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EBHI Holdings, Inc. 10-K 2007
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 30, 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 number 000-51676
 
 
 
 
 
     
Delaware
  42-1672352
(State of or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
15010 NE 36th Street
Redmond, WA 98052
(425) 755-6544
(Address and telephone number, including area code, of registrant’s principal executive offices)
 
 
 
 
Common Stock, Par Value $0.01 per share
Name of each exchange on which registered
The NASDAQ Stock Market LLC
Securities Registered Pursuant to Section 12(g) of the Act:
None
 
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in any definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o     Accelerated filer o     Non-accelerated filer þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.).  Yes o     No þ
 
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of July 1, 2006 was $345,000,000 based on the closing price of the registrant’s common stock on June 30, 2006, the last business day of the registrant’s most recently completed second fiscal quarter.
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes þ     No o
 
The number of shares of the registrant’s common shares outstanding as of March 28, 2007 was 30,309,931.
 
 
Portions of the proxy statement for the registrant’s 2007 annual meeting of stockholders, to be filed subsequently with the Securities and Exchange Commission pursuant to Regulation 14A, are incorporated by reference in Part III of this Annual Report on Form 10-K.
 


 

 
 
             
        Page
 
  Business   1
  Risk Factors   20
  Unresolved Staff Comments   36
  Properties   36
  Legal Proceedings   37
  Submission of Matters to a Vote of Security Holders   38
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities   39
  Selected Financial Data   41
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   48
  Quantitative and Qualitative Disclosures About Market Risk   79
  Financial Statements and Supplementary Data   80
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   81
  Controls and Procedures   81
 
  Directors, Executive Officers and Corporate Governance   83
  Executive Compensation   83
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   83
  Certain Relationships and Related Transactions and Director Independence   84
  Principal Accounting Fees and Services   84
 
  Exhibits, Financial Statement Schedules   84
 EXHIBIT 21
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2


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We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this report or made by us involve risks and uncertainties and are subject to change based on various important factors, many of which are beyond our control. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “planned,” “potential” and similar expressions may identify forward-looking statements. The following factors, among others, in some cases have affected and in the future could affect our financial performance and actual results and could cause actual results to differ materially from those expressed or implied in any forward-looking statements included in this report or otherwise made by us:
 
  •  our ability to refinance our secured term loan on acceptable terms or at all, including our ability to raise junior capital as part of our refinancing efforts and thus avoid the anticipated breach of the financial covenants in our secured term loan credit agreement during the first half of fiscal 2007;
 
  •  consumer acceptance of our products and our ability to keep up with fashion trends, develop new merchandise, launch new product lines successfully, offer products at the appropriate price points and enhance our brand image;
 
  •  the highly competitive nature of the retail industry generally and the segment in which we operate particularly;
 
  •  the possible lack of availability of suitable store locations on appropriate terms;
 
  •  our reliance on foreign sources of production, including risks related to the disruption of imports by labor disputes, political instability, legal and regulatory matters, duties, taxes, other charges and quotas on imports, local business practices and political issues and risks related to currency and exchange rates;
 
  •  our ability to service any debt we incur from time to time, as well as the requirements the agreements related to such debt impose upon us;
 
  •  shifts in general economic conditions, consumer confidence and consumer spending patterns;
 
  •  our ability to retain, hire and train key personnel and management;
 
  •  the seasonality of our business;
 
  •  the ability of our manufacturers to deliver products in a timely manner or meet quality standards;
 
  •  changes in weather patterns;
 
  •  the impact of the material weaknesses in internal control identified by management and the lack of effectiveness of our disclosure controls and procedures currently;
 
  •  increases in the costs of mailing, paper and printing;
 
  •  the price and supply volatility of energy supplies;
 
  •  our reliance on information technology, including risks related to the implementation of new information technology systems, risks associated with service interruptions and risks related to utilizing third parties to provide information technology services;
 
  •  natural disasters;
 
  •  the potential impact of national and international security concerns on the retail environment, including any possible military action, terrorist attacks or other hostilities; and
 
  •  the other risks identified in this Annual Report on Form 10-K.
 
These forward-looking statements speak only as of the date stated and, except as required by law, we do not intend to make publicly available any update or other revisions to any of the forward-looking statements contained in this report to reflect circumstances existing after the date of this report or to reflect the occurrence of future events even if experience or future events make clear that any expected results expressed or implied by those forward-looking statements will not be realized.


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Item 1.   Business
 
Eddie Bauer Holdings, Inc. was formed in June 2005 as a new parent company in connection with the emergence from bankruptcy of our principal operating subsidiary, Eddie Bauer, Inc. When we use the terms “Eddie Bauer,” “we,” “us,” “our” or similar words in this annual report, unless the context otherwise requires, we are referring to Eddie Bauer Holdings, Inc. and its subsidiaries, including Eddie Bauer, Inc. For more information on the bankruptcy, see “The Spiegel Bankruptcy” under this Item 1.
 
 
Eddie Bauer is a specialty retailer that sells casual sportswear and accessories for the modern outdoor lifestyle. Our primary target customers are women and men who are 30-54 years old with an average annual household income of $75,000. Eddie Bauer is a nationally recognized brand that we believe stands for high quality, innovation, style and customer service. Founded in 1920, Eddie Bauer has an established reputation in the outerwear market and was ranked as the number three outerwear brand in a survey conducted by Women’s Wear Daily in July 2006.
 
In June 2005, we emerged from bankruptcy as a stand-alone company for the first time in 34 years. We are committed to turning our business around and revitalizing Eddie Bauer as a premium quality brand, both by continuing to implement initiatives that we commenced over the past several years and by actively changing initiatives that are not performing up to our expectations.
 
We sell our products through two interdependent sales channels that share product sourcing, design and marketing resources:
 
  •  retail, which consists of our Eddie Bauer stores and our Eddie Bauer outlet stores located in the United States and Canada; and
 
  •  direct, which consists of our Eddie Bauer catalogs and our websites www.eddiebauer.com and www.eddiebaueroutlet.com.
 
We aim to offer our customers a seamless retail experience and structure our operations to reflect that goal. Customers can purchase our products through either of our sales channels and return or exchange our products at any of our stores, regardless of the channel of purchase. Our U.S. stores also offer a direct phone connection to our customer call centers that allows an in-store customer to order for home delivery a particular size, color or item that may not be available in the store.
 
As of December 30, 2006, we operated 394 stores, consisting of 279 retail stores and 115 outlet stores in the U.S. and Canada. During 2006, we had 33.7 million visits to our two websites and circulation of approximately 80.8 million catalogs.
 
In addition, we are minority participants in joint venture operations in Japan and Germany. As of December 30, 2006, Eddie Bauer Japan operated 40 retail stores and nine outlet stores, distributed 11 major catalogs annually and operated a website located at www.eddiebauer.co.jp and Eddie Bauer Germany operated seven retail stores and two outlet stores, distributed six major catalogs annually and operated a website located at www.eddiebauer.de. As a result of weak retail sales due partially to a continued poor apparel retail market in Germany, in January 2007 Eddie Bauer Germany made the decision to close all of its retail stores. We anticipate that all Eddie Bauer Germany retail stores will be closed by August 2007. Eddie Bauer Germany will continue to sell its products through its catalogs, website and outlet stores. We also license the Eddie Bauer name to various consumer product manufacturers and other retailers whose products complement our modern outdoor lifestyle brand image.
 
We design and source almost all of our clothing and accessories that we sell through our stores and direct sales channel. Although we do not manufacture any of our products, each of our vendors must comply with our Global Labor Practices Program that includes prohibitions against forced labor, child labor, harassment and abuse. Our sourcing and logistics infrastructure is designed to provide the timely distribution of products


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to our customers and stores, and our customer call center is designed to deliver a consistently high level of customer service.
 
