.96                                                                                            |       | (1 | ) | 11/29/2015 |   | $ | 5,832,535 |   |
| Karen W. Katz       |       | 10,682.08                                                         |       | 14.35                                                                                            |       | (1 | ) | 11/29/2015 |   | $ | 3,957,442 |   |
| James E. Skinner    |       | 5,341.04                                                          |       | 7.18                                                                                             |       | (1 | ) | 11/29/2015 |   | $ | 1,978,721 |   |
| Brendan L.  Hoffman |       | 5,341.04                                                          |       | 7.18                                                                                             |       | (1 | ) | 11/29/2015 |   | $ | 1,978,721 |   |
| James J. Gold       |       | 5,341.04                                                          |       | 7.18                                                                                             |       | (1 | ) | 11/29/2015 |   | $ | 1,978,721 |   |

 

----

(1)           Optionsgranted during the 2006 fiscal year are nonqualified stock options grantedunder the Neiman Marcus, Inc. Management Equity Incentive Plan (the “ManagementEquity Incentive Plan”) and will expire no later than the tenth anniversarydate of the grant.  Options grantedpursuant to the Management Equity Incentive Plan to each of the Named ExecutiveOfficers include both performance options and fair value options.  The performance options have an exerciseprice of $1,445 per share, subject to annual accretion at ten percent (10%)compound rate beginning on the date of grant and continuing until the fifthanniversary date of the grant (a “Performance Option”).  The fair value options were granted at thefixed rate of $1,445 per share, or the fair market value of the underlyingcommon stock on the date of grant (a “Fair Value Option”).  For those options granted in connection withthe Transactions, for purposes of the

58

----

accreting exercise price,vesting and expiration of the Options, the grant date was deemed to be October6, 2005.  Mr. Tansky was granted theoption to purchase 9,079.7947 shares considered Performance Options and 7,269.3851shares that are considered Fair Value Options. His Performance Options vest and become exercisable in twenty-fivepercent (25%) increments on each of the first four anniversary dates of October6, 2005.  His Fair Value Options vest andbecome exercisable with respect to 459.5392 shares on the first anniversarydate of October 6, 2005 with the remaining shares vesting and becomingexercisable in 2,269.9486 share increments on the next three anniversary datesof October 6, 2005.  Fifty-percent (50%)of each nonqualified stock option granted under the Management Equity IncentivePlan to Karen W. Katz, James E. Skinner, Brendan L. Hoffman, and James J. Goldis considered Performance Options and fifty-percent (50%) is considered FairValue Options.  The Performance Optionsand Fair Value Options granted to the Named Executive Officers, other than toMr. Tansky, vest and become exercisable twenty-percent (20%) on the firstanniversary date of October 6, 2005 and thereafter in forty-eight equal monthlyinstallments over the forty-eight months following the first anniversary ofOctober 6, 2005.  Vesting of the optionsaccelerates in certain circumstances following a change of control.

(2)                                  Basedon a total of 74,433.0770 shares subject to options granted to employees underthe Plan during fiscal year 2006.

(3)                                  Theseamounts represent the estimated present value of these stock options on thedate of grant calculated using the Black-Scholes option pricing model, based onthe following assumptions used in developing the grant valuations:  an expected volatility of 29.72% determinedusing implied volatilities; an expected term to exercise of five years from thedate of grant; a risk-free interest rate of 4.23%; and a dividend yield ofzero.  In accordance with SEC rules, thedollar amounts are not intended to forecast possible future appreciation.

**AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCALYEAR-END OPTION VALUES**
| ** **                                                | ** ** | ** **                                         | ** ** | ** **                       | ** ** | **Number of Securities** | ** ** | **Value of Unexercised**                       | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------|------------|------------------------------------|------------|----------------------------------------------------------|------------|
| **Name**                                                  | ** ** | **Shares  Acquired on  Exercise (#)(1)** | ** ** | **Value Realized ($)** | ** ** | **Underlying Unexercised**    | ** ** | **In-the-Money Options at July 29,** | ** ** |
| **Options at July 29, 2006 (#)** | ** ** | **2006 ($)(2)**                               |
| **Exercisable**                                           | ** ** | **Unexercisable**                                  | ** ** | **Exercisable**                  | ** ** | **Unexercisable**                  |
| Burton M. Tansky                                          |       | 371,200                                            |       | $                                | 26,069,025 |                               | 7,283      |                                                     | 16,349.18  |   | $ | 7,908,125 |   | — |   |
| Karen M. Katz                                             |       | 146,500                                            |       | 9,571,693                        |       | —                             |       | 10,682.08                                                |       | — |   | — |   |
| James E. Skinner                                          |       | 81,000                                             |       | 5,369,270                        |       | —                             |       | 5,341.04                                                 |       | — |   | — |   |
| Brendan L.  Hoffman                                       |       | 100,542                                            |       | 5,568,470                        |       | —                             |       | 5,341.04                                                 |       | — |   | — |   |
| James J. Gold                                             |       | 28,600                                             |       | 1,634,580                        |       | —                             |       | 5,341.04                                                 |       | — |   | — |   |
|                                                           |            |                                                    |            |                                  |            |                                    |            |                                                          |            |  |  |  |  |  |  |

 

----

(1)           Atthe completion of the Transactions, the existing equity incentive plans,including the 1987 Stock Incentive Plan, the 1997 Stock Incentive Plan and the2005 Stock Incentive Plan, terminated and, except for certain outstandingequity awards held by senior management that were rolled over in connectionwith the Transactions, all outstanding awards thereunder were cashed out inaccordance with the merger agreement.

 

(2)           Thereis no established public market for our common stock.  Based on customary corporate valuationtechniques, we believe that the value of our stock has not materially changedsince the stock options were granted, therefore the value of any unexercisedstock options is shown as zero.

**PENSIONPLAN TABLE**

Wemaintain a funded, qualified pension plan known as The Neiman Marcus Group,Inc. Retirement Plan (the “Retirement Plan”). Most non-union employees over age 21 who have completed one year ofservice with 1,000 or more hours participate in the Retirement Plan, which paysbenefits upon retirement or termination of employment.  The Retirement Plan is a “career-average”plan, under which a participant earns each year a retirement annuity equal to 1percent of his or her compensation for the year up to the Social Security wagebase and 1.5 percent of his or her compensation for the year in excess of suchwage base.  Benefits under the RetirementPlan become fully vested after five years of service with us.

59

----

Wealso maintain a Supplemental Executive Retirement Plan (the “SERP”).  The SERP is an unfunded, nonqualified planunder which benefits are paid from our general assets to supplement RetirementPlan benefits and Social Security.  Executive,administrative and professional employees (other than those employed assalespersons) with an annual base salary at least equal to a minimum establishedby the Company ($160,000 as of July 29, 2006) are eligible to participate.  At normal retirement age (age 65), aparticipant with 25 or more years of service is entitled to payments under theSERP sufficient to bring his or her combined annual benefit from the RetirementPlan and SERP, computed as a straight life annuity, up to 50 percent of theparticipant’s highest consecutive 60 month average of annual pensionableearnings, less 60 percent of his or her estimated annual primary SocialSecurity benefit.  If the participant hasfewer than 25 years of service, the combined benefit is proportionatelyreduced.  Benefits under the SERP becomefully vested after five years of service with us.

Thefollowing table, which includes benefits under the Retirement Plan and theSERP, shows the estimated annual pension benefits payable to employees invarious compensation and years of service categories.  The estimated benefits apply to an employeeretiring at age 65 in 2006 who elects to receive his or her benefit in the formof a straight line annuity.  The amountsactually payable will be lower than the amounts shown below, since such amountswill be reduced by 60 percent of the participant’s estimated primary SocialSecurity benefit.

**EstimatedAnnual Retirement BenefitsUnder the Retirement Plan and SERP**
| ** **                                            | ** ** | **Total Years of Service** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| **Final Average Pensionable Earnings** | ** ** | **5**                                     | ** ** | **10** | ** ** | **15** | ** ** | **20** | ** ** | **25** | ** ** |
|                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| $  400,000                                  |       | $                                         | 40,000     |   | $ | 80,000 |   | $ | 120,000 |   | $ | 160,000 |   | $ | 200,000 |   |
|     600,000                       |       | 60,000                                    |       | 120,000 |   | 180,000 |   | 240,000 |   | 300,000 |   |
|     800,000                       |       | 80,000                                    |       | 160,000 |   | 240,000 |   | 320,000 |   | 400,000 |   |
|  1,000,000                                       |       | 100,000                                   |       | 200,000 |   | 300,000 |   | 400,000 |   | 500,000 |   |
|  1,200,000                                       |       | 120,000                                   |       | 240,000 |   | 360,000 |   | 480,000 |   | 600,000 |   |
|  1,500,000                                       |       | 150,000                                   |       | 300,000 |   | 450,000 |   | 600,000 |   | 750,000 |   |
|                                                       |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

The following table showsthe pensionable earnings and credited years of service for the Named ExecutiveOfficers as of July 29, 2006, and years of service creditable at age 65.
| **Name**                          | ** ** | **Pensionable  Earnings For  Year Ended  July 29, 2006(1)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Years of Service(2)** |
| **At July 29,**         | ** ** | **At Age**                                                                 |
| **2006**                          | ** ** | **65**                                                                          |
| Burton M. Tansky                  |       | $                                                                               | 1,350,000  |       | —     | (3)        | 25         | (3) |
| Karen M. Katz                     |       | 760,000                                                                         |       | 21         |       | 37         |       |
| James E. Skinner                  |       | 530,000                                                                         |       | 5          |       | 17         |       |
| Brendan L.  Hoffman               |       | 460,000                                                                         |       | 8          |       | 35         |       |
| James J. Gold                     |       | 425,000                                                                         |       | 15         |       | 38         |       |
|                                   |            |                                                                                 |            |            |            |            |            |  |

 

----

(1)                                  Incomputing the combined benefit under the Retirement Plan and SERP, “pensionableearnings” means, with respect to the Retirement Plan, base salary and any bonusand, with respect to the SERP, base salary only.  The amounts shown above include base salaryonly.

(2)                                  Thecredited years of service set forth in the table reflect years of creditedservice under the Retirement Plan, which is a “career average plan” with nolimitation on years of credited service. However, credited service under the SERP may not exceed 25 years.

(3)                                  Forpurposes of determining Mr. Tansky’s retirement benefits under the SERP, Mr.Tansky will be credited with two times his years of service with the Companyprovided he does not compete with the Company for a period of three yearsfollowing his retirement and the Company does not terminate his employmentother than for cause.  Upon completion ofthe merger, Mr. Tansky’s SERP was amended such that he will continue to earncredit for each year of service, and will also be credited with prior years ofservice in which he did not receive service credit for purposes of the SERPbecause of the 25-year cap.  Mr. Tanskyhad 28 years of credited service immediately following the Transactions (andwill continue to accrue additional years of service).

60

----

**EmploymentContracts and Termination of Employment and Change-in-Control Arrangements**

TheNeiman Marcus Group, Inc. has entered into employment agreements with Burton M.Tansky and Karen W. Katz.  The employmentagreement with Mr. Tansky provides that he will act as our Chief ExecutiveOfficer until October 2008.  Thereafter,under the terms of the agreement and until October 2011, he will act aschairman of the Board and shall have such duties as are customary for theposition.  This agreement may beterminated by either party on three months notice, subject to severanceobligations in the event of termination under certain circumstances (asdescribed below).

Duringthe period he serves as chairman, Mr. Tansky will be entitled to 75% of thebase compensation he earned as Chief Executive Officer.  Mr. Tansky will, under certain circumstances,be entitled to severance similar to that provided in his change of controltermination protection agreement summarized below once the two-year period ofthat agreement has ended, except that (i) the severance multiple after (a) achange of control subsequent to the change of control that occurred uponcompletion of the Transactions or (b) the third anniversary of the completionof the Transactions will be two times rather than three times; and (ii) upon asubsequent change of control, Mr. Tansky will be permitted to terminate hisemployment with The Neiman Marcus Group, Inc. within a thirty-day periodcommencing on the six-month anniversary of the subsequent change of control andreceive severance under his agreements.

Theemployment agreement with Ms. Katz provides that she will act as ChiefExecutive Officer and President of Neiman Marcus Stores, a division of TheNeiman Marcus Group, Inc., until October 2010, subject to automatic one-yearrenewals of the term if neither party submits a notice of termination at leastthree months prior to the end of the then-current term.  This agreement may be terminated by eitherparty on three months’ notice, subject to severance obligations in the eventMs. Katz is terminated by The Neiman Marcus Group, Inc. without cause, sheterminates her employment with The Neiman Marcus Group, Inc. for good reason,or The Neiman Marcus Group, Inc. delivers a notice of non-renewal of theemployment agreement’s term.

Oncethe two-year period under the change of control termination protectionagreement summarized below has ended, Ms. Katz will be entitled to lump sumseverance in the event of a termination as described above equal to (i) hertarget bonus, pro rated to her length of service in the year of termination;and (ii) two times her annual base salary plus bonus.  Ms. Katz will also be entitled to receivemedical, dental and life insurance benefits for a two-year period following aseverance triggering termination and may be entitled to an unreduced SERPbenefit in the event Ms. Katz experiences a severance triggering terminationbefore age 65.

Eachof the Named Executive Officers is a party to a change of control terminationprotection agreement.  Under each of thechange of control termination protection agreements, upon a change of control(which includes completion of the merger as part of the Transactions), any timeperiods, conditions or contingencies relating to the exercise or realizationof, or lapse of restrictions under, any outstanding equity incentive awardwould be automatically accelerated or waived other than any grants made inconnections with the Transactions.  Inaddition, if the Named Executive Officer’s employment is terminated by TheNeiman Marcus Group, Inc. without “cause” or by the Named Executive Officer for“good reason” (which includes in most cases, among other things, a reduction inthe Named Executive Officer’s base salary or total bonus, a relocation greaterthan 50 miles from the Named Executive Officer’s current principal place ofbusiness or a diminution in the Named Executive Officer’s title or primaryreporting relationship or substantial diminution in duties or responsibilities(other than solely as a result of our ceasing to be a publicly heldcorporation), as those terms are defined in the agreement, within two yearsfollowing, or in some cases before (an “anticipatory termination”), a change ofcontrol, the Named Executive Officer will be entitled to receive a lump sumamount equal to (a) the sum of two times, or in the case of Mr. Tansky, threetimes, (1) the officer’s annual base salary and (2) his or her annual targetbonus for the year of the termination, (b) a pro rata target bonus (providedthat if the Named Executive Officer’s employment terminates after more than 75%of our fiscal year has elapsed, the Named Executive Officer may be entitled toa pro rata portion of the actual bonus to which he or she would have beenentitled if such actual bonus would have been greater than the target bonus;for purposes of calculating the actual bonus it is assumed that all qualitativeand subjective performance criteria were achieved) and (c) in the case of ananticipatory termination, an amount equal to the base salary from the date of terminationthrough the date of the change of control and any bonus for the most recentlycompleted fiscal year if not previously paid due to the anticipatorytermination.  Payments to Mr. Tansky andMs. Katz under their change of control termination protection agreements are inlieu of any severance provided for in their employment agreements.

61

----

If aNamed Executive Officer becomes entitled to receive these severance amounts,the Named Executive Officer will also be entitled to the following:

·                      Deemedparticipation in and accelerated vesting of benefits under the SERP and a lumpsum cash payment equal to the actuarial equivalent of the incremental benefitspayable under the SERP if the Named Executive Officer were credited withenhanced years of service (two or three years) for purposes of eligibility forparticipation, eligibility for retirement, for early commencement of actuarialsubsidies and for purposes of benefit accrual (modified as described above forMr. Tansky and Ms. Katz);

·                      Acceleratedvesting of any outstanding equity awards held by such Named Executive Officerthat are not otherwise accelerated pursuant to the terms under which suchawards were granted other than any equity awards granted in connection with theTransactions;

·                      Continuingcoverage under our group health, dental and life insurance plans for the NamedExecutive Officer, their spouse and any dependents for two years (three in thecase of Mr. Tansky) (any such medical and dental benefits will become secondaryto coverage provided by a subsequent employer) and certain retiree medicalcoverage benefits; and

·                      Reimbursementfor outplacement expenses and merchandise discounts for the Named ExecutiveOfficer, his or her spouse and dependents.

Eachagreement also contains a tax gross-up provision whereby if the Named ExecutiveOfficer incurs any excise tax by reason of his or her receipt of any paymentthat constitutes an excess parachute payment as defined in Section 280G of theInternal Revenue Code of 1986, as amended (the “Code”), the Named ExecutiveOfficer will receive a gross-up payment in an amount that would place the NamedExecutive Officer in the same after-tax position that he or she would have beenin if no excise tax had applied. However, under certain conditions, rather than receive a gross-uppayment, the payments payable to the Named Executive Officer will be reduced sothat no excise tax is imposed.  As acondition to receiving any payments or benefits under the agreements, theofficers must execute a release of claims in respect of their employment withus.

Inaddition to the change of control termination protection agreements, each ofthe Named Executive Officers and certain other officers, except for Mr. Tansky,are party to a confidentiality, non-competition and termination benefitsagreement that will provide for severance benefits once the change of controltermination protection agreements expire if the employment of the affectedindividual is terminated by the Company other than in the event of death,disability or termination for cause. These agreements provide for a severance payment equal to one andone-half annual base salary payable over an eighteen month period, andreimbursement for COBRA premiums for the same period.

**Cash Incentive Plan**

Following theconsummation of the Transactions, the Newton Acquisition, Inc. Cash IncentivePlan (the “Cash Incentive Plan”) was adopted to aid in the retention of certainkey executives, including the Named Executive Officers.  The Cash Incentive Plan provides for thecreation of a $14 million cash bonus pool to be shared by all participantsbased on the number of vested and unvested stock options and underlying sharesthat were granted pursuant to the Management Equity Incentive Plan.  Each participant in the Cash Incentive Plan willbe entitled to a cash bonus upon the earlier to occur of a change of control oran initial public offering, as defined in the Cash Incentive Plan, providedthat the internal rate of return to the Sponsors is positive.

**Compensation Committee Interlocksand Insider Participation**

Infiscal year 2006 prior to the consummation of the Transactions, Walter J.Salmon, Matina S. Horner, Paula Stern, and John R. Cook served as members ofthe Compensation Committee.  All werequalified as independent directors and none of them were considered employeesduring fiscal year 2006.  John R. Cookserved as our Senior Vice President and Chief Financial Officer from September1992 to July 2001.  Following theAcquisition in fiscal year 2006, Jonathan Coslet, Kewsong Lee, and John G.Danhakl served as members of our Compensation Committee.  No officer or employee served on thecompensation committee (or equivalent), or the board of directors, of anotherentity whose executive officer(s) served on our compensation committee orboard.

62

----

**ITEM12.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

**SecuritiesAuthorized for Issuance under Equity Compensation Plans**

Thefollowing table sets forth information regarding equity compensation plansapproved by shareholders and equity compensation plans not approved byshareholders as of July 29, 2006.

| Plan Category                                          | ** ** | **Number of  Securities to be  Issued upon  exercise of   outstanding  options** | ** ** | **Weighted-average  exercise price of  outstanding  options, warrants,  and rights** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                                        | ** ** | **(b)**                                                                                                  | ** ** | **(c)**                                                                                                                                                                                                      | ** ** |
|                                                        |       |                                                                                                           |       |                                                                                                     |       |                                                                                                                                                                                                         |       |
| Equity  compensation plans approved by security holders     |       | 74,433.077                                                                                                     | (1)        | $                                                                                                        | 1,445      |                                                                                                                                                                                                         | 6,275.6955 |   |
|                                                        |       |                                                                                                           |       |                                                                                                     |       |                                                                                                                                                                                                         |       |
| Equity  compensation plans not approved by security holders |       | 0                                                                                                              |       | $                                                                                                        | 00.00      |                                                                                                                                                                                                         | 0          |   |
|                                                        |       |                                                                                                           |       |                                                                                                     |       |                                                                                                                                                                                                         |       |
| Total                                                       |       | 74,433.077                                                                                                     |       | $                                                                                                        | 1,445      |                                                                                                                                                                                                         | 6,275.6955 |   |

 

----

(1)                                  This numberrepresents options issuable under the Management Equity Incentive Plan that wasapproved by a majority of the shares of common stock of Neiman Marcus, Inc. onNovember 29, 2005.  The Plan becameeffective on November 29, 2005 and will expire on November 29, 2015.

**SecurityOwnership of Certain Beneficial Owners and Management**

Thefollowing table sets forth information regarding beneficial ownership of ourcommon stock as of September 15, 2006 by (i) each person we believe ownsbeneficially more than five percent of our outstanding common stock, (ii) eachof our directors, (iii) each of Named Executive Officers and (iv) all directorsand executive officers as a group.

**SecurityOwnership of Certain Beneficial Owners and Management**

Thefollowing table sets forth information regarding beneficial ownership of ourcommon stock as of September 15, 2006 by (i) each person we believe ownsbeneficially more than five percent of our outstanding common stock, (ii) eachof our directors, (iii) each of Named Executive Officers and (iv) all directorsand executive officers as a group.
| **Name**                                                                                          | ** ** | **Number of Common  Shares  Beneficially Owned** | ** ** | **Percent of Class (1)** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
|                                                                                              |       |                                             |       |                     |       |
| **Newton Holding, LLC**301 Commerce Street  Suite 3300  Fort Worth, Texas 76102                   |       | 1,000,000                                        |       | 98.79                    | %          |
|                                                                                              |       |                                             |       |                     |       |
| **Affiliates of Texas Pacific  Group(2)**301 Commerce Street  Suite 3300  Fort Worth, Texas 76102 |       | 1,000,000                                        |       | 98.79                    | %          |
|                                                                                              |       |                                             |       |                     |       |
| **Affiliates of Warburg Pincus,  LLC(3)**466 Lexington Avenue  New York, NY 10017                 |       | 1,000,000                                        |       | 98.79                    | %          |

 

63

----

 
| **David A. Barr(4)**466 Lexington Avenue  New York, NY 10017                       |   | 1,000,000 |   | 98.79  | %      |
|------------------------------------------------------------------------------------|--------|-----------|--------|--------|--------|
|                                                                               |   |      |   |   |   |
| **James Coulter(5)**345 California Street, Suite 3300  San Francisco, CA 94104     |   | 1,000,000 |   | 98.79  | %      |
|                                                                               |   |      |   |   |   |
| **Sidney Lapidus(4)**466 Lexington Avenue  New York, NY 10017                      |   | 1,000,000 |   | 98.79  | %      |
|                                                                               |   |      |   |   |   |
| **Kewsong Lee(4)**466 Lexington Avenue  New York, NY 10017                         |   | 1,000,000 |   | 98.79  | %      |
|                                                                               |   |      |   |   |   |
| **Burton M. Tansky(6)**1618 Main Street  Dallas, TX 75201                          |   | 10,941    |   | 1.07   | %      |
|                                                                               |   |      |   |   |   |
| **Karen W. Katz(7)**1618 Main Street  Dallas, TX 75201                             |   | 6,341     |   |   | *      |
|                                                                               |   |      |   |   |   |
| **James E. Skinner(8)**1618 Main Street  Dallas, TX 75201                          |   | 3,264     |   |   | *      |
|                                                                               |   |      |   |   |   |
| **Brendan L. Hoffman(9)**1618 Main Street  Dallas, TX 75201                        |   | 2,605     |   |   | *      |
|                                                                               |   |      |   |   |   |
| **James J. Gold(10)**754 Fifth Avenue  New York, NY10019                           |   | 2,059     |   |   | *      |
|                                                                               |   |      |   |   |   |
| **Ron Beegle**150 N. Santa Anita Avenue  Suite 300  Arcadia, CA 91006              |   | —    |   |   | *      |
|                                                                               |   |      |   |   |   |
| **Jonathan Coslet(5)**345 California Street  Suite 3300  San Francisco, CA 94104   |   | —    |   |   | *      |
|                                                                               |   |      |   |   |   |
| **John G. Danhakl**11111 Santa Monica Boulevard  Suite 2000  Los Angeles, CA 90025 |   | —    |   |   | *      |
|                                                                               |   |      |   |   |   |
| **Carrie Wheeler(5)**345 California Street  Suite 3300  San Francisco, CA 94104    |   | —    |   |   | *      |
|                                                                               |   |      |   |   |   |
| **All current executive officers  and directors as a group (17 persons)**          |   | 1,026,985 |   | 99.77  | %      |

 

----

*  Representsless than 1% of the class.

64

----

(1)                                  Percentageof class beneficially owned is based on 1,012,264 common shares outstanding asof September 15, 2006, together with the applicable options to purchase commonshares for each shareholder exercisable on September 15, 2006 or within 60 daysthereafter.  Shares issuable upon theexercise of options currently exercisable or exercisable 60 days afterSeptember 15, 2006 are deemed outstanding for computing the percentageownership of the person holding the options, but are not deemed outstanding forcomputing the percentage of any other person. The amounts and percentages of common stock beneficially owned arereported on the basis of regulations of the SEC governing the determination ofbeneficial ownership of securities. Under the rules of the SEC, a person is deemed to be a “beneficialowner” of a security if that person has or shares “voting power,” whichincludes the power to vote or to direct the voting of such security, or“investment power,” which includes the power to dispose of or to direct thedisposition of such security.  A personis also deemed to be a beneficial owner of any securities of which that personhas a right to acquire beneficial ownership within 60 days.  Under these rules, more than one person maybe deemed to be a beneficial owner of such securities as to which such personhas voting or investment power.

(2)                                  Includesthe 1,000,000 shares owned by Newton Holding, LLC over which TPG Partners IV,L.P., TPG Newton III, LLC and TPG Newton Co-Invest I, LLC (the “TPG Entities”)may be deemed, as a result of their ownership of 41.52% of Newton Holding,LLC’s total outstanding shares and certain provisions under the Newton Holding,LLC operating agreement, to have shared voting or dispositive power.  David Bonderman, James G. Coulter and WilliamS. Price, III are directors, officers and sole shareholders of each of i) TPGAdvisors III, Inc., which is the general partner of TPG Partners III, which inturn is the managing member of TPG Newton III, LLC; and ii) TPG Advisors IV,Inc., which is the general partner of TPG GenPar IC, L.P., which in turn is a)the general partner of TPG Partners IV, L.P. and b) the managing member of TPGNewton Co-Invest I, LLC.  By virtue oftheir position in relation to the TPG Entities, Mr. Bonderman, Mr. Coulter andMr. Price may be deemed to have investment powers and beneficial ownership withrespect to the securities described herein. Each of Mr. Bonderman, Mr. Coulter and Mr. Price disclaims beneficialownership of such securities.  NeitherMr. Coslet nor Ms. Wheeler has voting or dispositive power over any of theshares of common stock that may be deemed to be beneficially owned by TexasPacific Group.

(3)                                  Includesthe 1,000,000 shares owned by Newton Holding, LLC over which Warburg PincusPrivate Equity VIII, L.P., Warburg Pincus Netherlands Private Equity VIII, C.V.I, Warburg Pincus Germany Private Equity VIII K. G. (collectively, “WP VIII”)and Warburg Pincus Private Equity IX, L.P. (“WP IX”) may be deemed, as a resultof their ownership of 43.25% of Newton Holding, LLC’s total outstanding sharesand certain provisions under the Newton Holding, LLC operating agreement, tohave shared voting or dispositive power. Warburg Pincus Partners, LLC, a direct subsidiary of Warburg Pincus& Co. (“WP”), is the general partner of WP VIII.  Warburg Pincus IX, LLC, an indirectsubsidiary of WP, is the general partner of WP IX.  Warburg Pincus LLC (“WP LLC”) is the managerof each of WP VIII and WP IX.  WP and WPLLC may be deemed to beneficially own all of the shares of common stock ownedby WP VIII and WP IX.  Messrs. Barr,Lapidus, and Lee disclaim beneficial ownership of all of the shares of commonstock owned by the Warburg Pincus entities.

(4)                                  Messrs.Bar, Lapidus and Lee, as partners of WP and managing directors and members ofWP LLC, may be deemed to beneficially own all of the shares of common stockbeneficially owned by the Warburg Pincus entities.  Messrs. Barr, Lapidus and Lee disclaim anybeneficial ownership of these shares of common stock.

(5)                                  Mr.Coulter, as managing general partner of Texas Pacific Group, may be deemed tobeneficially own all of the shares of common stock owned by the TPGEntities.  Mr. Coulter disclaims anybeneficial ownership of these shares of common stock.  Neither Mr. Coslet nor Ms. Wheeler has votingor dispositive power over any of the shares of common stock that may be deemedto be beneficially owned by Texas Pacific Group.

(6)                                  Includes10,012 shares not currently owned, but which are issuable upon the exercise ofstock options that are currently exercisable or that become exercisable within60 days.

(7)                                  Includes2,314 shares not currently owned, but which are issuable upon the exercise ofstock options that are currently exercisable or that become exercisable within60 days.

 

65

----

(8)                                  Includes1,157 shares not currently owned, but which are issuable upon the exercise ofstock options that are currently exercisable or that become exercisable within60 days.

(9)                                  Includes1,157 shares not currently owned, but which are issuable upon the exercise ofstock options that are currently exercisable or that become exercisable within60 days.

(10)                            Includes1,157 shares not currently owned, but which are issuable upon the exercise ofstock options that are currently exercisable or that become exercisable within60 days.

**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

**Newton Holding, LLC LimitedLiability Company Operating Agreement**

Theinvestment funds associated with or designated by a Sponsor (Sponsor Funds) andcertain investors who agreed to co-invest with the Sponsor Funds or through avehicle jointly controlled by the Sponsors to provide equity financing for theTransactions (Co-Investors), entered into a limited liability company operatingagreement in respect of our parent company, Newton Holding, LLC (the “LLCAgreement”).  The LLC Agreement containsagreements among the parties with respect to the election of our directors andthe directors of our parent companies, restrictions on the issuance or transferof interests in us, including tag-along rights and drag-along rights, and othercorporate governance provisions (including the right to approve variouscorporate actions).

Pursuantto the LLC Agreement, each of Texas Pacific Group and Warburg Pincus has theright, which is freely assignable to other members or indirect members, tonominate four directors, and Texas Pacific Group and Warburg Pincus areentitled to jointly nominate additional directors.  The rights of Texas Pacific Group and WarburgPincus to nominate directors are subject to their ownership percentages inNewton Holding, LLC remaining above a specified percentage of their initialownership percentage.  Each of theSponsors has the right to have at least one of its directors sit on eachcommittee of the Board of Directors, to the extent permitted by applicable lawsand regulations.

TheSponsors have assigned the right to appoint one of our directors to investmentfunds that are affiliates of Credit Suisse Securities (USA) LLC and the rightto appoint one of our directors to investment funds associated with LeonardGreen Partners.

Forpurposes of any board action, each director nominated by Texas Pacific Group orWarburg Pincus has three votes and each of the directors (including any jointlynominated directors and the directors nominated by investment funds that areaffiliates of Credit Suisse Securities (USA) LLC and Leonard Green Partners)has one vote.  Certain major decisions ofthe board of directors of Newton Holding, LLC require the approval of each ofTexas Pacific Group and Warburg Pincus and certain other decisions of the boardof directors of Newton Holding, LLC require the approval of a specified numberof directors designated by each of Texas Pacific Group and Warburg Pincus, ineach case subject to the requirement that their respective ownership percentagein Newton Holding, LLC remains above a specified percentage of their initialownership percentage.

**Registration Rights Agreement**

TheSponsor Funds and the Co-Investors entered into a registration rights agreementwith us upon completion of the Transactions. Pursuant to this agreement, the Sponsor Funds can cause us to registertheir interests in NMG under the Securities Act and to maintain a shelfregistration statement effective with respect to such interests.  The Sponsor Funds and the Co-Investors arealso entitled to participate on a pro rata basis in any registration of ourequity interests under the Securities Act that we may undertake.

**Management Services Agreement**

Inconnection with the Transactions, we entered into a management servicesagreement with affiliates of the Sponsors pursuant to which affiliates of oneof the Sponsors received on the closing date of the Acquisition a transactionfee of $25 million in cash in connection with the Transactions.  Affiliates of the other Sponsor waived any cashtransaction fee in connection with the Transactions.  In addition, pursuant to such agreement, andin exchange for consulting and management advisory services that will beprovided to us by the Sponsors and their affiliates, affiliates of the Sponsorswill receive an aggregate annual management fee equal to the lesser of (i)0.25% of consolidated annual revenue and (ii) $10 million.  Also, affiliates of the Sponsors are entitledto receive reimbursement for out-of-pocket expenses incurred by them or theiraffiliates

66

----

in connection withthe provision of services pursuant to the agreement.  The management services agreement alsoprovides that affiliates of the Sponsors may receive fees in connection withcertain subsequent financing and acquisition or disposition transactions.  The management services agreement includescustomary exculpation and indemnification provisions in favor of the Sponsorsand their affiliates.

**Certain Charter and BylawsProvisions**

Ouramended and restated certificate of incorporation and our amended and restatedbylaws contain provisions limiting directors’ obligations in respect ofcorporate opportunities.  In addition,our amended and restated certificate of incorporation provide that Section 203of the Delaware General Corporation Law will not apply to the Company.  Section 203 restricts “business combinations”between a corporation and “interested stockholders,” generally defined asstockholders owning 15% or more of the voting stock of a corporation.

**Loan to Mr. Tansky**

Infiscal 2006, Mr. Tansky had an outstanding loan balance under our former KeyExecutive Stock Purchase Loan Plan (the “Loan Plan”) in the amount of$369,253.  The loan was used to exercisestock options and discharge tax liabilities, as provided in the Loan Plan.  The loan bore interest at the annual rate offive percent, payable quarterly.  Underthe terms of the Loan Plan, loans became due and payable seven months followingcessation of employment with us. Effective July 30, 2002, the Loan Plan was terminated and we have notmade any other loans to any executive officer or director under the Loan Plan,nor has the loan to Mr. Tansky been modified in any material way.  The loan to Mr. Tansky was fully paid atclosing of the Transactions.  No otherexecutive officer, director or five percent security holder was indebted to ussince the beginning of our 2006 fiscal year. See “Employment Contracts and Termination of Employment andChange-in-Control Arrangements” for a description of the Employment Agreementwith Mr. Tansky.

**Management Stockholders’ Agreement**

Subject to theManagement Stockholders’ Agreement, certain members of management, includingBurton M. Tansky, Karen W. Katz, James E. Skinner, Brendan L. Hoffman, andJames J. Gold, along with 21 other members of management, elected to invest inthe Company by contributing cash or equity interests in NMG, or a combinationof both, to the Company prior to the merger and receiving equity interests inthe Company in exchange therefor immediately after completion of the merger pursuantto rollover agreements with NMG and the Company entered into prior to theeffectiveness of the merger.  Theaggregate amount of this investment was approximately $25.6 million.  The Management Stockholders’ Agreementcreates certain rights and restrictions on these equity interests, includingtransfer restrictions and tag-along, drag-along, put call and restrictionrights in certain circumstances.

67

----

**ITEM14.  PRINCIPAL ACCOUNTING FEES ANDSERVICES**

The Audit Committee has adoptedpolicies and procedures for pre-approving all audit and permissible non-auditservices performed by Deloitte & Touche LLP. Under these policies, theAudit Committee pre-approves the use of audit and audit-related servicesfollowing approval of the independent registered public accounting firm’s auditplan. All services detailed in the audit plan are considered pre-approved. If,during the course of the audit, the independent registered public accountingfirm expects fees to exceed the approved fee estimate between 10 percentand 15 percent, those fees must be pre-approved in advance by the AuditCommittee Chairman. If fees are expected to exceed the approved estimate bymore than 15 percent, those fees must be approved in advance by the AuditCommittee.

Other non-audit services of lessthan $50,000 that are not restricted services may be pre-approved by both thechief financial officer and the controller, provided those services will notimpair the independence of the independent auditor. These services will be consideredapproved by the Audit Committee, provided those projects are discussed with theAudit Committee at its next scheduled meeting. Services between $50,000 and$100,000 in estimated fees must be pre-approved by the Chairman of the AuditCommittee, acting on behalf of the entire Audit Committee. Services of greaterthan $100,000 in estimated fees must be pre-approved by the Audit Committee.All fee overruns will be discussed with the Audit Committee at the nextscheduled meeting.

**Principal Accounting Fees and Services**

For the fiscal years endedJuly 29, 2006 and July 30, 2005, professional services were performedby Deloitte & Touche LLP, the member firms of Deloitte ToucheTohmatsu, and their respective affiliates, which includes Deloitte consulting(collectively, “Deloitte & Touche”).