 
 
On November 13, 2006, we announced that we had entered into a merger agreement with Eddie B Holding Corp., a company owned by affiliates of Sun Capital Partners, Inc. and Golden Gate Capital. Under the terms of the merger agreement all of the Company’s outstanding shares of common stock were to be converted into the right to receive $9.25 per share in cash upon closing of the transaction. On February 8, 2007, at a special meeting of our stockholders, an insufficient number of shares were voted in favor of approving the Company’s proposed sale. As a result of this vote by stockholders, Eddie Bauer terminated the merger agreement and will continue to operate as a stand-alone publicly traded company. We intend to continue to operate the business and implement initiatives in substantial conformance with our previously announced plans.
 
 
We are committed to turning our business around and revitalizing Eddie Bauer, by continuing to implement previously announced initiatives and by actively changing initiatives that are not performing up to our expectations. Although we believe our strategies will help stabilize our business in the long term, this process comes with significant risks and challenges and will take time. As a result, even if we are successful, we may not see improvements in our results of operations in the near term. Due to the required investments in our brand, infrastructure and personnel, we do not expect a significant increase in our results of operations over the next 12-18 months, even in the event of a successful turnaround.
 
 
Our primary focus with the 2006 Fall/Holiday line has been to re-align the offering with the needs and preferences of our 30-54 year-old core customers, including:
 
  •  re-setting the styling, fit and construction of our products, while leveraging Eddie Bauer’s unique outdoor heritage as a point of differentiation;
 
  •  returning to a color palette that emphasizes Eddie Bauer’s tradition of rich, textured and natural colors inspired by the outdoors;
 
  •  increasing emphasis on down outerwear and accessories as we seek to capitalize on our past success in these classifications as well as our reputation as one of the world’s most recognized outerwear brands; and
 
  •  modifying pricing in certain areas to improve the price/value equation for our customers.
 
We made significant changes in the fabric, materials and fit used in both our men’s and women’s pants sold in our stores and via direct channels. In addition, we have updated the styles in these lines with a goal of improving the appeal and functionality of our line. The promotion we ran in September 2006 to publicize these changes received positive customer response with sales in these categories tracking above the previous year’s disappointing results. Product with similarly revised fabric, materials and styles will be introduced gradually in our Eddie Bauer outlet stores over the course of 2007. The 2006 Fall/Holiday collection reflected a move to more traditional colors in our basic offerings unlike our 2005 Fall/Holiday merchandise that featured a non-traditional color scheme. Many of our products represent core items in our customers’ wardrobes and thus maintaining a consistent color scheme is important in reaching our core customers.
 
To support the 2006 Fall/Holiday products, we redirected our catalog and store merchandising to present more product-specific marketing, including a product-focused advertising campaign that we launched in the November and December issues of key magazines that we believe our customers read. In addition, we placed an emphasis on gift giving in our marketing efforts. We believe that the reduced emphasis on wardrobing (i.e.,


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presentation of products as unified outfits) in the 2006 Fall/Holiday sales materials and displays has contributed to improved customer response, particularly in the men’s categories where this revised approach was emphasized. In addition, our recent catalogs have featured a model group that is more age appropriate for our target demographics and a greater emphasis on individual product images to enhance the ability of customers to evaluate fit and finish. Customer response to the 2006 Fall/Holiday line has been encouraging, as evidenced by increases in comparable store sales of 4.6% and 9.5% in the fourth quarter of 2006 and the first quarter of 2007 (through March 10, 2007) and an increase in sales in our direct channel in the first quarter of 2007 (through March 10, 2007) of 12.9%, when compared to the same period in 2006. These results reinforce our belief that we are on the correct path.
 
 
On September 6, 2006, we launched our first full-scale customer loyalty program, Eddie Bauer Friends, for Eddie Bauer customers based on the results of a pilot program that we had tested since mid-2004. Customers may enroll in the program via our stores, catalog call centers or at www.eddiebauerfriends.com. The loyalty program allows customers in the United States to accrue points that may be redeemed for Eddie Bauer reward certificates or used toward acquiring special Eddie Bauer merchandise at www.eddiebauerfriends.com. For every dollar spent on Eddie Bauer products, a member of the loyalty program receives loyalty points. Members who hold Eddie Bauer credit cards are eligible for bonus points and to participate in exclusive online auctions for special items, such as outdoor vacations, resort getaways, electronics, day spa retreats and more, using their points. The full terms and conditions of the loyalty program are available at www.eddiebauerfriends.com. As of December 30, 2006, approximately 851,000 customers have enrolled in our loyalty program.
 
We intend to evaluate the performance of the program on an on-going basis. We believe that the program will be a valuable tool in driving customer purchases and fostering customer loyalty while facilitating our ability to track and market to our customers.
 
 
In 1920, our founder, Eddie Bauer (1899-1986), opened his first store in Seattle, Washington, to sell outdoor sporting and recreational equipment, clothing and accessories. The first store specialized in sporting goods such as tennis rackets, fishing tackle and golf clubs hand-made by Mr. Bauer. Mr. Bauer’s own experience with hypothermia on a fishing trip in 1923 led to the invention of the Skyliner down parka, which was patented in 1940. During World War II, the U.S. Army Corps commissioned more than 50,000 “Eddie Bauer B-9 Flight Parkas” designed to help keep pilots warm during high altitude flights. Mr. Bauer also produced 250,000 down sleeping bags and many other items to meet military orders. Eddie Bauer was the first government supplier granted permission to put his label on his products during World War II, which raised product awareness and built a market for his merchandise. Mr. Bauer believed in high quality products and customer satisfaction. While building his business, he wrote letters to customers inquiring about their level of satisfaction and requesting suggestions for improvements. He insisted on complete satisfaction with any Eddie Bauer product or it could be returned for a refund — a tradition that continues today.
 
In 1945, we issued our first mail-order catalog. In 1971, we were acquired by General Mills, Inc., and in 1972 we opened our first store outside of Seattle in San Francisco, California. We celebrated our first $100 million sales year in 1983, at which time we operated 27 retail stores. Between July 1988, when we were acquired by Spiegel, Inc. (“Spiegel”) and the end of fiscal 2002, our retail stores increased from 58 to 399 and our outlet stores from 3 to 102. In addition, from fiscal 1990 to fiscal 2002, our catalog circulation increased from 61.2 million to 101.6 million (excluding Eddie Bauer Home catalogs). In 1996, we started selling products over the Internet.
 
In March 2003, Spiegel, together with 19 of its subsidiaries and affiliates, including our principal operating subsidiary, Eddie Bauer, Inc., filed petitions for relief under Chapter 11 of the U.S. Bankruptcy Code. For more information on the bankruptcy, see “The Spiegel Bankruptcy” under this Item 1. In June 2005,


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we emerged from bankruptcy as a stand-alone company for the first time in 34 years and are a publicly-owned company for the first time.
 
 
Our apparel lines consist of clothing for women and men, including outerwear, pants, jeans, dresses, skirts, sweaters, shirts, sleepwear, underwear, swimwear, gadgets and gift items. We offer a wide variety of options in fabric, color, style, fit and size and a mix of basic offerings and seasonal collections. In addition, we offer accessories such as scarves, belts, hats, jewelry, daypacks, bags and footwear that complement our outdoor-inspired apparel lines. We also offer select down products for the home, such as comforters and pillows.
 
 
Our primary target customers are women and men who are 30-54 years old with an average annual household income of $75,000. According to the 2006 Apparel Market Research Yearbook published by Richard K. Miller & Associates, in 2004, apparel spending in the United States by women and men between the ages of 35 and 54 totaled $31 billion and $17 billion, respectively. According to the Bureau of Labor Statistics, women between the ages of 45 and 54 spend more on apparel than any other segment of the population and belong to the highest household income bracket. We intend to capitalize on this market opportunity by leveraging our established reputation and brand image among this demographic group that has historically made up our core customer base and that has historically spent a larger portion of discretionary income on specialty apparel.
 