***AuditFees.***  The aggregate fees billed for the audits ofthe Company’s annual financial statements for the fiscal years endedJuly 29, 2006 and July 30, 2005 and for the reviews of the financialstatements included in our Quarterly Reports on Form 10-Q were $1,957,000and $1,346,000, respectively.

***Audit-RelatedFees.***  The aggregate fees billed for audit-relatedservices for the fiscal years ended July 29, 2006 and July 30, 2005were $1,008,000 and $534,000, respectively. These fees related to accountingresearch and consultation and attestation services for certain subsidiarycompanies for the fiscal years ended July 29, 2006 and July 30, 2005.

***TaxFees.***  The aggregate fees billed for tax servicesfor the fiscal years ended July 29, 2006 and July 30, 2005 were$83,000 and $47,000, respectively. These fees related to tax compliance andplanning for the fiscal years ended July 29, 2006 and July 30, 2005.

The Audit Committee hasconsidered and concluded that the provision of permissible non-audit servicesis compatible with maintaining Deloitte & Touche’s independence.

68

----

**PART IV**

**ITEM 15. EXHIBITS, FINANCIALSTATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

The following documents are filedas part of this report.

**1.             FinancialStatements**

The list of financial statementsrequired by this item is set forth in Item 8.

**2.             Indexto Financial Statement Schedules**
|                                                                       | ** ** | **Page  Number** |
|-----------------------------------------------------------------------|------------|------------------|
| Report of  Independent Registered Public Accounting Firm              |       | F-3              |
| Schedule II—Valuation  and Qualifying Accounts and Reserves |       | 75               |

 

Allother financial statement schedules for which provision is made in theapplicable accounting regulations of the Securities and Exchange Commission arenot required under the related instructions or are not applicable.

**3.             Exhibits**
| Exhibit No. | ** ** | **Exhibit**                                                                                                                                                                                                                                                                                                                                     |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 2.1         |       | Agreement and Plan of Merger, dated May 1, 2005,  among The Neiman Marcus Group, Inc., Newton Acquisition, Inc., and Newton  Merger Sub, Inc., incorporated herein by reference to The Neiman Marcus  Group, Inc.’s Current Report on Form 8-K dated May 4, 2005.                                                                          |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 2.2         |       | Purchase, Sale and Servicing Transfer Agreement  dated as of June 8, 2005, among The Neiman Marcus Group, Inc., Bergdorf  Goodman, Inc., HSBC Bank Nevada, N.A. and HSBC Finance Corporation,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated June 8, 2005.                         |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 3.1         |       | Amended and Restated Certificate of Incorporation of  Neiman Marcus, Inc., incorporated herein by reference to The Neiman Marcus  Group, Inc.’s Registration Statement on Form S-1 (Registration No.  333-133184) dated April 10, 2006.                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 3.2         |       | Amended and Restated Bylaws of Neiman Marcus, Inc.,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Registration Statement on Form S-1 (Registration No. 333-133184) dated April  10, 2006.                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 4.1         |       | Indenture, dated as of May 27, 1998, between The  Neiman Marcus Group, Inc. and The Bank of New York, as trustee, incorporated  herein by reference to The Neiman Marcus Group, Inc.’s Annual Report on Form  10-K for the fiscal year ended July 31, 2004.                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 4.2         |       | Form of 7.125% Senior Notes Due 2028, dated May 27,  1998, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Annual Report on Form 10-K for the fiscal year ended July 31, 2004.                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 4.3         |       | Senior Indenture dated as of October 6, 2005, among  Newton Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the Subsidiary  Guarantors, and Wells Fargo Bank, National Association, trustee, incorporated  herein by reference to The Neiman Marcus Group, Inc.’s Current Report on Form  8-K dated October 12, 2005.              |
|        |       |                                                                                                                                                                                                                                                                                                                                            |
| 4.4         |       | Senior Subordinated Indenture dated as of October 6,  2005, among Newton Acquisition, Inc., Newton Acquisition Merger Sub, Inc.,  the Subsidiary Guarantors, and Wells Fargo Bank, National Association,  trustee, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Current Report on Form 8-K dated October 12, 2005. |

 

69

----

 
| 4.5    |   | Form of 9%/9 3/4% Senior Notes due 2015,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.6    |   | Form of 10 3/8% Senior Subordinated Notes due 2015,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.7    |   | Registration Rights Agreement dated October 6, 2005,  among Newton Acquisition, Inc., Newton Acquisition Merger Sub, Inc., the  Subsidiary Guarantors, The Neiman Marcus Group, Inc., and the Initial  Purchasers, incorporated herein by reference to The Neiman Marcus Group,  Inc.’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.8    |   | First Supplemental Indenture, dated as of July 11,  2006, to the Indenture, dated as of May 27, 1998, among The Neiman Marcus  Group, Inc., Neiman Marcus, Inc., and The Bank of New York Trust Company,  N.A., as successor trustee, incorporated herein by reference to The Neiman  Marcus Group, Inc.’s Current Report on Form 8-K dated July 11, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.9    |   | Second Supplemental Indenture, dated as of August  14, 2006, to the Indenture, dated as of May 27, 1998, among The Neiman Marcus  Group, Inc., Neiman Marcus, Inc., and The Bank of New York Trust Company,  N.A., as successor trustee, incorporated herein by reference to the Company’s  Current Report on Form 8-K dated August 15, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1*  |   | Employment Agreement dated as of October 6, 2005 by  and among The Neiman Marcus Group, Inc., Newton Acquisition Merger Sub, Inc.,  Newton Acquisition, Inc., and Burton M. Tansky, incorporated herein by  reference to The Neiman Marcus Group, Inc.’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 Neiman Marcus Group, Inc., Newton Acquisition, Inc., and Burton  M. Tansky, incorporated herein by reference to The Neiman Marcus Group,  Inc.’s Current Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.3*  |   | Form of Rollover Agreement by and among The Neiman  Marcus Group, Inc., Newton Acquisition, Inc., and certain members of management,  incorporated herein by reference to The Neiman Marcus Group, Inc.’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 Neiman  Marcus Group, Inc., 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 Neiman Marcus Group, Inc.’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 Neiman  Marcus Group, Inc., 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 Neiman Marcus Group, Inc.’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 Neiman Marcus Group,  Inc., Newton Acquisition, Inc., the Subsidiary Guarantors and Deutsche Bank  Trust Company Americas, as administrative agent and collateral agent,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated October 12, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

70

----

 
| 10.7   |   | Pledge and Security and Intercreditor Agreement  dated as of October 6, 2005, among Newton Acquisition Merger Sub, Inc., The  Neiman Marcus Group, Inc., Newton Acquisition, Inc., the Subsidiary  Guarantors and Credit Suisse, as administrative agent and collateral agent,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated October 12, 2005.                                                                                      |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.8   |   | Lien Subordination and Intercreditor Agreement dated  as of October 6, 2005, among Newton Acquisition, Inc., Newton Acquisition  Merger Sub, Inc., the Subsidiary Guarantors, Deutsche Bank Trust Company  Americas, as revolving facility agent, and Credit Suisse, as term loan agent,  incorporated herein by reference to The Neiman Marcus Group, Inc.’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 Neiman  Marcus Group, Inc. to Credit Suisse, incorporated herein by reference to The  Neiman Marcus Group, Inc.’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 Neiman Marcus Group, Inc. to Credit Suisse, incorporated herein by  reference to The Neiman Marcus Group, Inc.’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 Neiman  Marcus Group, Inc. to Deutsche Bank Trust Company Americas, incorporated  herein by reference to The Neiman Marcus Group, Inc.’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 Neiman Marcus Group, Inc. to Deutsche Bank Trust Company Americas,  incorporated herein by reference to The Neiman Marcus Group, Inc.’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 Neiman Marcus Group,  Inc., Newton Acquisition, Inc., each subsidiary of The Neiman Marcus Group,  Inc. from time to time party thereto, the Lenders thereunder, and Credit  Suisse, as administrative agent and as collateral agent for the Lenders,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated October 12, 2005.    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.14* |   | Newton Acquisition, Inc. Management Equity Incentive  Plan, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Current Report on Form 8-K dated December 5, 2005.                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.15* |   | Stock Option Grant Agreement made as of November 29,  2005 between Newton Acquisition, Inc. and Burton M. Tansky, incorporated  herein by reference to The Neiman Marcus Group, Inc.’s Current Report on Form  8-K dated December 5, 2005.                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.16* |   | Form of Stock Option Grant Agreement made as of  November 29, 2005 between Newton Acquisition, Inc. and certain eligible key  employees, incorporated herein by reference to The Neiman Marcus Group,  Inc.’s Current Report on Form 8-K dated December 5, 2005.                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.17  |   | Amendment No. 2 dated as of January 26, 2006 to the  Credit Agreement dated as of October 6, 2005, as amended, among The Neiman  Marcus Group, Inc., Newton Acquisition, Inc., each subsidiary of The Neiman  Marcus Group, Inc. from time to time party thereto, the Lenders thereunder  and Credit Suisse, as administrative agent and collateral agent for the  Lenders, incorporated by reference to The Neiman Marcus Group, Inc.’s Current  Report on Form 8-K dated January 30, 2006. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.18* |   | Employment Agreement between The Neiman Marcus  Group, Inc. and Karen Katz, dated February 1, 2006, effective as of October  6, 2005, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Current Report on Form 8-K dated February 1, 2006.                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.19  |   | Management Services Agreement, dated as of October  6, 2005 among Newton Acquisition Merger Sub, Inc., Newton Acquisition, Inc.,  TPG GenPar IV, L.P., TPG GenPar III, L.P. and Warburg Pincus LLC incorporated  herein by reference to The Neiman Marcus Group, Inc.’s Quarterly Report on  Form 10-Q for the quarter ended January 28, 2006.                                                                                                                                               |

 

71

----

 
| 10.20  |       | Registration Rights Agreement, dated as of October  6, 2005, among Newton Acquisition Merger Sub, Inc., Newton Acquisition, Inc.,  Newton Holding, LLC and the “Holders” identified therein as parties thereto  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Quarterly  Report on Form 10-Q for the quarter ended January 28, 2006.                                                                                           |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.21  |       | Amendment No. 1, dated as of March 28, 2006, to the  Pledge and Security Intercreditor Agreement dated as of October 6, 2005,  among Neiman Marcus, Inc., The Neiman Marcus Group, Inc., the Subsidiaries  party thereto and Credit Suisse, as administrative agent and collateral  agent, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Current Report on Form 8-K dated March 29, 2006.                                               |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.22  |       | Credit Card Program Agreement, dated as of June 8,  2005, by and among The Neiman Marcus Group, Inc., Bergdorf Goodman, Inc.,  HSBC Bank Nevada, N.A. and Household Corporation, incorporated herein by  reference to The Neiman Marcus Group, Inc.’s Current Report on Form 8-K dated  June 8, 2005.                                                                                                                                                          |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.23  |       | Form of Servicing Agreement, by and between The  Neiman Marcus Group, Inc. and HSBC Bank Nevada, N.A., incorporated herein by  reference to The Neiman Marcus Group, Inc.’s Current Report on Form 8-K dated  June 8, 2005.                                                                                                                                                                                                                                    |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.24* |       | Confidentiality, Non-Competition and Termination  Benefits Agreement between Bergdorf Goodman, Inc. and James J. Gold dated May  3, 2004, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Annual Report on Form 10-K for the fiscal year ended July 31, 2004.                                                                                                                                                                             |
|   | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.25  |       | Credit Agreement dated as of June 9, 2004 among The  Neiman Marcus Group, Inc., the Lenders parties thereof, Bank of America,  N.A., as Syndication Agent, Wachovia Bank, N.A., Wells Fargo Bank National  Association, and BNP Paribas, as Documentation Agents, and JPMorgan Chase  Bank, as Administrative Agent, incorporated herein by reference to The Neiman  Marcus Group, Inc.’s Annual Report on Form 10-K for the fiscal year ended  July 31, 2004. |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.26* |       | The Neiman Marcus Group, Inc. 2005 Stock Incentive  Plan, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Current Report on Form 8-K dated January 21, 2005.                                                                                                                                                                                                                                                                              |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.27  |       | Stockholder Agreement, dated as of May 1, 2005,  among Newton Acquisition, Inc., Newton Acquisition Merger Sub, Inc. and the other  parties signatory thereto, incorporated herein by reference to The Neiman  Marcus Group, Inc.’s Current Report on Form 8-K dated May 4, 2005.                                                                                                                                                                              |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.28* |       | Confidentiality, Non-Competition and Termination  Benefits Agreement between The Neiman Marcus Group, Inc. and Steven P. Dennis  dated September 9, 2004, incorporated herein by reference to The Neiman  Marcus Group, Inc.’s Current Report on Form 8-K dated September 9, 2004.                                                                                                                                                                             |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.29* |       | Change of Control Termination Protection Agreement  between The Neiman Marcus Group, Inc. and Burton M. Tansky, dated April 1,  2005, incorporated herein by reference to The Neiman Marcus Group, Inc.’s  Quarterly Report on Form 10-Q for the quarter ended April 30, 2005.                                                                                                                                                                                 |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.30* |       | Form of Change of Control Termination Protection  Agreement between The Neiman Marcus Group, Inc. and certain eligible  executives, including the Named Executive Officers, dated April 1, 2005,  incorporated herein by reference to The Neiman Marcus Group, Inc.’s Quarterly  Report on Form 10-Q for the quarter ended April 30, 2005.                                                                                                                     |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.31* |       | The Neiman Marcus Group, Inc. Executive Change of  Control Severance Plan dated April 1, 2005, incorporated herein by reference  to The Neiman Marcus Group, Inc.’s Quarterly Report on Form 10-Q for the  quarter ended April 30, 2005.                                                                                                                                                                                                                       |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.32* |       | The Neiman Marcus Group, Inc. General Change of  Control Severance Plan dated April 1, 2005, incorporated herein by reference  to The Neiman Marcus Group, Inc.’s Quarterly Report on Form 10-Q for the  quarter ended April 30, 2005.                                                                                                                                                                                                                         |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33* |       | Newton Acquisition, Inc. Cash Incentive Plan  effective as of November 29, 2005.  (1)                                                                                                                                                                                                                                                                                                                                                                          |

 

72

----

 
| 10.34  |   | Management Stockholders’ Agreement dated as of  October 6, 2005 between Newton Acquisition, Inc., Newton Holding, LLC, TPG  Newton III, LLC, TPG Partners IV, L.P., TPG Newton Co-Invest I, LLC, Warburg  Pincus Private Equity VIII, L.P., Warburg Pincus Netherlands Private Equity  VIII C.V. I, Warburg Pincus Germany Private Equity VIII K.G , Warburg Pincus  Private Equity IX, L.P., and the other parties signatory thereto.  (1) |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.35* |   | The Neiman Marcus Group, Inc. Key Employee Deferred  Compensation Plan effective as of January 1, 2006.  (1)                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 12.1   |   | Computation of Ratio of Earnings to Fixed  Charges.  (1)                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 14.1   |   | The Neiman Marcus Group, Inc. Code of Ethics and  Conduct, incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the fiscal year ended July 31, 2004.                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 14.2   |   | The Neiman Marcus Group, Inc. Code of Ethics for  Financial Professionals, incorporated herein by reference to The Neiman  Marcus Group, Inc.’s Annual Report on Form 10-K for the fiscal year ended  August 2, 2003.                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 21.1   |   | Subsidiaries of the Company.  (1)                                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 23.1   |   | Consent of Deloitte & Touche LLP.  (1)                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.  (1)                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.  (1)                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 32     |   | Certifications of Chief Executive Officer and Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.  (1)                                                                                                                                                                                                                                                                                                          |

 

----

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

 

73

----

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**
|                                                                        | **Page** |
|------------------------------------------------------------------------|----------|
| Management’s  Report on Internal Control over Financial Reporting | F-2      |
| Report  of Independent Registered Public Accounting Firm               | F-3      |
| Consolidated  Balance Sheets                                           | F-4      |
| Consolidated  Statements of Earnings                                   | F-5      |
| Consolidated  Statements of Cash Flows                                 | F-6      |
| Consolidated  Statements of Shareholders’ Equity                  | F-8      |
| Notes to Consolidated Financial Statements                             | F-10     |

 

F-1

----

**MANAGEMENT’S REPORT ON INTERNAL CONTROLOVER FINANCIAL REPORTING**

We areresponsible for the integrity and objectivity of the financial and operatinginformation contained in this Annual Report, including the consolidatedfinancial statements covered by the Report of Independent Registered PublicAccounting Firm. These statements were prepared in conformity with generallyaccepted accounting principles and include amounts that are based on our bestestimates and judgment.

Wemaintain a system of internal controls which provides management withreasonable assurance that transactions are recorded and executed in accordancewith its authorizations, assets are properly safeguarded and accounted for, andrecords are maintained so as to permit preparation of financial statements inaccordance with generally accepted accounting principles. This system includeswritten policies and procedures, an organizational structure that segregatesduties, financial reviews and a comprehensive program of periodic audits by theinternal auditors. We have also instituted policies and guidelines whichrequire employees to maintain a high level of ethical standards.

Inaddition, the Audit Committee of the Board of Directors meets periodically withmanagement, the internal auditors and the independent registered publicaccounting firm to review internal accounting controls, audit results andaccounting principles and practices and annually recommends to the Board ofDirectors the selection of the independent registered public accounting firm.

We areresponsible for establishing and maintaining adequate internal control overfinancial reporting as defined in Rule 13a-15(f) under the SecuritiesExchange Act of 1934. Under our supervision and with the participation of otherkey members of our management, we conducted an evaluation of the effectivenessof our internal control over financial reporting based on the framework andcriteria established in *InternalControl—Integrated Framework*, issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on this evaluation, managementconcluded that our internal control over financial reporting was effective asof July 29, 2006. During its assessment, management did not identify anymaterial weaknesses in our internal control over financial reporting.

Deloitte & Touche LLP, the independentregistered public accounting firm that audited our consolidated financialstatements included in this Annual Report on Form 10-K, has issued anunqualified attestation report on management’s assessment of internal controlover financial reporting.

 

 

BURTON M. TANSKY

President and Chief ExecutiveOfficer

JAMES E. SKINNER

Senior Vice President and ChiefFinancial Officer

T. DALE STAPLETON

Vice President and Controller

F-2

----

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders of NeimanMarcus, Inc.

Dallas, Texas

We haveaudited the accompanying consolidated balance sheets of Neiman Marcus, Inc. andsubsidiaries (the Company) as of July 29, 2006 (Successor Company) andJuly 30, 2005 (Predecessor Company), and the related consolidatedstatements of earnings, cash flows, and shareholders’ equity for the nine weeksended October 1, 2005 (Predecessor Company), the forty-three weeks ended July29, 2006 (Successor Company) and each of the two years in the period ended July30, 2005 and July 31, 2004 (Predecessor Company). Our audits also included thefinancial statement schedule listed in the Index at Item 15. We also haveaudited management’s assessment, included in the accompanying “Management’sReport on Internal Control over Financial Reporting”, that the Companymaintained effective internal control over financial reporting as ofJuly 29, 2006, based on the criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.The Company’s management is responsible for these financial statements andfinancial statement schedule, for maintaining effective internal control overfinancial reporting, and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon these financial statements and financial statement schedule, an opinion onmanagement’s assessment, and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audits.

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement and whether effectiveinternal control over financial reporting was maintained in all materialrespects. Our audit of financial statements included examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. Our audit of internal control over financial reporting includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudits provide a reasonable basis for our opinions.

Acompany’s internal control over financial reporting is a process designed by,or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected bythe company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that(1) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (2) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles and that receipts and expendituresof the company are being made only in accordance with authorizations ofmanagement and directors of the company; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use, or disposition of the company’s assets that could have a material effecton the financial statements.

Becauseof the inherent limitations of internal control over financial reporting,including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented ordetected on a timely basis. Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to futureperiods are subject to the risk that the controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of the Company as ofJuly 29, 2006 (Successor Company) and July 30, 2005 (PredecessorCompany), and the results of its operations and its cash flows for the nineweeks ended October 1, 2005 (Predecessor Company), the forty-three weeks ended July29, 2006 (Successor Company) and each of the two years in the period ended July30, 2005 and July 31, 2004 (Predecessor Company), in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, such financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly, inall material respects, the information set forth therein. Also, in our opinion,management’s assessment that the Company maintained effective internal controlover financial reporting as of July 29, 2006, is fairly stated, in allmaterial respects, based on the criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of July 29, 2006,based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.
| /S/ DELOITTE & TOUCHE LLP |   |
|-------------------------------|--------|
|                          |
| Dallas, Texas                 |
| September 25, 2006            |

 

F-3

----

**NEIMAN MARCUS, INC.**

**CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                       | ** **   | **(Successor)**         | ** **   | ** **   | **(Predecessor)**       | ** **   |
|--------------------------------------------------------------------------------------------------|--------------|-------------------------|--------------|--------------|-------------------------|--------------|
| **(in thousands, except shares)**                                                 | ** **   | **July 29,  2006** | ** **   | ** **   | **July 30,  2005** | ** **   |
| ** **                                                                                       | ** **   | ** **              | ** **   | ** **   | ** **              | ** **   |
| ASSETS                                                                                           |         |                    |         |         |                    |         |
| Current assets:                                                                                  |         |                    |         |         |                    |         |
| Cash and cash  equivalents                                                                       |         | $                       | 224,763      |         |                    | $            | 853,419 |   |
| Accounts  receivable, net of allowance                                                           |         | 34,024                  |         |         | 19,398                  |         |
| Merchandise  inventories                                                                         |         | 804,211                 |         |         | 742,891                 |         |
| Deferred income  taxes                                                                           |         | 31,572                  |         |         | 16,598                  |         |
| Other current  assets                                                                            |         | 41,286                  |         |         | 58,379                  |         |
| Current assets  of discontinued operation                                                        |         | —                  |         |         | 17,796                  |         |
| Total current  assets                                                                            |         | 1,135,856               |         |         | 1,708,481               |         |
| Property and Equipment:                                                                          |         |                    |         |         |                    |         |
| Land, buildings  and improvements                                                                |         | 698,399                 |         |         | 793,745                 |         |
| Fixtures and  equipment                                                                          |         | 378,062                 |         |         | 806,960                 |         |
| Construction in  progress                                                                        |         | 74,032                  |         |         | 118,376                 |         |
|                                                                                             |         | 1,150,493               |         |         | 1,719,081               |         |
| Less accumulated  depreciation and amortization                                                  |         | 106,679                 |         |         | 867,665                 |         |
| Property and  equipment, net                                                                     |         | 1,043,814               |         |         | 851,416                 |         |
| Customer lists, net                                                                              |         | 540,631                 |         |         | —                  |         |
| Favorable lease  commitments, net                                                                |         | 465,197                 |         |         | —                  |         |
| Trademarks                                                                                       |         | 1,667,385               |         |         | 52,180                  |         |
| Goodwill                                                                                         |         | 1,628,981               |         |         | 14,872                  |         |
| Debt issuance costs                                                                              |         | 97,537                  |         |         | 3,526                   |         |
| Other assets                                                                                     |         | 28,560                  |         |         | 22,075                  |         |
| Non-current assets of  discontinued operation                                                    |         | —                  |         |         | 8,110                   |         |
| Total assets                                                                                     |         | $                       | 6,607,961    |         |                    | $            | 2,660,660 |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                       |         |                    |         |         |                    |         |
| Current liabilities:                                                                             |         |                    |         |         |                    |         |
| Accounts payable                                                                                 |         | $                       | 309,582      |         |                    | $            | 280,432 |   |
| Accrued  liabilities                                                                             |         | 383,339                 |         |         | 326,645                 |         |
| Notes payable and  current maturities of long-term liabilities                                   |         | 6,137                   |         |         | 200                     |         |
| Current  liabilities of discontinued operation                                                   |         | —                  |         |         | 9,997                   |         |
| Total current  liabilities                                                                       |         | 699,058                 |         |         | 617,274                 |         |
| Long-term  liabilities:                                                                          |         |                    |         |         |                    |         |
| Senior secured  term loan facility                                                               |         | 1,875,000               |         |         | —                  |         |
| Senior debentures  due 2028                                                                      |         | 120,711                 |         |         | 124,823                 |         |
| Senior notes                                                                                     |         | 700,000                 |         |         | —                  |         |
| Senior  subordinated notes                                                                       |         | 500,000                 |         |         | —                  |         |
| Senior notes due  2008                                                                           |         | —                  |         |         | 124,957                 |         |
| Deferred real  estate credits, net                                                               |         | 27,647                  |         |         | 86,043                  |         |
| Deferred income  taxes                                                                           |         | 1,059,365               |         |         | —                  |         |
| Other long-term  liabilities                                                                     |         | 192,199                 |         |         | 120,973                 |         |
| Non-current  liabilities of discontinued operation                                               |         | —                  |         |         | 532                     |         |
| Total long-term  liabilities                                                                     |         | 4,474,922               |         |         | 457,328                 |         |
| Minority interest                                                                                |         | 6,314                   |         |         | 12,112                  |         |
| ***Predecessor:***                                                                               | *** *** | *** ***            | *** *** | *** *** | *** ***            | *** *** |
| Class A common stock  ($0.01 par value; authorized 100 million shares; issued 29,774,476 shares) |         |                    |         |         | 298                     |         |
| Class B common stock  ($0.01 par value; authorized 100 million shares; issued 19,941,833 shares) |         |                    |         |         | 199                     |         |
| ***Successor:***                                                                                 | *** *** | *** ***            | *** *** | *** *** | *** ***            | *** *** |
| Common stock (par value  $0.01 per share, issued 1,012,264 shares)                               |         | 10                      |         |         |                    |         |
| Additional paid-in  capital                                                                      |         | 1,405,373               |         |         | 520,414                 |         |
| Accumulated other  comprehensive income (loss)                                                   |         | 9,829                   |         |         | (47,030                 | )            |
| Retained earnings                                                                                |         | 12,455                  |         |         | 1,125,726               |         |
| Treasury stock, at cost  (768,731 shares at July 30, 2005)                                  |         | —                  |         |         | (25,661                 | )            |
| Total shareholders’  equity                                                                 |         | 1,427,667               |         |         | 1,573,946               |         |
| Total liabilities and shareholders’ equity                                                  |         | $                       | 6,607,961    |         |                    | $            | 2,660,660 |   |

* *

*See Notes toConsolidated Financial Statements.*

F-4

----

**NEIMANMARCUS, INC.**

**CONSOLIDATED STATEMENTS OF EARNINGS**
| ** **                                                                        | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                                                           | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  Ended  July 31,  2004** | ** ** |
|                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| Revenues                                                                          |       | $                                                      | 3,462,219  |       |                                              | $          | 643,377 |   | $ | 3,774,798 |   | $ | 3,483,999 |   |
| Cost of goods sold  including buying and occupancy costs (excluding depreciation) |       | 2,259,137                                              |       |       | 378,242                                           |       | 2,390,283 |   | 2,231,209 |   |
| Selling, general and  administrative expenses (excluding depreciation)            |       | 822,104                                                |       |       | 160,683                                           |       | 931,619 |   | 863,403 |   |
| Income from credit card  operations                                               |       | (49,353                                                | )          |       | (7,818                                            | )          | (71,644 | ) | (55,750 | ) |
| Depreciation expense                                                              |       | 111,086                                                |       |       | 19,726                                            |       | 106,346 |   | 98,051 |   |
| Amortization of  customer lists                                                   |       | 45,382                                                 |       |       | —                                            |       | — |   | — |   |
| Amortization of  favorable lease commitments                                      |       | 14,783                                                 |       |       | —                                            |       | — |   | — |   |
| Transaction and other  costs                                                      |       | —                                                 |       |       | 23,544                                            |       | — |   | — |   |
| Loss on disposition of  Chef’s Catalog                                       |       | —                                                 |       |       | —                                            |       | 15,348 |   | — |   |
| Gain on credit card  sale                                                         |       | —                                                 |       |       | —                                            |       | (6,170 | ) | — |   |
| Impairment and other  charges                                                     |       | —                                                 |       |       | —                                            |       | — |   | 3,853 |   |
| Operating earnings                                                                |       | 259,080                                                |       |       | 69,000                                            |       | 409,016 |   | 343,233 |   |
| Interest expense  (income), net                                                   |       | 217,930                                                |       |       | (889                                              | )          | 12,302 |   | 15,903 |   |
| Earnings from  continuing operations before income taxes and minority interest    |       | 41,150                                                 |       |       | 69,889                                            |       | 396,714 |   | 327,330 |   |
| Income taxes                                                                      |       | 14,636                                                 |       |       | 25,736                                            |       | 145,607 |   | 120,191 |   |
| Earnings from  continuing operations before minority interest                     |       | 26,514                                                 |       |       | 44,153                                            |       | 251,107 |   | 207,139 |   |
| Minority interest in  net (earnings) loss of subsidiaries                         |       | (204                                                   | )          |       | 347                                               |       | (3,107 | ) | (2,957 | ) |
| Earnings from  continuing operations                                              |       | 26,310                                                 |       |       | 44,500                                            |       | 248,000 |   | 204,182 |   |
| (Loss) earnings from  discontinued operation, net of taxes                        |       | (13,855                                                | )          |       | (346                                              | )          | 824 |   | 650 |   |
| Net earnings                                                                      |       | $                                                      | 12,455     |       |                                              | $          | 44,154 |   | $ | 248,824 |   | $ | 204,832 |   |

 

*See Notes to Consolidated FinancialStatements.*

F-5

----

**NEIMAN MARCUS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                                        | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                                                                           | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
| ** **                                                                                        | ** ** | ** **                                             | ** ** | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **CASH FLOWS—OPERATING ACTIVITIES**                                                          |       |                                                   |       |       |                                              |       |   |   |   |   |
| Net earnings                                                                                      |       | $                                                      | 12,455     |       |                                              | $          | 44,154 |   | $ | 248,824 |   | $ | 204,832 |   |
| Loss (earnings) from  discontinued operation                                                      |       | 13,855                                                 |       |       | 346                                               |       | (824 | ) | (650 | ) |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:              |       |                                                   |       |       |                                              |       |   |   |   |   |
| Depreciation                                                                                      |       | 111,086                                                |       |       | 19,726                                            |       | 106,346 |   | 98,051 |   |
| Amortization of  debt issue costs                                                                 |       | 11,728                                                 |       |       | 96                                                |       | 831 |   | 370 |   |
| Amortization of  customer lists and favorable lease commitments                                   |       | 60,165                                                 |       |       | —                                            |       | — |   | — |   |
| Non-cash charges  related to step-up in carrying value of inventory                               |       | 38,067                                                 |       |       | —                                            |       | — |   | — |   |
| Stock-based  compensation charges                                                                 |       | 3,951                                                  |       |       | 19,968                                            |       | — |   | — |   |
| Deferred income  taxes                                                                            |       | (65,939                                                | )          |       | (6,921                                            | )          | (15,336 | ) | 22,969 |   |
| Loss on  disposition of Chef’s Catalog                                                       |       | —                                                 |       |       | —                                            |       | 15,348 |   | — |   |
| Gain on Credit  Card Sale                                                                         |       | —                                                 |       |       | —                                            |       | (6,170 | ) | — |   |
| Net cash  received from Credit Card Sale                                                          |       | —                                                 |       |       | —                                            |       | 533,656 |   | — |   |
| Impairment of  intangible assets and other charges                                                |       | —                                                 |       |       | —                                            |       | — |   | 3,853 |   |
| Minority  interest                                                                                |       | 204                                                    |       |       | (347                                              | )          | 3,107 |   | 2,957 |   |
| Other—primarily  costs related to defined benefit pension and other long-term benefit  plans |       | 15,315                                                 |       |       | 650                                               |       | 39,138 |   | 33,510 |   |
|                                                                                              |       | 200,887                                                |       |       | 77,672                                            |       | 924,920 |   | 365,892 |   |
| Changes in operating  assets and liabilities:                                                     |       |                                                   |       |       |                                              |       |   |   |   |   |
| Increase in accounts  receivable                                                                  |       | (7,413                                                 | )          |       | (7,213                                            | )          | (68,781 | ) | (528,658 | ) |
| Decrease in  undivided interests                                                                  |       | —                                                 |       |       | —                                            |       | — |   | 242,565 |   |
| Decrease  (increase) in merchandise inventories                                                   |       | 111,798                                                |       |       | (173,118                                          | )          | (39,118 | ) | (31,520 | ) |
| Decrease  (increase) in other current assets                                                      |       | 10,829                                                 |       |       | 6,264                                             |       | (4,641 | ) | 12,170 |   |
| Decrease  (increase) in other assets                                                              |       | 5,627                                                  |       |       | (2,274                                            | )          | 10,743 |   | (4,454 | ) |
| Increase in  accounts payable and accrued liabilities                                             |       | 56,845                                                 |       |       | 114,417                                           |       | 23,950 |   | 39,312 |   |
| Increase in  deferred real estate credits                                                         |       | 24,334                                                 |       |       | 4,305                                             |       | 14,868 |   | 1,556 |   |
| Payment of  deferred compensation and stock-based awards                                          |       | (12,901                                                | )          |       | —                                            |       | — |   | — |   |
| Funding of  defined benefit pension plan                                                          |       | —                                                 |       |       | —                                            |       | (20,000 | ) | (45,000 | ) |
| Net cash provided by  continuing operating activities                                             |       | 390,006                                                |       |       | 20,053                                            |       | 841,941 |   | 51,863 |   |
| Net cash (used for)  provided by discontinued operation                                           |       | (9,241                                                 | )          |       | (618                                              | )          | 3,459 |   | 709 |   |
| **Net cash provided by operating  activities**                                                    |       | 380,765                                                |       |       | 19,435                                            |       | 845,400 |   | 52,572 |   |
| **CASH FLOWS—INVESTING ACTIVITIES**                                                          |       |                                                   |       |       |                                              |       |   |   |   |   |
| Capital expenditures                                                                              |       | (140,990                                               | )          |       | (26,231                                           | )          | (199,698 | ) | (119,069 | ) |
| Acquisition of The  Neiman Marcus Group, Inc.                                                     |       | (5,156,423                                             | )          |       | —                                            |       | — |   | — |   |
| Proceeds from sale of  Gurwitch Products, L.L.C.                                                  |       | 40,752                                                 |       |       | —                                            |       | — |   | — |   |
| Net increase in cash  restricted for repayment of borrowings under Credit Card Facility           |       | —                                                 |       |       | —                                            |       | (40,713 | ) | — |   |
| Proceeds from sale of  Chef’s Catalog and other assets                                       |       | —                                                 |       |       | —                                            |       | 14,419 |   | 3,183 |   |
| Net cash used for  continuing investing activities                                                |       | (5,256,661                                             | )          |       | (26,231                                           | )          | (225,992 | ) | (115,886 | ) |
| Net cash used for  discontinued operation                                                         |       | (3,141                                                 | )          |       | (80                                               | )          | (2,837 | ) | (1,404 | ) |
| **Net cash used for investing activities**                                                        |       | (5,259,802                                             | )          |       | (26,311                                           | )          | (228,829 | ) | (117,290 | ) |
|                                                                                                   |            |                                                        |            |            |                                                   |            |  |  |  |  |  |  |  |  |

 

F-6

----

 
| ** **                                                            | ** **                                                                                 | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|-----------------------------------------------------------------------|--------------------------------------------------------------------------------------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| ** **                                                            | ** **                                                                                 | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2006** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
| **CASH FLOWS—FINANCING ACTIVITIES**                              | ** **                                                                                 | ** **                                             | ** ** | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  borrowings                                             |                                                                                       | 15,250                                                 |       |       | 4,000                                             |       | 5,500 |   | — |   |
| Repayment of borrowings                                               |                                                                                       | (18,078                                                | )          |       | —                                            |       | (5,613 | ) | — |   |
| Borrowings under  asset-based revolving credit facility               |                                                                                       | 150,000                                                |       |       | —                                            |       | — |   | — |   |
| Repayment of borrowings  under asset-based revolving credit facility  |                                                                                       | (150,000                                               | )          |       | —                                            |       | — |   | — |   |
| Borrowings under senior  term loan facility                           |                                                                                       | 1,975,000                                              |       |       | —                                            |       | — |   | — |   |
| Repayment of borrowings  under senior term loan facility              |                                                                                       | (100,000                                               | )          |       | —                                            |       | — |   | — |   |
| Borrowings under senior  notes and subordinated debt                  |                                                                                       | 1,200,000                                              |       |       | —                                            |       | — |   | — |   |
| Repayment of senior  notes due 2008                                   |                                                                                       | (134,734                                               | )          |       | —                                            |       | — |   | — |   |
| Borrowings under Credit  Card Facility                                |                                                                                       | —                                                 |       |       | —                                            |       | — |   | 225,000 |   |
| Repayment of borrowings  under Credit Card Facility                   |                                                                                       | —                                                 |       |       | —                                            |       | (112,500 | ) | — |   |
| Debt issuance costs  paid                                             |                                                                                       | (102,854                                               | )          |       | —                                            |       | — |   | — |   |
| Cash equity  contributions                                            |                                                                                       | 1,427,739                                              |       |       | —                                            |       | — |   | — |   |
| Acquisition of treasury  stock                                        |                                                                                       | —                                                 |       |       | —                                            |       | (3,088 | ) | (7,553 | ) |
| Cash dividends paid                                                   |                                                                                       | —                                                 |       |       | (7,346                                            | )          | (27,398 | ) | (12,632 | ) |
| Distributions paid                                                    |                                                                                       | —                                                 |       |       | —                                            |       | (3,898 | ) | (3,172 | ) |
| Proceeds from exercises  of stock options and restricted stock grants |                                                                                       | —                                                 |       |       | —                                            |       | 16,100 |   | 23,797 |   |
| Net cash provided by  (used for) continuing financing activities      |                                                                                       | 4,262,323                                              |       |       | (3,346                                            | )          | (130,897 | ) | 225,440 |   |
| Net cash (used for)  provided by discontinued operation               |                                                                                       | (2,418                                                 | )          |       | 1,000                                             |       | (559 | ) | 695 |   |
| **Net cash (used for) provided by  financing activities**             |                                                                                       | 4,259,905                                              |       |       | (2,346                                            | )          | (131,456 | ) | 226,135 |   |
| **CASH AND CASH EQUIVALENTS**                                         |                                                                                       |                                                   |       |       |                                              |       |   |   |   |   |
| (Decrease) increase  during the year                                  |                                                                                       | (619,132                                               | )          |       | (9,222                                            | )          | 485,115 |   | 161,417 |   |
| Beginning balance                                                     |                                                                                       | 843,895                                                |       |       | 853,482                                           |       | 368,367 |   | 206,950 |   |
| Ending balance                                                        |                                                                                       | 224,763                                                |       |       | 844,260                                           |       | 853,482 |   | 368,367 |   |
| Less cash and cash  equivalents of discontinued operation             |                                                                                       | —                                                 |       |       | 365                                               |       | 63 |   | — |   |
| **Ending balance of continuing  operations**                          |                                                                                       | $                                                      | 224,763    |       |                                              | $          | 843,895 |   | $ | 853,419 |   | $ | 368,367 |   |
| ** **                                                            | ** **                                                                                 | ** **                                             | ** ** | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Supplemental Schedule of Cash  Flow Information:**                  |                                                                                       |                                                   |       |       |                                              |       |   |   |   |   |
| Cash paid during  the year for:                                       |                                                                                       |                                                   |       |       |                                              |       |   |   |   |   |
| Interest                                                              |                                                                                       | $                                                      | 181,022    |       |                                              | $          | 134 |   | $ | 22,717 |   | $ | 17,833 |   |
| Income taxes                                                          |                                                                                       | $                                                      | 22,815     |       |                                              | $          | 10,693 |   | $ | 144,626 |   | $ | 104,742 |   |
| Noncash  activities:                                                  |                                                                                       |                                                   |       |       |                                              |       |   |   |   |   |
| Equity  contribution from Holding                                     |                                                                                       | $                                                      | 25,000     |       |                                              | $          | — |   | $ | — |   | $ | — |   |
| Equity  contribution from management shareholders                     |                                                                                       | $                                                      | 17,891     |       |                                              | $          | — |   | $ | — |   | $ | — |   |
| Reduction in  equity for deemed dividend to management shareholders   |                                                                                       | $                                                      | 69,200     |       |                                              | $          | — |   | $ | — |   | $ | — |   |
| Additions to  property and equipment                                  |                 | $                                                      | 15,085     |       |                                              | $          | — |   | $ | — |   | $ | — |   |
| Borrowings assumed by  HSBC in connection with the Credit Card Sale   |                                                                                       | $                                                      | —     |       |                                              | $          | — |   | $ | 112,500 |   | $ | — |   |

 

*See Notes to Consolidated FinancialStatements.*

F-7

----

**NEIMANMARCUS, INC.**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**
| ** **                                                                                      | ** ** | **Common  stocks** | ** ** | ** **      | ** ** | **Additional**    | ** ** | **Accumulated  other** | ** ** | ** **                            | ** ** | ** **             | ** ** | **Total**           | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|---------------------------------------|------------|------------------------|------------|---------------------|------------|
| **(in thousands)**                                                                         | ** ** | **Class  A**       | ** ** | **Class  B**    | ** ** | **Common  stock** | ** ** | **paid-in  capital**   | ** ** | **comprehensive  income (loss)** | ** ** | **Retained  earnings** | ** ** | **Treasury  stock** | ** ** | **shareholders’  equity** | ** ** |
| ** **                                                                                      | ** ** | **(Predecessor)**  | ** ** | **(Successor)** | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                            | ** ** | ** **             | ** ** | ** **          | ** ** |
| ***Predecessor:***                                                                              |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       |   |   |
| BALANCE AT AUGUST 2,  2003                                                                      |       | 282                |       | 197             |       | —            |       | $                      | 458,520    |                                  | $          | (25,573                | )          | $                   | 719,442    |   | $ | (15,020 | ) | $ | 1,137,848 |   |
| Issuance  of 950 shares for stock based compensation awards                                     |       | 10                 |       | —          |       | —            |       | 23,787                 |       | —                                |       | —                 |       | —              |       | 23,797 |   |
| Acquisition  of treasury stock                                                                  |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | —                 |       | (7,553              | )          | (7,553 | ) |
| Cash  dividends declared ($0.39 per share)                                                      |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | (18,944                | )          | —              |       | (18,944 | ) |
| Other  equity transactions                                                                      |       | 1                  |       | 2               |       | —            |       | 9,542                  |       | —                                |       | —                 |       | —              |       | 9,545 |   |
| Comprehensive  income:                                                                          |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       |   |   |
| Net  earnings                                                                                   |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | 204,832                |       | —              |       | 204,832 |   |
| Adjustments  for fluctuations in fair market value of financial instruments, net of tax  ($349) |       | —             |       | —          |       | —            |       | —                 |       | (546                                  | )          | —                 |       | —              |       | (546 | ) |
| Reclassification  of amounts to net earnings, net of tax of ($466)                              |       | —             |       | —          |       | —            |       | —                 |       | (744                                  | )          | —                 |       | —              |       | (744 | ) |
| Minimum  pension liability, net of tax of $13,755                                               |       | —             |       | —          |       | —            |       | —                 |       | 22,071                                |       | —                 |       | —              |       | 22,071 |   |
| Other                                                                                           |       | —             |       | —          |       | —            |       | —                 |       | 256                                   |       | —                 |       | —              |       | 256 |   |
| Total  comprehensive income                                                                     |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       | 225,869 |   |
| BALANCE AT JULY 31, 2004                                                                        |       | 293                |       | 199             |       | —            |       | 491,849                |       | (4,536                                | )          | 905,330                |       | (22,573             | )          | 1,370,562 |   |
| Issuance  of 491 shares for stock based compensation awards                                     |       | 5                  |       | —          |       | —            |       | 16,095                 |       | —                                |       | —                 |       | —              |       | 16,100 |   |
| Acquisition  of treasury stock                                                                  |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | —                 |       | (3,088              | )          | (3,088 | ) |
| Cash  dividends declared ($0.58 per share)                                                      |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | (28,428                | )          | —              |       | (28,428 | ) |
| Other  equity transactions                                                                      |       | —             |       | —          |       | —            |       | 12,470                 |       | —                                |       | —                 |       | —              |       | 12,470 |   |
| Comprehensive  income:                                                                          |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       |   |   |
| Net  earnings                                                                                   |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | 248,824                |       | —              |       | 248,824 |   |
| Adjustments  for fluctuations in fair market value of financial instruments, net of tax  ($706) |       | —             |       | —          |       | —            |       | —                 |       | (1,114                                | )          | —                 |       | —              |       | (1,114 | ) |
| Reclassification  of amounts to net earnings, net of tax of $349                                |       | —             |       | —          |       | —            |       | —                 |       | 546                                   |       | —                 |       | —              |       | 546 |   |
| Minimum  pension liability, net of tax of ($26,511)                                             |       | —             |       | —          |       | —            |       | —                 |       | (42,248                               | )          | —                 |       | —              |       | (42,248 | ) |
| Other                                                                                           |       | —             |       | —          |       | —            |       | —                 |       | 322                                   |       | —                 |       | —              |       | 322 |   |
| Total  comprehensive income                                                                     |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       | 206,330 |   |
| BALANCE AT JULY 30, 2005                                                                        |       | 298                |       | 199             |       | —            |       | 520,414                |       | (47,030                               | )          | 1,125,726              |       | (25,661             | )          | 1,573,946 |   |
| Stock  based compensation expense                                                               |       | —             |       | —          |       | —            |       | 19,032                 |       | —                                |       | —                 |       | —              |       | 19,032 |   |
| Other  equity transactions                                                                      |       | —             |       | —          |       | —            |       | 637                    |       | —                                |       | —                 |       | —              |       | 637 |   |
| Comprehensive  income:                                                                          |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       |   |   |
| Net  earnings                                                                                   |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | 44,154                 |       | —              |       | 44,154 |   |
| Adjustments  for fluctuations in fair market value of financial instruments, net of tax  ($593) |       | —             |       | —          |       | —            |       | —                 |       | (950                                  | )          | —                 |       | —              |       | (950 | ) |
| Reclassification  of amounts to net earnings, net of tax of $706                                |       | —             |       | —          |       | —            |       | —                 |       | 1,114                                 |       | —                 |       | —              |       | 1,114 |   |
| Other                                                                                           |       | —             |       | —          |       | —            |       | —                 |       | 246                                   |       | —                 |       | —              |       | 246 |   |
| Total  comprehensive income                                                                     |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       | 44,564 |   |
| BALANCE AT OCTOBER 1, 2005                                                                      |       | 298                |       | 199             |       | —            |       | $                      | 540,083    |                                  | $          | (46,620                | )          | $                   | 1,169,880  |   | $ | (25,661 | ) | $ | 1,638,179 |   |

 

F-8

----

** **
| ** **                                                                                         | ** ** | **Common  stocks** | ** ** | ** **      | ** ** | **Additional**    | ** ** | **Accumulated  other** | ** ** | ** **                            | ** ** | ** **             | ** ** | **Total**           | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|---------------------------------------|------------|------------------------|------------|---------------------|------------|
| **(in thousands)**                                                                            | ** ** | **Class  A**       | ** ** | **Class  B**    | ** ** | **Common  stock** | ** ** | **paid-in  capital**   | ** ** | **comprehensive  income (loss)** | ** ** | **Retained  earnings** | ** ** | **Treasury  stock** | ** ** | **shareholders’  equity** | ** ** |
| ** **                                                                                         | ** ** | **(Predecessor)**  | ** ** | **(Successor)** | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                            | ** ** | ** **             | ** ** | ** **          | ** ** |
| ***Successor:***                                                                                   | ** ** | ** **         | ** ** | ** **      | ** ** | ** **        | ** ** | ** **             | ** ** | ** **                            | ** ** | ** **             | ** ** | ** **          | ** ** | ** ** | ** ** |
| Equity contributions                                                                               |       |               |       |            |       | 10                |       | $                      | 1,470,622  |                                  | $          | —                 |       | $                   | —     |   | $ | — |   | $ | 1,470,632 |   |
| Carryover basis  adjustment                                                                        |       | —             |       | —          |       | —            |       | (69,200                | )          | —                                |       | —                 |       | —              |       | (69,200 | ) |
| Stock based compensation  expense                                                                  |       | —             |       | —          |       | —            |       | 3,951                  |       | —                                |       | —                 |       | —              |       | 3,951 |   |
| Comprehensive income:                                                                              |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       |   |   |
| Net earnings                                                                                       |       | —             |       | —          |       | —            |       | —                 |       | —                                |       | 12,455                 |       | —              |       | 12,455 |   |
| Adjustments for  fluctuations in fair market value of financial instruments, net of tax of  $6,510 |       | —             |       | —          |       | —            |       | —                 |       | 9,990                                 |       | —                 |       | —              |       | 9,990 |   |
| Other                                                                                              |       | —             |       | —          |       | —            |       | —                 |       | (161                                  | )          | —                 |       | —              |       | (161 | ) |
| Total comprehensive  income                                                                        |       |               |       |            |       |              |       |                   |       |                                  |       |                   |       |                |       | 22,284 |   |
| BALANCE AT JULY 29, 2006                                                                           |       | —             |       | —          |       | 10                |       | $                      | 1,405,373  |                                  | $          | 9,829                  |       | $                   | 12,455     |   | $ | — |   | $ | 1,427,667 |   |

* *

*See Notes to Consolidated Financial Statements.*

F-9

----

**NEIMAN MARCUS, INCNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**BASIS OF PRESENTATION**

On April 22, 2005, Neiman Marcus, Inc.,formerly Newton Acquisition, Inc. (the Company), and its wholly-ownedsubsidiary, Newton Acquisition Merger Sub, Inc. (Merger Sub), were formedand incorporated in the state of Delaware. On April 29, 2005, the Companyreceived subscriptions for 900 shares of its common stock from NewtonHolding, LLC (Holding) in exchange for a capital contribution of $900 andMerger Sub issued 900 shares of its common stock to the Company in exchange fora capital contribution of $900. Holding, the Company and Merger Sub were formedby investment funds affiliated with Texas Pacific Group and Warburg Pincus LLC(the Sponsors) for the purpose of acquiring The Neiman Marcus Group, Inc.(NMG). The equity subscriptions were subsequently funded by the Sponsors.

In connection with the acquisition of NMG, Holding madean aggregate cash equity contribution of $1,420.0 million and a noncashequity contribution of $25.0 million to the Company in exchange for theCompany issuing 999,100 shares of its common stock to Holding. In addition,certain members of executive management of the Company made cash equity contributionsaggregating $7.7 million and noncash equity contributions, consisting ofshares of common stock and common stock options in NMG, aggregating$17.9 million in exchange for 12,264 shares of common stock in theCompany.

The acquisition of NMG was completed on October 6,2005 through the merger of Merger Sub with and into NMG, with NMG being thesurviving entity (the Acquisition). Subsequent to the Acquisition, NMG is asubsidiary of the Company, which is controlled by Holding.

Prior to the Acquisition, the Company had no independentassets or operations.  After theAcquisition, the Company represents the Successor to NMG since the Company’ssole asset is its investment in NMG and its operations consist solely of theoperating activities of NMG as well as costs incurred by the Company related toits investment in NMG.  For periods priorto the Acquisition, NMG is deemed to be the predecessor to the Company.  As a result, for periods prior to theTransactions, the financial statements of the Company consist of the financialstatements of NMG for such periods.  Allreferences to “we” and “our” relate to the Company for periods subsequent tothe Transactions and to NMG for periods prior to the Transactions. TheAcquisition has been recorded as of October 1, 2005, the beginning of theCompany’s October accounting period.  Theaccompanying consolidated statements of earnings and cash flows present ourresults of operations and cash flows for the periods preceding the Acquisition(Predecessor) and the periods succeeding the Acquisition (Successor),respectively.

Our fiscal year ends on the Saturday closest toJuly 31.  All references to fiscalyear 2006 relate to the combined period comprised of forty-three weeks endedJuly 29, 2006 (Successor) and the nine weeks ended October 1, 2005(Predecessor); all references to fiscal year 2005 relate to the 52 weeks endedJuly 30, 2005 and all references to fiscal year 2004 related to the 52weeks ended July 31, 2004.

We have prepared the accompanying audited consolidatedfinancial statements in accordance with generally accepted accountingprinciples.  In our opinion, theaccompanying audited consolidated financial statements contain all adjustments,consisting of normal recurring adjustments, necessary to present fairly our financialposition, results of operations and cash flows for the applicable periods.

On July 27, 2006, we soldour former majority interest in Gurwitch Products, L.L.C. to Alticor Inc.,for pretax net cash proceeds of approximately $40.8 million (Gurwitch Disposition).  See Note 4 for further information.  The Company’s financial statements,accompanying notes and other information provided in this Annual Report on Form10-K reflect Gurwitch Products, L.L.C. as a discontinued operation for allperiods presented.

Certain prior period balances have been reclassified toconform to the current period presentation. Depreciation expense and incomefrom credit card operations are now shown as separate line items on ourconsolidated statements of earnings.  Inprior years, depreciation expense was included in buying and occupancy costsand the income from our credit card operations was included as a reduction toselling, general and administrative expenses.

F-10

----

**ESTIMATES AND CRITICAL ACCOUNTING POLICIES**

We make estimates and assumptionsabout future events in preparing our financial statements in conformity withgenerally accepted accounting principles. These estimates and assumptionsaffect the amounts of assets, liabilities, revenues and expenses and thedisclosure of gain and loss contingencies at the date of the consolidatedfinancial statements.

While we believe that our pastestimates and assumptions have been materially accurate, the amounts currentlyestimated are subject to change if we make different assumptions as to theoutcome of future events. We evaluate our estimates and judgments on an ongoingbasis and predicate those estimates and judgments on historical experience andon various other factors that we believe to be reasonable under thecircumstances. We make adjustments to our assumptions and judgments when factsand circumstances dictate. Since future events and their effects cannot bedetermined with absolute certainty, actual results may differ from theestimates used in preparing the accompanying consolidated financial statements.

***Purchase Accounting.* **Wehave accounted for the Acquisition in accordance with the provisions ofStatement of Financial Accounting Standards No. 141, “Business Combinations,”(SFAS No. 141) whereby the purchase price paid to effect the Acquisition isallocated to state the acquired assets and liabilities at fair value. TheAcquisition and the allocation of the purchase price have been recorded as ofOctober 1, 2005, the beginning of our October 2005 accounting period.In connection with the purchase price allocation, we have made estimates of thefair values of our long-lived and intangible assets based upon assumptionsrelated to future cash flows, discount rates and asset lives utilizingcurrently available information which resulted in  increases in the carrying value of ourproperty and equipment and inventory, the recording of intangible assets forour tradenames, customer lists and favorable lease commitments and therevaluation of our long-term benefit plan obligations, among other things.

***Cash and Cash Equivalents.***  Cash andcash equivalents primarily consist of cash on hand in the stores, deposits withbanks and overnight investments with banks and financial institutions. Cashequivalents are stated at cost, which approximates fair value. Our cashmanagement system provides for the reimbursement of all major bank disbursementaccounts on a daily basis. Accounts payable includes $66.5 million ofoutstanding checks not yet presented for payment at July 29, 2006 and$45.0 million at July 30, 2005.

***Accounts Receivable.***  Accountsreceivable primarily consist of credit card receivables.

***Merchandise Inventories and Cost Of GoodsSold.***  We utilize the retail method of accountingfor substantially all of our merchandise inventories. Merchandise inventoriesare stated at the lower of cost or market. The retail inventory method iswidely used in the retail industry due to its practicality.

Under the retail inventory method, the valuation ofinventories at cost and the resulting gross margins are determined by applyinga calculated cost-to-retail ratio, for various groupings of similar items, tothe retail value of inventories. The cost of the inventory reflected on theconsolidated balance sheets is decreased by charges to cost of goods sold atthe time the retail value of the inventory is lowered through the use ofmarkdowns. Earnings are negatively impacted when merchandise ismarked down.

Our sales activities are conducted during two primaryselling seasons—Fall and Spring. The Fall selling season is conducted primarilyin our first and second quarters and the Spring selling season is conductedprimarily in the third and fourth quarters. During each season, we recordmarkdowns to reduce the retail value of our inventories. Factors considered indetermining markdowns include current and anticipated demand, customerpreferences, age of merchandise and fashion trends. During the season, werecord both temporary and permanent markdowns. Temporary markdowns are recordedat the time of sale and reduce the retail value of only the goods sold.Permanent markdowns are designated primarily for clearance activity and reducethe retail value of all goods subject to markdown. At the end of each sellingseason, we record permanent markdowns for clearance goods remaining in endinginventory.

The areas requiring significant judgment related to thevaluation of our inventories include 1) setting the original retail valuefor the merchandise held for sale, 2) recognizing merchandise for whichthe customer’s perception of value has declined and appropriately marking theretail value of the merchandise down to the perceived value and3) estimating the shrinkage that has occurred between physical inventorycounts. These judgments and estimates, coupled with the averaging processeswithin the retail method can, under certain circumstances, produce varyingfinancial results. Factors that can lead to different financial results include1) determination of original retail values for merchandise held for sale,2) identification of declines in perceived value of inventories andprocessing the appropriate retail value markdowns and 3) overly optimisticor conservative estimates of shrinkage. We believe appropriate merchandisevaluation and pricing controls minimize the risk that our inventory valueswould be materially misstated.

F-11

----

Consistent with industry business practice, we receiveallowances from certain of our vendors in support of the merchandise wepurchase for resale. We receive certain allowances to reimburse us formarkdowns taken and/or to support the gross margins earned in connection withthe sales of the vendor’s merchandise. We recognize these allowances as anincrease to gross margin when the allowances are earned and approved by thevendor. Other allowances we receive represent reductions to the amounts paid toacquire the merchandise. We recognize these allowances as a reduction in thecost of the acquired merchandise resulting in an increase to gross margin atthe time the goods are sold. The amounts of vendor reimbursements we receiveddid not have a significant impact on the year-over-year change in gross marginduring fiscal years 2006, 2005 or 2004. Vendor allowances received were $86.8million for the forty-three weeks ended July 29, 2006, $2.1 million for thenine weeks ended October 1, 2005, $82.8 million in fiscal year 2005 and$79.3 million in fiscal year 2004.

We obtain certain merchandise, primarily preciousjewelry, on a consignment basis in order to expand our product assortment.Consignment merchandise with a cost basis of $251.3 million atJuly 29, 2006 and $226.8 million at July 30, 2005 is notreflected in our consolidated balance sheets.

***Long-lived Assets.***  Propertyand equipment are stated at historical cost less accumulated depreciation. Forfinancial reporting purposes, we compute depreciation principally using thestraight-line method over the estimated useful lives of the assets. Buildingsand improvements are depreciated over five to 30 years while fixtures andequipment are depreciated over three to 15 years. Leasehold improvementsare amortized over the shorter of the asset life or the lease term. Costsincurred for the development of internal computer software are capitalized andamortized using the straight-line method over three to ten years.

To the extent we remodel or otherwise replace or disposeof property and equipment prior to the end of the assigned depreciable lives,we could realize a loss or gain on the disposition. To the extent assetscontinue to be used beyond their assigned depreciable lives, no depreciationexpense is incurred. We reassess the depreciable lives of our long-lived assetsin an effort to reduce the risk of significant losses or gains at dispositionand utilization of assets with no depreciation charges. The reassessment ofdepreciable lives involves utilizing historical remodel and dispositionactivity and forward-looking capital expenditure plans.

We assess the recoverability of the carrying values ofour store assets annually and upon the occurrence of certain events (e.g.,opening a new store near an existing store or announcing plans for a storeclosing). The recoverability assessment requires judgment and estimates offuture store generated cash flows. The underlying estimates of cash flowsinclude estimates for future revenues, gross margin rates and store expenses.We base these estimates upon the stores’ past and expected future performance.New stores may require two to five years to develop a customer base necessaryto generate the cash flows of our more mature stores. To the extent ourestimates for revenue growth and gross margin improvement are not realized,future annual assessments could result in impairment charges.

***Goodwill and Intangible Assets.***  Goodwilland indefinite-lived intangible assets, such as tradenames, are not subject toamortization. Rather, recoverability of goodwill and indefinite-livedintangible assets is assessed annually and upon the occurrence of certainevents. The recoverability assessment requires us to make judgments andestimates regarding fair values. Fair values are determined using estimatedfuture cash flows, including growth assumptions for future revenues, grossmargin rates and other estimates. To the extent that our estimates are notrealized, future assessments could result in impairment charges.

Customer lists are amortized using the straight-linemethod over their estimated useful lives, ranging from 5 to 26 years (weightedaverage life of 13 years).  Favorablelease commitments are amortized straight-line over the remaining lives of theleases, ranging from 6 to 49 years (weighted average life of 33 years).  Total estimated amortization of allacquisition-related intangible assets for the next five fiscal years iscurrently estimated as follows (in thousands):
| 2007 |   | $      | 72,889 |   |
|------|--------|--------|--------|--------|
| 2008 |   | 72,889 |   |
| 2009 |   | 72,889 |   |
| 2010 |   | 72,889 |   |
| 2011 |   | 62,178 |   |

 

F-12

----

***Leases.***  We leasecertain retail stores and office facilities. Stores we own are often subject toground leases. The terms of our real estate leases, including renewal options,range from 15 to 99 years. Most leases provide for monthly fixed minimumrentals or contingent rentals based upon sales in excess of stated amounts andnormally require us to pay real estate taxes, insurance, common area maintenancecosts and other occupancy costs. For leases that contain predetermined, fixedcalculations of the minimum rentals, we recognize rent expense on astraight-line basis over the lease term.

We receive allowances from developers related to theconstruction of our stores. We record these allowances as deferred real estatecredits which we recognize as a reduction of rent expense on a straight-linebasis over the lease term. We received construction allowances aggregating$30.0 million for the forty-three weeks ended July 29, 2006, $2.0 million forthe nine weeks ended October 1, 2005, $25.6 million in fiscal year 2005and $2.3 million in fiscal year 2004.

***FinancialInstruments.***  Weuse derivative financial instruments to help manage our interest rate risks.  At July 29, 2006, we have outstandingfloating and fixed interest rate swap agreements for an aggregate notionalamount of $1,000.0 million.  Theseinterest rate swap agreements have been designated as cash flow hedges and arerecorded at fair value on the consolidated balance sheets.

At July 29, 2006, the fair value of NMG’s interestrate swap agreements was a gain of approximately $20.2 million, whichamount is included in other assets.

***Benefit Plans.***  We sponsora noncontributory defined benefit pension plan (Pension Plan) coveringsubstantially all full-time employees and an unfunded supplemental executiveretirement plan (SERP Plan) which provides certain employees additional pensionbenefits. In calculating our obligations and related expense, we make variousassumptions and estimates, after consulting with outside actuaries andadvisors. The annual determination of expense involves calculating theestimated total benefits ultimately payable to plan participants and allocatingthis cost to the periods in which services are expected to be rendered. We usethe projected unit credit method in recognizing pension liabilities. ThePension and SERP Plans are valued annually as of the beginning of each fiscalyear.

Significant assumptions related to the calculation of ourobligations include the discount rate used to calculate the actuarial presentvalue of benefit obligations to be paid in the future, the expected long-termrate of return on assets held by the Pension Plan and the average rate ofcompensation increase by plan participants. We review these actuarialassumptions annually based upon currently available information.

***Self-insurance and Other Employee BenefitReserves.***  We use estimates in the determination of therequired accruals for general liability, workers’ compensation and healthinsurance as well as short-term disability, supplemental executive retirementbenefits and postretirement health care benefits. We base these estimates uponan examination of historical trends, industry claims experience and, in certaincases, calculations performed by third-party actuaries. Projected claimsinformation may change in the future and may require us to revise thesereserves.

***Other Long-term Liabilities.***  Otherlong-term liabilities consist primarily of certain employee benefitobligations, postretirement health care benefit obligations and the liabilityfor scheduled rent increases.

***Revenues.***  Revenuesinclude sales of merchandise and services, net commissions earned from leaseddepartments in our retail stores and delivery and processing revenues relatedto merchandise sold. We recognize revenues from our retail operations at thelater of the point of sale or the delivery of goods to the customer. Werecognize revenues from our direct marketing operation when the merchandise isdelivered to the customer.

We maintain reserves for anticipated sales returnsprimarily based on our historical trends related to returns by our retail andDirect Marketing customers.

***Buying and Occupancy Costs.***  Our buyingcosts consist primarily of salaries and expenses incurred by our merchandisingand buying operations. Occupancy costs primarily include rent, property taxesand operating costs of our retail, distribution and support facilities andexclude depreciation expense.

***Selling, General and Administrative Expenses(excluding depreciation).***  Selling, general andadministrative expenses are comprised principally of the costs related toemployee compensation and benefits in the selling and administrative supportareas, preopening expenses, advertising and catalog costs and insuranceexpense.

F-13

----

We receive allowances from certain merchandise vendors inconjunction with compensation programs for employees who sell the vendors’merchandise. These allowances are netted against the related compensationexpense that we incur. Amounts received from vendors related to compensationprograms were $49.4 million for the forty-three weeks ended July 29, 2006,$10.1 million for the nine weeks ended October 1, 2005, $53.2 million infiscal year 2005 and $46.3 million in fiscal year 2004.

We incur costs to advertise and promote the merchandiseassortment offered by both Specialty Retail stores and Direct Marketing.Advertising costs incurred by our Specialty Retail stores consist primarily ofprint media costs related to promotional materials mailed to our customers.These costs are expensed at the time of mailing to the customer. Advertisingcosts incurred by Direct Marketing relate to the production, printing anddistribution of our print catalogs and the production of the photographiccontent on our websites. We amortize the costs of print catalogs during theperiods we expect to generate revenues from such catalogs, generally three tosix months. We expense the costs incurred to produce the photographic contenton our websites at the time the images are first loaded onto the website. Weexpense website design costs as incurred.

Deferred catalog costs included in other current assetsin the consolidated balance sheets were $7.0 million as of July 29, 2006 and$8.7 million as of July 30, 2005. Net advertising expenses were $99.3 million for the forty-three weeksended July 29, 2006, $14.7 million for the nine weeks ended October 1, 2005,$117.5 million in fiscal year 2005 and $122.3 million in fiscal year 2004.

Consistent with industry practice, we receive advertisingallowances from certain of our merchandise vendors. Substantially all theadvertising allowances we receive represent reimbursements of direct, specificand incremental costs that we incur to promote the vendor’s merchandise inconnection with our various advertising programs, primarily catalogs and otherprint media. As a result, these allowances are recorded as a reduction of ouradvertising costs when earned. Vendor allowances earned and recorded as areduction to selling, general and administrative expenses aggregatedapproximately $43.1 million for the forty-three weeks ended July 29, 2006,$18.6 million for nine weeks ended October 1, 2005, $57.5 million infiscal year 2005 and $55.3 million in fiscal year 2004.

Preopening expenses primarily consist of payroll andrelated media costs incurred in connection with new and replacement storeopenings and are expensed when incurred. We incurred preopening expenses of $7.4 million for the forty-threeweeks ended July 29, 2006, $3.9 million for the nine weeks ended October 1,2005, and $5.9 million in fiscal year 2005.  We had no preopening expenses in fiscal year2004.

***Income from credit card operations.***  We soldour proprietary credit card accounts to HSBC on July 7, 2005 (Credit CardSale).  As a part of the Credit CardSale, we entered into a long-term marketing and servicing alliance with HSBC.Under the terms of this alliance, HSBC offers credit card and non-card paymentplans bearing our brands and we receive ongoing payments from HSBC based oncredit card sales and compensation for marketing and servicing activities (HSBCProgram Income).  We recognize HSBCProgram Income when earned.

Prior to the Credit Card Sale, we extended credit tocertain of our customers pursuant to our proprietary retail credit cardprogram.  Our credit card operationsgenerated finance charge income, net of credit losses, which was recognized asincome when earned and we maintained reserves for potential credit losses. Weevaluated the collectibility of our accounts receivable based on a combinationof factors, including analysis of historical trends, aging of accountsreceivable, write-off experience and expectations of future performance.

In connection witha revolving Credit Card Facility (Credit Card Facility) established inSeptember 2000, we transferred substantially all of our credit card receivablesto a wholly-owned subsidiary which in turn sold such receivables to the NeimanMarcus Credit Card Master Trust (Trust). In connection with the Credit Card Sale, HSBC assumed our outstandingobligations pursuant to the Credit Card Facility.

At the inception of the Credit Card Facility in September 2000, theTrust issued certificates representing undivided interests in the credit cardreceivables to both third-party investors (Sold Interests) and to NMG(Retained Interests).  We held RetainedInterests represented by the Class B Certificate ($23.8 million facevalue), the Class C Certificate ($68.2 million face value) and theSeller’s Certificate (representing the excess of the total receivables sold tothe Trust over the Sold Interests and the Class B and Class CCertificates). In addition, we held rights to certain residual cash flowscomprised of excess finance charge collections (IO Strip).  From the inception of the Credit CardFacility until December 2003, our transfers and sales of credit cardreceivables pursuant to the terms of the Credit Card Facility were accountedfor as sales (Off-Balance Sheet Accounting). During the periods for which themonthly transfers to the Trust qualified for Off-Balance Sheet Accounting, werecognized income on our Retained Interests on the basis of their estimatedyield to maturity and gains on the Sold Interests arising from the monthlytransfers of new credit card receivables to the Trust.

F-14

----

Under the Credit Card Facility, we serviced the credit card receivablesfor a contractually defined servicing fee. We earned servicing fees of$5.4 million in fiscal year 2005 and $6.3 million in fiscal year2004.

***Gift Cards.***  We sellgift cards at our Specialty Retail stores and through our Direct Marketingoperation. Unredeemed gift cards aggregated $30.1 million at July 29,2006 and $25.6 million at July 30, 2005. The gift cards sold to ourcustomers have no stated expiration dates and are subject to actual and/orpotential escheatment rights in various of the jurisdictions in which weoperate. As a result, we have not reversed any unredeemed gift card balancesinto income in fiscal years 2006, 2005 or 2004 pending a final determination asto the invalidity of current and potential escheatment claims in any applicablejurisdictions with respect to the unredeemed balances of gift cards.

***Loyalty Programs.***  Wemaintain customer loyalty programs in which customers accumulate points forqualifying purchases. Upon reaching certain levels, customers may redeem theirpoints for gifts. Generally, points earned in a given year must be redeemed nolater than 90 days subsequent to the end of the annual program period.

The estimates of the costs associated with the loyaltyprograms require us to make assumptions related to customer purchasing levels,redemption rates and costs of awards to be chosen by our customers. Ourcustomers redeem a substantial portion of the points earned in connection withour loyalty programs for gift cards. At the time the qualifying sales givingrise to the loyalty program points are made, we defer the portion of therevenues on the qualifying sales transactions equal to the estimate of theretail value of the gift cards to be issued upon conversion of the points togift cards. We record the deferral of revenues related to gift card awardsunder our loyalty programs as a reduction of revenues. In addition, we chargethe cost of all other awards under our loyalty programs to cost of goods sold.

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

In December 2004, the FASB issued SFAS No. 123(R),“Share-Based Payment” (SFAS No. 123(R)). This standard is a revision of SFASNo. 123 and supersedes APB No. 25 and its related implementationguidance. SFAS No. 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values. We adopted SFASNo. 123(R) as of the beginning of our first quarter of fiscal year 2006using the modified prospective method, which required us to record stock compensationfor all unvested and new awards as of the adoption date. Accordingly, we havenot restated prior period amounts presented herein.

In connection with the adoption of the provisions of SFASNo. 123(R), we recorded non-cash charges for stock compensation ofapproximately $20.0 million in the period from July 31, 2005 toOctober 1, 2005 primarily as a result of the accelerated vesting of allPredecessor options and restricted stock in connection with the Transactions(see Note 2).

The following table illustrates the pro forma effect onnet earnings for periods prior to the adoption of SFAS No. 123(R) as ifthe Predecessor had applied the fair value recognition provisions of SFASNo. 123 during fiscal years 2005 and 2004:
|                                                                                                            | ** ** | **Fiscal years ended** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(in thousands)**                                                                                    | ** ** | **July 30,  2005**          | ** ** | **July 31,  2004** | ** ** |
|                                                                                                       |       |                             |       |   |   |
| Net earnings:                                                                                              |       |                             |       |   |   |
| As reported                                                                                                |       | $                                | 248,824    |   | $ | 204,832 |   |
| Add: stock-based  employee compensation recorded under intrinsic value method, net of related  taxes       |       | 4,999                            |       | 3,119 |   |
| Less: stock-based  employee compensation expense determined under fair value method, net of  related taxes |       | (13,302                          | )          | (11,806 | ) |
| Pro forma net earnings                                                                                     |       | $                                | 240,521    |   | $ | 196,145 |   |

 

F-15

----

The Predecessor estimated the fair value of each optiongrant on the date of the grant using the Black-Scholes option pricingmodel with the following assumptions used for grants in fiscal years 2005 and2004:
|                          | ** ** | **Fiscal years ended** | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **July 30,  2005**     | ** ** | **July 31,  2004** | ** ** |
| Expected life (years)    |       | 5                      |       | 5 |   |
| Expected volatility      |       | 25.0                   | %          | 32.7 | % |
| Risk-free  interest rate |       | 3.3                    | %          | 3.1 | % |
| Dividend yield           |       | 1.0                    | %          | — |   |

 

The weighted-average fair value of options grantedwas $14.38 in fiscal year 2005 and $14.79 in fiscal year 2004.