Revitalizing the Eddie Bauer Brand
 
Our sales performance has consistently declined over the past six years. Net merchandise sales has declined since 2000, from $1.6 billion in fiscal 2000 (the first year for which financial statements excluding Eddie Bauer Home are available) to $1.0 billion in fiscal 2006. In addition, comparable store sales, which we generally define as net sales from stores that have been open for one complete fiscal year, have decreased in 23 of the 28 quarters since the beginning of fiscal 2000.
 
 
As a result of the negative sales trends described above, we attempted to re-launch the Eddie Bauer brand in late 2005. We believed one of the key reasons for our declining net merchandise sales, generally negative comparable store sales and declining traffic in our stores that we experienced since 2000 was that over time our product design had lost its strong brand identity and had become indistinguishable from other specialty retailers’ products. Our principal turnaround objective was to position the Eddie Bauer brand to represent premium quality products for the modern outdoor lifestyle and to offer a collection of products that reflected and distinguished our brand.
 
We intended to elevate and revitalize the Eddie Bauer brand by substantially updating our product line and redesigning our brand communication approach to generate excitement about our brand both from our core customers and potential new customers. We hired an experienced chief merchandising officer and a new head of design in the Summer of 2004 to substantially redesign our clothing lines. In addition, in early 2005 we hired a new vice president of marketing and later in the year a new vice president of creative.
 
In August 2005, we launched the significantly redesigned product line for Fall/ Holiday 2005 aimed at enhancing the style relevance and image of the Eddie Bauer brand. These efforts not only involved a significant overhaul and redesign of our product line, but also a substantial change in our brand communication approach. The new collection incorporated a wider range of color, more novelty pieces and updated products with modified style, fit and more premium fabric, trim and hardware. We created new catalog imagery that focused on brand communication and provided our stores with new ways to merchandise and display the apparel and accessories. We also engaged in a public relations and marketing initiative in New York City during the Holidays to promote our down collection.


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We understood that in making significant changes to our collection, we faced numerous risks. See “Risk Factors — Risks Related to Our Business — If we cannot revitalize the Eddie Bauer brand, our business will be adversely impacted” under Item 1A. We expected to experience some sales declines due to discontinued products, but we anticipated that we could offset this decrease with new customers and with more purchases by our core customers. We believed that by making substantial changes to our product line and our creative presentation of the brand, we would generate significant customer interest and excitement about Eddie Bauer. Our results from the Fall/Holiday 2005 roll-out as a whole were disappointing and indicated that our customers did not respond positively to the changes we made to our product offerings or marketing approach. Compared to the same quarters in the prior year, net merchandise sales for the third and fourth quarters of fiscal 2005 were down $18.3 million and $29.5 million respectively, or approximately 8.2% and 7.6%, respectively, and comparable store sales declined by 4.3% and 7.1%, respectively. Results for the first three quarters of fiscal 2006 continued to be disappointing, with declines in net merchandise sales of $26.0 million, $17.8 million and $5.4 million, or approximately 12.6%, 7.7% and 2.7%, in the first, second and third quarters respectively. Comparable store sales also declined approximately 10.0%, 5.9% and 1.5% in the first, second and third quarters of fiscal 2006 compared to the same periods in the prior year.
 
 
We believe Eddie Bauer’s legacy and our company heritage continue to resonate with our core and targeted customers and that Eddie Bauer has always been a brand with a strong connection to an outdoor lifestyle. Accordingly, we are redirecting our modern outdoor lifestyle brand strategy to emphasize our heritage and build upon the legacy of our founder, Eddie Bauer. His legacy serves as the foundation for our rich company heritage that provides us with the philosophy upon which we are launching a revitalized brand — a love for the outdoors, premium quality, passionate product design, great customer service, creative marketing and spirit of innovation. We intend to leverage this connection by focusing our brand messaging on our outdoor heritage to build on this strength and provide differentiation from other specialty retailers. Our ability to reflect these elements in our business is the basis of our business strategy and we believe will be key to our turnaround. Our strategy reflects the following principles:
 
  •  Leverage outdoor heritage.  We plan to leverage our outdoor heritage by infusing products with functionality and designs that more explicitly reference the outdoors and with marketing that reflects our outdoor inspired brand.
 
  •  Offer basics, neutrals and heritage pieces.  We are building on products in which we have a strong history by expanding product offerings in these core product areas and introducing new updated products featuring similar styles, fits and functionality. We are retaining our tradition of offering rich, textured, natural colors inspired by the outdoors by featuring neutral and seasonally appropriate colors and targeted use of some brighter colors on selected novelty pieces to generate excitement. We are also updating classic designs with proven selling histories that reflect our outdoor heritage, and we are replacing the less successful items offered in 2005.
 
  •  Address core customer preferences — age appropriate styling, fits and construction.  Our target demographic range is 30 to 54, and the average age of our customer is 45. We are balancing our product line to appeal to our target demographic base through product offerings with appropriate fits, styles and functionality that meet the needs and preferences of our core customers.
 
  •  Leverage our authority in outerwear.  We believe that Eddie Bauer has an established reputation in the outerwear market, and Eddie Bauer was ranked as the number three outerwear brand in a survey conducted by Women’s Wear Daily in July 2006. We will continue with our efforts to maintain and strengthen our authority in outerwear by leveraging our brand recognition in the outerwear category, emphasizing both technical and heritage attributes, and revising our products to reflect seasonal apparel needs.
 
  •  Redirect our catalog and our store merchandising to present more product specific marketing.  We are working on better balancing wardrobing and product presentation. We also are diversifying our models


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  to reflect the full scope of our target demographic and to inspire customer confidence in the fit of our products.
 
  •  Refine our marketing to enhance our image as a lifestyle brand.  We believe that how we present and talk about our products in use has a significant impact on how our customers relate to them and to Eddie Bauer as a brand. Therefore, we are placing increased emphasis on showing and talking about our products being used in locations, contexts and activities that our customers can easily relate to in terms of how they live their own lives.
 
  •  Reset price/value equation.  We found our prices were not consistent with customer expectations, in part because we did not emphasize to our customers our use of more expensive materials in the products and in part because the change in quality may not have justified a relative price increase in the minds of our customers. We plan to continue to offer high quality, durable products at prices that appeal to our customers.
 
Our results began to show improvement in the fourth quarter of fiscal 2006, with an increase in net merchandise sales of $4.4 million, or 1.2%, and an increase in comparable store sales of 4.6%, in each case as compared to the fourth quarter of fiscal 2005. Net merchandise sales in our retail stores and direct channel were flat with the prior year quarter, while net merchandise sales in our outlet stores increased $4.5 million.
 
 
In addition to revitalizing our brand, we also are implementing several other initiatives as part of our commitment to stabilize and turn around our business, some of which we were not able to implement until our emergence from bankruptcy and others of which were limited during the time we were exploring strategic alternatives and in advance of our stockholder meeting in February 2007 regarding the proposed merger:
 
  •  focusing on recruiting a highly qualified chief executive officer and chief financial officer and filling other senior management positions;
 
  •  increasing profitability at our retail stores, by right-sizing the stores, increasing traffic and increasing conversion;
 
  •  rebuilding our customer database through customer acquisition and retention measures and making investments to improve website functionality;
 
  •  restructuring our capital structure, including attempting to refinance our existing secured term loan;
 
  •  improving the customer’s experience by making our stores more appealing, improving the presentation of our products in our catalogs and on our websites, and improving the quality of customer service in our stores and at our call centers; and
 
  •  further streamlining our back-end operations to maximize productivity.
 
For more information on these initiatives, see “— Our Strategy.”
 
Although we expect that the initiatives already underway should stabilize our business, they have significant risks and challenges, as discussed in more detail under “Risk Factors” and will take time to implement. Moreover, even if we are successful, we do not expect improvements in operating results for approximately 12-18 months. We also face numerous challenges as a result of our involvement in the Spiegel bankruptcy process, including being required to incur significant debt upon our emergence from bankruptcy. See “Risk Factors — We face numerous challenges as a result of our involvement in the Spiegel bankruptcy process which, if not addressed, could have a material adverse effect on our business,” under Item 1A.
 