The effects on pro forma net earnings of expensing theestimated fair value of stock options are not necessarily representative of theeffects on reported net earnings for future periods due to such factors as thevesting periods of stock options and the potential issuance of additional stockoptions in future years.

***Income Taxes.***  We areroutinely under audit by federal, state or local authorities in the area ofincome taxes. These audits include questioning the timing and amount ofdeductions and the allocation of income among various tax jurisdictions. Inevaluating the exposure associated with various tax filing positions, we accruecharges for probable exposures. Based on our annual evaluations of taxpositions, we believe we have appropriately accrued for probable exposures. Tothe extent we were to prevail in matters for which accruals have beenestablished or be required to pay amounts in excess of recorded reserves, oureffective tax rate in a given financial statement period could be materiallyimpacted.

***Recent Accounting Pronouncements.***   InMarch 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 assetretirement obligations meet the definition of liabilities and should be recognizedwhen incurred if their fair values can be reasonably estimated. We adopted FIN47 as of the beginning of fiscal year 2006 with no material impact on ourconsolidated financial statements.

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifiesthe accounting for uncertainty in tax positions.  This Interpretation requires that werecognize in our consolidated financial statements the impact of a taxposition, if that position is more likely than not of being sustained uponexamination, based on the technical merits of the position.  FIN 48 will be effective for the first fiscalyear beginning after December 15, 2006, or our fiscal year ending August 2,2008.  We have not yet evaluated theimpact, if any, of adopting FIN 48 on our consolidated financial statements.

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin No. 108 (SAB 108).  SAB 108addresses the process and diversity in practice of quantifying financialstatement misstatements resulting in the potential build up of improper amountson the balance sheet.  We will berequired to adopt the provisions of SAB 108 in fiscal year 2007.  We currently do not believe that the adoptionof SAB 108 will have a material impact on our consolidated financialstatements.

**NOTE 2.  THETRANSACTIONS**

***The Transactions.***  Asdiscussed in Note 1, the Acquisition was completed on October 6, 2005and was financed by:

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

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

·                  theissuance of 10.375% senior subordinated notes due 2015 (Senior SubordinatedNotes); and

·                  equityinvestments funded by direct and indirect equity investments from the Sponsors,co-investors and management.

F-16

----

The Acquisition occurred simultaneously with:

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

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

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

·                  thetermination of a previous $350 million unsecured revolving creditagreement (Credit Agreement).

We refer to the above transactions, the Acquisition andour payment of any costs related to these transactions collectively herein asthe “Transactions.”

***Transaction and Other Costs***.  Duringthe period from July 30, 2005 to October 1, 2005, the Predecessorexpensed $23.5 million in connection with the Transactions. These costsconsisted primarily of $4.5 million of accounting, investment banking,legal and other costs associated with the Transactions and a $19.0 millionnon-cash charge for stock compensation resulting from the accelerated vestingof Predecessor stock options and restricted stock in connection with theAcquisition.

**NOTE 3.  PURCHASEACCOUNTING**

We have accounted for the Acquisition in accordance withthe provisions of SFAS No. 141, whereby the purchase price paid to effectthe Acquisition is allocated to state the acquired assets and liabilities atfair value. The Acquisition and the allocation of the purchase price have beenrecorded as of October 1, 2005, the beginning of our October accountingperiod. The purchase price was approximately $5,461.7 million. The sourcesand uses of funds in connection with the Transactions and the redemption of our2008 Notes are summarized below (in millions):
| **Sources**                                                                                   | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|
| Asset-Based Revolving Credit Facility                                                         |       | $          | 150.0      |   |
| Secured Term Loan Facility                                                                    |       | 1,975.0    |       |
| Senior Notes                                                                                  |       | 700.0      |       |
| Senior Subordinated Notes                                                                     |       | 500.0      |       |
| Cash on hand                                                                                  |       | 666.1      |       |
| Equity contribution—cash                                                                 |       | 1,427.7    |       |
| Equity contribution—non-cash                                                             |       | 42.9       |       |
| Total sources                                                                                 |       | $          | 5,461.7    |   |
| ** **                                                                                    | ** ** | ** ** | ** ** |
| **Uses**                                                                                      | ** ** | ** ** | ** ** |
| Consideration paid to stockholders (including non-cash  management rollover of $17.9 million) |       | $          | 5,110.8    |   |
| Transaction costs (including non-cash items of $18.8 million)                                 |       | 82.3       |       |
| Redemption of existing 2008 Notes                                                             |       | 134.7      |       |
| Debt issuance costs (including non-cash items of $6.3 million)                                |       | 109.2      |       |
| Payment of deferred compensation obligations and other accrued  liabilities                   |       | 24.7       |       |
| Total uses                                                                                    |       | $          | 5,461.7    |   |

 

In connection with the purchase price allocation, we havemade estimates of the fair values of our long-lived and intangible assets basedupon assumptions related to future cash flows, discount rates and asset livesutilizing currently available information. As of July 29, 2006, we haverecorded purchase accounting adjustments to increase the carrying value of ourproperty and equipment and inventory, to establish intangible assets for ourtradenames, customer lists and favorable lease commitments and to revalue ourlong-term benefit plan obligations, among other things.

F-17

----

The purchase price has been allocated as follows (inmillions):
| Cash consideration:                                                          |   |     |   |    |    |
|------------------------------------------------------------------------------|--------|----------|--------|---------|---------|
| Paid to  shareholders                                                        |   |     |   | $       | 5,092.9 |   |
| Transaction  costs                                                           |   |     |   | 63.5    |    |
|                                                                         |   |     |   | 5,156.4 |    |
| Non-cash  consideration                                                      |   |     |   | 36.7    |    |
| Total consideration                                                          |   |     |   | 5,193.1 |    |
|                                                                         |   |     |   |    |    |
| Net assets acquired at historical cost                                       |   |     |   | 1,638.2 |    |
| Adjustments to state acquired assets at fair value:                          |   |     |   |    |    |
| 1) Increase carrying  value of property and equipment                        |   | $        | 137.8  |    |    |   |
| 2) Increase carrying  value of inventory                                     |   | 38.1     |   |    |    |
| 3) Write-off  historical goodwill and tradenames                             |   | (71.5    | )      |    |    |
| 4) Record intangible  assets acquired                                        |   |     |   |    |    |
| Customer lists                                                               |   | 586.0    |   |    |    |
| Favorable lease  commitments                                                 |   | 480.0    |   |    |    |
| Tradenames                                                                   |   | 1,667.4  |   |    |    |
| 5) Write-off  other assets, primarily debt issue costs                       |   | (3.7     | )      |    |    |
| 6) Adjustment to state  2008 Notes at redemption value                       |   | (6.2     | )      |    |    |
| 7) Adjustment to state  2028 Debentures at fair value                        |   | 4.5      |   |    |    |
| 8) Write-off  deferred real estate credits                                   |   | 90.2     |   |    |    |
| 9) Increase in long-term  benefit obligations, primarily pension obligations |   | (57.6    | )      |    |    |
| 10) Tax impact of  purchase accounting adjustments                           |   | (1,049.3 | )      |    |    |
| 11) Increase carrying  values of assets of Gurwitch Products, L.L.C.         |   | 41.0     |   |    |    |
| Deemed dividend to management shareholders                                   |   | 69.2     |   | 1,925.9 |    |
| Net assets acquired at fair value                                            |   |     |   | 3,564.1 |    |
| Goodwill at Acquisition date                                                 |   |     |   | $       | 1,629.0 |   |
|                                                                              |        |          |        |         |         |  |  |

 

***Pro Forma Financial Information.***  Thefollowing unaudited pro forma results of operations assume that theTransactions occurred on August 1, 2004. The following unaudited pro formaresults reflect Gurwitch Products, L.L.C. as a discontinued operation and donot give effect to the sale of our credit card receivables, which was completedon July 7, 2005, or the disposition of Chef’s Catalog, which was completedon November 8, 2004.  This unauditedpro forma information should not be relied upon as necessarily being indicativeof the historical results that would have been obtained if the Transactions hadactually occurred on that date, nor the results that may be obtained in thefuture.
|            | ** ** | **Fiscal years ended** | ** ** |
|------------|------------|----------------------------------|------------|
| ** ** | ** ** | **July 29,  2006**          | ** ** | **July 30,  2005** | ** ** |
|       |       |                             |       |   |   |
| Revenues   |       | $                                | 4,105,596  |   | $ | 3,774,798 |   |
| Net income |       | $                                | 44,692     |   | $ | 35,517 |   |

 

Pro forma adjustments for fiscal year 2006 consistprimarily of adjustments for the nine-week Predecessor period prior to theAcquisition for 1) depreciation and amortization charges of $13.4 million and2) interest expense of $44.4 million offset by 3) the reversal of thehistorical non-cash charges of $39.6 million to cost of goods sold recordedsubsequent to the Acquisition related to the step-up in the carrying value ofour inventories as of the Acquisition date.

Pro forma adjustments for fiscal year 2005 consistprimarily of 1) non-cash charges of $39.6 million to cost of goods sold relatedto the step-up in the carrying value of our inventories as of the Acquisitiondate, 2) depreciation and amortization charges aggregating $77.5 million and 3)interest expense of $225.0 million.

F-18

----

**NOTE 4. DISPOSITION OF GURWITCH PRODUCTS, L.L.C.**

On July 27, 2006, we sold our former majority interest in GurwitchProducts, L.L.C. to Alticor Inc., for pretax net cash proceeds ofapproximately $40.8 million (Gurwitch Disposition).  Gurwitch Products, L.L.C. designs and marketsLaura Mercier cosmetics line and had annual revenues of approximately $71.6million in fiscal year 2006.  At July 27,2006, Gurwitch Products, L.L.C. had 1) net tangible assets, primarily accountsreceivable, inventory and property and equipment of $31.6 million, 2) netintangible assets and goodwill of $40.7 million and 3) total liabilitiesof $31.5 million. In addition, we recorded tax expense of $13.3 million,payable by the Company, on the excess of the tax over book gain realized inconnection with the Gurwitch Disposition. TheCompany’s consolidated financial statements, accompanying notes and otherinformation provided in this Annual Report on Form 10-K reflect GurwitchProducts, L.L.C. as a discontinued operation for all periods presented.

**NOTE 5. TRANSACTIONS WITH SPONSORS**

In connection with the Transactions, we entered into amanagement services agreement with affiliates of the Sponsors pursuant to whichaffiliates of one of the Sponsors received on the closing date a transactionfee of $25 million in cash. Affiliates of the other Sponsor waived anycash transaction fee in connection with the Transactions.

In addition, pursuant to such agreement, and in exchangefor on-going consulting and management advisory services that will be providedto us by the Sponsors and their affiliates, affiliates of the Sponsors willreceive an aggregate annual management fee equal to the lesser of(i) 0.25% of our consolidated annual revenues or(ii) $10 million. Affiliates of the Sponsors will also receivereimbursement for out-of-pocket expenses incurred by them or their affiliatesin connection with services provided pursuant to the agreement. Thesemanagement fees are payable quarterly in arrears. During the forty-three weeksended July 29, 2006, we recorded management fees of $8.7 million,which are included in selling, general and administrative expenses in theconsolidated statement of earnings.

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

**NOTE 6. CREDIT CARD RECEIVABLES**

***Credit Card Sale.***  On July 7,2005, HSBC Bank Nevada, National Association (HSBC) purchased our approximatelythree million private label Neiman Marcus and Bergdorf Goodman credit cardaccounts and related assets, as well as the outstanding balances associatedwith such accounts (Credit Card Sale). The total purchase price wasapproximately $647 million, consisting of $534 million in net cashproceeds and the assumption of approximately $113 million of ouroutstanding debt under our previous revolving credit card securitization facility(Credit Card Facility). We recognized a gain of $6.2 million in connectionwith the sale of our credit card portfolio to HSBC in the fourth quarter offiscal year 2005.

As a part of the Credit Card Sale, we entered into along-term marketing and servicing alliance with HSBC. Under the terms of thisalliance, HSBC offers credit card and non-card payment plans bearing our brandsand we receive ongoing payments from HSBC related to credit card sales andcompensation for marketing and servicing activities (HSBC Program Income). Inaddition, we continue to handle certain key customer service functions. Intandem with HSBC, we have initiated various changes in our credit card programto alter the credit terms available to our cardholders and to enhance the earningsof the portfolio. These changes have increased the level of HSBC Program Incomeearned by the Company. In the future, the HSBC Program Income may be eitherdecreased based upon the level of future services we provide to HSBC orincreased based upon other changes to our historical credit card programrelated to, among other things, the interest rates applied to unpaid balancesand the assessment of late fees.

***Prior to the Credit Card Sale.***  Prior tothe Credit Card Sale on July 7, 2005, we transferred substantially all ofour credit card receivables to a wholly-owned subsidiary, Neiman MarcusFunding Corporation, which in turn sold such receivables to the Neiman MarcusCredit Card Master Trust (Trust) pursuant to a revolving credit cardsecuritization program (the Credit Card Facility). At the inception of theCredit Card Facility in September 2000, the Trust issued certificatesrepresenting undivided interests in the credit card receivables to both third-partyinvestors (Sold Interests) and to the Company (Retained Interests). From theinception of the Credit Card Facility until December 2003, our transfersand sales of credit card receivables pursuant to the terms of the Credit CardFacility were accounted for as sales (Off-Balance Sheet Accounting). As aresult, $225.0 million of credit card receivables were removed from ourbalance sheet at the inception of the Credit Card Facility and

F-19

----

the Trust’s $225.0 million repayment obligation to the holders ofthe certificates representing the Sold Interests was not shown as a liabilityon our consolidated balance sheet.

The Sold Interests were represented by Class ACertificates, aggregating $225.0 million at face value. The holders of theClass A Certificates were entitled to monthly interest distributions atthe contractually-defined rate of one month LIBOR plus 0.27% annually.The distributions to the Class A Certificate holders were payable from thefinance charge income generated by the credit card receivables held by theTrust. In order to maintain the committed level of securitized assets, cashcollections on the securitized receivables were used by the Trust to purchasenew credit card balances from us in accordance with the terms of the CreditCard Facility.

We held Retained Interests represented by theClass B Certificate ($23.8 million face value), the Class CCertificate ($68.2 million face value) and the Seller’s Certificate(representing the excess of the total receivables sold to the Trust over theSold Interests and the Class B and Class C Certificates). Inaddition, we held rights to certain residual cash flows comprised of excessfinance charge collections (IO Strip). Pursuant to the terms of the Trust, ourrights to payments with respect to the Class B Certificate, theClass C Certificate, the Seller’s Certificate and the IO Strip weresubordinated to the rights of the holders of the Class A Certificates. Asa result, the credit quality of the Class A Certificates was enhanced,thereby lowering the interest cost paid by the Trust on the Class A Certificates.Recourse to the Company with respect to the sale of assets was limited to ourRetained Interests.  Changes in the fairvalue of the IO Strip were reflected as a component of other comprehensiveincome. Income was recorded on the Retained Interests on the basis of theirestimated effective yield to maturity.

Under the Credit Card Facility, we serviced the creditcard receivables for a contractually defined servicing fee.  We earned servicing fees of $5.4 million in2005 and $6.3 million in 2004.

Transfers to the Trust ceased to qualify for Off-BalanceSheet Accounting beginning in December 2003 since the receivablestransferred after November 2003 were subject to our future repurchasebased upon the provisions of the Credit Card Facility. Rather, these transferswere recorded as secured borrowings (Financing Accounting). As a consequence,the credit card receivables generated after November 2003 remained on ourbalance sheet as assets and the portions of Class A Certificates that fundedsuch receivables were reflected as a liability. The transition period fromOff-Balance Sheet Accounting to Financing Accounting (Transition Period) lastedapproximately four months (December 2003 to March 2004). During theTransition Period, cash collections of receivables were allocated to theprevious Sold Interests and Retained Interests until such time as thosebalances were reduced to zero. By the end of the Transition Period, our entirecredit card portfolio was included in accounts receivable in our consolidatedbalance sheet and the $225.0 million repayment obligation was shown as aliability.

As of the start of the Transition Period inDecember 2003, the carrying value of the Sold and Retained Interestsexceeded face value by approximately $7.6 million as a result of theapplication of the provisions of current accounting rules related to thecalculation of the gains on sale of the previous Sold Interests and thevaluation of both Sold and Retained Interests. During the Transition Period,the $7.6 million premium was amortized as a reduction of our net earningsfrom our credit card portfolio. Of the $7.6 million premium,$5.3 million was amortized in the second quarter of fiscal year 2004 andthe remaining $2.3 million was amortized in the third quarter of fiscalyear 2004.

Beginning in April 2005, cash collections were usedby the Trust to repay the $225.0 million principal balance of theClass A Certificates in six monthly installments of $37.5 million(Amortization Period). Prior to the Credit Card Sale, we had repaid$112.5 million of the principal balance of the Class A Certificatesand had placed $40.7 million on deposit with the Trust to fund futurerepayment obligations. In connection with the Credit Card Sale, HSBC assumedthe remaining obligations related to the outstanding Class A Certificates.

F-20

----

The table below summarizes theamount of cash flows between us and the Trust (prior to the Credit Card Sale inJuly 2005):

|                                                              | ** ** | **(Predecessor)**                | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **Fiscal years ended** | ** ** |
| **(in millions)**                                       | ** ** | **July 30,  2005**          | ** ** | **July 31,  2004** | ** ** |
|                                                         |       |                             |       |   |   |
| Principal collections:                                       |       |                             |       |   |   |
| Reinvested by  the Trust in revolving period securitizations |       | $                                | 2,013.4    |   | $ | 1,958.9 |   |
| Reinvested  portion allocable to Retained Interests          |       | —                           |       | 483.4 |   |
| Servicing fees received  by the Company                      |       | 5.4                              |       | 6.3 |   |
| Excess cash flows related to the IO Strip                    |       | $                                | 52.4       |   | $ | 53.6 |   |

 

The table below provideshistorical credit card delinquencies and net credit losses:

|                                                      | ** ** | **(Predecessor)**                                | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(in millions, except percentages)** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|                                                 |       |                                             |       |
| Total face value of  receivables                     |       | $                                                | 527.7      |   |
| Delinquent principal  over 90 days                   |       | 1.8                                              | %          |
| Annual credit losses (net of recoveries)             |       | $                                                | 14.3       |   |

 

A summary of the income earned in connection with ourproprietary credit card program is as follows:

|                                      | ** ** | **(Successor)**                              | ** ** | ** ** | **(Predecessor)**                       | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|------------|-----------------------------------------|------------|
| **(in  thousands)**                  | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
| ** **                           | ** ** | ** **                                   | ** ** | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income:                              |       |                                         |       |       |                                    |       |   |   |   |   |
| HSBC Program Income                  |       | $                                            | 49,353     |       |                                    | $          | 7,818 |   | $ | 2,157 |   | $ | — |   |
| Finance charge income                |       | —                                       |       |       | —                                  |       | 78,706 |   | 39,936 |   |
| Servicing fee income                 |       | —                                       |       |       | —                                  |       | 5,437 |   | 6,340 |   |
| Gain on sales of Sold  Interests     |       | —                                       |       |       | —                                  |       | — |   | 3,189 |   |
| Income from Retained  Interests, net |       | —                                       |       |       | —                                  |       | — |   | 21,478 |   |
| Expenses:                            |       |                                         |       |       |                                    |       |   |   |   |   |
| Bad debt, net                        |       | —                                       |       |       | —                                  |       | (14,656 | ) | (7,610 | ) |
| Amortization of premium              |       | —                                       |       |       | —                                  |       | — |   | (7,583 | ) |
|                                 |       | $                                            | 49,353     |       |                                    | $          | 7,818 |   | $ | 71,644 |   | $ | 55,750 |   |

 

F-21

----

**NOTE 7.  GOODWILLAND INTANGIBLE ASSETS**

The significant components of goodwill and intangibleassets, by our operating segments, are as follows:

| (in thousands)                           | ** ** | **Specialty  Retail** | ** ** | **Direct  Marketing** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                                    | ** ** | ** **            | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ***Predecessor***                             |       |                  |       |                  |       |       |       |       |       |
| Trademarks (indefinite  lives)                |       | $                     | —     |                  | $          | 23,700     |       | $          | 28,480     |   | $ | 52,180 |   |
| Goodwill                                      |       | —                |       | 14,872                |       | —     |       | 14,872     |       |
| Balance at July 30,  2005 and October 1, 2005 |       | $                     | —     |                  | $          | 38,572     |       | $          | 28,480     |   | $ | 67,052 |   |
|                                          |       |                  |       |                  |       |       |       |       |       |
| ***Successor***                               |       |                  |       |                  |       |       |       |       |       |
| Customer lists                                |       | $                     | 490,314    |                  | $          | 86,174     |       | $          | 9,525      |   | $ | 586,013 |   |
| Accumulated  amortization                     |       | (32,642               | )          | (12,215               | )          | (525       | )          | (45,382    | )          |
| Customer lists,  net                          |       | 457,672               |       | 73,959                |       | 9,000      |       | 540,631    |       |
|                                          |       |                  |       |                  |       |       |       |       |       |
| Favorable lease  commitments                  |       | 479,954               |       | —                |       | —     |       | 479,954    |       |
| Accumulated  amortization                     |       | (14,757               | )          | —                |       | —     |       | (14,757    | )          |
| Favorable lease  commitments, net             |       | 465,197               |       | —                |       | —     |       | 465,197    |       |
|                                          |       |                  |       |                  |       |       |       |       |       |
| Trademarks (indefinite  lives)                |       | 1,406,030             |       | 215,758               |       | 45,597     |       | 1,667,385  |       |
| Goodwill                                      |       | 1,286,881             |       | 291,200               |       | 50,900     |       | 1,628,981  |       |
| Balance at July 29, 2006                      |       | $                     | 3,615,780  |                  | $          | 580,917    |       | $          | 105,497    |   | $ | 4,302,194 |   |

 

**NOTE 8.  ACCRUEDLIABILITIES**

The significant components ofaccrued liabilities are as follows:

|                                           | ** ** | **(Successor)**         | ** ** | ** ** | **(Predecessor)**       | ** ** |
|-------------------------------------------|------------|-------------------------|------------|------------|-------------------------|------------|
| ** **                                | ** ** | **July 29,  2006** | ** ** | ** ** | **July 30,  2005** | ** ** |
|                                      |       |                    |       |       |                    |       |
| Accrued salaries and  related liabilities |       | $                       | 65,853     |       |                    | $          | 65,982 |   |
| Amounts due customers                     |       | 48,045                  |       |       | 44,214                  |       |
| Self-insurance  reserves                  |       | 45,505                  |       |       | 43,209                  |       |
| Sales returns reserves                    |       | 43,742                  |       |       | 35,170                  |       |
| Interest payable                          |       | 40,337                  |       |       | 3,005                   |       |
| Income taxes payable                      |       | 32,670                  |       |       | 19,702                  |       |
| Sales tax                                 |       | 21,824                  |       |       | 15,071                  |       |
| Loyalty program  liability                |       | 18,127                  |       |       | 16,780                  |       |
| Other                                     |       | 67,236                  |       |       | 83,512                  |       |
| Total                                     |       | $                       | 383,339    |       |                    | $          | 326,645 |   |

 

F-22

----

**NOTE 9.  LONG-TERM DEBT**

The significant components of ourlong-term debt are as follows:

|                                        | ** ** | ** **             | ** ** | **(Successor)**         | ** ** | ** ** | **(Predecessor)**       | ** ** |
|----------------------------------------|------------|------------------------|------------|-------------------------|------------|------------|-------------------------|------------|
| ** **                             | ** ** | **Interest Rate** | ** ** | **July 29,  2006** | ** ** | ** ** | **July 30,  2005** | ** ** |
|                                   |       |                   |       |                    |       |       |                    |       |
| Asset-Based  Revolving Credit Facility |       | variable               |       | $                       | —     |       |                    | $          | — |   |
| Senior Secured Term  Loan Facility     |       | variable               |       | 1,875,000               |       |       | —                  |       |
| 2028 Debentures                        |       | 7.125%                 |       | 120,711                 |       |       | 124,823                 |       |
| Senior Notes                           |       | 9.0%/9.75%             |       | 700,000                 |       |       | —                  |       |
| Senior Subordinated  Notes             |       | 10.375%                |       | 500,000                 |       |       | —                  |       |
| 2008 Notes                             |       | 6.65%                  |       | —                  |       |       | 124,957                 |       |
| Credit Card Facility                   |       | variable               |       | —                  |       |       | —                  |       |
| Long-term debt                         |       |                   |       | $                       | 3,195,711  |       |                    | $          | 249,780 |   |

 

***Senior Secured Asset-Based RevolvingCredit Facility.***  On October 6, 2005, in connection withthe Transactions, NMG entered into a credit agreement and related security andother agreements for a senior secured Asset-Based Revolving CreditFacility with Deutsche Bank Trust Company Americas as administrative agent andcollateral agent. The Asset-Based Revolving Credit Facility providesfinancing of up to $600.0 million, subject to a borrowing base equal to atany time the lesser of 80% of eligible inventory (valued at the lower of costor market value) and 85% of net orderly liquidation value of the eligibleinventory, less certain reserves. The Asset-Based Revolving CreditFacility includes borrowing capacity available for letters of credit and forborrowings on same-day notice. At the closing of the Transactions, NMG utilized$150.0 million of the Asset-Based Revolving Credit Facility forloans and approximately $16.5 million for letters of credit. In the secondquarter of fiscal year 2006, NMG repaid all loans under the Asset-BasedRevolving Credit Facility. As of July 29, 2006, NMG had$570.9 million of unused borrowing availability under the Asset-BasedRevolving Credit Facility based on a borrowing base of over $600.0 millionand after giving effect to $29.1 million used for letters of credit.

The Asset-Based Revolving Credit Facility providesthat NMG has 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 NMG 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 NMG’s 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 NMG’s option, either(a) a base rate determined by reference to the higher of (1) theprime rate of Deutsche Bank Trust Company Americas and (2) the federalfunds effective rate plus  1¤2 of 1% or(b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin. The initial applicable margin is 0% with respect to baserate borrowings and 1.75% with respect to LIBOR borrowings. The applicablemargin is subject to adjustment based on the historical availability under theAsset-Based Revolving Credit Facility. In addition, NMG is required topay a commitment fee of 0.375% per annum in respect of the unutilizedcommitments. If the average revolving loan utilization is 50% or more for anyapplicable period, the commitment fee will be reduced to 0.250% for suchperiod. The Company must also pay customary letter of credit fees and agencyfees.

If at any time the aggregate amount of outstanding loans,unreimbursed letter of credit drawings and undrawn letters of credit under theAsset-Based Revolving Credit Facility exceeds the lesser of (i) thecommitment amount and (ii) the borrowing base, NMG 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 theamount available under the Asset-Based Revolving Credit Facility is lessthan $60 million or an event of default has occurred, NMG will be requiredto repay outstanding loans and cash collateralize letters of credit with thecash NMG would then be required to deposit daily in a collection accountmaintained with the agent under the Asset-Based Revolving CreditFacility. The Company may voluntarily reduce the unutilized portion of thecommitment amount and repay outstanding loans at any time without premium orpenalty other than customary “breakage” costs with respect to LIBOR loans.There is no scheduled amortization under the Asset-Based Revolving CreditFacility; the principal amount of the loans outstanding is due and payable infull on October 6, 2010.

All obligations under the Asset-Based RevolvingCredit Facility are guaranteed by the Company and certain of NMG’s existing andfuture domestic subsidiaries (excluding, among others, Kate Spade LLC). As ofJuly 29, 2006, the liabilities of

F-23

----

NMG’s non-guarantor subsidiaries totaled approximately$21.0 million, or 0.4% of consolidated liabilities, and the assets of NMG’snon-guarantor subsidiaries aggregated approximately $143.3 million, or2.2% of consolidated total assets. All obligations under NMG’s Asset-BasedRevolving Credit Facility, and the guarantees of those obligations, aresecured, subject to certain significant exceptions, by substantially all of NMG’sassets and the assets of NMG and NMG’s subsidiaries that have guaranteed theAsset-Based Revolving Credit Facility (subsidiary guarantors), including:

·                  afirst-priority security interest in personal property consisting ofinventory and related accounts, cash, deposit accounts, all payments receivedby NMG or the subsidiary guarantors from credit card clearinghouses andprocessors or otherwise in respect of all credit card charges for sales ofinventory by NMG and the subsidiary guarantors, certain related assets andproceeds of the foregoing; and

·                  asecond-priority pledge of 100% of NMG’s capital stock and certain of thecapital stock held by NMG, the Company or any subsidiary guarantor (whichpledge, in the case of any foreign subsidiary is limited to 100% of thenon-voting stock (if any) and 65% of the voting stock of such foreignsubsidiary); and

·                  asecond-priority security interest in, and mortgages on, substantially allother tangible and intangible assets of NMG, the Company and each subsidiaryguarantor, including a significant portion of NMG’s material owned and leasedreal property (which currently consists of approximately half of NMG’sfull-line retail stores) and equipment.

Capital stock and other securities of a subsidiary of NMGthat are owned by NMG or any subsidiary guarantor will not constitutecollateral under NMG’s Asset-Based Revolving Credit Facility to theextent that such securities cannot secure NMG’s 2028 Debentures or othersecured public debt obligations without requiring the preparation and filing ofseparate financial statements of such subsidiary in accordance with applicableSecurities and Exchange Commission’s rules. As a result, the collateral underNMG’s Asset-Based Revolving Credit Facility will include shares ofcapital stock or other securities of subsidiaries of NMG or any subsidiaryguarantor only to the extent that the applicable value of such securities (on asubsidiary-by-subsidiary basis) is less than 20% of the aggregate principalamount of the 2028 Debentures or other secured public debt obligations of NMG.Stock of Kate Spade LLC and its assets also do not constitute collateral underNMG’s Asset-Based Revolving Credit Facility.

The Company’s Asset-Based Revolving Credit Facilitycontains a number of covenants that, among other things and subject to certainsignificant exceptions, restrict its ability and the ability of itssubsidiaries to:

·                  incuradditional indebtedness;

·                  paydividends on NMG’s capital stock or redeem, repurchase or retire NMG’s capitalstock or indebtedness;

·                  makeinvestments, loans, advances and acquisitions;

·                  createrestrictions on the payment of dividends or other amounts to NMG from itssubsidiaries that are not guarantors;

·                  engagein transactions with NMG’s affiliates;

·                  sellassets, including capital stock of NMG’s subsidiaries;

·                  consolidateor merge;

·                  createliens; and

·                  enterinto sale and lease back transactions.

The covenants limiting dividends and other restrictedpayments; investments, loans, advances and acquisitions; and prepayments orredemptions of other indebtedness, each permit the restricted actions in anunlimited amount, subject to the satisfaction of certain payment conditions,principally that NMG must have at least $75.0 million of pro forma excessavailability under the Asset-Based Revolving Credit Facility and that NMGmust be in pro forma compliance with the fixed charge coverage ratio describedbelow.

F-24

----

Although the credit agreement governing the Asset-BasedRevolving Credit Facility does not require NMG to comply with any financialratio maintenance covenants, if less than $60.0 million were available tobe borrowed under the Asset-Based Revolving Credit Facility at any time,NMG would not be permitted to borrow any additional amounts unless its 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 creditagreement also contains customary affirmative covenants and events of default.

***Senior Secured Term Loan Facility.***  OnOctober 6, 2005, in connection with the Transactions, NMG entered into acredit agreement and related security and other agreements for a$1,975.0 million Senior Secured Term Loan Facility with Credit Suisse asadministrative agent and collateral agent. The full amount of the SeniorSecured Term Loan Facility was borrowed on October 6, 2005. In the secondquarter of fiscal year 2006, NMG repaid $100.0 million principal amount ofthe loans under the Senior Secured Term Loan Facility.

Borrowings under the Senior Secured Term Loan Facilitybear interest at a rate per annum equal to, at NMG’s 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¤2 of 1% or(b) a LIBOR rate, subject to certain adjustments, in each case plus anapplicable margin. The applicable margin is 1.5% with respect to base rateborrowings and 2.5% with respect to LIBOR borrowings. The interest rate on theoutstanding borrowings pursuant to the Senior Secured Term Loan Facility was7.77% at July 29, 2006.

The credit agreement governing the Senior Secured TermLoan Facility requires NMG to prepay outstanding term loans with 50% (whichpercentage will be reduced to 25% if NMG’s total leverage ratio is less than aspecified ratio and will be reduced to 0% if NMG’s total leverage ratio is lessthan a specified ratio) of its annual excess cash flow (as defined in thecredit agreement). For fiscal year 2006, NMG was not required to prepay anyoutstanding term loans pursuant to the annual excess cash flow requirements.  If a change of control (as defined in thecredit agreement) occurs, NMG will be required to offer to prepay alloutstanding term loans, at a prepayment price equal to 101% of the principalamount to be prepaid, plus accrued and unpaid interest to the date ofprepayment. The Company also must offer to prepay outstanding term loans at100% of the principal amount to be prepaid, plus accrued and unpaid interest,with the proceeds of certain asset sales under certain circumstances.

The Company may voluntarily prepay outstanding loansunder the Senior Secured Term Loan Facility at any time without premium orpenalty other than customary “breakage” costs with respect to LIBOR loans. IfNMG repays all or any portion of the Senior Secured Term Loan Facility prior toOctober 6, 2006 (other than a prepayment that is made with certaindesignated asset sale proceeds), NMG must pay 101% of the principal amount tobe repaid. There is no scheduled amortization under the Senior Secured TermLoan Facility. The principal amount of the loans outstanding is due and payablein full on April 6, 2013.

All obligations under the Senior Secured Term LoanFacility are unconditionally guaranteed by the Company and each direct andindirect domestic subsidiary of NMG that guarantees the obligations of NMGunder its Asset-Based Revolving Credit Facility. All obligations underthe Senior Secured Term Loan Facility, and the guarantees of those obligations,are secured, subject to certain significant exceptions, by substantially all ofNMG’s assets and the assets of the Company and the subsidiary guarantors,including:

·                  afirst-priority pledge of 100% of NMG’s capital stock and certain of thecapital stock held by NMG, the Company or any subsidiary guarantor (whichpledge, in the case of any foreign subsidiary is limited to 100% of thenon-voting stock (if any) and 65% of the voting stock of such foreignsubsidiary); and

·                  afirst-priority security interest in, and mortgages on, substantially allother tangible and intangible assets of NMG, the Company and each subsidiaryguarantor, including a significant portion of NMG’s material owned and leasedreal property (which currently consists of approximately half of NMG’sfull-line retail stores) and equipment, but excluding, among other things, thecollateral described in the following bullet point; and

·                  asecond-priority security interest in personal property consisting ofinventory and related accounts, cash, deposit accounts, all payments receivedby NMG or the subsidiary guarantors from credit card clearinghouses andprocessors or otherwise in respect of all credit card charges for sales ofinventory by NMG and the subsidiary guarantors, certain related assets andproceeds of the foregoing.

Capital stock and other securities of a subsidiary of NMGthat are owned by NMG or any subsidiary guarantor will not constitutecollateral under NMG’s Senior Secured Term Loan Facility to the extent thatsuch securities cannot secure the 2028 Debentures or other secured public debtobligations without requiring the preparation and filing of separate financialstatements of such subsidiary in accordance with applicable SEC rules. As aresult, the collateral under NMG’s Senior Secured Term Loan 

F-25

----

Facility will include shares of capital stock or other securities ofsubsidiaries of NMG or any subsidiary guarantor only to the extent that theapplicable value of such securities (on a subsidiary-by-subsidiary basis) isless than 20% of the aggregate principal amount of the 2028 Debentures or othersecured public debt obligations of NMG. Stock of Kate Spade LLC and its assetsalso will not constitute collateral under NMG’s Senior Secured Term LoanFacility.

The credit agreement governing the Senior Secured TermLoan Facility contains a number of negative covenants that are substantiallysimilar to those governing the Senior Notes and additional covenants related tothe security arrangements for the Senior Secured Term Loan Facility. The creditagreement also contains customary affirmative covenants and events of default.

***2028 Debentures.***  InMay 1998, NMG issued $125.0 million aggregate principal amount of its7.125% 2028 Debentures. In connection with the Transactions, NMG equally andratably secured the 2028 Debentures by a first lien security interest on certaincollateral subject to liens granted under NMG’s Senior Secured CreditFacilities constituting (a) (i) 100% of the capital stock of certain ofNMG’s existing and future domestic subsidiaries, and (ii) 100% of thenon-voting stock and 65% of the voting stock of certain of NMG’s existing andfuture foreign subsidiaries and (b) certain of NMG’s principal propertiesthat include approximately half of NMG’s full-line stores, in each case, to theextent required by the terms of the indenture governing the 2028 Debentures.The 2028 Debentures contain covenants that restrict NMG’s ability to createliens and enter into sale and lease back transactions. The collateral securingthe 2028 Debentures will be released upon the release of liens on suchcollateral under NMG’s Senior Secured Credit Facilities and any other debt(other than the 2028 Debentures) secured by such collateral. Capital stock andother securities of a subsidiary of NMG that are owned by NMG or any subsidiarywill not constitute collateral under the 2028 Debentures to the extent suchproperty does not constitute collateral under NMG’s Senior Secured CreditFacilities as described above. The 2028 Debentures are guaranteed on anunsecured, senior basis by the Company.

Thefair value of 2028 Debentures at July 29, 2006 was approximately $118.4million.

***Senior Notes.**** *On October 6, 2005,Newton Acquisition Merger Sub, Inc. issued $700.0 million aggregateoriginal principal amount of 9.0% / 9.75% Senior Notes under a senior indenture(Senior Indenture) with Wells Fargo Bank, National Association, as trustee. Atthe closing of the Transactions, as the surviving corporation in theAcquisition, NMG assumed all the obligations of Newton Acquisition MergerSub, Inc. under the Senior Indenture. The Senior Notes mature onOctober 15, 2015.

For any interest payment period through October 15,2010, NMG 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 Senior Notes accrues at the rate of 9% perannum. PIK Interest on the Senior Notes accrues at the rate of 9.75% per annum.After October 15, 2010, NMG will make all interest payments on the SeniorNotes entirely in cash. All Senior Notes mature on October 15, 2015 andhave the same rights and benefits as the senior notes issued on October 6,2005. Interest on the Senior Notes is payable quarterly in arrears on eachJanuary 15, April 15, July 15 and October 15, commencing onJanuary 15, 2006.

The Senior Notes are fully and unconditionallyguaranteed, on a joint and several unsecured, senior basis, by each of NMG’swholly-owned domestic subsidiaries that guarantee NMG’s obligations underits Senior Secured Credit Facilities and by the Company. The Senior Notes andthe guarantees thereof are NMG’s and the guarantors’ unsecured, seniorobligations and rank (i) equal in the right of payment with all of NMG’sand the guarantors’ existing and future senior indebtedness, including anyborrowings under NMG’s Senior Secured Credit Facilities and the guaranteesthereof and NMG’s 2028 Debentures; and (ii) senior to all of NMG’s and itsguarantors’ existing and future subordinated indebtedness, including the SeniorSubordinated Notes due 2015 and the guarantees thereof. The Senior Notes alsoare effectively junior in priority to NMG’s and its guarantors’ obligationsunder all secured indebtedness, including NMG’s Senior Secured Credit Facilities,the 2028 Debentures, and any other secured obligations of NMG, in each case, tothe extent of the value of the assets securing such obligations. In addition,the Senior Notes are structurally subordinated to all existing and futureliabilities, including trade payables, of NMG’s subsidiaries that are notproviding guarantees.

The Company is not required to make any mandatoryredemption or sinking fund payments with respect to the Senior Notes, but undercertain circumstances, NMG may be required to offer to purchase Senior Notes asdescribed below. The Company may from time to time acquire Senior Notes bymeans other than a redemption, whether by tender offer, in open marketpurchases, through negotiated transactions or otherwise, in accordance with applicablesecurities laws.

Except as described below, the Senior Notes are notredeemable at NMG’s option prior to October 15, 2010. From and afterOctober 15, 2010, NMG may redeem the Senior Notes, in whole or in part, ata redemption price equal to 104.5% of

F-26

----

principal amount, declining annually to 100% of the principal amount onOctober 15, 2013, plus accrued and unpaid interest, and AdditionalInterest (as defined in the Senior Indenture), if any, thereon to theapplicable redemption date.

Prior to October 15, 2008, NMG may, at its option,subject to certain conditions, redeem up to 35% of the original aggregateprincipal amount of Senior Notes at a redemption price equal to 109% of theaggregate 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 NMG or any direct or indirectparent of NMG to the extent such net proceeds are contributed to NMG. At anytime prior to October 15, 2010, NMG 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, and accrued and unpaid interest and Additional Interest, if any, tothe redemption date.

Upon the occurrence of a change of control (as defined inthe Senior Indenture), each holder of the Senior Notes has the right to requireNMG to repurchase some or all of such holder’s Senior Notes at a price in cashequal to 101% 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 Notes containscovenants that limit NMG’s ability and certain of its subsidiaries’ ability to:

·                  incuradditional indebtedness;

·                  paydividends on NMG’s capital stock or redeem, repurchase or retire NMG’s capitalstock or subordinated indebtedness;

·                  makeinvestments;

·                  createrestrictions on the payment of dividends or other amounts to NMG from itsrestricted subsidiaries that are not guarantors of the notes;

·                  engagein transactions with NMG’s affiliates;

·                  sellassets, including capital stock of NMG’s subsidiaries;

·                  consolidateor merge;

·                  createliens; and

·                  enterinto sale and lease back transactions.

The Company’s majority interest in Kate Spade LLC is notsubject to the covenants contained in the Senior Indenture. The SeniorIndenture also provides for events of default, which, if any of them occurs,would permit or require the principal, premium, if any, interest and any othermonetary obligations on all outstanding Senior Notes to be due and payableimmediately.

Thefair value of NMG’s Senior Notes at July 29, 2006 was approximately $737.6million.

***Senior Subordinated Notes.**** *On October 6, 2005,Newton Acquisition Merger Sub, Inc. issued $500.0 million aggregateprincipal amount of 10.375% Senior Subordinated Notes under a seniorsubordinated indenture (Senior Subordinated Indenture) with Wells Fargo Bank,National Association, as trustee. At the closing of the Transactions, as thesurviving corporation in the Acquisition, NMG assumed all the obligations ofNewton Acquisition Merger Sub, Inc. under the Senior SubordinatedIndenture. The Senior Subordinated Notes mature on October 15, 2015.Interest on the Senior Subordinated Notes is payable in cash semi-annually inarrears on each April 15 and October 15, commencing April 15,2006.

The Senior Subordinated Notes are fully andunconditionally guaranteed, on a joint and several unsecured, seniorsubordinated basis, by each of NMG’s wholly-owned domestic subsidiariesthat guarantee NMG’s obligations under its Senior Secured Credit Facilities andby the Company. The Senior Subordinated Notes and the guarantees thereof areNMG’s and the guarantors’ unsecured, senior subordinated obligations and rank(i) junior to all of NMG’s and the guarantors’ existing and future seniorindebtedness, including the Senior Notes and any borrowings under NMG’s SeniorSecured Credit Facilities, and the guarantees thereof and NMG’s 2028Debentures; (ii) equally with any of NMG’s and the guarantors’ futuresenior subordinated indebtedness; and (iii) senior to any of NMG’s and theguarantors’ future subordinated indebtedness. In addition, the Senior

F-27

----

Subordinated Notes are structurally subordinated to all existing andfuture liabilities, including trade payables, of NMG’s subsidiaries that arenot providing guarantees.

The Company is not required to make any mandatoryredemption or sinking fund payments with respect to the Senior SubordinatedNotes, but, under certain circumstances, NMG may be required to offer topurchase Senior Subordinated Notes as described below. The Company may fromtime 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 Subordinated Notesare not redeemable at NMG’s option prior to October 15, 2010. From andafter October 15, 2010, NMG may redeem the Senior Subordinated Notes, inwhole or in part, at a redemption price equal to 105.188% of principal amount,declining annually to 100% of principal amount on October 15, 2013, plusaccrued and unpaid interest, and Additional Interest (as defined in the SeniorSubordinated Indenture), if any, thereon to the applicable redemption date.

Prior to October 15, 2008, NMG may, at its option,subject to certain conditions, redeem up to 35% of the original aggregateprincipal amount of Senior Subordinated Notes at a redemption price equal to110.375% of the aggregate principal amount thereof, plus accrued and unpaidinterest, and Additional Interest, if any, thereon to the redemption date, withthe net cash proceeds of one or more equity offerings of NMG or any direct orindirect parent of NMG to the extent such net proceeds are contributed to NMG.

At any time prior to October 15, 2010, NMG also mayredeem all or a part of the Senior Subordinated Notes at a redemption priceequal to 100% of the principal amount of Senior Subordinated Notes redeemedplus an applicable premium, as provided in the Senior Subordinated Indenture,and accrued and unpaid interest and Additional Interest, if any, to theredemption date.

Upon the occurrence of a change of control (as defined inthe Senior Subordinated Indenture), NMG will make an offer to purchase all ofthe Senior Subordinated Notes at a price in cash equal to 101% of the aggregateprincipal amount thereof plus accrued and unpaid interest, and AdditionalInterest, if any, to the date of purchase.

The indenture governing the Senior Subordinated Notescontains covenants substantially similar to those applicable to NMG’s SeniorNotes described above. The Senior Subordinated Indenture also provides forevents of default, which, if any of them occurs, would permit or require theprincipal, premium, if any, interest and any other monetary obligations on alloutstanding Senior Notes to be due and payable immediately, subject to certainexceptions.

The fair value ofNMG’s Senior Subordinated Notes at July 29, 2006 was approximately $531.3million.

***Redemption of 2008 Notes.***  InMay 1998, NMG issued $125.0 million aggregate principal amount of its2008 Notes. Upon closing of the Transactions, NMG called its 2008 Notes forredemption pursuant to their terms. On November 7, 2005, NMG used$134.7 million of reserved cash to redeem its 2008 Notes, which included acall premium of $6.2 million plus accrued interest of $3.5 millionthrough the redemption date.

***Maturities of Long-Term Debt.***  AtJuly 29, 2006, annual maturities of long-term debt during the next fivefiscal years and thereafter are as follows (in millions):
| 2007       |   | $       | — |   |
|------------|--------|---------|--------|--------|
| 2008       |   | —  |   |
| 2009       |   | —  |   |
| 2010       |   | —  |   |
| 2011       |   | —  |   |
| Thereafter |   | 3,195.7 |   |

 

The above table does not reflect future excess cash flowprepayments, if any, that may be required under the term loan facility.

***Interest Rate Swaps.***  TheCompany uses derivative financial instruments to help manage its interest raterisk. Effective December 6, 2005, NMG entered into floating to fixedinterest rate swap agreements for an aggregate notional amount of$1,000.0 million to limit its exposure to interest rate increases relatedto a portion of its floating rate indebtedness. The interest rate swapagreements terminate after five years. As of the effective date, NMG designatedthe interest rate swaps as cash flow

F-28

----

hedges.As a result, changes in the fair value of NMG’s swaps are recorded primarilysubsequent to the effective date as a component of other comprehensive income. Forthe forty-three weeks ended July 29, 2006, we recorded $10.6 million ofunrecognized gains in other comprehensive income.

At July 29, 2006, the fair value of NMG’s interestrate swap agreements was a gain of approximately $20.2 million, whichamount is included in other assets. As a result of the swap agreements, NMG’seffective fixed interest rates as to the $1,000.0 million in floating rateindebtedness will range from 6.931% to 7.499% per quarter and result in anaverage fixed rate of 7.285%.

***Interest expense.***  Thesignificant components of interest expense are as follows:

|                                             | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                     | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year   ended  July 30,  2005** | ** ** | **Fiscal year   ended  July 31,  2004** | ** ** |
|                                        |       |                                                   |       |       |                                              |       |   |   |   |   |
| Asset-Based  Revolving Credit Facility      |       | $                                                      | 1,332      |       |                                              | $          | — |   | $ | — |   | $ | — |   |
| Senior Secured  Term Loan Facility          |       | 111,662                                                |       |       | —                                            |       | — |   | — |   |
| 2028 Debentures                             |       | 7,266                                                  |       |       | 1,542                                             |       | 8,904 |   | 8,904 |   |
| Senior Notes                                |       | 51,421                                                 |       |       | —                                            |       | — |   | — |   |
| Senior  Subordinated Notes                  |       | 42,339                                                 |       |       | —                                            |       | — |   | — |   |
| Credit Agreement                            |       | —                                                 |       |       | —                                            |       | 5,803 |   | 2,200 |   |
| 2008 Notes                                  |       | 638                                                    |       |       | 1,439                                             |       | 8,308 |   | 8,308 |   |
| Amortization of  debt issue costs and other |       | 12,275                                                 |       |       | 322                                               |       | 1,193 |   | 1,659 |   |
| Total interest expense                      |       | 226,933                                                |       |       | 3,303                                             |       | 24,208 |   | 21,071 |   |
| Less:                                       |       |                                                   |       |       |                                              |       |   |   |   |   |
| Interest income                             |       | 5,557                                                  |       |       | 3,046                                             |       | 6,556 |   | 2,132 |   |
| Capitalized interest                        |       | 3,446                                                  |       |       | 1,146                                             |       | 5,350 |   | 3,036 |   |
| Interest expense, net                       |       | $                                                      | 217,930    |       |                                              | $          | (889 | ) | $ | 12,302 |   | $ | 15,903 |   |

 

**NOTE 10. COMMON SHAREHOLDERS’ EQUITY**

**Successor**

***Carryover Basis Adjustment for ManagementShareholders.***  Executive management participants heldcertain equity interests, including stock options, in the Predecessor prior tothe Transactions and continue to hold equity interests in the  Company, representing indirect equityinterests in the Successor after the Transactions.  In accordance with the provisions of EmergingIssues Task Force No. 88-16, “Basis in Leveraged Buyout Transactions,” thebasis of executive management’s indirect interests in the Successor after theTransactions is carried over at the basis of their interests in the Predecessorprior to the Transactions. The carryover basis of such interests less the netcash received by the management participants represents a deemed dividend of$69.2 million to the management participants and has been recognized as areduction to shareholders’ equity.

***Successor Stock-Based CompensationAccounting.***  In connection with the Transactions, theCompany authorized new equity-based management arrangements whichauthorize equity awards to be granted for up to 87,992.0 shares of the commonstock of the Company, of which options for 81,716.3 shares were issued tocertain management employees. All options are outstanding at July 29, 2006. Substantiallyall options have an exercise price of $1,445 per share, with the exercise pricewith respect to approximately 50% of such options escalating at a 10% compoundrate per year until the earlier to occur of (i) exercise, (ii) thefifth anniversary of the date of grant or (iii) the occurrence of a changein control; provided that in the event the Sponsors cause the sale of shares ofthe Company to an unaffiliated entity, the exercise price will cease to accreteat the time of the sale with respect to a pro rata portion of theaccreting options. Using the Black-Scholes option-pricing model,the per share fair value of these options was approximately $494 for the fixedprice options and $247 for the options with escalating exercise prices. Inestimating the fair value of our options, we made the following assumptions:expected term to exercise of five years; expected volatility of 30%; risk-freeinterest rate of 4.23%; and no dividend yield. Expected volatility is based ona combination of the Predecessor’s historical volatility adjusted for our newleverage and estimates of implied volatility of our peer group.  Options generally vest over four to fiveyears and expire 10 years from the date of grant.  At July 29, 2006, options for 7,283.2 shareswere vested.

F-29

----

Forthe forty-three weeks ended July 29, 2006, we recognized non-cash stockcompensation expense of $4.0 million, which is included in selling,general and administrative expenses. The adoption of SFAS No. 123(R) hadno impact on our cash flows from operations or financing activities. At July29, 2006, unearned non-cash stock-based compensation that we expect torecognize as expense over the next 5 years aggregates approximately$23.8 million.

 

**Predecessor**

***Cashdividend program.***  In the second quarter of 2005, thePredecessor Board of Directors increased the Predecessor quarterly cashdividend from $0.13 per share to $0.15 per share.  In fiscal year 2006, the Predecessor did notdeclare or pay any dividends.  In 2005,the Predecessor declared dividends aggregating $28.4 million, of whichdividends payable of $7.3 million were included in accrued liabilities inthe accompanying consolidated balance sheet as of July 30, 2005 and werepaid in August 2005.

***StockRepurchase Program.***  In prior years, the Predecessor Board ofDirectors authorized various stock repurchase programs and increases in thenumber of shares subject to repurchase. The Predecessor repurchased 58,504shares at an average price of $52.74 in fiscal year 2005 and repurchased175,600 shares at an average purchase price of $40.01 during the first quarterand 10,450 shares at an average price of $50.48 during the fourth quarter offiscal year 2004.

***Common Stock IncentivePlans.***  The Predecessor had established common stockincentive plans allowing for the granting of 1) stock options,2) stock appreciation rights, 3) restricted stock and stock units(restricted stock awards) and 4) other stock-based awards to ouremployees. All outstanding Predecessor options and restricted shares as ofOctober 5, 2005 were accelerated in connection with Transactions resulting in a$19.0 million non-cash charge for stock compensation.

In fiscal years 2005 and 2004,the Predecessor made stock-based awards in the form of 1) restrictedstock awards for which there was no exercise price payable by the employee,2) purchased restricted stock awards for which the exercise price wasequal to 50% of the fair value of our common stock on the date of grant and3) matching restricted stock awards pursuant to which restricted stockawards were granted equal to qualifying stock purchases by the employees. Infiscal year 2005, the Predecessor restricted stock and purchased restrictedstock awards aggregated 261,998 shares at a weighted-average exerciseprice of $23.82 as of the grant date. In fiscal year 2004, the Predecessorrestricted stock and purchased restricted stock awards aggregated 254,757shares at a weighted-average exercise price of $15.89 as of the grantdate.

Compensation cost for Predecessorrestricted stock and purchased restricted stock awards was recognized in anamount equal to the difference between the exercise price of the award and fairvalue at the date of grant. The Predecessor recorded such expense on astraight-line basis over the expected life of the award with the offsettingentry to additional paid-in capital. For performance accelerated restrictedstock, the expected life was determined based on the best estimate of thenumber of years from the grant date to the date at which it was probable thatthe performance targets would be met (four or five years, depending on thegrant). Compensation cost was calculated as if all instruments granted thatwere subject only to a service requirement would vest.  Compensation expense related to thePredecessor restricted stock grants was $8.5 million in the nine-weeksended October 1, 2005, $5.0 million in fiscal year 2005 and$3.1 million in fiscal year 2004.

Asummary of the status of the Predecessor common stock incentive plans asOctober 1, 2005, July 30, 2005 and July 31, 2004 and changes during thefiscal years ended on those dates are presented in the following table:
| ** **                        | ** ** | **October 1, 2005** | ** ** | **July 30, 2005**             | ** ** | **July 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|-----------------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **Shares**                    | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares**                  | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding at  beginning of year |       | 3,050,855                     |       | $                                       | 38.12      |                        | 3,009,155  |   | $ | 33.35 |   | 3,079,705 |   | $ | 29.54 |   |
| Granted                           |       | —                        |       | —                                  |       | 569,161                     |       | 56.89 |   | 903,650 |   | 43.33 |   |
| Exercised                         |       | (3,050,855                    | )          | 38.12                                   |       | (376,140                    | )          | 28.38 |   | (780,600 | ) | 29.34 |   |
| Canceled                          |       | —                        |       | —                                  |       | (151,321                    | )          | 38.87 |   | (193,600 | ) | 35.16 |   |
| Outstanding at end of  year       |       | —                        |       | $                                       | —     |                        | 3,050,855  |   | $ | 38.12 |   | 3,009,155 |   | $ | 33.37 |   |
| Exercisable at year end           |       | —                        |       | $                                       | —     |                        | 717,890    |   | $ | 28.76 |   | 713,110 |   | $ | 28.68 |   |

 

Predecessor options exercised inthe period ended October 1, 2005 were cashed out in connection with theTransaction, with the same economic effect as an exercise and sale for theTransaction consideration.

F-30

----

**NOTE 11. INCOME TAXES**

The significant components ofincome tax expense are as follows:
|                         | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)** | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|                    |       |                                                   |       |       |                                              |       |   |   |   |   |
| Current:                |       |                                                   |       |       |                                              |       |   |   |   |   |
| Federal                 |       | $                                                      | 72,010     |       |                                              | $          | 30,200 |   | $ | 147,407 |   | $ | 93,536 |   |
| State                   |       | 8,447                                                  |       |       | 2,437                                             |       | 13,229 |   | 3,319 |   |
| Foreign                 |       | 118                                                    |       |       | 20                                                |       | 307 |   | 367 |   |
|                    |       | 80,575                                                 |       |       | 32,657                                            |       | 160,943 |   | 97,222 |   |
| Deferred:               |       |                                                   |       |       |                                              |       |   |   |   |   |
| Federal                 |       | (58,575                                                | )          |       | (6,148                                            | )          | (13,510 | ) | 20,903 |   |
| State                   |       | (7,364                                                 | )          |       | (773                                              | )          | (1,826 | ) | 2,066 |   |
|                    |       | (65,939                                                | )          |       | (6,921                                            | )          | (15,336 | ) | 22,969 |   |
| Income tax expense      |       | $                                                      | 14,636     |       |                                              | $          | 25,736 |   | $ | 145,607 |   | $ | 120,191 |   |

 

A reconciliation of income taxexpense to the amount calculated based on the federal and state statutory ratesis as follows:
|                                                                                           | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                                                                   | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|                                                                                      |       |                                                   |       |       |                                              |       |   |   |   |   |
| Income tax expense at  statutory rate                                                     |       | $                                                      | 14,403     |       |                                              | $          | 24,461 |   | $ | 138,850 |   | $ | 114,566 |   |
| State income taxes, net  of federal income tax benefit                                    |       | 1,414                                                  |       |       | 2,136                                             |       | 14,005 |   | 12,885 |   |
| Tax benefit related to  favorable tax settlements and other reductions in tax liabilities |       | (113                                                   | )          |       | (222                                              | )          | (7,585 | ) | (7,500 | ) |
| Non-taxable income                                                                        |       | (1,378                                                 | )          |       | (1,058                                            | )          | (2,121 | ) | (265 | ) |
| Non-deductible expenses                                                                   |       | 256                                                    |       |       | 607                                               |       | 2,633 |   | 599 |   |
| Other                                                                                     |       | 54                                                     |       |       | (188                                              | )          | (175 | ) | (94 | ) |
| Total                                                                                     |       | $                                                      | 14,636     |       |                                              | $          | 25,736 |   | $ | 145,607 |   | $ | 120,191 |   |

 

Our effective income tax rate was35.6% for the forty-three weeks ended July 29, 2006 and 36.8% for the nineweeks ended October 1, 2005.  Oureffective tax rate in the current year was favorably impacted by a higher levelof tax-exempt interest income earned. Our effective income tax rate was 36.7% for the fiscal year endedJuly 30, 2005 and was favorably impacted by tax-exempt interest income,offset by non-deductible transaction costs. In the fourth fiscal quarter of fiscal year 2005, we recognized taxbenefits aggregating $7.6 million related to a favorable settlementassociated with previous state tax filings and reductions in previouslyrecorded deferred tax liabilities. Excluding these benefits, our effective taxrate was 38.6% for fiscal year 2005.  Inthe second quarter of fiscal year 2004, we also recognized a tax benefit of$7.5 million related to favorable settlements associated with previousstate tax filings. Excluding this benefit, our effective tax rate was 39.0% for2004.

The Company’s federal tax returns for fiscal years 2004and 2003 are currently under examination by the Internal Revenue Service (IRS).We believe our recorded tax liabilities as of July 29, 2006 are sufficientto cover any potential assessments to be made by the IRS upon the completion oftheir examinations. We will continue to monitor the progress of the IRSexaminations and review our recorded tax liabilities for potential auditassessments.  Adjustments to increase ordecrease the recorded tax liabilities may be required in the future asadditional facts become known.

F-31

----

Significant components of our net deferred income taxasset are as follows:
| (in thousands)                         | ** ** | **July 29,  2006** | ** ** | **July 30,  2005** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| Deferred income tax  assets:                |       |                    |       |                    |       |
| Accruals and reserves                       |       | $                       | 31,679     |                    | $          | 22,955 |   |
| Employee  benefits                          |       | 61,247                  |       | 52,794                  |       |
| Pension  obligation                         |       | 31,214                  |       | 6,327                   |       |
| Other                                       |       | 2,044                   |       | 2,035                   |       |
| Total deferred  tax assets                  |       | $                       | 126,184    |                    | $          | 84,111 |   |
|                                        |       |                    |       |                    |       |
| Deferred income tax  liabilities:           |       |                    |       |                    |       |
| Inventory                                   |       | $                       | (10,993    | )                       | $          | (11,674 | ) |
| Depreciation and  amortization              |       | (56,053                 | )          | (39,343                 | )          |
| Intangible  assets                          |       | (1,082,867              | )          | —                  |       |
| Other                                       |       | (4,064                  | )          | (3,610                  | )          |
| Total deferred  tax liabilities             |       | (1,153,977              | )          | (54,627                 | )          |
| Net deferred income tax  asset (liability)  |       | $                       | (1,027,793 | )                       | $          | 29,484 |   |
|                                        |       |                    |       |                    |       |
| Net deferred income tax  asset (liability): |       |                    |       |                    |       |
| Current                                     |       | $                       | 31,572     |                    | $          | 16,598 |   |
| Non-current                                 |       | (1,059,365              | )          | 12,886                  |       |
| Total                                       |       | $                       | (1,027,793 | )                       | $          | 29,484 |   |

 

The net deferred tax liability of$1,027.8 million at July 29, 2006 increased from a $29.5 million net deferredasset at July 30, 2005.  This increasewas comprised of 1) $1,123.0 million deferred tax liability related to purchaseaccounting valuations and 2) $7.2 million of deferred tax liabilities relatedto financial instruments charged directly to other comprehensive loss in thestatement of shareholders’ equity net of 3) $72.9 million deferred tax benefitfor fiscal year 2006. We believe it is more likely than not that we willrealize the benefits of our recorded deferred tax assets.

**NOTE 12. EMPLOYEE BENEFIT PLANS**

***Description of BenefitPlans.***  We sponsor a defined benefit pension plan(Pension Plan) covering substantially all full-time employees. We also sponsoran unfunded supplemental executive retirement plan (SERP Plan) which providescertain employees additional pension benefits. Benefits under both plans arebased on the employees’ years of service and compensation over defined periodsof employment.

Retirees and active employeeshired prior to March 1, 1989 are eligible for certain limitedpostretirement health care benefits (Postretirement Plan) if they meet certainservice and minimum age requirements. The cost of these benefits is accruedduring the years in which an employee provides services. We paid postretirementhealth care benefit claims of $1.9 million during fiscal year 2006(including $0.4 million for the Predecessor), $1.7 million during fiscalyear 2005 and $1.8 million during fiscal year 2004.

We have a qualified definedcontribution 401(k) plan, which covers substantially all employees. Employees makecontributions to the plan and we match an employee’s contribution up to amaximum of 6% of the employee’s compensation subject to statutory limitations.We also sponsor an unfunded key employee deferred compensation plan, whichprovides certain employees additional benefits and a profit sharing and adefined contribution retirement plan for employees of Kate Spade LLC. Ouraggregate expense related to these plans were approximately $9.1 million forthe forty-three weeks ended July 29, 2006, $1.8 million for the nine weeksended October 1, 2005, $10.8 million for fiscal year 2005 and$9.5 million for fiscal year 2004.

F-32

----

***Costsof Benefits.***  The components of the expenses we incurredunder our Pension Plan, SERP Plan and Postretirement Plan are as follows:
|                                                     | ** ** | **(Successor)**                                    | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)**                             | ** ** | **Forty-three  weeks  ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|                                                |       |                                               |       |       |                                              |       |   |   |   |   |
| Pension Plan:                                       |       |                                               |       |       |                                              |       |   |   |   |   |
| Service cost                                        |       | $                                                  | 13,320     |       |                                              | $          | 2,823 |   | $ | 12,785 |   | $ | 10,827 |   |
| Interest cost                                       |       | 17,365                                             |       |       | 3,468                                             |       | 18,544 |   | 16,484 |   |
| Expected return  on plan assets                     |       | (18,802                                            | )          |       | (3,636                                            | )          | (19,307 | ) | (16,527 | ) |
| Net amortization  of losses and prior service costs |       | —                                             |       |       | 1,205                                             |       | 4,835 |   | 3,192 |   |
| Pension Plan  expense                               |       | $                                                  | 11,883     |       |                                              | $          | 3,860 |   | $ | 16,857 |   | $ | 13,976 |   |
| SERP Plan:                                          |       |                                               |       |       |                                              |       |   |   |   |   |
| Service cost                                        |       | $                                                  | 1,570      |       |                                              | $          | 330 |   | $ | 1,445 |   | $ | 1,345 |   |
| Interest cost                                       |       | 3,685                                              |       |       | 730                                               |       | 4,057 |   | 3,849 |   |
| Net amortization  of losses and prior service costs |       | —                                             |       |       | 394                                               |       | 1,535 |   | 1,444 |   |
| SERP Plan expense                                   |       | $                                                  | 5,255      |       |                                              | $          | 1,454 |   | $ | 7,037 |   | $ | 6,638 |   |
| Postretirement Plan:                                |       |                                               |       |       |                                              |       |   |   |   |   |
| Service cost                                        |       | $                                                  | 38         |       |                                              | $          | 8 |   | $ | 57 |   | $ | 81 |   |
| Interest cost                                       |       | 708                                                |       |       | 139                                               |       | 1,168 |   | 1,570 |   |
| Net amortization  of losses                         |       | —                                             |       |       | (5                                                | )          | 75 |   | 450 |   |
| Postretirement expense                              |       | $                                                  | 746        |       |                                              | $          | 142 |   | $ | 1,300 |   | $ | 2,101 |   |

 

***BenefitObligations.***  Our obligations for the Pension Plan, SERPPlan and Postretirement Plan are valued annually as of the beginning of eachfiscal year. With respect to the Pension Plan and the SERP Plan, ourobligations consist of both a projected benefit obligation (PBO) and anaccumulated benefit obligation (ABO). The PBO represents the actuarial presentvalue of benefits ultimately payable to plan participants for both past andfuture services expected to be provided by the plan participants. The ABOrepresents the actuarial present value of benefits payable to plan participantsfor only services rendered at the valuation date. Our obligations pursuant toour Pension Plan, SERP Plan and Postretirement Plan are as follows:
| ** **                        | ** ** | **Pension Plan** | ** ** | **SERP Plan**    | ** ** | **Postretirement Plan** | ** ** |
|-----------------------------------|------------|-----------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                        | ** ** | **Fiscal years** | ** ** | **Fiscal years** | ** ** | **Fiscal years**        | ** ** |
| **(in thousands)**           | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2006**                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(Successor)**       | ** ** | **(Predecessor)**     | ** ** | **(Successor)**              | ** ** | **(Predecessor)** | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Projected benefit  obligations:   |       |                  |       |                  |       |                         |       |   |   |   |   |   |   |
| Beginning of  year                |       | $                     | 361,434    |                  | $          | 281,423                      |       | $ | 78,259 |   | $ | 65,864 |   | $ | 15,755 |   | $ | 20,994 |   |
| Service cost                      |       | 16,143                |       | 12,785                |       | 1,900                        |       | 1,445 |   | 46 |   | 57 |   |
| Interest cost                     |       | 20,834                |       | 18,544                |       | 4,415                        |       | 4,057 |   | 847 |   | 1,168 |   |
| Actuarial loss  (gain)            |       | (25,168               | )          | 56,400                |       | (4,209                       | )          | 8,826 |   | (2,416 | ) | (5,344 | ) |
| Benefits paid,  net               |       | (8,523                | )          | (7,718                | )          | (2,043                       | )          | (1,933 | ) | (1,257 | ) | (1,120 | ) |
| End of year                       |       | $                     | 364,720    |                  | $          | 361,434                      |       | $ | 78,322 |   | $ | 78,259 |   | $ | 12,975 |   | $ | 15,755 |   |
|                              |       |                  |       |                  |       |                         |       |   |   |   |   |   |   |
| Accumulated benefit  obligations: |       |                  |       |                  |       |                         |       |   |   |   |   |   |   |
| Beginning of  year                |       | $                     | 304,063    |                  | $          | 240,082                      |       | $ | 65,028 |   | $ | 56,209 |   |   |   |   |   |
| End of year                       |       | $                     | 308,255    |                  | $          | 304,063                      |       | $ | 66,890 |   | $ | 65,028 |   |   |   |   |   |

 

F-33

----

 

A summary of expected benefit payments related to ourPension Plan, SERP Plan and Postretirement Plan is as follows:

| (in thousands)    | ** ** | **Pension  Plan** | ** ** | **SERP  Plan** | ** ** | **Postretirement  Plan** | ** ** |
|------------------------|------------|-------------------|------------|----------------|------------|--------------------------|------------|
| ** **             | ** ** | ** **        | ** ** | ** **     | ** ** | ** **               | ** ** |
| Fiscal year 2007       |       | $                 | 10,583     |           | $          | 2,870                    |       | $ | 1,547 |   |
| Fiscal year 2008       |       | 11,561            |       | 2,899          |       | 1,639                    |       |
| Fiscal year 2009       |       | 12,646            |       | 3,323          |       | 1,697                    |       |
| Fiscal year 2010       |       | 13,766            |       | 3,765          |       | 1,728                    |       |
| Fiscal year 2011       |       | 14,939            |       | 4,050          |       | 1,774                    |       |
| Fiscal years 2012-2016 |       | $                 | 99,509     |           | $          | 25,855                   |       | $ | 9,681 |   |

 

***Purchase Accounting Adjustments.***  Theobligations and assets related to our benefit plans were valued at fair valueas of the date of the Acquisition as follows:
| **(in thousands)**                                                     | ** ** | **Pension Plan** | ** ** | **SERP Plan** | ** ** | **Postretirement  Plan** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|--------------------------|------------|
|                                                                        |       |                  |       |               |       |                     |       |
| Benefit obligations at  fair value (5.75% discount rate)                    |       | $                     | 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               | )          | (63,540            | )          | (18,205                  | )          |
| Adjustment to increase (decrease) benefit plan obligations                  |       | $                     | 47,281     |               | $          | 13,266                   |       | $ | (2,924 | ) |

 

***ActuarialAssumptions.***  Significant assumptions related to thecalculation of our obligations pursuant to our employee benefit plans includethe discount rate used to calculate the actuarial present value of benefitobligations to be paid in the future, the expected long-term rate of return onassets held by the Pension Plan, the average rate of compensation increase byPension Plan and SERP Plan participants and the health care cost trend rate forthe Postretirement Plan. We review these actuarial assumptions annually basedupon currently available information. The assumptions we utilized incalculating the projected benefit obligations and periodic expense of ourPension Plan, SERP Plan and Postretirement Plan are as follows:
|                                                   | ** ** | **August 1,  2006** | ** ** | **October 1,  2005** | ** ** | **August 1,  2005** | ** ** | **August 1,  2004** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|---------------------------|------------|--------------------------|------------|--------------------------|------------|
| Pension Plan:                                     |       |                     |       |                      |       |                     |       |                     |       |
| Discount rate                                     |       | 6.25                     | %          | 5.75                      | %          | 5.50                     | %          | 6.25                     | %          |
| Expected long-term rate of return on plan  assets |       | 8.00                     | %          | 8.00                      | %          | 8.00                     | %          | 8.00                     | %          |
| Rate of future compensation increase              |       | 4.50                     | %          | 4.50                      | %          | 4.50                     | %          | 4.50                     | %          |
| SERP Plan:                                        |       |                     |       |                      |       |                     |       |                     |       |
| Discount rate                                     |       | 6.25                     | %          | 5.75                      | %          | 5.50                     | %          | 6.25                     | %          |
| Rate of future compensation increase              |       | 4.50                     | %          | 4.50                      | %          | 4.50                     | %          | 4.50                     | %          |
| Postretirement  Plan:                             |       |                     |       |                      |       |                     |       |                     |       |
| Discount rate                                     |       | 6.25                     | %          | 5.75                      | %          | 5.50                     | %          | 6.25                     | %          |
| Initial health care cost trend rate               |       | 8.00                     | %          | 8.00                      | %          | 9.00                     | %          | 10.00                    | %          |
| Ultimate health  care cost trend rate             |       | 5.00                     | %          | 5.00                      | %          | 5.00                     | %          | 5.00                     | %          |

 

*Discount rate.*  Theassumed discount rate utilized is based, in part, upon the Moody’s Aa corporatebond yield as of the measurement date and the expected timing of cash outlaysfor plan benefits. The discount rate is utilized principally in calculating theactuarial present value of our obligations and periodic expense pursuant to ouremployee benefit plans. At August 1, 2006, the discount rate was 6.25%. Asa result of the increase in the discount rate from 5.75% at the Acquisitiondate to 6.25% at August 1, 2006, the projected benefit obligations relatedto our employee benefit plans decreased $37.4 million.