 
We believe that our following strengths will help stabilize and grow our business:
 
Established brand heritage and awareness.  Our company was founded in 1920 by Eddie Bauer, an outdoorsman and innovator with a strong dedication to premium quality and his customers. We believe the


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Eddie Bauer brand has a long established reputation for high quality products, leadership in outerwear, a wide range of sizes, innovation, functionality and strong customer service. According to a 2004 study commissioned and paid for by us and conducted by Harris Interactive, in 2004 Eddie Bauer had the second highest aided brand awareness among six U.S. casual apparel retailers that target adults, including Gap, Banana Republic, L.L. Bean, Lands’ End and J. Crew. Aided awareness is defined as a person’s expressing familiarity with a brand when it is read from a list. In addition, DNR magazine ranked the Eddie Bauer brand as the 20th best-known men’s brand among the top 50 best known brands in its November 21, 2005 issue. In our efforts to reintroduce customers to our brand and target new customers, we plan to leverage our existing brand awareness and established reputation.
 
Recognized strength in outerwear.  We believe that Eddie Bauer has consistently been recognized for its high quality, outdoor-inspired outerwear collections. In 1936, we manufactured our first quilted goose down insulated garment, the Skyliner jacket, which was patented in 1940. Throughout our history, we have outfitted notable scientific and exploratory expeditions in Eddie Bauer outerwear. For example, Jim Whittaker was wearing Eddie Bauer outerwear when he became the first American to summit Mt. Everest in 1963. We continue to be named among the top outerwear brands — in July 2006, Eddie Bauer was ranked third among the top 10 best-known outerwear brands by Women’s Wear Daily. We intend to continue to use our recognized strength in outerwear as we design and market our outerwear apparel to serve our existing customers and attract new customers.
 
Already focused on desirable market segment.  We believe that our brand appeals most to upscale customers between the ages of 30 and 54. We believe this segment provides an attractive growth opportunity for us. We traditionally have focused on this segment which we believe provides us with a competitive advantage over many of our competitors who are expanding their marketing strategies and product offerings as well as starting new concepts to appeal more to this segment.
 
Integrated distribution network.  We allow customers to order our products through our retail and direct sales channels and return or exchange products at any of our retail or outlet stores, regardless of the channel of purchase. In addition, our U.S. stores offer a direct phone connection to our customer call centers that allows an in-store customer to order for home delivery a specific item, color or size that may not be available in the store. We believe these conveniences increase customer loyalty and strengthen our brand awareness, while increasing our sales across all of our channels. This integrated distribution network allows us to expand our product offering by allowing us to offer a wider range of sizes through our catalogs and websites while also providing us with tools to manage our store inventory levels.
 
Ability to control inventory in our direct channel.  We target our best customers to receive preview catalogs with incentives to purchase items prior to the official launch of a new season. We use the customer response to these preview catalogs to adjust our product offerings in our direct channel and to plan more accurately inventory commitments and assortments.
 
Licensing opportunities support our modern outdoor lifestyle brand image while providing an additional stream of revenue.  We license the Eddie Bauer name to various consumer product manufacturers and other retailers whose products complement our modern outdoor lifestyle brand image. We currently license the Eddie Bauer name for use with infant products, luggage and travel accessories, SUV models, camping gear and home furnishings among other things. We believe that these licensing opportunities not only enhance and extend our lifestyle brand, but also provide another source of revenue. We received approximately $15.7 million in royalty revenues in fiscal 2006 from our licensing arrangements.
 
 
We intend to continue our turnaround and improve our operating results through the following key business strategies:
 
Revitalizing our brand.  We believe we need to reestablish Eddie Bauer as a brand that represents premium quality products for the modern outdoor lifestyle. We are building on our Eddie Bauer heritage and offering products that are relevant to our core customers and attractive to new customers. We are modifying


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our product assortment in a manner designed to more clearly embrace the heritage of the Eddie Bauer brand while meeting the evolving desires of our customers. We believe these actions should revitalize our brand, capture new customers and continue to interest our core customers.
 
Increasing sales and productivity across both of our channels.  We intend to increase sales per square foot realized in our retail stores through several means, including increased traffic and conversion at our retail stores. We believe that approximately 5,500 square feet is the appropriate size for most of our retail stores, (which does not include our outlet stores) because we believe this size allows us to achieve the correct balance among product assortment, displays, inventory and sales. As of December 30, 2006, approximately 55% of our stores are within plus or minus 15% of our model store size. We are in the process of realigning our remaining retail stores as opportunities arise, mainly through down-sizing retail stores and opening new retail stores in select locations based on a more uniform size and configuration that we believe will improve the sales per square foot realized in the retail store. We are also seeking to increase the sales per square foot realized in our retail stores by, among other things, emphasizing our outdoor heritage and offering both updated popular styles and products that feature improved fit and higher quality fabric, trim and hardware and come in a variety of sizes including petite, tall and plus to drive traffic and conversions. We intend to increase sales through our direct channel by balancing our product assortment, revising our product presentation to better appeal to our direct customers and improving our circulation strategy through the use of new models and lifetime value to increase the profitability of our circulation.
 
Augmenting our management team.  With the recent departure of Fabian Mansson, our former chief executive officer who resigned on February 9, 2007, we retained Spencer Stuart, one of the world’s leading executive search firms, to lead the search for a new chief executive officer and a permanent chief financial officer. Howard Gross, a member of our Board of Directors, is currently serving as our interim chief executive officer. From 1996 to 2004, Mr. Gross served as president and chief executive officer of HUB Distributing, Millers Outpost and Levi’s Outlet Stores of the American Retail Group, Inc. From 1994 to 1995, Mr. Gross served as the president and chief operating officer of Today’s Man, Inc. Formerly, Mr. Gross spent over 20 years at Limited Brands, Inc., where he held various positions, including president of Victoria’s Secrets Stores and president of the Limited Stores. We are also renewing our efforts to recruit additional executives to complete our senior management team, including a chief operating officer, senior vice president of human resources and vice president of direct.
 
Optimizing productivity of our back-end operations.  As a result of the Spiegel reorganization process, we inherited many back-end infrastructure operations that we are in the process of streamlining to better fit our business and to reduce costs. For example, we seek to improve our sourcing operations by reducing the number of vendors and countries from which we source to attain volume pricing and more consistent quality. We also aim to make our distribution center more productive and to improve our inventory control through better planning and coordination of our design, sourcing, distribution, planning and allocation operations.
 
Improving the customer experience.  We plan to improve the customer experience in each of our sales channels to increase sales across our entire business. In our stores, we aim to create appealing window arrangements to make our stores more interesting and drive traffic into our stores. In addition, we are aggressively focused on initiatives enhancing customer service, and customer service associates audit our progress by posing as shoppers and evaluating stores. Our aim is to establish a consistent store image to create a familiar look and feel in each store. In our direct channel, we intend to improve the presentation of our redesigned apparel lines in our catalogs and on our websites by highlighting individual products, tightening the focus of our catalog and Internet marketing to customers who we believe fit our target profile, using more brand appropriate photography and by replenishing our customer database, which was severely impacted by the liquidation of First Consumers National Bank, or FCNB. See “— The Spiegel Bankruptcy” for more details. We also seek to continuously improve the quality of service in our stores and at our call centers to be more responsive to customer questions and comments.
 
Increasing Customer Loyalty.  We recently launched our first full-scale customer loyalty program, Eddie Bauer Friends, for Eddie Bauer customers. The loyalty program allows customers in the United States to accrue points that may be redeemed for Eddie Bauer reward certificates or used toward acquiring special


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Eddie Bauer merchandise at www.eddiebauerfriends.com. For every dollar spent on Eddie Bauer products, a member of the loyalty program receives loyalty points. Members who hold Eddie Bauer credit cards are eligible for bonus points. Members who hold Eddie Bauer credit cards are also eligible to participate in exclusive online auctions for special items, such as outdoor vacations, resort getaways, electronics, day spa retreats and more, using their points. We believe that the program will be a valuable tool in driving customer purchases and fostering customer loyalty while facilitating our ability to track and market to our customers.
 