The estimated effect of a 0.25%decrease in the discount rate would increase the Pension Plan obligation by$15.7 million and increase annual Pension Plan expense by$0.9 million. The estimated effect of a 0.25% decrease in the discountrate would increase the SERP Plan obligation by $2.7 million and increasethe SERP Plan annual expense by $0.1 million. The estimated effect of a0.25% decrease in the discount rate would increase the Postretirement Planobligation by $0.3 million and increase the Postretirement Plan annualexpense by an immaterial amount.

F-34

----

*Expectedlong-term rate of return on plan assets.*  Theassumed expected long-term rate of return on assets is the weighted averagerate of earnings expected on the funds invested or to be invested to providefor the pension obligation. During fiscal year 2006, we utilized 8.0% as theexpected long-term rate of return on plan assets. We periodically evaluate theallocation between investment categories of the assets held by the PensionPlan. We base the expected average long-term rate of return on assetsprincipally on the counsel of our outside actuaries and advisors. This rate isutilized primarily in calculating the expected return on plan assets componentof the annual pension expense. To the extent the actual rate of return onassets realized over the course of a year is greater than the assumed rate,that year’s annual pension expense is not affected. Rather this gain reducesfuture pension expense over a period of approximately 12 to 18 years. Tothe extent the actual rate of return on assets is less than the assumed rate,that year’s annual pension expense is likewise not affected. Rather this lossincreases pension expense over approximately 12 to 18 years.

*Rate of futurecompensation increase.*  The assumed average rate of compensationincrease is the average annual compensation increase expected over theremaining employment periods for the participating employees. We utilized arate of 4.5% for the periods beginning July 29, 2006. This rate isutilized principally in calculating the obligation and annual expense for thePension and SERP Plans. The estimated effect of a 0.25% increase in the assumedrate of compensation increase would increase the projected benefit obligationfor the Pension Plan by $2.3 million and increase annual pension expenseby $0.3 million. The estimated effect of a 0.25% increase in the assumedrate of compensation increase would increase the SERP Plan projected benefitobligation by $1.0 million and increase the SERP Plan annual expense by$0.1 million.

*Health carecost trend rate.*  The assumed health care cost trend raterepresents our estimate of the annual rates of change in the costs of thehealth care benefits currently provided by the Postretirement Plan. The healthcare cost trend rate implicitly considers estimates of health care inflation, changesin health care utilization and delivery patterns, technological advances andchanges in the health status of the plan participants. We utilized a healthcare cost trend rate of 8% as of August 1, 2006, trending down over timeto an ultimate health care cost trend rate of 5%. If the assumed health carecost trend rate were increased one percentage point, Postretirement Plan costsfor 2006 would have been $0.1 million higher and the accumulatedpostretirement benefit obligation as of July 29, 2006 would have been$1.4 million higher. If the assumed health care trend rate were decreasedone percentage point, Postretirement Plan costs for 2006 would have been$0.1 million lower and the accumulated postretirement benefit obligationas of July 29, 2006 would have been $1.2 million lower.

*Effect ofMedicare Subsidy on Postretirement Plan.*  InDecember 2003, the U.S. Congress enacted the Medicare Prescription Drug,Improvement and Modernization Act of 2003 (Act) that provides a prescriptiondrug subsidy, beginning in January 2006, to companies that sponsorpostretirement health care plans that provide drug benefits. Based upon theprovisions of the legislation enacted in January 2005, we reviewed theprovisions of our Postretirement Plan to determine whether the benefits offeredby our plan meet the statutory definition of “actuarially equivalent”prescription drug benefits that qualify for the federal subsidy. Based uponthis review, we believe that our benefits qualify for the subsidy.

In accordance with the provisionsof the FASB Staff Position 106-2, “Accounting and Disclosure RequirementsRelated to the Medicare Prescription Drug, Improvement and Modernization Act of2003,” we revalued our projected benefit obligation as of January 31, 20051) to incorporate the benefit associated with the federal subsidy weexpect to receive and 2) to reduce the discount rate to 5.75%. The revisedobligation as of January 31, 2005 was approximately $19.1 million,reflecting a reduction of approximately $2.6 million for the impact of thefederal subsidy, offset by an increase of approximately $0.8 million forthe change in discount rate.

Effective August 1, 2006, we moved to an Enhanced PartD arrangement and will no longer directly receive the federal subsidy.  The move to an Enhanced Part D plan isexpected to result in additional savings which reduced our obligation at August1, 2006 by $2.2 million and is estimated to reduce the net periodic cost forfiscal year 2007 by $0.2 million.

***FundingPolicy and Plan Assets.***  Our policy is to fund the Pension Plan at orabove the minimum required by law. We made the following voluntarycontributions to our Pension Plan:
|                        | ** ** | **Fiscal years** | ** ** |
|------------------------|------------|-----------------------|------------|
| **(in millions)** | ** ** | **2006**              | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **             | ** ** | **(Successor)**       | ** ** | ** ** | **(Predecessor)** | ** ** | **(Predecessor)** | ** ** |
| Plan Year Ended:       |       |                  |       |   |   |   |   |   |
| July 31, 2006          |       | $                     | —     |   |   | $ | — |   | $ | — |   |
| July 31, 2005          |       | —                |       |   | — |   | — |   |
| July 31, 2004          |       | —                |       |   | 20.0 |   | 15.0 |   |
| July 31, 2003          |       | —                |       |   | — |   | 30.0 |   |
| Total                  |       | $                     | —     |   |   | $ | 20.0 |   | $ | 45.0 |   |

 

F-35

----

Based upon currently availableinformation, we will not be required to make contributions to the Pension Planfor the plan year ended July 31, 2006.

Assets held by the Pension Planare invested in accordance with the provisions of our approved investmentpolicy. The asset allocation for our Pension Plan at the end of 2006 and thetarget allocation for 2007, by asset category, are as follows:
|                         | ** ** | **Pension Plan**                       | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **Allocation  at July 31,  2006** | ** ** | **2007  Target  Allocation** | ** ** |
| Equity securities       |       | 73                                          | %          | 80 | % |
| Fixed income securities |       | 24                                          | %          | 20 | % |
| Cash and equivalents    |       | 3                                           | %          | — |   |
| Total                   |       | 100                                         | %          | 100 | % |

 

The Pension Plan’s strategicasset allocation was structured to reduce volatility through diversificationand enhance return to approximate the amounts and timing of the expectedbenefit payments.

Changes in the assets held by the Pension Plan in fiscalyears 2006 and 2005 are as follows:
|                                            | ** ** | **Fiscal years** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                    | ** ** | **2006**              | ** ** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(Successor)**       | ** ** | ** ** | **(Predecessor)** | ** ** |
| Fair value of assets at  beginning of year |       | $                     | 288,267    |   |   | $ | 243,097 |   |
| Actual return on assets                    |       | 13,976                |       |   | 32,888 |   |
| Company contributions                      |       | —                |       |   | 20,000 |   |
| Benefits paid                              |       | (8,523                | )          |   | (7,718 | ) |
| Fair value of assets at end of year        |       | $                     | 293,720    |   |   | $ | 288,267 |   |

 

***FundedStatus.***  The funded status of our Pension Plan, SERPPlan and Postretirement Plan is as follows:
| ** **                                                             | ** ** | **Pension Plan** | ** ** | **SERP Plan**    | ** ** | **Postretirement Plan** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                                             | ** ** | **Fiscal years** | ** ** | **Fiscal years** | ** ** | **Fiscal years**        | ** ** |
| **(in thousands)**                                                | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2006**                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                             | ** ** | **(Successor)**       | ** ** | **(Predecessor)**     | ** ** | **(Successor)**              | ** ** | **(Predecessor)** | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Projected benefit  obligation                                          |       | $                     | 364,720    |                  | $          | 361,434                      |       | $ | 78,322 |   | $ | 78,259 |   | $ | 12,975 |   | $ | 15,755 |   |
| Fair value of plan  assets                                             |       | 293,720               |       | 288,267               |       | —                       |       | — |   | — |   | — |   |
| Excess of projected  benefit obligation over fair value of plan assets |       | (71,000               | )          | (73,167               | )          | (78,322                      | )          | (78,259 | ) | (12,975 | ) | (15,755 | ) |
| Unrecognized net  actuarial loss (gain)                                |       | (7,819                | )          | 121,862               |       | (2,036                       | )          | 25,160 |   | (2,004 | ) | (2,515 | ) |
| Unrecognized prior  service (income) cost                              |       | —                |       | (155                  | )          | —                       |       | 2,619 |   | — |   | 161 |   |
| Unrecognized net  obligation at transition                             |       | —                |       | 157                   |       | —                       |       | — |   | — |   | — |   |
| Prepaid asset (accrued  obligation)                                    |       | $                     | (78,819    | )                     | $          | 48,697                       |       | $ | (80,358 | ) | $ | (50,480 | ) | $ | (14,979 | ) | $ | (18,109 | ) |
| Accumulated benefit  obligation                                        |       | $                     | 308,255    |                  | $          | 304,063                      |       | $ | 66,890 |   | $ | 65,028 |   |   |   |   |   |
| Fair value of plan  assets                                             |       | 293,720               |       | 288,267               |       | —                       |       | — |   |   |   |   |   |
| Deficiency of assets over obligation                                   |       | $                     | (14,535    | )                     | $          | (15,796                      | )          | $ | (66,890 | ) | $ | (65,028 | ) |   |   |   |   |

 

Our Pension Plan and SERP Planobligations and funded status of such plans are recognized in our consolidatedbalance sheets as follows:
| ** **                                                        | ** ** | **Pension Plan** | ** ** | **SERP Plan**    | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                        | ** ** | **Fiscal years** | ** ** | **Fiscal years** | ** ** |
| **(in thousands)**                                           | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                        | ** ** | **(Successor)**       | ** ** | **(Predecessor)**     | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Prepaid asset (accrued  obligation)                               |       | $                     | (78,819    | )                     | $          | 48,697 |   | $ | (80,358 | ) | $ | (50,480 | ) |
| Intangible asset                                                  |       | —                |       | (2                    | )          | — |   | (2,619 | ) |
| Other comprehensive  loss—additional minimum liability       |       | —                |       | (64,491               | )          | — |   | (11,929 | ) |
| Net accrued benefit obligation in the consolidated balance sheets |       | $                     | (78,819    | )                     | $          | (15,796 | ) | $ | (80,358 | ) | $ | (65,028 | ) |

 

F-36

----

In fiscal year 2005, theaccumulated benefit obligation exceeded the fair value of the assets held bythe Pension Plan, which required us to record additional minimum liabilities of$64.5 million related to the Pension Plan and $3.7 million related tothe SERP Plan. In recording the additional minimum liabilities, we reducedshareholders’ equity by $68.8 million ($42.2 million, net of tax).

The projected benefit obligationof the Pension Plan exceeded the plan’s assets by $71.0 million in fiscalyear 2006 and $73.2 million in fiscal year 2005. The underfunded status isreflected in our consolidated balance sheets as follows:
|                                                                                                            | ** ** | **Fiscal years** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                                                                                    | ** ** | **2006**              |       |   | **2005** | ** ** |
| ** **                                                                                                 | ** ** | **(Successor)**       |       |   | **(Predecessor)** | ** ** |
| Prepaid pension  contribution reflected in the consolidated balance sheets and not yet charged  to expense |       | $                     | (78,819    | ) |   | $ | 48,697 |   |
| Liability charged to  shareholders’ equity and not yet recognized in expense                          |       | —                |       |   | (64,491 | ) |
| Liability reflected in  other assets and not yet charged to expense                                        |       | —                |       |   | (2 | ) |
| Unrecognized gain  (loss) not yet recognized in expense                                                    |       | 7,819                 |       |   | (57,371 | ) |
| Underfunded status                                                                                         |       | $                     | (71,000    | ) |   | $ | (73,167 | ) |

 

The unrecognized asset of$7.8 million for the Pension Plan at July 29, 2006 relates primarilyto the change in discount rate from the date of the Acquisition to the end ofthe year.  In addition, we had cumulativeunrecognized gains for the SERP Plan and Postretirement Plan aggregating$4.0 million at July 29, 2006.

**NOTE 13. LOSS ON DISPOSITION OF CHEF’S CATALOG**

In November 2004, we soldour Chef’s Catalog direct marketing business to a private equity firm. Chef’sCatalog is a multi-channel retailer of professional-qualitykitchenware with revenues of approximately $73 million in fiscal year2004. At October 30, 2004, Chef’s Catalog had net tangible assets,primarily inventory, of $12.5 million and net intangible assets of$17.2 million. We received proceeds, net of selling costs, of$14.4 million from the sale. As the carrying value of the Chef’s Catalogassets exceeded the net proceeds from the sale, we incurred a pretax loss of$15.3 million in the first quarter of 2005 related to the disposition ofChef’s Catalog.

**NOTE 14. COMMITMENTS AND CONTINGENCIES**

***Leases.***  We leasecertain property and equipment under various non-cancelable capital andoperating leases. The leases provide for monthly fixed rentals and/or contingentrentals based upon sales in excess of stated amounts and normally require us topay real estate taxes, insurance, common area maintenance costs and otheroccupancy costs. Generally, the leases have primary terms ranging from one to99 years and include renewal options ranging from two to 80 years.

Rent expense under operatingleases is as follows:
|                         | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| **(in thousands)** | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|                    |       |                                                   |       |       |                                              |       |   |   |   |   |
| Minimum rent            |       | $                                                      | 36,700     |       |                                              | $          | 6,800 |   | $ | 42,100 |   | $ | 37,400 |   |
| Contingent rent         |       | 22,900                                                 |       |       | 4,700                                             |       | 23,800 |   | 20,300 |   |
| Total rent expense      |       | $                                                      | 59,600     |       |                                              | $          | 11,500 |   | $ | 65,900 |   | $ | 57,700 |   |

 

Future minimum rental commitments,excluding renewal options, under non-cancelable leases are as follows: fiscalyear 2007—$50.4 million; fiscal year 2008—$51.6 million; fiscal year2009—$50.4 million; fiscal year 2010—$47.5 million; fiscal year2011—$46.1 million; all fiscal years thereafter—$568.2 million.

Common area maintenance costswere $10.9 million for the forty-three weeks ended July 29, 2006, $2.1 millionfor the nine weeks ended October 1, 2005, $12.6 million for fiscal year2005 and $11.8 million for fiscal year 2004.

F-37

----

***Long-term Incentive Plan.***  Following the consummation of theTransactions, the Company created a long-term incentive plan (Long-termIncentive Plan) that provides for a cash incentive payable upon a change ofcontrol, as defined, subject to the attainment of certain performanceobjectives to employees who have historically been eligible for stock-basedcompensation.  Performance objectives andtargets are based on cumulative EBITDA percentages for three year periodsbeginning in fiscal year 2006.  Earned awardsfor each completed performance period will be credited to a book account andwill earn interest at the rate of 5% annually until the award is paid.  Awards will be paid within 30 days of achange of control or the first day there is a public market of at least 20% oftotal outstanding common stock.

***Cash Incentive Plan. ***Followingthe consummation of the Transactions, the Company also adopted a cash incentiveplan (Cash Incentive Plan) to aid in the retention of certain keyexecutives.  The Cash Incentive Planprovides for the creation of a $14 million cash bonus pool to be shared by allparticipants based on the number of vested and unvested stock options andunderlying shares that were granted pursuant to the Management Equity IncentivePlan.  Each participant in the CashIncentive Plan will be entitled to a cash bonus upon the earlier to occur of achange of control or an initial public offering, as defined in the CashIncentive Plan, provided that the internal rate of return to the Sponsors is positive.

***Investment in Kate Spade LLC. ***We currently own a 56% interest in Kate Spade LLC, which designs andmarkets high-end designer handbags and accessories.  A minority investor owns the remaining 44%interest.  Our investment in andrelationship with Kate Spade LLC are governed by an operating agreementthat provides for an orderly transition process in the event either investorwishes to sell its interest, or purchase the other investor’s interest. Amongother things, this operating agreement contains currently exercisable putoption provisions entitling the minority investor to put its interest to us,and currently exercisable call option provisions entitling us to purchase theminority investor’s interest, at a purchase price mutually agreed to by the parties.The purchase price will be determined by the parties or, in the event theparties are unable to agree on a mutually acceptable price, by a mutuallyacceptable nationally recognized investment banking firm, subject to certainconditions. We may elect to defer the consummation of a put option for a periodof six months by cooperating with the minority investor in seeking either asale of Kate Spade LLC to a third party or a public offering of KateSpade LLC’s securities. If a sale to a third party or public offering ofKate Spade LLC’s securities is not consummated within six months after theexercise of the put option (which period may be automatically extended for anadditional two months if a registration statement for Kate Spade LLC isfiled with the Securities and Exchange Commission), we are obligated toconsummate the put option. Under the terms of the Kate Spade LLC operatingagreement, consummation of the put option shall occur within thirty days afterthe determination of the valuation with respect to the exercise of the putoption, unless we have elected to defer the consummation of the put option forthe six-month period referred to above, and should a third party sale or publicoffering of Kate Spade LLC occur within such six-month period, we arerequired to pay the minority investor the excess, if any, of the put optionvaluation price for its interest over the amount it realizes through the thirdparty sale or public offering.

In April 2005, the minority investor in Kate SpadeLLC exercised the put option described above with respect to the full amount ofits stake in such company. We subsequently entered into a standstill agreementto postpone the put process while we engaged in discussions with the minorityinvestor in Kate Spade LLC regarding certain strategic alternatives, includingthe possible sale of such company. The standstill agreement, as extended,expired on March 21, 2006, but the parties are continuing to pursuediscussions regarding a possible sale of such company while the put valuationprocess proceeds. Although such discussions are ongoing, no assurance can begiven that they will ultimately lead to any transaction. It is possible that wemay be required to purchase the shares of the minority investor in Kate SpadeLLC pursuant to the option as early as the second quarter of fiscal year 2007.

***Litigation.***  We arecurrently involved in various legal actions and proceedings that arose in theordinary course of business. We believe that any liability arising as a resultof these actions and proceedings will not have a material adverse effect on ourfinancial position, results of operations or cash flows.

***Other.***  We hadapproximately $29.1 million of outstanding irrevocable letters of creditrelating to purchase commitments and insurance and other liabilities atJuly 29, 2006. We had approximately $4.0 million in surety bonds atJuly 29, 2006 relating primarily to merchandise imports, state sales taxand utility requirements.

F-38

----

**NOTE 15. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)**

The following table shows thecomponents of accumulated other comprehensive income (loss):
|                                                     | ** ** | **(Successor)**         | ** ** | ** ** | **(Predecessor)**       | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|------------|-------------------------|------------|
| **(in thousands)**                             | ** ** | **July 29,  2006** | ** ** | ** ** | **July 30,  2005** | ** ** |
| ** **                                          | ** ** | ** **              | ** ** | ** ** | ** **              | ** ** |
| Unrealized gain (loss)  on financial instruments    |       | $                       | 9,990      |       |                    | $          | (1,114 | ) |
| Minimum pension  liability adjustments              |       | —                  |       |       | (46,921                 | )          |
| Other                                               |       | (161                    | )          |       | 1,005                   |       |
| Total accumulated other comprehensive (loss) income |       | $                       | 9,829      |       |                    | $          | (47,030 | ) |

 

**NOTE 16. SEGMENT REPORTING**

We have identified two reportable segments: SpecialtyRetail stores and Direct Marketing. The Retail stores segment includes allNeiman Marcus and Bergdorf Goodman retail stores, including Neiman Marcusclearance stores. The Direct Marketing segment conducts both online and printcatalog operations under the Neiman Marcus, Bergdorf Goodman and Horchow brandnames.  Other includes the operations ofKate Spade LLC.

Both the Specialty Retail storesand Direct Marketing segments, as well as Kate Spade LLC, derive their revenuesfrom the sales of high-end fashion apparel, accessories, cosmetics andfragrances from leading designers, precious and fashion jewelry and decorativehome accessories.

Operatingearnings for the segments include 1) revenues, 2) cost of sales, 3) directselling, general, and administrative expenses, 4) other direct operatingexpenses, 5) income from credit card operations and 6) depreciation expense forthe respective segment.  Items notallocated to our operating segments include those items not considered bymanagement in measuring the assets and profitability of our segments. Theseamounts include 1) corporate expenses including, but not limited to, treasury,investor relations, legal and finance support services, and general corporatemanagement, 2) charges related to the application of purchase accountingadjustments made in connection with the Acquisition including amortization ofcustomer lists and favorable lease commitments and other non-cash valuationcharges and 3) interest expense.  Theseitems, while often times related to the operations of a segment, are notconsidered by segment operating management, corporate operating management andthe chief operating decision maker in assessing segment operatingperformance.  The accounting policies ofthe operating segments are the same as those described in the summary ofsignificant accounting policies (except with respect to purchase accountingadjustments not allocated to the operating segments).  Our seniormanagement evaluates the performance of our assets on a consolidated basis.

F-39

----

The following tables set forth the information for ourreportable segments:
| ** **                                                                                        | ** ** | **(Successor)**                                        | ** ** | ** ** | **(Predecessor)**                                 | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------|---------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **Forty-three  weeks ended  July 29,  2006** | ** ** | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | **Fiscal year  ended  July 30,  2005** | ** ** | **Fiscal year  ended  July 31,  2004** | ** ** |
|                                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| REVENUES                                                                                          |       |                                                   |       |       |                                              |       |   |   |   |   |
| Specialty Retail stores                                                                           |       | $                                                      | 2,829,966  |       |                                              | $          | 544,857 |   | $ | 3,102,952 |   | $ | 2,850,088 |   |
| Direct Marketing                                                                                  |       | 567,771                                                |       |       | 87,515                                            |       | 592,122 |   | 570,626 |   |
| Other                                                                                             |       | 64,482                                                 |       |       | 11,005                                            |       | 79,724 |   | 63,285 |   |
| Total                                                                                             |       | $                                                      | 3,462,219  |       |                                              | $          | 643,377 |   | $ | 3,774,798 |   | $ | 3,483,999 |   |
|                                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| OPERATING EARNINGS                                                                                |       |                                                   |       |       |                                              |       |   |   |   |   |
| Specialty Retail stores                                                                           |       | $                                                      | 312,296    |       |                                              | $          | 91,372 |   | $ | 377,772 |   | $ | 310,579 |   |
| Direct Marketing                                                                                  |       | 89,967                                                 |       |       | 8,246                                             |       | 75,178 |   | 61,307 |   |
| Other                                                                                             |       | 1,024                                                  |       |       | (1,265                                            | )          | 11,578 |   | 10,986 |   |
| Subtotal                                                                                          |       | 403,287                                                |       |       | 98,353                                            |       | 464,528 |   | 382,872 |   |
| Corporate expenses                                                                                |       | (45,857                                                | )          |       | (5,809                                            | )          | (46,334 | ) | (35,786 | ) |
| Amortization of  customer lists and favorable lease commitments                                   |       | (60,165                                                | )          |       | —                                            |       | — |   | — |   |
| Non-cash charges  related to other valuation adjustments made in connection with the  Acquisition |       | (38,185                                                | )          |       | —                                            |       | — |   | — |   |
| Transaction and other  costs                                                                      |       | —                                                 |       |       | (23,544                                           | )          | — |   | — |   |
| Loss on disposition of  Chef’s Catalog                                                       |       | —                                                 |       |       | —                                            |       | (15,348 | ) | — |   |
| Gain on Credit Card  Sale                                                                         |       | —                                                 |       |       | —                                            |       | 6,170 |   | — |   |
| Impairment and other  charges                                                                     |       | —                                                 |       |       | —                                            |       | — |   | (3,853 | ) |
| Total                                                                                             |       | $                                                      | 259,080    |       |                                              | $          | 69,000 |   | $ | 409,016 |   | $ | 343,233 |   |
|                                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| CAPITAL EXPENDITURES                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| Specialty Retail stores                                                                           |       | $                                                      | 123,694    |       |                                              | $          | 22,784 |   | $ | 176,519 |   | $ | 101,101 |   |
| Direct Marketing                                                                                  |       | 14,519                                                 |       |       | 2,791                                             |       | 13,736 |   | 13,319 |   |
| Other                                                                                             |       | 2,777                                                  |       |       | 656                                               |       | 9,443 |   | 4,649 |   |
| Total                                                                                             |       | $                                                      | 140,990    |       |                                              | $          | 26,231 |   | $ | 199,698 |   | $ | 119,069 |   |
|                                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| DEPRECIATION EXPENSE                                                                              |       |                                                   |       |       |                                              |       |   |   |   |   |
| Specialty Retail stores                                                                           |       | $                                                      | 93,941     |       |                                              | $          | 16,970 |   | $ | 94,386 |   | $ | 88,265 |   |
| Direct Marketing                                                                                  |       | 9,642                                                  |       |       | 1,836                                             |       | 9,203 |   | 8,058 |   |
| Other                                                                                             |       | 3,732                                                  |       |       | 920                                               |       | 2,757 |   | 1,728 |   |
| Depreciation expense on  step-up of fixed assets made in connection with the Acquisition          |       | 3,771                                                  |       |       | —                                            |       | — |   | — |   |
| Total                                                                                             |       | $                                                      | 111,086    |       |                                              | $          | 19,726 |   | $ | 106,346 |   | $ | 98,051 |   |

 

F-40

----

**NOTE 17. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (with respect to NMG’sobligations under the****SeniorNotes and the Senior Subordinated Notes)**

All of NMG’s obligations under the Senior Notes and theSenior Subordinated Notes, as well as its obligations under the Asset-BasedRevolving Credit Facility and the Senior Secured Term Loan Facility, areguaranteed by the Company and certain of NMG’s existing and future domesticsubsidiaries (principally, Bergdorf Goodman, Inc. through which NMGconducts the operations of its Bergdorf Goodman stores and NM Nevada Trustwhich holds legal title to certain real property and intangible assets used bythe Company in conducting its operations). Non-guarantor subsidiaries consistprincipally of Kate Spade LLC and Neiman Marcus Funding Corporation throughwhich the Company previously conducted its credit card operations prior to theCredit Card Sale. The guarantees by the Company and each subsidiary guarantorare full and unconditional and joint and several.

The following condensed consolidating financialinformation represents the financial information of Neiman Marcus, Inc.and its wholly-owned subsidiary guarantors, prepared on the equity basisof accounting. The information is presented in accordance with the requirementsof Rule 3-10 under the Securities and Exchange Commission’sRegulation S-X. The financial information may not necessarily beindicative of results of operations, cash flows or financial position had thesubsidiary guarantors operated as independent entities.
| ** **                                                     | ** ** | **July 29, 2006 (Successor)** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------|------------|
| **(in thousands)**                                        | ** ** | **Company**                                  | ** ** | **NMG** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **ASSETS**                                                     | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                     |       | $                                            | —     |   | $ | 222,308 |   | $ | 986 |   | $ | 1,469 |   | $ | — |   | $ | 224,763 |   |
| Accounts  receivable, net of allowance                         |       | —                                       |       | 22,189 |   | 3,750 |   | 7,472 |   | 613 |   | 34,024 |   |
| Merchandise  inventories                                       |       | —                                       |       | 711,443 |   | 84,252 |   | 11,043 |   | (2,527 | ) | 804,211 |   |
| Other current  assets                                          |       | —                                       |       | 67,170 |   | 4,544 |   | 1,144 |   | — |   | 72,858 |   |
| Total current  assets                                          |       | —                                       |       | 1,023,110 |   | 93,532 |   | 21,128 |   | (1,914 | ) | 1,135,856 |   |
| Property and equipment,  net                                   |       | —                                       |       | 875,725 |   | 152,109 |   | 15,980 |   | — |   | 1,043,814 |   |
| Goodwill and  intangibles, net                                 |       | —                                       |       | 1,980,770 |   | 2,215,987 |   | 105,437 |   | — |   | 4,302,194 |   |
| Other assets                                                   |       | —                                       |       | 124,929 |   | 389 |   | 779 |   | — |   | 126,097 |   |
| Investments in  subsidiaries                                   |       | 1,427,667                                    |       | 2,469,428 |   | — |   | — |   | (3,897,095 | ) | — |   |
| Total assets                                                   |       | $                                            | 1,427,667  |   | $ | 6,473,962 |   | $ | 2,462,017 |   | $ | 143,324 |   | $ | (3,899,009 | ) | $ | 6,607,961 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                 | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                                           |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                               |       | $                                            | —     |   | $ | 263,800 |   | $ | 31,835 |   | $ | 13,334 |   | $ | 613 |   | $ | 309,582 |   |
| Accrued  liabilities                                           |       | —                                       |       | 312,623 |   | 67,340 |   | 3,026 |   | 350 |   | 383,339 |   |
| Notes payable  and current maturities of long-term liabilities |       | —                                       |       | 3,887 |   | — |   | 2,250 |   | — |   | 6,137 |   |
| Total current  liabilities                                     |       | —                                       |       | 580,310 |   | 99,175 |   | 18,610 |   | 963 |   | 699,058 |   |
| Long-term  liabilities:                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Long-term  debt                                                |       | —                                       |       | 3,195,711 |   | — |   | — |   | — |   | 3,195,711 |   |
| Deferred income  taxes                                         |       | —                                       |       | 1,059,365 |   | — |   | — |   | — |   | 1,059,365 |   |
| Other long-term  liabilities                                   |       | —                                       |       | 210,909 |   | 6,597 |   | 2,340 |   | — |   | 219,846 |   |
| Total long-term  liabilities                                   |       | —                                       |       | 4,465,985 |   | 6,597 |   | 2,340 |   | — |   | 4,474,922 |   |
| Minority interest                                              |       | —                                       |       | — |   | — |   | — |   | 6,314 |   | 6,314 |   |
| Total shareholders’  equity                               |       | 1,427,667                                    |       | 1,427,667 |   | 2,356,245 |   | 122,374 |   | (3,906,286 | ) | 1,427,667 |   |
| Total liabilities and shareholders’ equity                |       | $                                            | 1,427,667  |   | $ | 6,473,962 |   | $ | 2,462,017 |   | $ | 143,324 |   | $ | (3,899,009 | ) | $ | 6,607,961 |   |

 

F-41

----

 
| ** **                                                     | ** ** | **July 30, 2005 (Predecessor)** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------|------------|
| **(in thousands)**                                        | ** ** | **NMG**                                        | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **ASSETS**                                                     | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                |       |                                           |       |   |   |   |   |   |   |   |   |
|                                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                      |       | $                                              | 317,346    |   | $ | 795 |   | $ | 535,278 |   | $ | — |   | $ | 853,419 |   |
| Accounts receivable, net of allowance                          |       | 7,910                                          |       | 2,929 |   | 8,221 |   | 338 |   | 19,398 |   |
| Merchandise inventories                                        |       | 650,918                                        |       | 78,390 |   | 14,423 |   | (840 | ) | 742,891 |   |
| Other current assets                                           |       | 67,720                                         |       | 5,603 |   | 1,654 |   | — |   | 74,977 |   |
| Current assets of discontinued operation                       |       | —                                         |       | — |   | 17,796 |   | — |   | 17,796 |   |
| Total current assets                                           |       | 1,043,894                                      |       | 87,717 |   | 577,372 |   | (502 | ) | 1,708,481 |   |
| Property and  equipment, net                                   |       | 697,514                                        |       | 136,503 |   | 17,399 |   | — |   | 851,416 |   |
| Goodwill and  intangibles, net                                 |       | 14,875                                         |       | 23,700 |   | 28,477 |   | — |   | 67,052 |   |
| Other assets                                                   |       | 24,035                                         |       | 371 |   | 1,195 |   | — |   | 25,601 |   |
| Investments in  subsidiaries                                   |       | 706,979                                        |       | — |   | — |   | (706,979 | ) | — |   |
| Non-current  assets of discontinued operation                  |       | —                                         |       | — |   | 8,110 |   | — |   | 8,110 |   |
|                                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Total assets                                                   |       | $                                              | 2,487,297  |   | $ | 248,291 |   | $ | 632,553 |   | $ | (707,481 | ) | $ | 2,660,660 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                 | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current  liabilities:                                          |       |                                           |       |   |   |   |   |   |   |   |   |
| Accounts payable                                               |       | $                                              | 233,116    |   | $ | 32,199 |   | $ | 14,779 |   | $ | 338 |   | $ | 280,432 |   |
| Accrued liabilities                                            |       | 244,798                                        |       | 60,396 |   | 19,452 |   | 1,999 |   | 326,645 |   |
| Notes payable and current maturities of long-term  liabilities |       | 200                                            |       | — |   | — |   | — |   | 200 |   |
| Current liabilities of discontinued operation                  |       | —                                         |       | — |   | 9,997 |   | — |   | 9,997 |   |
| Total current liabilities                                      |       | 478,114                                        |       | 92,595 |   | 44,228 |   | 2,337 |   | 617,274 |   |
| Long-term  liabilities:                                        |       |                                           |       |   |   |   |   |   |   |   |   |
| Long-term debt                                                 |       | 249,780                                        |       | — |   | — |   | — |   | 249,780 |   |
| Other long-term liabilities                                    |       | 185,457                                        |       | 18,626 |   | 2,933 |   | — |   | 207,016 |   |
| Non-current liabilities of discontinued operation              |       | —                                         |       | — |   | 532 |   | — |   | 532 |   |
| Total long-term liabilities                                    |       | 435,237                                        |       | 18,626 |   | 3,465 |   | — |   | 457,328 |   |
|                                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Minority  interest                                             |       | —                                         |       | — |   | — |   | 12,112 |   | 12,112 |   |
|                                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Total  shareholders’ equity                               |       | 1,573,946                                      |       | 137,070 |   | 584,860 |   | (721,930 | ) | 1,573,946 |   |
|                                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Total liabilities and  shareholders’ equity               |       | $                                              | 2,487,297  |   | $ | 248,291 |   | $ | 632,553 |   | $ | (707,481 | ) | $ | 2,660,660 |   |

 