 
Our in-house design team aims to create products that reinforce our brand image by designing and merchandising products that incorporate quality fabrics and construction as well as provide comfortable, consistent fits and relevant detailing for men and women.
 
The design process begins with our designers’ development of four seasonal collections 10 to 12 months in advance of each season. Our design team regularly travels nationally and internationally to develop color, fabric and design ideas. Once the design team has developed a season’s color palette and design concepts, they build a complete prototype sample collection to evaluate the details, such as how color takes to a particular fabric, how a fabric performs to our fit specifications, and the overall look and feel of the garment with our coordinated accessories.
 
Merchants provide our design team with periodic updates regarding the results of product performance. This feedback helps guide the designers as they create and update products for upcoming seasons. Our design process is iterative, with regularly scheduled sessions between the merchandising and design groups to ensure that new products meet internal and customer expectations.
 
Our designers then create a sample collection and present it in a still life presentation format so our merchandising teams can select which items to market in each of our sales channels and edit the collection as necessary to increase its commercial strength. Our teams communicate regularly and work closely with each other to leverage market data, ensure the quality of our products and remain true to a unified brand image. Our technical design teams develop construction and fit specifications for every product, ensuring quality workmanship and consistency across product lines. We are able to efficiently offer an assortment of styles within each season’s line while still maintaining a unified brand image, because our product offerings originate from a single concept collection. As a final guarantee of brand image consistency, senior management reviews the four seasonal collections before selections are finalized.
 
Apparel products designed for our outlet stores generally follow a design and merchandising process similar to core products designed for our retail stores, with the same level of quality and fit, but with slightly less expensive fabrics and trims.
 
 
We distribute our apparel and accessories through our retail channel, which consists of our network of retail and outlet stores, and through our direct channel, which consists of our Eddie Bauer catalogs and our websites located at www.eddiebauer.com and www.eddiebaueroutlet.com.
 
 
In fiscal 2006, our retail channel generated net merchandise sales of $700.1 million, comprising 73.2% of our net merchandise sales.
 
Retail Stores.  Our retail stores generated net merchandise sales of $455.4 million in fiscal 2006, comprising 47.6% of our net merchandise sales. Our retail stores are generally located in regional malls and lifestyle centers and in metropolitan areas. We also have stores in smaller markets where we believe concentrations of our target customers exist. We believe situating our stores in desirable locations is key to the success of our business, and we determine store locations based on several factors, including geographic location, demographic information, presence of anchor tenants in mall locations and proximity to other


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specialty retail stores that target a similar demographic. Our retail stores are designed and fixtured to create a distinctive and inviting atmosphere, with clear displays and information about product quality and fabrication.
 
We believe that approximately 5,500 square feet is the appropriate size for most of our retail stores, as we believe this size allows us to achieve the correct balance between product assortment, inventory and sales. As of December 30, 2006, approximately 55% of our retail stores are within plus or minus 15% of our model retail store size. We are in the process of realigning our remaining retail stores as opportunities arise, mainly through down-sizing and opening new retail stores in select locations with a more uniform size and configuration that we believe will improve the sales per square foot realized in the retail store. Additionally, we intend to increase the sales per square foot and comparable store sales by, among other things, offering products featuring improved fit and higher quality fabric, trim and hardware and emphasizing our outdoor heritage to drive traffic and conversion.
 
We train our retail sales associates to provide a high standard of customer service and to create appealing head-to-toe outfit displays to show our customers how to wear our apparel to encourage multiple purchases by customers. To provide our sales associates with an incentive to deliver superior customer service and to drive sales, each retail sales associate’s compensation consists of a base hourly rate supplemented by eligibility for incentive bonuses based on overall store performance. Our associates are eligible to earn an incentive based on monthly store sales thresholds, payable after the end of each month in which the threshold sales goal has been met. We believe our compensation policies enable us to maintain high standards of customer service in our stores.
 
As of December 30, 2006, we operated 243 retail stores in the U.S. and 36 in Canada. In order to increase our net merchandise sales we intend to close under-performing retail stores as their leases expire and open new retail stores. The number of stores we ultimately open during any given year will depend on our ability, among other things, to obtain suitable locations on favorable terms, our working capital position and requirements, general economic conditions and the terms of our debt agreements. See “Item 2. Properties” and “Item 1A — Risk Factors — Risks Relating to our Business — If we cannot negotiate leases on reasonable terms, our business would be adversely affected.” In fiscal 2007, we intend to open approximately 22 additional retail stores and expect to close 29 retail stores, all of which were closed in January 2007.
 
Outlet Stores.  Our outlet stores generated net merchandise sales of $244.8 million in fiscal 2006, comprising 25.6% of our net merchandise sales. Our outlet stores target customers seeking Eddie Bauer apparel at lower prices. Our outlet net merchandise sales consist of apparel designed exclusively for the outlet stores and excess inventory from our retail stores, and we regularly monitor this mix. Apparel products designed for our outlet stores leverage the same design process, brand image principles and quality standards, as apparel sold in our retail stores, but with less expensive fabrics and hardware. Outlet products typically are priced at least 20% to 40% below full retail store product prices.
 
As of December 30, 2006, we operated 115 outlet stores in the U.S. Our outlet stores are located predominantly in outlet centers, value strip centers and “destination” outlet areas such as Palm Springs, California, and Hilton Head, South Carolina. See “Item 2. Properties.” In fiscal 2007, we expect to open approximately 11 additional outlet stores and expect to close one outlet store, which closed in January 2007.
 
Sales associates in our outlet stores adhere to customer service practices similar to our retail stores, and are trained to provide similar services to those provided in our retail stores. The compensation policies for our outlet sales associates are the same as those of our retail sales associates.
 
 
In fiscal 2006, our direct channel generated net merchandise sales of $256.5 million, comprising 26.8% of our net merchandise sales. We believe that the increasing trend of consumers shopping via the Internet will drive growth in our Internet sales, offsetting anticipated declines in our catalog sales. Our direct channel consists of our catalog and website operations, both of which we believe reinforce our brand image and drive sales across both of our sales channels. Our catalogs and websites offer the broadest assortment of available colors, styles and sizes, including petite, tall and plus, as well as certain products, such as swimwear, dresses


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and footwear, that are not available in our stores. Our U.S. stores offer a direct phone connection to our customer call centers that allows an in-store customer to order for home delivery a particular size, color or item that may not be available in the store. We account for these sales under direct channel sales. In addition, our website and catalogs are linked through our “Catalog Quick Order” feature, which allows a customer to input a catalog item number to place an order on the website.
 
As of December 30, 2006, we maintained a customer database of approximately 8.0 million customers, of which approximately 3.1 million were households that had purchased from us at least once in the past 12 months, and approximately 1.8 million were customers with e-mail addresses who receive regular promotional e-mails from us. We update our customer database on a continuous basis. Our customer database enables us to analyze customer purchases by numerous metrics, including frequency and average transaction size, which allows us to implement more advanced circulation and strategic marketing programs. We focus on continually improving the segmentation of our customer database and the acquisition of additional customer names from several sources, including our retail stores, our websites, list rentals and list exchanges with other catalog companies.
 
Catalogs.  In fiscal 2006, we distributed 28 catalog editions with a circulation of approximately 80.8 million catalogs. Our top catalog customers receive a new catalog every two to three weeks. In addition, we target our best customers to receive preview catalogs with incentives to purchase items approximately 10 to 12 weeks prior to the official launch of a new season. Customer response to these preview catalogs is important information we use to adjust our product offerings in our direct channel and also enables us to better control inventory commitments and assortments. All creative work on our catalogs is coordinated by our in-house personnel, and we believe this allows us to shape and reinforce our brand image.
 
Websites.  Our www.eddiebauer.com and www.eddiebaueroutlet.com websites were launched in 1996 and 1999, respectively, and allow our customers to purchase our merchandise over the Internet. We design and operate our websites using an in-house technical staff and outside web hosting provider. Our websites emphasize simplicity and ease of customer use while integrating our brand’s modern outdoor lifestyle imagery used in our catalogs. In fiscal 2006, our websites had over 33.7 million visits. Our website has received a number of awards, being named a “Top 50 Best of the Web” online retailing website for 2005 by Internet Retailer in November 2005.
 
We conduct online advertising and send targeted e-mails to reach customers looking to purchase apparel and accessories over the Internet. We are an apparel category partner with AOL. We advertise in AOL Shopping and the apparel categories within that site. Advertising includes banners, Eddie Bauer store listing, AOL Keywords, product feeds and other editorial features. We also advertise on the top three search engines, Google, Yahoo! And MSN, sponsoring pay-per-click listings on brand and product related keywords and keyword phrases. Our online advertising allows us to target many different segments of our customer base without incurring significant marketing costs.
 
 
We participate in two joint ventures, one in Japan and one in Germany that extend the reach of the Eddie Bauer brand. We have granted the joint ventures the right to sell in their markets a mixture of Eddie Bauer apparel and accessories from the U.S. core assortment in addition to products developed by the joint venture partner exclusively for the applicable joint venture. As a minority participant in both of the joint ventures, we do not determine the strategic direction of either joint venture. However, in each case, through board participation and our license agreement, we provide oversight and also retain the right to approve all products offered by the joint ventures that carry the Eddie Bauer brand. We assist both joint ventures in building an appropriate product line, approving new store designs and site locations and ensuring consistency of the Eddie Bauer brand.
 
We provide the joint ventures with access to our designs, sourcing network, marketing materials, catalog photography, page layouts and general operational knowledge. In exchange, we receive a royalty payment on all products sold plus our share, as an equity holder, in the earnings or losses of each joint venture. As of


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December 30, 2006, our equity investment balances were approximately $12.9 million and $3.1 million in Eddie Bauer Japan and Eddie Bauer Germany, respectively.
 
 
Eddie Bauer Japan reported joint venture net sales of $128.8 million in fiscal 2006. As of December 30, 2006 we had contributed approximately $8.6 million to the joint venture (net of dividends received of $0.7 million). In fiscal 2006, we received approximately $4.6 million in royalties from the joint venture and recorded income of approximately $0.8 million for our equity share.
 
We own 30% of Eddie Bauer Japan, a joint venture with Otto-Sumisho, Inc. (a joint venture company of Otto KG, a former Spiegel affiliate, and Sumitomo Corporation). As of December 30, 2006, Eddie Bauer Japan operated 40 retail stores and nine outlet stores, distributed 11 major catalogs annually and operated a website located at www.eddiebauer.co.jp. A substantial majority of the products sold by Eddie Bauer Japan are Eddie Bauer products while the remaining products are developed exclusively for the joint venture. Eddie Bauer Japan sources the U.S.-designed Eddie Bauer products primarily from our principal sourcing agent, Eddie Bauer International, Ltd., a subsidiary of Otto KG. Eddie Bauer Japan sources the majority of its exclusive products from outside vendors, but we retain the right to approve all vendors under the guidelines of our Global Labor Practices Program. See “— Our Product Sourcing — Our Global Labor Practices Program.”
 
 
Eddie Bauer Germany reported joint venture net sales of $60.1 million in fiscal 2006. As of December 30, 2006, we had contributed approximately $17.6 million to the joint venture (with no dividends received). In fiscal 2006, we received approximately $2.0 million in royalties from the joint venture and recorded a loss of $4.2 million for our equity share.
 
We own 40% of Eddie Bauer Germany, a joint venture with Heinrich Heine GmbH and Sport-Scheck GmbH (both former Spiegel affiliates and subsidiaries of Otto KG). As of December 30, 2006, Eddie Bauer Germany operated seven retail stores and two outlet stores, distributed six major catalogs annually and operated a website located at www.eddiebauer.de. As a result of weak retail sales due partially to a continued poor apparel retail market in Germany, in January 2007 Eddie Bauer Germany made the decision to close all of its retail stores. We anticipate that all Eddie Bauer Germany retail stores will be closed by August 2007. Eddie Bauer Germany will continue to sell its products through its catalogs, website and outlet stores. A substantial majority of the products sold in Germany are U.S.-designed Eddie Bauer products while the remaining products are developed exclusively for the joint venture. Eddie Bauer Germany sources the traditional Eddie Bauer products primarily from Eddie Bauer International, Ltd. Eddie Bauer Germany sources the products that are developed exclusively for Eddie Bauer Germany from outside sources, but we retain the right to approve all vendors under the guidelines of our Global Labor Practices Program. See “— Our Product Sourcing — Our Global Labor Practices Program.”
 
 
We selectively license our brand name and logo to be included on products sold by other companies to enhance and extend the Eddie Bauer brand. We received $15.7 million in royalty revenues in fiscal 2006 relating to our licensing arrangements.
 
We seek licensees who are leaders in the outdoor, juvenile, home, SUV and personal categories. We typically enter into multi-year license agreements with one licensee per product category to prevent price competition and market saturation of our brand. Our top performing licenses by royalty revenues received for fiscal 2006 were Cosco Management, Inc. (a subsidiary of Dorel Industries Inc.) for infant and juvenile car seats and strollers; Skyway Luggage Company for luggage and travel accessories; Ford Motor Company, which uses the Eddie Bauer name and logo on premium Explorer and Expedition models; American Recreation Products, Inc. for camping gear; Lowe’s Companies for home products; and Franco Apparel Group for juvenile clothing. In each of our licensing arrangements, we work closely with our licensees and have a final right of approval to ensure our brand is consistently presented.


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As part of our emergence as a stand-alone company, we have closed our Eddie Bauer Home operations and are pursuing additional licensing opportunities in the home furnishings category.
 
 
 
We design our marketing strategy to present a consistent and unified brand image grounded in our outdoor heritage to increase traffic, purchase frequency and sales through both of our sales channels and create an emotional connection between our target customers and the Eddie Bauer brand. Our target customers are women and men, ages 30-54 who desire high quality outdoor-inspired casual sportswear. We believe that our customers lead a busy, engaged lifestyle and expect to find easy, comfortable and stylish apparel and non-apparel solutions from Eddie Bauer. Our goal is to create marketing campaigns to amplify our seasonal merchandising messages and to make our target customers aware of new merchandise, special events and sale offers. Our primary methods of driving traffic to our sales channels are extensive catalog and e-mail circulation, product presentation in our store windows, mall advertising and online advertising. Through the efforts of our public relations department, we also receive uncompensated product coverage from independent publications such as Oprah, In Style and Men’s Journal. This coverage features our new merchandise and we believe further solidifies our brand image. We believe that our licensing arrangements also extend and enhance the reach of the Eddie Bauer brand.
 
To increase purchasing frequency, we utilize our customer database of approximately 8.0 million customers to monitor customer purchase patterns so we can better target segments of our customer database with specific marketing programs. We believe that our direct mail programs and e-mails allow us to further strengthen our current customer relationships on a monthly basis and to attract lapsed customers to shop the brand again. In addition to our own database, we regularly send catalogs to third party databases to attract new customers to the brand. We also seek to increase customer loyalty with special programs for our private label credit card holders and loyalty programs in the U.S. and Canada that provide incentives for customers to shop more at Eddie Bauer.
 
Marketing expenses accounted for 9.9% (including catalog production costs) of our net merchandise sales in fiscal 2006.
 