F-42

----

 
| ** **                                                                            | ** ** | **Forty-three weeks ended July 29, 2006 (Successor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **Company**                                                                         | ** ** | **NMG** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                                   | —     |   | $ | 2,885,321 |   | $ | 512,007 |   | $ | 66,734 |   | $ | (1,843 | ) | $ | 3,462,219 |   |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation)     |       | —                                                                              |       | 1,885,917 |   | 332,938 |   | 42,804 |   | (2,522 | ) | 2,259,137 |   |
| Selling, general  and administrative expenses (excluding depreciation)                |       | —                                                                              |       | 704,846 |   | 97,767 |   | 19,491 |   | — |   | 822,104 |   |
| Income from  credit card operations                                                   |       | —                                                                              |       | (44,765 | ) | (4,588 | ) | — |   | — |   | (49,353 | ) |
| Depreciation  expense                                                                 |       | —                                                                              |       | 89,545 |   | 17,028 |   | 4,513 |   | — |   | 111,086 |   |
| Amortization of  customer lists and favorable lease commitments                       |       | —                                                                              |       | 49,830 |   | 9,760 |   | 575 |   | — |   | 60,165 |   |
| Operating  earnings                                                                   |       | —                                                                              |       | 199,948 |   | 59,102 |   | (649 | ) | 679 |   | 259,080 |   |
| Interest  expense, net                                                                |       | —                                                                              |       | 217,664 |   | — |   | 266 |   | — |   | 217,930 |   |
| Intercompany  royalty charges (income)                                                |       | —                                                                              |       | 201,879 |   | (201,879 | ) | — |   | — |   | — |   |
| Equity in  earnings of subsidiaries                                                   |       | (12,455                                                                             | )          | (246,686 | ) | — |   | — |   | 259,141 |   | — |   |
| Earnings (loss)  from continuing operations before income taxes and minority interest |       | 12,455                                                                              |       | 27,091 |   | 260,981 |   | (915 | ) | (258,462 | ) | 41,150 |   |
| Income taxes                                                                          |       | —                                                                              |       | 14,636 |   | — |   | — |   | — |   | 14,636 |   |
| Earnings (loss)  from continuing operations before minority interest                  |       | 12,455                                                                              |       | 12,455 |   | 260,981 |   | (915 | ) | (258,462 | ) | 26,514 |   |
| Minority  interest in net earnings of subsidiaries                                    |       | —                                                                              |       | — |   | — |   | — |   | (204 | ) | (204 | ) |
| Earnings (loss)  from continuing operations                                           |       | 12,455                                                                              |       | 12,455 |   | 260,981 |   | (915 | ) | (258,666 | ) | 26,310 |   |
| (Loss) earnings  from discontinued operation, net of taxes                            |       | —                                                                              |       | — |   | — |   | (14,317 | ) | 462 |   | (13,855 | ) |
| Net earnings (loss)                                                                   |       | $                                                                                   | 12,455     |   | $ | 12,455 |   | $ | 260,981 |   | $ | (15,232 | ) | $ | (258,204 | ) | $ | 12,455 |   |

 
|                                                                                       | ** ** | **Nine weeks ended October 1, 2005 (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **NMG**                                                                          | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                                | 530,666    |   | $ | 101,556 |   | $ | 12,283 |   | $ | (1,128 | ) | $ | 643,377 |   |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation)     |       | 312,454                                                                          |       | 58,986 |   | 7,644 |   | (842 | ) | 378,242 |   |
| Selling, general  and administrative expenses (excluding depreciation)                |       | 135,278                                                                          |       | 20,491 |   | 4,914 |   | — |   | 160,683 |   |
| Income from  credit card operations                                                   |       | (6,994                                                                           | )          | (824 | ) | — |   | — |   | (7,818 | ) |
| Depreciation  expense                                                                 |       | 16,118                                                                           |       | 3,015 |   | 593 |   | — |   | 19,726 |   |
| Transaction and  other costs                                                          |       | 23,544                                                                           |       | — |   | — |   | — |   | 23,544 |   |
| Operating  earnings                                                                   |       | 50,266                                                                           |       | 19,888 |   | (868 | ) | (286 | ) | 69,000 |   |
| Interest  (income) expense, net                                                       |       | (909                                                                             | )          | — |   | 20 |   | — |   | (889 | ) |
| Intercompany  royalty charges (income)                                                |       | 46,240                                                                           |       | (46,240 | ) | — |   | — |   | — |   |
| Equity in  earnings of subsidiaries                                                   |       | (64,955                                                                          | )          | — |   | — |   | 64,955 |   | — |   |
| Earnings (loss)  from continuing operations before income taxes and minority interest |       | 69,890                                                                           |       | 66,128 |   | (888 | ) | (65,241 | ) | 69,889 |   |
|                                                                                  |       |                                                                             |       |   |   |   |   |   |   |   |   |
| Income taxes                                                                          |       | 25,736                                                                           |       | — |   | — |   | — |   | 25,736 |   |
| Earnings (loss)  from continuing operations before minority interest                  |       | 44,154                                                                           |       | 66,128 |   | (888 | ) | (65,241 | ) | 44,153 |   |
| Minority  interest in net loss of subsidiaries                                        |       | —                                                                           |       | — |   | — |   | 347 |   | 347 |   |
| Earnings (loss)  from continuing operations                                           |       | 44,154                                                                           |       | 66,128 |   | (888 | ) | (64,894 | ) | 44,500 |   |
| (Loss) earnings  from discontinued operation, net of taxes                            |       | —                                                                           |       | — |   | (552 | ) | 206 |   | (346 | ) |
| Net earnings (loss)                                                                   |       | $                                                                                | 44,154     |   | $ | 66,128 |   | $ | (1,440 | ) | $ | (64,688 | ) | $ | 44,154 |   |

 

F-43

----

 
| ** **                                                                            | ** ** | **Fiscal year ended July 30, 2005 (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **NMG**                                                                         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                               | 3,175,675  |   | $ | 518,492 |   | $ | 86,143 |   | $ | (5,512 | ) | $ | 3,774,798 |   |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation)     |       | 2,009,096                                                                       |       | 339,543 |   | 47,312 |   | (5,668 | ) | 2,390,283 |   |
| Selling, general  and administrative expenses (excluding depreciation)                |       | 796,060                                                                         |       | 112,101 |   | 23,458 |   | — |   | 931,619 |   |
| Income from  credit card operations                                                   |       | —                                                                          |       | — |   | (71,644 | ) | — |   | (71,644 | ) |
| Depreciation  expense                                                                 |       | 84,831                                                                          |       | 18,301 |   | 3,214 |   | — |   | 106,346 |   |
| Loss on  disposition of Chef’s Catalog                                           |       | 7,048                                                                           |       | 8,300 |   | — |   | — |   | 15,348 |   |
| Gain on credit  card sale                                                             |       | —                                                                          |       | — |   | (6,170 | ) | — |   | (6,170 | ) |
| Operating  earnings                                                                   |       | 278,640                                                                         |       | 40,247 |   | 89,973 |   | 156 |   | 409,016 |   |
| Interest  expense, net                                                                |       | 7,019                                                                           |       | — |   | 5,283 |   | — |   | 12,302 |   |
| Intercompany  royalty charges (income)                                                |       | 195,572                                                                         |       | (195,572 | ) | — |   | — |   | — |   |
| Equity in  earnings of subsidiaries                                                   |       | (318,382                                                                        | )          | — |   | — |   | 318,382 |   | — |   |
| Earnings (loss)  from continuing operations before income taxes and minority interest |       | 394,431                                                                         |       | 235,819 |   | 84,690 |   | (318,226 | ) | 396,714 |   |
| Income taxes                                                                          |       | 145,607                                                                         |       | — |   | — |   | — |   | 145,607 |   |
| Earnings (loss)  from continuing operations before minority interest                  |       | 248,824                                                                         |       | 235,819 |   | 84,690 |   | (318,226 | ) | 251,107 |   |
| Minority  interest in net earnings of subsidiaries                                    |       | —                                                                          |       | — |   | — |   | (3,107 | ) | (3,107 | ) |
| Earnings (loss)  from continuing operations                                           |       | 248,824                                                                         |       | 235,819 |   | 84,690 |   | (321,333 | ) | 248,000 |   |
| Earnings (loss)  from discontinued operation, net of taxes                            |       | —                                                                          |       | — |   | 1,554 |   | (730 | ) | 824 |   |
| Net earnings (loss)                                                                   |       | $                                                                               | 248,824    |   | $ | 235,819 |   | $ | 86,244 |   | $ | (322,063 | ) | $ | 248,824 |   |

 
| ** **                                                                            | ** ** | **Fiscal year ended July 31, 2004 (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **NMG**                                                                         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                               | 2,969,417  |   | $ | 450,526 |   | $ | 70,422 |   | $ | (6,366 | ) | $ | 3,483,999 |   |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation)     |       | 1,901,967                                                                       |       | 298,795 |   | 36,975 |   | (6,528 | ) | 2,231,209 |   |
| Selling, general  and administrative expenses (excluding depreciation)                |       | 745,773                                                                         |       | 99,079 |   | 18,551 |   | — |   | 863,403 |   |
| Income from  credit card operations                                                   |       | —                                                                          |       | — |   | (55,750 | ) | — |   | (55,750 | ) |
| Depreciation  expense                                                                 |       | 77,659                                                                          |       | 17,137 |   | 3,255 |   | — |   | 98,051 |   |
| Impairment and  other charges                                                         |       | —                                                                          |       | 3,853 |   | — |   | — |   | 3,853 |   |
| Operating  earnings                                                                   |       | 244,018                                                                         |       | 31,662 |   | 67,391 |   | 162 |   | 343,233 |   |
| Interest  expense, net                                                                |       | 13,792                                                                          |       | — |   | 2,111 |   | — |   | 15,903 |   |
| Intercompany  royalty charges (income)                                                |       | 164,994                                                                         |       | (164,994 | ) | — |   | — |   | — |   |
| Equity in  earnings of subsidiaries                                                   |       | (259,791                                                                        | )          | — |   | — |   | 259,791 |   | — |   |
| Earnings (loss)  from continuing operations before income taxes and minority interest |       | 325,023                                                                         |       | 196,656 |   | 65,280 |   | (259,629 | ) | 327,330 |   |
| Income taxes                                                                          |       | 120,191                                                                         |       | — |   | — |   | — |   | 120,191 |   |
| Earnings (loss)  from continuing operations before minority interest                  |       | 204,832                                                                         |       | 196,656 |   | 65,280 |   | (259,629 | ) | 207,139 |   |
| Minority  interest in net earnings of subsidiaries                                    |       | —                                                                          |       | — |   | — |   | (2,957 | ) | (2,957 | ) |
| Earnings (loss)  from continuing operations                                           |       | 204,832                                                                         |       | 196,656 |   | 65,280 |   | (262,586 | ) | 204,182 |   |
| Earnings (loss)  from discontinued operation, net of taxes                            |       | —                                                                          |       | — |   | 1,242 |   | (592 | ) | 650 |   |
| Net earnings (loss)                                                                   |       | $                                                                               | 204,832    |   | $ | 196,656 |   | $ | 66,522 |   | $ | (263,178 | ) | $ | 204,832 |   |

 

F-44

----

 
| ** **                                                                                   | ** ** | **Forty-three weeks ended July 29, 2006 (Successor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **Company**                                                                         | ** ** | **NMG** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS—OPERATING ACTIVITIES**                                                    | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings  (loss)                                                                         |       | $                                                                                   | 12,455     |   | $ | 12,455 |   | $ | 260,981 |   | $ | (15,232 | ) | $ | (258,204 | ) | $ | 12,455 |   |
| Loss (earnings)  from discontinued operation                                                 |       | —                                                                              |       | — |   | — |   | 14,317 |   | (462 | ) | 13,855 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Depreciation                                                                                 |       | —                                                                              |       | 89,545 |   | 17,028 |   | 4,513 |   | — |   | 111,086 |   |
| Amortization of debt issue costs                                                             |       | —                                                                              |       | 11,728 |   | — |   | — |   | — |   | 11,728 |   |
| Amortization of customer lists and favorable lease  commitments                              |       | —                                                                              |       | 49,830 |   | 9,760 |   | 575 |   | — |   | 60,165 |   |
| Non-cash charges related to step-up in  carrying value of inventory                          |       | —                                                                              |       | 32,890 |   | 5,177 |   | — |   | — |   | 38,067 |   |
| Stock-based compensation charges                                                             |       | —                                                                              |       | 3,951 |   | — |   | — |   | — |   | 3,951 |   |
| Deferred income taxes                                                                        |       | —                                                                              |       | (65,939 | ) | — |   | — |   | — |   | (65,939 | ) |
| Minority interest                                                                            |       | —                                                                              |       | — |   | — |   | — |   | 204 |   | 204 |   |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | —                                                                              |       | 14,438 |   | 1,590 |   | (713 | ) | — |   | 15,315 |   |
| Intercompany royalty income payable (receivable)                                             |       | —                                                                              |       | 201,878 |   | (201,878 | ) | — |   | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (12,455                                                                             | )          | (246,686 | ) | — |   | — |   | 259,141 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | —                                                                              |       | 254,617 |   | (81,204 | ) | 16,385 |   | (679 | ) | 189,119 |   |
| Net cash  provided by continuing operating activities                                        |       | —                                                                              |       | 358,707 |   | 11,454 |   | 19,845 |   | — |   | 390,006 |   |
| Net cash used  for discontinued operation                                                    |       | —                                                                              |       | — |   | — |   | (9,241 | ) | — |   | (9,241 | ) |
| Net cash  provided by operating activities                                                   |       | —                                                                              |       | 358,707 |   | 11,454 |   | 10,604 |   | — |   | 380,765 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital  expenditures                                                                        |       | —                                                                              |       | (126,546 | ) | (11,390 | ) | (3,054 | ) | — |   | (140,990 | ) |
| Acquisition of  The Neiman Marcus Group, Inc.                                                |       | —                                                                              |       | (5,156,423 | ) | — |   | — |   | — |   | (5,156,423 | ) |
| Net proceeds  from the Gurwitch Disposition                                                  |       | —                                                                              |       | 40,752 |   | — |   | — |   | — |   | 40,752 |   |
| Intercompany  (receivable) payable                                                           |       | (1,427,739                                                                          | )          | — |   | — |   | — |   | 1,427,739 |   | — |   |
| Net cash used  for continuing investing activities                                           |       | (1,427,739                                                                          | )          | (5,242,217 | ) | (11,390 | ) | (3,054 | ) | 1,427,739 |   | (5,256,661 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                                              |       | — |   | — |   | (3,141 | ) | — |   | (3,141 | ) |
| Net cash used  for investing activities                                                      |       | (1,427,739                                                                          | )          | (5,242,217 | ) | (11,390 | ) | (6,195 | ) | 1,427,739 |   | (5,259,802 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  borrowings                                                                    |       | —                                                                              |       | 3,325,000 |   | — |   | 15,250 |   | — |   | 3,340,250 |   |
| Repayment of  borrowings                                                                     |       | —                                                                              |       | (385,812 | ) | — |   | (17,000 | ) | — |   | (402,812 | ) |
| Debt issuance  costs paid                                                                    |       | —                                                                              |       | (102,854 | ) | — |   | — |   | — |   | (102,854 | ) |
| Cash equity  contributions                                                                   |       | 1,427,739                                                                           |       | 1,427,739 |   | — |   | — |   | (1,427,739 | ) | 1,427,739 |   |
| Net cash  provided by (used for) continuing financing activities                             |       | 1,427,739                                                                           |       | 4,264,073 |   | — |   | (1,750 | ) | (1,427,739 | ) | 4,262,323 |   |
| Net cash used  for discontinued operation                                                    |       | —                                                                              |       | — |   | — |   | (2,418 | ) | — |   | (2,418 | ) |
| Net cash  provided by (used for) financing activities                                        |       | 1,427,739                                                                           |       | 4,264,073 |   | — |   | (4,168 | ) | (1,427,739 | ) | 4,259,905 |   |
| **CASH  AND CASH EQUIVALENTS**                                                               | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| (Decrease)  increase during the period                                                       |       | —                                                                              |       | (619,437 | ) | 64 |   | 241 |   | — |   | (619,132 | ) |
| Beginning  balance                                                                           |       | —                                                                              |       | 841,745 |   | 922 |   | 1,228 |   | — |   | 843,895 |   |
| Ending balance                                                                               |       | $                                                                                   | —     |   | $ | 222,308 |   | $ | 986 |   | $ | 1,469 |   | $ | — |   | $ | 224,763 |   |

 

F-45

----

 
| ** **                                                                                   | ** ** | **Nine weeks ended October 1, 2005 (Predecessor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **NMG**                                                                          | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS—OPERATING ACTIVITIES**                                                    | ** ** | ** **                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings  (loss)                                                                         |       | $                                                                                | 44,154     |   | $ | 66,128 |   | $ | (1,440 | ) | $ | (64,688 | ) | $ | 44,154 |   |
| Loss (earnings)  from discontinued operation                                                 |       | —                                                                           |       | — |   | 552 |   | (206 | ) | 346 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                             |       |   |   |   |   |   |   |   |   |
| Depreciation                                                                                 |       | 16,118                                                                           |       | 3,015 |   | 593 |   | — |   | 19,726 |   |
| Stock-based compensation charges                                                             |       | 19,968                                                                           |       | — |   | — |   | — |   | 19,968 |   |
| Deferred income taxes                                                                        |       | (6,921                                                                           | )          | — |   | — |   | — |   | (6,921 | ) |
| Minority interest                                                                            |       | —                                                                           |       | — |   | — |   | (347 | ) | (347 | ) |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | (345                                                                             | )          | 254 |   | 837 |   | — |   | 746 |   |
| Intercompany royalty income payable (receivable)                                             |       | 46,240                                                                           |       | (46,240 | ) | — |   | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (64,955                                                                          | )          | — |   | — |   | 64,955 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | 499,941                                                                          |       | (20,294 | ) | (537,552 | ) | 286 |   | (57,619 | ) |
| Net cash provided  by (used for) continuing operating activities                             |       | 554,200                                                                          |       | 2,863 |   | (537,010 | ) | — |   | 20,053 |   |
| Net cash used  for discontinued operation                                                    |       | —                                                                           |       | — |   | (618 | ) | — |   | (618 | ) |
| Net cash  provided by (used for) operating activities                                        |       | 554,200                                                                          |       | 2,863 |   | (537,628 | ) | — |   | 19,435 |   |
| **CASH FLOWS—INVESTING  ACTIVITIES**                                                    | ** ** | ** **                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital  expenditures                                                                        |       | (22,455                                                                          | )          | (2,736 | ) | (1,040 | ) | — |   | (26,231 | ) |
| Net cash used  for continuing investing activities                                           |       | (22,455                                                                          | )          | (2,736 | ) | (1,040 | ) | — |   | (26,231 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                                           |       | — |   | (80 | ) | — |   | (80 | ) |
| Net cash used  for investing activities                                                      |       | (22,455                                                                          | )          | (2,736 | ) | (1,120 | ) | — |   | (26,311 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    | ** ** | ** **                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  borrowings on lines of credit                                                 |       | —                                                                           |       | — |   | 4,000 |   | — |   | 4,000 |   |
| Repayment of  borrowings on lines of credit                                                  |       | —                                                                           |       | — |   | — |   | — |   | — |   |
| Cash dividends  paid                                                                         |       | (7,346                                                                           | )          | — |   | — |   | — |   | (7,346 | ) |
| Net cash (used  for) provided by continuing financing activities                             |       | (7,346                                                                           | )          | — |   | 4,000 |   | — |   | (3,346 | ) |
| Net cash  provided by discontinued operation                                                 |       | —                                                                           |       | — |   | 1,000 |   | — |   | 1,000 |   |
| Net cash (used  for) provided by financing activities                                        |       | (7,346                                                                           | )          | — |   | 5,000 |   | — |   | (2,346 | ) |
| **CASH  AND CASH EQUIVALENTS**                                                               | ** ** | ** **                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Increase  (decrease) during the period                                                       |       | 524,399                                                                          |       | 127 |   | (533,748 | ) | — |   | (9,222 | ) |
| Beginning  balance                                                                           |       | 317,346                                                                          |       | 795 |   | 535,341 |   | — |   | 853,482 |   |
| Ending balance                                                                               |       | 841,745                                                                          |       | 922 |   | 1,593 |   | — |   | 844,260 |   |
| Less cash of  discontinued operation                                                         |       | —                                                                           |       | — |   | 365 |   | — |   | 365 |   |
| Ending balance                                                                               |       | $                                                                                | 841,745    |   | $ | 922 |   | $ | 1,228 |   | $ | — |   | $ | 843,895 |   |

 

F-46

----

 
| ** **                                                                                   | ** ** | **Year ended July 30, 2005 (Predecessor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **NMG**                                                             | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS - OPERATING ACTIVITIES**                                                       | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings  (loss)                                                                         |       | $                                                                   | 248,824    |   | $ | 235,819 |   | $ | 86,244 |   | $ | (322,063 | ) | $ | 248,824 |   |
| (Earnings) loss  from discontinued operation                                                 |       | —                                                              |       | — |   | (1,554 | ) | 730 |   | (824 | ) |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                |       |   |   |   |   |   |   |   |   |
| Depreciation                                                                                 |       | 84,831                                                              |       | 18,301 |   | 3,214 |   | — |   | 106,346 |   |
| Deferred income taxes                                                                        |       | (15,336                                                             | )          | — |   | — |   | — |   | (15,336 | ) |
| Loss on disposition of Chef’s catalog                                                   |       | 7,048                                                               |       | 8,300 |   | — |   | — |   | 15,348 |   |
| Gain on Credit Card Sale                                                                     |       | —                                                              |       | — |   | (6,170 | ) | — |   | (6,170 | ) |
| Net cash received from Credit Card Sale                                                      |       | —                                                              |       | — |   | 533,656 |   | — |   | 533,656 |   |
| Minority Interest                                                                            |       | —                                                              |       | — |   | — |   | 3,107 |   | 3,107 |   |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | 41,991                                                              |       | 1,474 |   | (3,496 | ) | — |   | 39,969 |   |
| Intercompany royalty income payable (receivable)                                             |       | 195,572                                                             |       | (195,572 | ) | — |   | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (318,382                                                            | )          | — |   | — |   | 318,382 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | (117,121                                                            | )          | (51,468 | ) | 85,766 |   | (156 | ) | (82,979 | ) |
| Net cash  provided by continuing operating activities                                        |       | 127,427                                                             |       | 16,854 |   | 697,660 |   | — |   | 841,941 |   |
| Net cash  provided by discontinued operation                                                 |       | —                                                              |       | — |   | 3,459 |   | — |   | 3,459 |   |
| Net cash  provided by operating activities                                                   |       | 127,427                                                             |       | 16,854 |   | 701,119 |   | — |   | 845,400 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital  expenditures                                                                        |       | (173,064                                                            | )          | (16,887 | ) | (9,747 | ) | — |   | (199,698 | ) |
| Net increase in  cash restricted for repayment of borrowings under Credit Card Facility      |       | —                                                              |       | — |   | (40,713 | ) | — |   | (40,713 | ) |
| Proceeds from  the sale of Chef’s Catalog                                               |       | 14,419                                                              |       | — |   | — |   | — |   | 14,419 |   |
| Net cash used  for continuing investing activities                                           |       | (158,645                                                            | )          | (16,887 | ) | (50,460 | ) | — |   | (225,992 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                              |       | — |   | (2,837 | ) | — |   | (2,837 | ) |
| Net cash used  for investing activities                                                      |       | (158,645                                                            | )          | (16,887 | ) | (53,297 | ) | — |   | (228,829 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  borrowings on lines of credit                                                 |       | —                                                              |       | — |   | 5,500 |   | — |   | 5,500 |   |
| Repayment of  borrowings on lines of credit                                                  |       | (113                                                                | )          | — |   | (5,500 | ) | — |   | (5,613 | ) |
| Repayment of  borrowings under Credit Card Facility                                          |       | —                                                              |       | — |   | (112,500 | ) | — |   | (112,500 | ) |
| Acquisitions of  treasury stock                                                              |       | (3,088                                                              | )          | — |   | — |   | — |   | (3,088 | ) |
| Proceeds from  stock-based compensation awards                                               |       | 16,100                                                              |       | — |   | — |   | — |   | 16,100 |   |
| Cash dividends  paid                                                                         |       | (27,398                                                             | )          | — |   | — |   | — |   | (27,398 | ) |
| Distributions  paid                                                                          |       | —                                                              |       | — |   | (3,898 | ) | — |   | (3,898 | ) |
| Net cash used  for continuing financing activities                                           |       | (14,499                                                             | )          | — |   | (116,398 | ) | — |   | (130,897 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                              |       | — |   | (559 | ) | — |   | (559 | ) |
| Net cash used  for financing activities                                                      |       | (14,499                                                             | )          | — |   | (116,957 | ) | — |   | (131,456 | ) |
| **CASH  AND CASH EQUIVALENTS**                                                               | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| (Decrease)  increase during the period                                                       |       | (45,717                                                             | )          | (33 | ) | 530,865 |   | — |   | 485,115 |   |
| Beginning  balance                                                                           |       | 363,063                                                             |       | 828 |   | 4,476 |   | — |   | 368,367 |   |
| Ending balance                                                                               |       | 317,346                                                             |       | 795 |   | 535,341 |   | — |   | 853,482 |   |
| Less cash of  discontinued operation                                                         |       | —                                                              |       | — |   | 63 |   | — |   | 63 |   |
| Ending balance                                                                               |       | $                                                                   | 317,346    |   | $ | 795 |   | $ | 535,278 |   | $ | — |   | $ | 853,419 |   |

 

F-47

----

 
| ** **                                                                                   | ** ** | **Year ended July 31, 2004 (Predecessor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **NMG**                                                             | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS - OPERATING ACTIVITIES**                                                       | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings  (loss)                                                                         |       | $                                                                   | 204,832    |   | $ | 196,656 |   | $ | 66,522 |   | $ | (263,178 | ) | $ | 204,832 |   |
| (Earnings) loss  from discontinued operation                                                 |       | —                                                              |       | — |   | (1,242 | ) | 592 |   | (650 | ) |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                |       |   |   |   |   |   |   |   |   |
| Depreciation                                                                                 |       | 77,659                                                              |       | 17,137 |   | 3,255 |   | — |   | 98,051 |   |
| Deferred income taxes                                                                        |       | 22,969                                                              |       | — |   | — |   | — |   | 22,969 |   |
| Impairment of intangible assets and other charges                                            |       | —                                                              |       | 3,853 |   | — |   | — |   | 3,853 |   |
| Minority Interest                                                                            |       | —                                                              |       | — |   | — |   | 2,957 |   | 2,957 |   |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | 34,562                                                              |       | 2,693 |   | (3,375 | ) | — |   | 33,880 |   |
| Intercompany royalty income payable (receivable)                                             |       | 164,994                                                             |       | (164,994 | ) | — |   | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (259,791                                                            | )          | — |   | — |   | 259,791 |   | — |   |
| Changes in operating  assets and liabilities, net                                            |       | 3,564                                                               |       | (35,387 | ) | (282,044 | ) | (162 | ) | (314,029 | ) |
| Net cash  provided by (used for) continuing operating activities                             |       | 248,789                                                             |       | 19,958 |   | (216,884 | ) | — |   | 51,863 |   |
| Net cash  provided by discontinued operation                                                 |       | —                                                              |       | — |   | 709 |   | — |   | 709 |   |
| Net cash  provided by (used for) operating activities                                        |       | 248,789                                                             |       | 19,958 |   | (216,175 | ) | — |   | 52,572 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital  expenditures                                                                        |       | (94,591                                                             | )          | (19,747 | ) | (4,731 | ) | — |   | (119,069 | ) |
| Proceeds from  sale of other assets                                                          |       | 3,183                                                               |       | — |   | — |   | — |   | 3,183 |   |
| Net cash used  for continuing investing activities                                           |       | (91,408                                                             | )          | (19,747 | ) | (4,731 | ) | — |   | (115,886 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                              |       | — |   | (1,404 | ) | — |   | (1,404 | ) |
| Net cash used  for investing activities                                                      |       | (91,408                                                             | )          | (19,747 | ) | (6,135 | ) | — |   | (117,290 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Repayment of  borrowings under Credit Card Facility                                          |       | —                                                              |       | — |   | 225,000 |   | — |   | 225,000 |   |
| Acquisitions of  treasury stock                                                              |       | (7,553                                                              | )          | — |   | — |   | — |   | (7,553 | ) |
| Proceeds from  stock-based compensation awards                                               |       | 23,797                                                              |       | — |   | — |   | — |   | 23,797 |   |
| Cash dividends  paid                                                                         |       | (12,632                                                             | )          | — |   | — |   | — |   | (12,632 | ) |
| Distributions  paid                                                                          |       | —                                                              |       | — |   | (3,172 | ) | — |   | (3,172 | ) |
| Net cash  provided by continuing financing activities                                        |       | 3,612                                                               |       | — |   | 221,828 |   | — |   | 225,440 |   |
| Net cash  provided by discontinued operation                                                 |       | —                                                              |       | — |   | 695 |   | — |   | 695 |   |
| Net cash  provided by financing activities                                                   |       | 3,612                                                               |       | — |   | 222,523 |   | — |   | 226,135 |   |
| **CASH  AND CASH EQUIVALENTS**                                                               | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Increase during  the period                                                                  |       | 160,993                                                             |       | 211 |   | 213 |   | — |   | 161,417 |   |
| Beginning  balance                                                                           |       | 202,070                                                             |       | 617 |   | 4,263 |   | — |   | 206,950 |   |
| Ending balance                                                                               |       | $                                                                   | 363,063    |   | $ | 828 |   | $ | 4,476 |   | $ | — |   | $ | 368,367 |   |

 

F-48

----

**NOTE 18. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (with respect to****NMG’s obligations under the 2028Debentures)**

All of NMG’s obligations under the 2028 Debentures areguaranteed by the Company. Non-guarantor subsidiaries consist principally ofBergdorf Goodman, Inc. through which NMG conducts the operations of itsBergdorf Goodman stores, NM Nevada Trust which holds legal title to certainreal property and intangible assets used by NMG in conducting its operations,Kate Spade LLC and Neiman Marcus Funding Corporation through which NMGpreviously conducted its credit card operations prior to the Credit Card Sale.The guarantee by the Company is full and unconditional and joint and several.

The following condensed consolidating financialinformation represents the financial information of Neiman Marcus, Inc.and its non-guarantor subsidiaries, prepared on the equity basis of accounting.The information is presented in accordance with the requirements ofRule 3-10 under the Securities and Exchange Commission’sRegulation S-X. The financial information may not necessarily beindicative of results of operations, cash flows or financial position had thenon-guarantor subsidiaries operated as independent entities.
| ** **                                                     | ** ** | **July 29, 2006 (Successor)** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------|------------|
| **(in thousands)**                                        | ** ** | **Company**                                  | ** ** | **NMG** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **ASSETS**                                                     | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                |       |                                         |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                      |       | $                                            | —     |   | $ | 222,308 |   | $ | 2,455 |   | $ | — |   | $ | 224,763 |   |
| Accounts receivable, net of allowance                          |       | —                                       |       | 22,189 |   | 11,222 |   | 613 |   | 34,024 |   |
| Merchandise inventories                                        |       | —                                       |       | 711,443 |   | 95,295 |   | (2,527 | ) | 804,211 |   |
| Other current assets                                           |       | —                                       |       | 67,170 |   | 5,688 |   | — |   | 72,858 |   |
| Total current assets                                           |       | —                                       |       | 1,023,110 |   | 114,660 |   | (1,914 | ) | 1,135,856 |   |
| Property and  equipment, net                                   |       | —                                       |       | 875,725 |   | 168,089 |   | — |   | 1,043,814 |   |
| Goodwill and  intangibles, net                                 |       | —                                       |       | 1,980,770 |   | 2,321,424 |   | — |   | 4,302,194 |   |
| Other assets                                                   |       | —                                       |       | 124,929 |   | 1,168 |   | — |   | 126,097 |   |
| Investments in  subsidiaries                                   |       | 1,427,667                                    |       | 2,469,428 |   | — |   | (3,897,095 | ) | — |   |
|                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Total assets                                                   |       | $                                            | 1,427,667  |   | $ | 6,473,962 |   | $ | 2,605,341 |   | $ | (3,899,009 | ) | $ | 6,607,961 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                 | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current  liabilities:                                          |       |                                         |       |   |   |   |   |   |   |   |   |
| Accounts payable                                               |       | $                                            | —     |   | $ | 263,800 |   | $ | 45,169 |   | $ | 613 |   | $ | 309,582 |   |
| Accrued liabilities                                            |       | —                                       |       | 312,623 |   | 70,366 |   | 350 |   | 383,339 |   |
| Notes payable and current maturities of long-term  liabilities |       | —                                       |       | 3,887 |   | 2,250 |   | — |   | 6,137 |   |
| Total current liabilities                                      |       | —                                       |       | 580,310 |   | 117,785 |   | 963 |   | 699,058 |   |
| Long-term  liabilities:                                        |       |                                         |       |   |   |   |   |   |   |   |   |
| Long-term debt                                                 |       | —                                       |       | 3,195,711 |   | — |   | — |   | 3,195,711 |   |
| Deferred income taxes                                          |       | —                                       |       | 1,059,365 |   | — |   | — |   | 1,059,365 |   |
| Other long-term liabilities                                    |       | —                                       |       | 210,909 |   | 8,937 |   | — |   | 219,846 |   |
| Total long-term liabilities                                    |       | —                                       |       | 4,465,985 |   | 8,937 |   | — |   | 4,474,922 |   |
| Minority  interest                                             |       | —                                       |       | — |   | — |   | 6,314 |   | 6,314 |   |
| Total  shareholders’ equity                               |       | 1,427,667                                    |       | 1,427,667 |   | 2,478,619 |   | (3,906,286 | ) | 1,427,667 |   |
|                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Total liabilities and  shareholders’ equity               |       | $                                            | 1,427,667  |   | $ | 6,473,962 |   | $ | 2,605,341 |   | $ | (3,899,009 | ) | $ | 6,607,961 |   |

 

F-49

----

 
| ** **                                                     | ** ** | **July 30, 2005 (Predecessor)** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------|------------|
| **(in thousands)**                                        | ** ** | **NMG**                                        | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **ASSETS**                                                     | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                |       |                                           |       |   |   |   |   |   |   |
| Cash and cash equivalents                                      |       | $                                              | 317,346    |   | $ | 536,073 |   | $ | — |   | $ | 853,419 |   |
| Accounts receivable, net of allowance                          |       | 7,910                                          |       | 11,150 |   | 338 |   | 19,398 |   |
| Merchandise inventories                                        |       | 650,918                                        |       | 92,813 |   | (840 | ) | 742,891 |   |
| Other current assets                                           |       | 67,720                                         |       | 7,257 |   | — |   | 74,977 |   |
| Current assets of discontinued operation                       |       | —                                         |       | 17,796 |   | — |   | 17,796 |   |
| Total current assets                                           |       | 1,043,894                                      |       | 665,089 |   | (502 | ) | 1,708,481 |   |
| Property and  equipment, net                                   |       | 697,514                                        |       | 153,902 |   | — |   | 851,416 |   |
| Goodwill and  intangibles, net                                 |       | 14,875                                         |       | 52,177 |   | — |   | 67,052 |   |
| Other assets                                                   |       | 24,035                                         |       | 1,566 |   | — |   | 25,601 |   |
| Investments in  subsidiaries                                   |       | 706,979                                        |       | — |   | (706,979 | ) | — |   |
| Non-current  assets of discontinued operation                  |       | —                                         |       | 8,110 |   | — |   | 8,110 |   |
| Total assets                                                   |       | $                                              | 2,487,297  |   | $ | 880,844 |   | $ | (707,481 | ) | $ | 2,660,660 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                 | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current  liabilities:                                          |       |                                           |       |   |   |   |   |   |   |
| Accounts payable                                               |       | $                                              | 233,116    |   | $ | 46,978 |   | $ | 338 |   | $ | 280,432 |   |
| Accrued liabilities                                            |       | 244,798                                        |       | 79,848 |   | 1,999 |   | 326,645 |   |
| Notes payable and current maturities of long-term  liabilities |       | 200                                            |       | — |   | — |   | 200 |   |
| Current liabilities of discontinued operation                  |       | —                                         |       | 9,997 |   | — |   | 9,997 |   |
| Total current liabilities                                      |       | 478,114                                        |       | 136,823 |   | 2,337 |   | 617,274 |   |
| Long-term  liabilities:                                        |       |                                           |       |   |   |   |   |   |   |
| Long-term debt                                                 |       | 249,780                                        |       | — |   | — |   | 249,780 |   |
| Other long-term liabilities                                    |       | 185,457                                        |       | 21,559 |   | — |   | 207,016 |   |
| Non-current liabilities of discontinued operation              |       | —                                         |       | 532 |   | — |   | 532 |   |
| Total long-term liabilities                                    |       | 435,237                                        |       | 22,091 |   | — |   | 457,328 |   |
| Minority  interest                                             |       | —                                         |       | — |   | 12,112 |   | 12,112 |   |
| Total  shareholders’ equity                               |       | 1,573,946                                      |       | 721,930 |   | (721,930 | ) | 1,573,946 |   |
| Total liabilities and  shareholders’ equity               |       | $                                              | 2,487,297  |   | $ | 880,844 |   | $ | (707,481 | ) | $ | 2,660,660 |   |

 