 
We also seek to increase customer loyalty and sales by offering customers our private-label Eddie Bauer credit card through a third party, World Financial Network National Bank (“WFNNB”), a subsidiary of Alliance Data Systems. Customers apply for the Eddie Bauer credit card, and if approved in accordance with WFNNB’s credit criteria policies, customers can use the Eddie Bauer credit card in either of our sales channels. WFNNB services include establishing credit criteria for customer acquisition, issuing and activating new cards, extending credit to new cardholders, authorizing purchases made with Eddie Bauer credit cards, as well as offering customer care, billing and remittance services. From time to time, we offer these cardholders exclusive offers, as well as advance notice of in-store promotional sales events. As of December 30, 2006, we had approximately 660,000 customers who had used the Eddie Bauer credit card at least once in the past 12 months. Sales using our credit card, after discounts, comprised approximately 14% of our total net merchandise sales in fiscal 2006.
 
Through arrangements with WFNNB, we expect to continue to replenish our customer database, which was depleted as we lost high-risk, low-credit customers in connection with the liquidation of First Consumers National Bank, or FCNB, which was the special-purpose bank that offered private-label credit cards imprinted with an Eddie Bauer, Newport News or Spiegel logo to qualifying customers as well as MasterCardtm and Visatm bankcards to the general public. For more information, see “— The Spiegel Bankruptcy.”


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We do not own or operate any manufacturing facilities and instead contract with third-party sourcing agents and vendors for sourcing and manufacturing of our merchandise. Our sourcing strategy emphasizes the quality fabrics and construction that our customers expect of our brand. To ensure that our standards of product quality and timely product delivery are met, we take the following actions:
 
  •  we retain close control over our product quality, design and costs by designing and developing most clothing and accessory products in-house;
 
  •  we work with a select group of sourcing agents and vendors, directly negotiate product cost with our vendors and send detailed specification packages to these sourcing agents and vendors;
 
  •  we inspect pre-production samples, make periodic site visits to our vendors’ factories and selectively inspect inbound shipments at our distribution center; and
 
  •  we establish quality standards at our headquarters in Redmond, Washington, that are included in our policies with these sourcing agents and vendors and enforced by our associates.
 
We have four sourcing seasons per year and typically place orders with our vendors approximately six months prior to the initial sale date, with approximately 11 to 12 weeks for reorders and seven to nine weeks for replenishment of our basic non-seasonal items. We use a similar sourcing calendar for each of our sales channels. We purchase approximately 85% to 90% of inventory for our stores in advance so as to permit all of our stores to have sufficient product to support demand. In the case of direct sales, we purchase only approximately 70% to 75% of inventory in advance because we can better gauge anticipated demand for products through our preview catalog, which we send to customers approximately 10 to 12 weeks in advance of a season’s product launch.
 
We believe our sourcing strategy maintains our strict quality control standards while allowing us to enhance our speed to market to respond to our customers’ preferences.
 
 
For fiscal 2006, on a purchase value basis, we sourced approximately 84% of our products through our main sourcing agents, Eddie Bauer International, Ltd. (“EBI”) (72%) and Eddie Bauer International (Americas), Inc. (“EBI Americas”) (12%), approximately 14% of our merchandise (primarily non-apparel and swimwear) direct or from domestic importers and the remainder (primarily footwear and home products) through other buying agents. EBI is a subsidiary of Otto International (Hong Kong) Ltd. (“OIHK”), and EBI Americas is a subsidiary of Otto International GmbH, both former affiliates of Spiegel, and we license our name to both entities.
 
In June 2006, we ended our sourcing arrangement with EBI Americas. In connection with the termination of this arrangement we expanded our in-house procurement capabilities to perform this sourcing. We hired eight additional associates in fiscal 2006 and anticipate hiring an additional associate in fiscal 2007 in connection with this expansion. We do not believe that this arrangement has impacted our ability to source products from the Americas and Caribbean as we have existing relationships with vendors in these areas. The termination of this arrangement resulted in net cost savings of approximately $0.1 million in fiscal 2006. We anticipate achieving additional annual net cost savings on a going forward basis as a result of taking this process in-house.
 
EBI maintains an office in Hong Kong and sources merchandise primarily from Asia. We are EBI’s sole customer, although the parent company, Otto Asia Holding KG and affiliates provide similar buying agency services for third parties and affiliates of Otto. EBI provides various services to us, including market research, product development, vendor screening, quality control standards implementation, labor compliance reviews, product delivery scheduling, and vendor stability. EBI operates on a commission-rate basis and our


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arrangements with EBI are automatically renewed each year, unless terminated by either party upon one year written notice.
 
 
As of December 30, 2006, our sourcing network consists of more than 200 vendors, who operate in 35 countries. In 2006, our largest countries of import were China (31% of total imports, of which 12% were from Hong Kong), Thailand (10% of total imports), Mexico (9% of total imports) and Sri Lanka (8% of total imports). In fiscal 2006, our top 30 vendors supplied approximately 70% of our total vendor purchases and no single vendor supplied more than 5% of our total vendor purchases. Our top 30 vendors have supplied us for an average of approximately nine years. We believe our long-term relationships with our vendors have also provided us with the ability to resolve supply issues efficiently and negotiate favorable pricing terms over time, further improving our overall cost structure. We intend to improve our sourcing operations by reducing the number of vendors and countries from which we source to attain volume pricing and more consistent quality.
 
Substantially all of our vendors that are sourced through EBI are paid pursuant to a Vendor Payment Services Agreement we have entered into with OIHK. Pursuant to this arrangement, OIHK pays our vendors the purchase price for inventory, less a volume discount and a small transaction fee paid by the vendor, typically within seven days of the receipt of purchase orders and certain other purchase documents from our buying agent. We typically reimburse OIHK in advance of payment to a vendor. This arrangement is beneficial to the vendors as it ensures prompt payment and is beneficial to us as it is less expensive than obtaining a letter of credit for each vendor from whom we source products. Our other vendors are paid directly by us. Substantially all of our foreign purchases are negotiated and paid for in U.S. dollars.
 
 
Established in 1995, our Global Labor Practices Program involves internal training and supplier education, evaluation and corrective action of vendor factories for compliance, and seeks to protect and promote workplace human rights. Our standards include prohibitions against forced labor, child labor, harassment and abuse. They also address non-discrimination, health and safety, freedom of association and collective bargaining, wages and benefits, hours of work, overtime compensation and environmental standards. All of our vendors who manufacture products for us must agree to comply with our Global Labor Practices Program. Our sourcing agent, EBI, and external monitors also conduct annual vendor audits on our behalf.
 
Since 2001, we also have been active participants in the Fair Labor Association, or FLA, a non-profit organization and monitoring system established to protect the rights of workers and improve working conditions worldwide. FLA enhancements to our Global Labor Practices Program include more systematic risk assessment, identification of best practices, collaboration on workplace improvements, expanded factory inspections, outreach to special interest groups knowledgeable about local issues, use of external auditors and public reporting by FLA on our compliance program. In May 2005, our Global Labor Practices Program was accredited by the FLA, signifying that we are in substantial compliance with FLA requirements to implement a rigorous workplace code of conduct in apparel factories making our products. In evaluating our program for accreditation, the FLA reviewed factory monitoring of and verification reports regarding supplier facilities conducted by external monitors and verified implementation of monitoring protocols, training programs and an auditing system. In accordance with FLA requirements, our Global Labor Practices Program will be reviewed for re-accreditation every two years.
 
 
 
Our transportation delivery chain is designed to ensure that our products are delivered from our vendors to our distribution centers in a safe, expedient and cost-effective manner. Each overseas vendor sends the finished products to a designated shipper or consolidator who assembles the shipments into containers. On average, shipments are in transit for approximately 30 days. Shipments generally arrive in Tacoma/Seattle and


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then move by rail to our distribution center in Groveport, Ohio, unless they are destined for our Canadian retail stores, in which case they generally arrive in Vancouver, British Columbia, and move by rail to our distribution center in Vaughan, Ontario. Domestic vendors generally use common carriers to deliver our products to the appropriate distribution center. The typical time from completion of product by the manufacturer, shipping, customs clearance, warehouse receipt, quality assurance inspection and outbound shipping from our distribution centers to stores is approximately six weeks.
 