F-50

----

 
| ** **                                                                            | ** ** | **Forty-three weeks ended July 29, 2006 (Successor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **Company**                                                                         | ** ** | **NMG** | ** ** | **Non-  Guarantors  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                                   | —     |   | $ | 2,885,321 |   | $ | 578,741 |   | $ | (1,843 | ) | $ | 3,462,219 |   |
| Cost of goods sold  including buying and occupancy costs (excluding depreciation)     |       | —                                                                              |       | 1,885,917 |   | 375,742 |   | (2,522 | ) | 2,259,137 |   |
| Selling, general and  administrative expenses (excluding depreciation)                |       | —                                                                              |       | 704,846 |   | 117,258 |   | — |   | 822,104 |   |
| Income from credit card  operations                                                   |       | —                                                                              |       | (44,765 | ) | (4,588 | ) | — |   | (49,353 | ) |
| Depreciation expense                                                                  |       | —                                                                              |       | 89,545 |   | 21,541 |   | — |   | 111,086 |   |
| Amortization of  customer lists and favorable lease commitments                       |       | —                                                                              |       | 49,830 |   | 10,335 |   | — |   | 60,165 |   |
| Operating earnings                                                                    |       | —                                                                              |       | 199,948 |   | 58,453 |   | 679 |   | 259,080 |   |
| Interest expense, net                                                                 |       | —                                                                              |       | 217,664 |   | 266 |   | — |   | 217,930 |   |
| Intercompany royalty  charges (income)                                                |       | —                                                                              |       | 201,879 |   | (201,879 | ) | — |   | — |   |
| Equity in earnings of  subsidiaries                                                   |       | (12,455                                                                             | )          | (246,686 | ) | — |   | 259,141 |   | — |   |
| Earnings (loss) from  continuing operations before income taxes and minority interest |       | 12,455                                                                              |       | 27,091 |   | 260,066 |   | (258,462 | ) | 41,150 |   |
| Income taxes                                                                          |       | —                                                                              |       | 14,636 |   | — |   | — |   | 14,636 |   |
| Earnings (loss) from  continuing operations before minority interest                  |       | 12,455                                                                              |       | 12,455 |   | 260,066 |   | (258,462 | ) | 26,514 |   |
| Minority interest in  net earnings of subsidiaries                                    |       | —                                                                              |       | — |   | — |   | (204 | ) | (204 | ) |
| Earnings (loss) from  continuing operations                                           |       | 12,455                                                                              |       | 12,455 |   | 260,066 |   | (258,666 | ) | 26,310 |   |
| (Loss) earnings from  discontinued operation, net of taxes                            |       | —                                                                              |       | — |   | (14,317 | ) | 462 |   | (13,855 | ) |
| Net earnings (loss)                                                                   |       | $                                                                                   | 12,455     |   | $ | 12,455 |   | $ | 245,749 |   | $ | (258,204 | ) | $ | 12,455 |   |

 
| ** **                                                                            | ** ** | **Nine weeks ended October 1, 2005 (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **NMG**                                                                          | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                                | 530,666    |   | $ | 113,839 |   | $ | (1,128 | ) | $ | 643,377 |   |
| Cost of goods sold  including buying and occupancy costs (excluding depreciation)     |       | 312,454                                                                          |       | 66,630 |   | (842 | ) | 378,242 |   |
| Selling, general and  administrative expenses (excluding depreciation)                |       | 135,278                                                                          |       | 25,405 |   | — |   | 160,683 |   |
| Income from credit card  operations                                                   |       | (6,994                                                                           | )          | (824 | ) | — |   | (7,818 | ) |
| Depreciation expense                                                                  |       | 16,118                                                                           |       | 3,608 |   | — |   | 19,726 |   |
| Transaction and other  costs                                                          |       | 23,544                                                                           |       | — |   | — |   | 23,544 |   |
| Operating earnings                                                                    |       | 50,266                                                                           |       | 19,020 |   | (286 | ) | 69,000 |   |
| Interest (income)  expense, net                                                       |       | (909                                                                             | )          | 20 |   | — |   | (889 | ) |
| Intercompany royalty  charges (income)                                                |       | 46,240                                                                           |       | (46,240 | ) | — |   | — |   |
| Equity in earnings of  subsidiaries                                                   |       | (64,955                                                                          | )          | — |   | 64,955 |   | — |   |
| Earnings (loss) from  continuing operations before income taxes and minority interest |       | 69,890                                                                           |       | 65,240 |   | (65,241 | ) | 69,889 |   |
| Income taxes                                                                          |       | 25,736                                                                           |       | — |   | — |   | 25,736 |   |
| Earnings (loss) from  continuing operations before minority interest                  |       | 44,154                                                                           |       | 65,240 |   | (65,241 | ) | 44,153 |   |
| Minority interest in  net loss of subsidiaries                                        |       | —                                                                           |       | — |   | 347 |   | 347 |   |
| Earnings (loss) from  continuing operations                                           |       | 44,154                                                                           |       | 65,240 |   | (64,894 | ) | 44,500 |   |
| (Loss) earnings from  discontinued operation, net of taxes                            |       | —                                                                           |       | (552 | ) | 206 |   | (346 | ) |
| Net earnings (loss)                                                                   |       | $                                                                                | 44,154     |   | $ | 64,688 |   | $ | (64,688 | ) | $ | 44,154 |   |

 

F-51

----

 
| ** **                                                                            | ** ** | **Year ended July 30, 2005 (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **NMG**                                                             | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                   | 3,175,675  |   | $ | 604,635 |   | $ | (5,512 | ) | $ | 3,774,798 |   |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation)     |       | 2,009,096                                                           |       | 386,855 |   | (5,668 | ) | 2,390,283 |   |
| Selling, general  and administrative expenses (excluding depreciation)                |       | 796,060                                                             |       | 135,559 |   | — |   | 931,619 |   |
| Income from  credit card operations                                                   |       | —                                                              |       | (71,644 | ) | — |   | (71,644 | ) |
| Depreciation  expense                                                                 |       | 84,831                                                              |       | 21,515 |   | — |   | 106,346 |   |
| Loss on  disposition of Chef’s catalog                                           |       | 7,048                                                               |       | 8,300 |   | — |   | 15,348 |   |
| Gain on Credit  Card Sale                                                             |       | —                                                              |       | (6,170 | ) | — |   | (6,170 | ) |
| Operating  earnings                                                                   |       | 278,640                                                             |       | 130,220 |   | 156 |   | 409,016 |   |
| Interest expense,  net                                                                |       | 7,019                                                               |       | 5,283 |   | — |   | 12,302 |   |
| Intercompany  royalty charges (income)                                                |       | 195,572                                                             |       | (195,572 | ) | — |   | — |   |
| Equity in  earnings of subsidiaries                                                   |       | (318,382                                                            | )          | — |   | 318,382 |   | — |   |
| Earnings (loss)  from continuing operations before income taxes and minority interest |       | 394,431                                                             |       | 320,509 |   | (318,226 | ) | 396,714 |   |
| Income taxes                                                                          |       | 145,607                                                             |       | — |   | — |   | 145,607 |   |
| Earnings (loss)  from continuing operations before minority interest                  |       | 248,824                                                             |       | 320,509 |   | (318,226 | ) | 251,107 |   |
| Minority  interest in net earnings of subsidiaries                                    |       | —                                                              |       | — |   | (3,107 | ) | (3,107 | ) |
| Earnings (loss)  from continuing operations                                           |       | 248,824                                                             |       | 320,509 |   | (321,333 | ) | 248,000 |   |
| Earnings (loss)  from discontinued operation, net of taxes                            |       | —                                                              |       | 1,554 |   | (730 | ) | 824 |   |
| Net earnings (loss)                                                                   |       | $                                                                   | 248,824    |   | $ | 322,063 |   | $ | (322,063 | ) | $ | 248,824 |   |

 
| ** **                                                                            | ** ** | **Year ended July 31, 2004 (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **NMG**                                                             | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                                                              |       | $                                                                   | 2,969,417  |   | $ | 520,948 |   | $ | (6,366 | ) | $ | 3,483,999 |   |
| Cost of goods  sold including buying and occupancy costs (excluding depreciation)     |       | 1,901,967                                                           |       | 335,770 |   | (6,528 | ) | 2,231,209 |   |
| Selling, general  and administrative expenses (excluding depreciation)                |       | 745,773                                                             |       | 117,630 |   | — |   | 863,403 |   |
| Income from  credit card operations                                                   |       | —                                                              |       | (55,750 | ) | — |   | (55,750 | ) |
| Depreciation  expense                                                                 |       | 77,659                                                              |       | 20,392 |   | — |   | 98,051 |   |
| Impairment and other  charges                                                         |       | —                                                              |       | 3,853 |   | — |   | 3,853 |   |
| Operating  earnings                                                                   |       | 244,018                                                             |       | 99,053 |   | 162 |   | 343,233 |   |
| Interest  expense, net                                                                |       | 13,792                                                              |       | 2,111 |   | — |   | 15,903 |   |
| Intercompany  royalty charges (income)                                                |       | 164,994                                                             |       | (164,994 | ) | — |   | — |   |
| Equity in  earnings of subsidiaries                                                   |       | (259,791                                                            | )          | — |   | 259,791 |   | — |   |
| Earnings (loss)  from continuing operations before income taxes and minority interest |       | 325,023                                                             |       | 261,936 |   | (259,629 | ) | 327,330 |   |
| Income taxes                                                                          |       | 120,191                                                             |       | — |   | — |   | 120,191 |   |
| Earnings (loss)  from continuing operations before minority interest                  |       | 204,832                                                             |       | 261,936 |   | (259,629 | ) | 207,139 |   |
| Minority  interest in net earnings of subsidiaries                                    |       | —                                                              |       | — |   | (2,957 | ) | (2,957 | ) |
| Earnings (loss)  from continuing operations                                           |       | 204,832                                                             |       | 261,936 |   | (262,586 | ) | 204,182 |   |
| Earnings (loss)  from discontinued operation, net of taxes                            |       | —                                                              |       | 1,242 |   | (592 | ) | 650 |   |
| Net earnings (loss)                                                                   |       | $                                                                   | 204,832    |   | $ | 263,178 |   | $ | (263,178 | ) | $ | 204,832 |   |

 

F-52

----

 
| ** **                                                                                   | ** ** | **Forty-three weeks ended July 29, 2006 (Successor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **Company**                                                                         | ** ** | **NMG** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS—OPERATING ACTIVITIES**                                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Net earnings  (loss)                                                                         |       | $                                                                                   | 12,455     |   | $ | 12,455 |   | $ | 245,749 |   | $ | (258,204 | ) | $ | 12,455 |   |
| Loss (earnings)  from discontinued operation                                                 |       | —                                                                              |       | — |   | 14,317 |   | (462 | ) | 13,855 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Depreciation                                                                                 |       | —                                                                              |       | 89,545 |   | 21,541 |   | — |   | 111,086 |   |
| Amortization of debt issue costs                                                             |       | —                                                                              |       | 11,728 |   | — |   | — |   | 11,728 |   |
| Amortization of customer lists and favorable lease  commitments                              |       | —                                                                              |       | 49,830 |   | 10,335 |   | — |   | 60,165 |   |
| Non-cash charges related to step-up in  carrying value of inventory                          |       | —                                                                              |       | 32,890 |   | 5,177 |   | — |   | 38,067 |   |
| Stock-based compensation charges                                                             |       | —                                                                              |       | 3,951 |   | — |   | — |   | 3,951 |   |
| Deferred income taxes                                                                        |       | —                                                                              |       | (65,939 | ) | — |   | — |   | (65,939 | ) |
| Minority interest                                                                            |       | —                                                                              |       | — |   | — |   | 204 |   | 204 |   |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | —                                                                              |       | 14,438 |   | 877 |   | — |   | 15,315 |   |
| Intercompany royalty income payable (receivable)                                             |       | —                                                                              |       | 201,878 |   | (201,878 | ) | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (12,455                                                                             | )          | (246,686 | ) | — |   | 259,141 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | —                                                                              |       | 254,617 |   | (64,819 | ) | (679 | ) | 189,119 |   |
| Net cash  provided by continuing operating activities                                        |       | —                                                                              |       | 358,707 |   | 31,299 |   | — |   | 390,006 |   |
| Net cash used  for discontinued operation                                                    |       | —                                                                              |       | — |   | (9,241 | ) | — |   | (9,241 | ) |
| Net cash  provided by operating activities                                                   |       | —                                                                              |       | 358,707 |   | 22,058 |   | — |   | 380,765 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                                        |       | —                                                                              |       | (126,546 | ) | (14,444 | ) | — |   | (140,990 | ) |
| Acquisition of  The Neiman Marcus Group, Inc.                                                |       | —                                                                              |       | (5,156,423 | ) | — |   | — |   | (5,156,423 | ) |
| Net proceeds  from the Gurwitch Disposition                                                  |       | —                                                                              |       | 40,752 |   | — |   | — |   | 40,752 |   |
| Intercompany  (receivable) payable                                                           |       | (1,427,739                                                                          | )          | — |   | — |   | 1,427,739 |   | — |   |
| Net cash (used  for) provided by continuing investing activities                             |       | (1,427,739                                                                          | )          | (5,242,217 | ) | (14,444 | ) | 1,427,739 |   | (5,256,661 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                                              |       | — |   | (3,141 | ) | — |   | (3,141 | ) |
| Net cash (used  for) provided by investing activities                                        |       | (1,427,739                                                                          | )          | (5,242,217 | ) | (17,585 | ) | 1,427,739 |   | (5,259,802 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Proceeds from  borrowings                                                                    |       | —                                                                              |       | 3,325,000 |   | 15,250 |   | — |   | 3,340,250 |   |
| Repayment of  borrowings                                                                     |       | —                                                                              |       | (385,812 | ) | (17,000 | ) | — |   | (402,812 | ) |
| Debt issuance  costs paid                                                                    |       | —                                                                              |       | (102,854 | ) | — |   | — |   | (102,854 | ) |
| Cash equity  contributions                                                                   |       | 1,427,739                                                                           |       | 1,427,739 |   | — |   | (1,427,739 | ) | 1,427,739 |   |
| Net cash  provided by (used for) continuing financing activities                             |       | 1,427,739                                                                           |       | 4,264,073 |   | (1,750 | ) | (1,427,739 | ) | 4,262,323 |   |
| Net cash used  for discontinued operation                                                    |       | —                                                                              |       | — |   | (2,418 | ) | — |   | (2,418 | ) |
| Net cash  provided by (used for) financing activities                                        |       | 1,427,739                                                                           |       | 4,264,073 |   | (4,168 | ) | (1,427,739 | ) | 4,259,905 |   |
| **CASH  AND CASH EQUIVALENTS**                                                               |       |                                                                                |       |   |   |   |   |   |   |   |   |
| (Decrease)  increase during the period                                                       |       | —                                                                              |       | (619,437 | ) | 305 |   | — |   | (619,132 | ) |
| Beginning  balance                                                                           |       | —                                                                              |       | 841,745 |   | 2,150 |   | — |   | 843,895 |   |
| Ending balance                                                                               |       | $                                                                                   | —     |   | $ | 222,308 |   | $ | 2,455 |   | $ | — |   | $ | 224,763 |   |

 

F-53

----

 
| ** **                                                                                   | ** ** | **Nine weeks ended October 1, 2005 (Predecessor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **NMG**                                                                          | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS—OPERATING ACTIVITIES**                                                    |       |                                                                             |       |   |   |   |   |   |   |
| Net earnings  (loss)                                                                         |       | $                                                                                | 44,154     |   | $ | 64,688 |   | $ | (64,688 | ) | $ | 44,154 |   |
| Loss (earnings)  from discontinued operation                                                 |       | —                                                                           |       | 552 |   | (206 | ) | 346 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                             |       |   |   |   |   |   |   |
| Depreciation                                                                                 |       | 16,118                                                                           |       | 3,608 |   | — |   | 19,726 |   |
| Stock-based compensation charges                                                             |       | 19,968                                                                           |       | — |   | — |   | 19,968 |   |
| Deferred income taxes                                                                        |       | (6,921                                                                           | )          | — |   | — |   | (6,921 | ) |
| Minority interest                                                                            |       | —                                                                           |       | — |   | (347 | ) | (347 | ) |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | (345                                                                             | )          | 1,091 |   | — |   | 746 |   |
| Intercompany royalty income payable (receivable)                                             |       | 46,240                                                                           |       | (46,240 | ) | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (64,955                                                                          | )          | — |   | 64,955 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | 499,941                                                                          |       | (557,846 | ) | 286 |   | (57,619 | ) |
| Net cash  provided by (used for) continuing operating activities                             |       | 554,200                                                                          |       | (534,147 | ) | — |   | 20,053 |   |
| Net cash used  for discontinued operation                                                    |       | —                                                                           |       | (618 | ) | — |   | (618 | ) |
| Net cash  provided by (used for) operating activities                                        |       | 554,200                                                                          |       | (534,765 | ) | — |   | 19,435 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    |       |                                                                             |       |   |   |   |   |   |   |
| Capital expenditures                                                                         |       | (22,455                                                                          | )          | (3,776 | ) | — |   | (26,231 | ) |
| Net cash used  for continuing investing activities                                           |       | (22,455                                                                          | )          | (3,776 | ) | — |   | (26,231 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                                           |       | (80 | ) | — |   | (80 | ) |
| Net cash used  for investing activities                                                      |       | (22,455                                                                          | )          | (3,856 | ) | — |   | (26,311 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    |       |                                                                             |       |   |   |   |   |   |   |
| Proceeds from  borrowings on lines of credit                                                 |       | —                                                                           |       | 4,000 |   | — |   | 4,000 |   |
| Cash dividends  paid                                                                         |       | (7,346                                                                           | )          | — |   | — |   | (7,346 | ) |
| Net cash (used  for) provided by continuing financing activities                             |       | (7,346                                                                           | )          | 4,000 |   | — |   | (3,346 | ) |
| Net cash  provided by discontinued operation                                                 |       | —                                                                           |       | 1,000 |   | — |   | 1,000 |   |
| Net cash (used  for) provided by financing activities                                        |       | (7,346                                                                           | )          | 5,000 |   | — |   | (2,346 | ) |
| **CASH  AND CASH EQUIVALENTS**                                                               |       |                                                                             |       |   |   |   |   |   |   |
| Increase  (decrease) during the period                                                       |       | 524,399                                                                          |       | (533,621 | ) | — |   | (9,222 | ) |
| Beginning  balance                                                                           |       | 317,346                                                                          |       | 536,136 |   | — |   | 853,482 |   |
| Ending balance                                                                               |       | 841,745                                                                          |       | 2,515 |   | — |   | 844,260 |   |
| Less cash of  discontinued operation                                                         |       | —                                                                           |       | 365 |   | — |   | 365 |   |
| Ending balance                                                                               |       | $                                                                                | 841,745    |   | $ | 2,150 |   | $ | — |   | $ | 843,895 |   |

 

F-54

----

 
| ** **                                                                                   | ** ** | **Year ended July 30, 2005 (Predecessor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **NMG**                                                             | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS—OPERATING ACTIVITIES**                                                    |       |                                                                |       |   |   |   |   |   |   |
| Net earnings  (loss)                                                                         |       | $                                                                   | 248,824    |   | $ | 322,063 |   | $ | (322,063 | ) | $ | 248,824 |   |
| (Earnings) loss  from discontinued operation                                                 |       | —                                                              |       | (1,554 | ) | 730 |   | (824 | ) |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                |       |   |   |   |   |   |   |
| Depreciation                                                                                 |       | 84,831                                                              |       | 21,515 |   | — |   | 106,346 |   |
| Loss on disposition of Chef’s catalog                                                   |       | 7,048                                                               |       | 8,300 |   | — |   | 15,348 |   |
| Deferred income taxes                                                                        |       | (15,336                                                             | )          | — |   | — |   | (15,336 | ) |
| Gain on Credit Card Sale                                                                     |       | —                                                              |       | (6,170 | ) | — |   | (6,170 | ) |
| Net cash received from Credit Card Sale                                                      |       | —                                                              |       | 533,656 |   | — |   | 533,656 |   |
| Minority Interest                                                                            |       | —                                                              |       | — |   | 3,107 |   | 3,107 |   |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | 41,991                                                              |       | (2,022 | ) | — |   | 39,969 |   |
| Intercompany royalty income payable (receivable)                                             |       | 195,572                                                             |       | (195,572 | ) | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (318,382                                                            | )          | — |   | 318,382 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | (117,121                                                            | )          | 34,298 |   | (156 | ) | (82,979 | ) |
| Net cash  provided by continuing operating activities                                        |       | 127,427                                                             |       | 714,514 |   | — |   | 841,941 |   |
| Net cash  provided by discontinued operation                                                 |       | —                                                              |       | 3,459 |   | — |   | 3,459 |   |
| Net cash  provided by operating activities                                                   |       | 127,427                                                             |       | 717,973 |   | — |   | 845,400 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    |       |                                                                |       |   |   |   |   |   |   |
| Capital  expenditures                                                                        |       | (173,064                                                            | )          | (26,634 | ) | — |   | (199,698 | ) |
| Net increase in  cash restricted for repayment of borrowings under Credit Card Facility      |       | —                                                              |       | (40,713 | ) | — |   | (40,713 | ) |
| Proceeds from  the sale of Chef’s Catalog                                               |       | 14,419                                                              |       | — |   | — |   | 14,419 |   |
| Net cash used  for continuing investing activities                                           |       | (158,645                                                            | )          | (67,347 | ) | — |   | (225,992 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                              |       | (2,837 | ) | — |   | (2,837 | ) |
| Net cash used  for investing activities                                                      |       | (158,645                                                            | )          | (70,184 | ) | — |   | (228,829 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    |       |                                                                |       |   |   |   |   |   |   |
| Proceeds from  borrowings on lines of credit                                                 |       | —                                                              |       | 5,500 |   | — |   | 5,500 |   |
| Repayment of  borrowings on lines of credit                                                  |       | (113                                                                | )          | (5,500 | ) | — |   | (5,613 | ) |
| Repayment of  borrowings under Credit Card Facility                                          |       | —                                                              |       | (112,500 | ) | — |   | (112,500 | ) |
| Acquisitions of  treasury stock                                                              |       | (3,088                                                              | )          | — |   | — |   | (3,088 | ) |
| Proceeds from  stock-based compensation awards                                               |       | 16,100                                                              |       | — |   | — |   | 16,100 |   |
| Cash dividends  paid                                                                         |       | (27,398                                                             | )          | — |   | — |   | (27,398 | ) |
| Distributions  paid                                                                          |       | —                                                              |       | (3,898 | ) | — |   | (3,898 | ) |
| Net cash used  for continuing financing activities                                           |       | (14,499                                                             | )          | (116,398 | ) | — |   | (130,897 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                              |       | (559 | ) | — |   | (559 | ) |
| Net cash used  for financing activities                                                      |       | (14,499                                                             | )          | (116,957 | ) | — |   | (131,456 | ) |
| **CASH  AND CASH EQUIVALENTS**                                                               |       |                                                                |       |   |   |   |   |   |   |
| (Decrease)  increase during the period                                                       |       | (45,717                                                             | )          | 530,832 |   | — |   | 485,115 |   |
| Beginning  balance                                                                           |       | 363,063                                                             |       | 5,304 |   | — |   | 368,367 |   |
| Ending balance                                                                               |       | 317,346                                                             |       | 536,136 |   | — |   | 853,482 |   |
| Less cash of  discontinued operation                                                         |       | —                                                              |       | 63 |   | — |   | 63 |   |
| Ending balance                                                                               |       | $                                                                   | 317,346    |   | $ | 536,073 |   | $ | — |   | $ | 853,419 |   |

 

F-55

----

 
| ** **                                                                                   | ** ** | **Year ended July 31, 2004 (Predecessor)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **NMG**                                                             | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **CASH  FLOWS—OPERATING ACTIVITIES**                                                    |       |                                                                |       |   |   |   |   |   |   |
| Net earnings  (loss)                                                                         |       | $                                                                   | 204,832    |   | $ | 263,178 |   | $ | (263,178 | ) | $ | 204,832 |   |
| (Earnings) loss  from discontinued operation                                                 |       | —                                                              |       | (1,242 | ) | 592 |   | (650 | ) |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:         |       |                                                                |       |   |   |   |   |   |   |
| Depreciation                                                                                 |       | 77,659                                                              |       | 20,392 |   | — |   | 98,051 |   |
| Deferred income taxes                                                                        |       | 22,969                                                              |       | — |   | — |   | 22,969 |   |
| Impairment of intangible assets and other charges                                            |       | —                                                              |       | 3,853 |   | — |   | 3,853 |   |
| Minority Interest                                                                            |       | —                                                              |       | — |   | 2,957 |   | 2,957 |   |
| Other, primarily costs related to defined benefit  pension and other long-term benefit plans |       | 34,562                                                              |       | (682 | ) | — |   | 33,880 |   |
| Intercompany royalty income payable (receivable)                                             |       | 164,994                                                             |       | (164,994 | ) | — |   | — |   |
| Equity in earnings of subsidiaries                                                           |       | (259,791                                                            | )          | — |   | 259,791 |   | — |   |
| Changes in  operating assets and liabilities, net                                            |       | 3,564                                                               |       | (317,431 | ) | (162 | ) | (314,029 | ) |
| Net cash  provided by (used for) continuing operating activities                             |       | 248,789                                                             |       | (196,926 | ) | — |   | 51,863 |   |
| Net cash  provided by discontinued operation                                                 |       | —                                                              |       | 709 |   | — |   | 709 |   |
| Net cash  provided by (used for) operating activities                                        |       | 248,789                                                             |       | (196,217 | ) | — |   | 52,572 |   |
| **CASH  FLOWS—INVESTING ACTIVITIES**                                                    |       |                                                                |       |   |   |   |   |   |   |
| Capital  expenditures                                                                        |       | (94,591                                                             | )          | (24,478 | ) | — |   | (119,069 | ) |
| Proceeds from  sale of other assets                                                          |       | 3,183                                                               |       | — |   | — |   | 3,183 |   |
| Net cash used  for continuing investing activities                                           |       | (91,408                                                             | )          | (24,478 | ) | — |   | (115,886 | ) |
| Net cash used  for discontinued operation                                                    |       | —                                                              |       | (1,404 | ) | — |   | (1,404 | ) |
| Net cash used  for investing activities                                                      |       | (91,408                                                             | )          | (25,882 | ) | — |   | (117,290 | ) |
| **CASH  FLOWS—FINANCING ACTIVITIES**                                                    |       |                                                                |       |   |   |   |   |   |   |
| Repayment of  borrowings under Credit Card Facility                                          |       | —                                                              |       | 225,000 |   | — |   | 225,000 |   |
| Acquisitions of  treasury stock                                                              |       | (7,553                                                              | )          | — |   | — |   | (7,553 | ) |
| Proceeds from  stock-based compensation awards                                               |       | 23,797                                                              |       | — |   | — |   | 23,797 |   |
| Cash dividends  paid                                                                         |       | (12,632                                                             | )          | — |   | — |   | (12,632 | ) |
| Distributions  paid                                                                          |       | —                                                              |       | (3,172 | ) | — |   | (3,172 | ) |
| Net cash  provided by continuing financing activities                                        |       | 3,612                                                               |       | 221,828 |   | — |   | 225,440 |   |
| Net cash  provided by discontinued operation                                                 |       | —                                                              |       | 695 |   | — |   | 695 |   |
| Net cash  provided by financing activities                                                   |       | 3,612                                                               |       | 222,523 |   | — |   | 226,135 |   |
| **CASH  AND CASH EQUIVALENTS**                                                               |       |                                                                |       |   |   |   |   |   |   |
| Increase during  the period                                                                  |       | 160,993                                                             |       | 424 |   | — |   | 161,417 |   |
| Beginning  balance                                                                           |       | 202,070                                                             |       | 4,880 |   | — |   | 206,950 |   |
| Ending balance                                                                               |       | $                                                                   | 363,063    |   | $ | 5,304 |   | $ | — |   | $ | 368,367 |   |

 

F-56

----

**NOTE 19.  QUARTERLYFINANCIAL INFORMATION (UNAUDITED)**
| ** **                                               | ** ** | **Fiscal year 2006**                    | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                               | ** ** | **Nine weeks  ended  October 1,  2005** | ** ** | ** ** | **Four  weeks ended  October 29,   2005** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Total** | ** ** |
| ** **                                               | ** ** | **(Predecessor)**                                 | ** ** | ** ** | ** ** | ** ** | **(Successor)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                 |       | $                                                 | 643.4      |   |   | $ | 319.6 |   | $ | 1,217.6 |   | $ | 1,009.6 |   | $ | 915.4 |   | $ | 4,105.6 |   |
| Gross profit (1)                                         |       | $                                                 | 265.1      |   |   | $ | 124.8 |   | $ | 382.1 |   | $ | 409.1 |   | $ | 287.1 |   | $ | 1,468.2 |   |
| Earnings from  continuing operations                     |       | $                                                 | 44.5       |   |   | $ | 10.8 |   | $ | 2.7 |   | $ | 40.3 |   | $ | (27.5 | ) | 70.8 |   |
| (Loss) earnings  from discontinued operation, net of tax |       | $                                                 | (0.3       | ) |   | $ | 0.1 |   | $ | 0.3 |   | $ | 0.2 |   | $ | (14.5 | ) | $ | (14.2 | ) |
| Net earnings                                             |       | $                                                 | 44.2       | (2) |   | $ | 10.9 |   | $ | 3.0 |   | $ | 40.5 |   | $ | (42.0 | )(3) | $ | 56.6 |   |

 
| ** **                                        | ** ** | ** ** | ** ** | **Fiscal year 2005** | ** ** |
|---------------------------------------------------|------------|------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | ** ** | ** ** | **First  Quarter**             | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Total** | ** ** |
| ** **                                        | ** ** | ** ** | ** ** | ** **                     | ** ** | **(Predecessor)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                          |       |       |       | $                              | 896.2      |   | $ | 1,118.1 |   | $ | 920.7 |   | $ | 839.8 |   | $ | 3,774.8 |   |
| Gross profit (1)                                  |       |       |       | $                              | 365.0      |   | $ | 381.7 |   | $ | 371.6 |   | $ | 266.2 |   | $ | 1,384.5 |   |
| Earnings from  continuing operations              |       |       |       | $                              | 64.1       |   | $ | 70.2 |   | $ | 79.8 |   | $ | 33.9 |   | $ | 248.0 |   |
| Earnings from  discontinued operation, net of tax |       |       |       | $                              | 0.0        |   | $ | 0.4 |   | $ | 0.0 |   | $ | 0.4 |   | $ | 0.8 |   |
| Net earnings                                      |       |       |       | $                              | 64.1       | (4) | $ | 70.6 |   | $ | 79.8 |   | $ | 34.3 | (5) | $         248.8 |   |

 

----

(1)          Gross profit includes revenues less cost of goodssold including buying and occupancy costs (excluding depreciation).

(2)          For the nine weeks ended October 1, 2005, netearnings includes $23.5 million of pretax transaction and other costsincurred in connection with the Transactions. These costs consist primarily of$4.5 million of accounting, investment banking, legal and other costsassociated with the Transactions and a $19.0 million non-cash charge forstock compensation resulting from the accelerated vesting of Predecessor stockoptions and restricted stock in connection with the Acquisition.

(3)          For the fourth quarter of fiscal year 2006, netearnings include a loss from discontinued operation of $13.9 million whichincludes $13.3 million of income tax expense related to the excess of the taxover book gain realized in connection with the Gurwitch Disposition.

(4)          Net earnings for the first quarter of fiscal year2005 includes a pretax loss of $15.3 million related to the disposition ofChef’s Catalog.

(5)          Net earnings for the fourth quarter of fiscal year2005 includes a pretax gain of $6.2 million related to the sale of ourcredit card portfolio, tax benefits aggregating $7.6 million related tofavorable settlements associated with previous state tax filings and reductionsin previously recorded deferred tax liabilities.

F-57

----

 

**SIGNATURES**

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the Registranthas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|        |   |   | NEIMAN MARCUS, INC. |
|--------|--------|--------|---------------------|
|   |   |   |                |   |
|   |   |   |                |   |
|   |   |   | By:                 | /s/ NELSON A. BANGS |   |
|   |   |   |                | Nelson A. Bangs  Senior Vice President and General Counsel |

 

Dated: September 27, 2006

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the following capacities and on the dates indicated.

 
| Signature              | ** ** | **Title**                                         | ** ** | **Date**            |
|------------------------|------------|---------------------------------------------------|------------|---------------------|
| ** **             | ** ** | ** **                                        | ** ** | ** **          |
| /s/ BURTON M.  TANSKY  |       | President and  Chief Executive                    |       | September 27,  2006 |
| Burton M. Tansky       |       | Officer,  Director                                |       |                |
|                   |       |                                              |       |                |
| /s/ JAMES E.  SKINNER  |       | Senior Vice  President and Chief                  |       |                |
| James E. Skinner       |       | Financial  Officer  (principal financial officer) |       | September 27,  2006 |
|                   |       |                                              |       |                |
| /s/ T. DALE  STAPLETON |       | Vice President  and Controller                    |       | September 27,  2006 |
| T. Dale Stapleton      |       | (principal  accounting officer)                   |       |                |
|                   |       |                                              |       |                |
| /s/ DAVID A.  BARR     |       | Director                                          |       | September 27,  2006 |
| David A. Barr          |       |                                              |       |                |
|                   |       |                                              |       |                |
| /s/ RON BEEGLE         |       | Director                                          |       | September 27,  2006 |
| Ron Beegle             |       |                                              |       |                |
|                   |       |                                              |       |                |
| /s/ JONATHAN  COSLET   |       | Director                                          |       | September 27,  2006 |
| Jonathan Coslet        |       |                                              |       |                |
|                   |       |                                              |       |                |
|                   |       | Director                                          |       |                |
| James G. Coulter       |       |                                              |       |                |
|                   |       |                                              |       |                |
| /s/ JOHN G.  DANHAKL   |       | Director                                          |       | September 27,  2006 |
| John G. Danhakl        |       |                                              |       |                |
|                   |       |                                              |       |                |
| /s/ SIDNEY  LAPIDUS    |       | Director                                          |       | September 27,  2006 |
| Sidney Lapidus         |       |                                              |       |                |
|                   |       |                                              |       |                |
| /s/ KEWSONG  LEE       |       | Director                                          |       | September 27,  2006 |
| Kewsong Lee            |       |                                              |       |                |
|                   |       |                                              |       |                |
| /s/ CARRIE  WHEELER    |       | Director                                          |       | September 27,  2006 |
| Carrie Wheeler         |       |                                              |       |                |

 

74

----

 

**SCHEDULE II**

Neiman Marcus, Inc.

Valuation and Qualifying Accounts and Reserves

(in thousands)

 

Three years ended July 29, 2006

 
| **Column A**                                                    | ** ** | **Column B**                              | ** ** | **Column C**                             | ** ** | **Column D**                    | ** ** | **Column E** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------|------------|-------------------|------------|
| ** **                                                           | ** ** | ** **                                     | ** ** | **Additions**                                 | ** ** | ** **                           | ** ** | ** **        | ** ** |
| **Description**                                                      | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Charged to  Other  Accounts** | ** ** | **Deductions**    | ** ** | **Balance at  End of  Period** | ** ** |
| *Forty-three  weeks ended July 29, 2006 (Successor)*                 |       |                                           |       |                                          |       |                                 |       |              |       |   |   |
| Allowance for  doubtful accounts (deducted from accounts receivable) |       | $                                              | 280        |                                          | $          | 100                                  |       | $                 | —     |   | $ | — |   | $ | 380 |   |
| Reserve for  estimated sales returns                                 |       | $                                              | 47,962     |                                          | $          | 442,616                              |       | $                 | —     |   | $ | (446,836 | )(A) | $ | 43,742 |   |
| *Nine  weeks ended October 1, 2005 (Predecessor)*                    |       |                                           |       |                                          |       |                                 |       |              |       |   |   |
| Allowance for  doubtful accounts (deducted from accounts receivable) |       | $                                              | 280        |                                          | $          | —                               |       | $                 | —     |   | $ | — |   | $ | 280 |   |
| Reserve for  estimated sales returns                                 |       | $                                              | 35,170     |                                          | $          | 93,435                               |       | $                 | —     |   | $ | (80,643 | )(A) | $ | 47,962 |   |
| *Year  ended July 30, 2005 (Predecessor)(B)*                         |       |                                           |       |                                          |       |                                 |       |              |       |   |   |
| Allowance for  doubtful accounts (deducted from accounts receivable) |       | $                                              | 9,948      |                                          | $          | 14,656                               |       | $                 | (11,116    | )(C) | $ | (13,208 | )(D) | $ | 280 |   |
| Reserve for  estimated sales returns                                 |       | $                                              | 30,829     |                                          | $          | 462,895                              |       | $                 | —     |   | $ | (458,554 | )(A) | $ | 35,170 |   |
| *Year  ended July 31, 2004 (Predecessor) (B)*                        |       |                                           |       |                                          |       |                                 |       |              |       |   |   |
| Allowance for  doubtful accounts (deducted from accounts receivable) |       | $                                              | 280        |                                          | $          | 7,609                                |       | $                 | 11,820     | (E) | $ | (9,761 | )(D) | $ | 9,948 |   |
| Reserve for estimated  sales returns                                 |       | $                                              | 26,457     |                                          | $          | 387,916                              |       | $                 | —     |   | $ | (383,544 | )(A) | $ | 30,829 |   |

 

----

(A)                              Gross margin on actual sales returns, net ofcommissions.

(B)                                Fiscal years 2005 and 2004 have been adjusted toexclude the operations of Gurwitch Products, L.L.C.

(C)                                Reserve eliminated in connection with the sale ofour proprietary credit card receivables.

(D)                               Write-off of uncollectible accounts net ofrecoveries and other miscellaneous deductions.

(E)                                 Reserve established in connection with thetransition from Off-Balance Sheet Accounting to Financing Accounting forborrowings under the previous revolving credit card securitization program.

75

----