We typically use United Parcel Service (“UPS”) for delivering shipments from our distribution center in Groveport, Ohio, to our retail and outlet stores across the U.S. and for expedited and non-U.S. shipments to our customers. All U.S. ground shipments originating from our catalogs or website are delivered to our customers by the United States Postal Service (“USPS”).
 
 
Pursuant to the Plan of Reorganization, we acquired a 2.2 million square foot distribution center in Groveport, Ohio, that was formerly owned by Spiegel. This distribution center handles logistics and distribution for our U.S. stores and worldwide direct channel operations. As part of our strategy, we aim to make this distribution center more productive. We also lease a 97,200 square foot distribution center in Vaughan, Ontario, to support our Canadian stores. Our Vaughan, Ontario, lease is scheduled to expire in April 2008. As of December 30, 2006, approximately 606 associates were employed by our distribution centers, consisting of 583 associates in Groveport and 23 associates in Vaughan, with the number of associates typically increasing in the fourth quarter to handle larger processing volume during the Holiday season.
 
 
As part of the Plan of Reorganization, we assumed the lease of a 37,815 square foot customer call center in Saint John, New Brunswick, Canada. In fiscal 2006, we supported approximately 2.4 million customer calls, and 3.2 million customer contacts. Our lease expires in May 2011. In August 2005, we opened a secondary call center within our distribution center in Groveport, Ohio, to primarily handle seasonal overflow and provide disaster recovery capabilities. As of December 30, 2006, approximately 427 associates were employed by our call centers, consisting of 357 associates in Saint John and 70 associates in Groveport, with the number of associates typically increasing in the fourth quarter to handle larger processing volume during the Holiday season.
 
 
Pursuant to the Plan of Reorganization, we acquired an approximately 50,000 square foot information technology center in Westmont, Illinois, that houses all of our information systems relating to product development, merchandising, marketing, planning, store operations, sourcing, finance, accounting, call centers, Internet, inventory and order fulfillment. As of December 30, 2006, approximately 123 associates were employed by the information technology center, with 104 located in Westmont, Illinois and 19 located in our Redmond and Groveport facilities. Our websites are hosted by a third party at its data center. We maintain a disaster recovery plan that can be implemented in the event we lose our capacity to perform daily data operations. All critical data is backed up and sent off site on a daily basis specifically for recovery purposes. We have contracted with a disaster recovery vendor to provide the necessary computing equipment at a hot site so that operations can be restored. We test the plan periodically to ensure its validity.
 
 
The retail apparel industry is highly competitive. We believe that the primary competitive factors in the industry are brand recognition, the selection, availability, quality and fit of products, the ability to anticipate and react to changing customer demands and fashion trends in a timely manner, price, effectiveness of marketing and advertising, and effectiveness of customer service. We compete with a variety of retailers, including national department store chains, national and international specialty apparel chains, global discount chains, outdoor specialty stores, catalog businesses, sportswear marketers and online businesses that sell


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similar lines of merchandise. In the United States, our retail stores compete primarily with other specialty retailers, such as Ann Taylor, Banana Republic, Talbots, Chico’s, Coldwater Creek, Gap, J. Crew, J. Jill and Timberland and national department store chains such as Macy’s and Nordstrom. We also compete with catalog businesses such as L.L. Bean and Lands’ End and outdoor specialty stores such as Columbia Sportswear, North Face, Patagonia and REI. In Canada, we compete primarily with retail stores such as Bluenotes and Roots, as well as various national and international department store chains. Our outlet stores compete with the outlet stores of other specialty retailers such as Ann Taylor, Banana Republic, Gap, J. Crew and Ralph Lauren/ Polo, as well as with other value-oriented apparel chains and national department store chains.
 
We believe that our primary competitive advantages are customer recognition of the Eddie Bauer brand name, our established position in the 30 to 54 year-old market, our integration of our two sales channels, our broad base of licensing relationships and our satisfaction guarantee. We believe that we also differentiate ourselves from competitors on the basis of our tradition of offering outdoor-inspired clothing and accessories, particularly in the outerwear category, our focus on the quality of our product offerings and our customer-service oriented culture. We believe our success depends in substantial part on our ability to anticipate, gauge and react in a timely manner to changing consumer preferences which, in turn, allows us to drive traffic to our channels, increase purchase frequency and improve conversions.
 
Many of our competitors may have greater financial, distribution, logistics and marketing resources than us. In addition, many of our competitors are not in the early stages of trying to stabilize their business and revitalize their brand. Many of our competitors therefore may be able to adapt to changes in customer requirements more quickly, devote greater resources to the design, sourcing, distribution, marketing and sale of their products, generate greater national brand recognition or adopt more aggressive pricing policies than we can.
 
For information on the primary factors on which we compete and the risks we face from competition, see “Risk Factors — Risks Relating to Our Industry — If we cannot compete effectively in the apparel industry our business and financial condition may be adversely affected” under Item 1A.
 
 
We are a seasonal business, with our sales and earnings peaking during the fourth quarter, particularly during the November through December Holiday periods. In addition, we typically experience higher sales of men’s products and accessories in June for Father’s Day. As a result of our seasonal sales patterns, we increase our inventory levels during these selling periods.
 
 
Substantially all of our global trademarks are owned by Eddie Bauer, Inc. As of December 30, 2006, we had over 80 trademark registrations and pending trademark applications in the U.S. and over 275 registered trademarks and 30 pending trademark applications in foreign countries. Our pending trademark applications may not result in issued trademark registrations. Our trademarks include Eddie Bauer®, EBTek®, Eddie Bauer Adventurer®, the Eddie Bauer signature logo, the Eddie Bauer goose logo and various other marks used in our business.
 
We regard our trademarks as key assets and believe they have substantial value in the marketing of our products. We protect these trademarks by registering them with the U.S. Patent and Trademark Office and with governmental agencies in other countries, particularly where our products are manufactured and/or sold. We work vigorously to enforce and protect our trademark rights by engaging in monitoring services, issuing cease-and-desist letters against third parties infringing or denigrating our trademarks and initiating litigation as necessary. We also work with trade groups and industry participants seeking to strengthen laws relating to the protection of intellectual property rights in markets around the world. We also grant licenses to other parties to manufacture and sell certain products with our trademarks.


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As of December 30, 2006, we had approximately 2,457 full-time associates and 7,156 part-time associates in the U.S. and Canada. As a result of our seasonal sales patterns, we hire additional temporary staff at our retail stores and at our distribution and call centers during the fourth quarter. Our associates are not represented by unions and are not covered by any collective bargaining agreements. We have had no labor-related work stoppages, and we consider relations with our associates to be good.
 
 
 
We are subject to federal, state and local laws and regulations affecting our business, including those related to labor, employment, worker health and safety, environmental protection, products liability, product labeling, consumer protection, privacy and anti-corruption. These laws include the Occupational Safety and Health Act, the Consumer Product Safety Act, the Trade Act of 2003, the Flammable Fabrics Act, the Textile Fiber Product Identification Act, the Foreign Corrupt Practices Act and the rules and regulations of the Consumer Products Safety Commission and the Federal Trade Commission. We also voluntarily participate in the Customs — Trade Partnership Against Terrorism (“C-TPAT”) and expect to receive our validation in the near future. We also are subject to import and export laws, including U.S. economic sanction and embargo regulations and other related laws such as the U.S. anti-boycott law and the U.S. export controls regulations.
 
 
We are subject to Canadian and other foreign laws and regulations affecting our business, including those related to labor, employment, worker health and safety, environmental protection, products liability, product labeling, consumer protection and anti-corruption. Our operations are also subject to international trade agreements and regulations such as the North American Free Trade Agreement, the Central American Free Trade Agreement, the Caribbean Basin Initiative and the European Economic Area Agreement and the activities and regulations of the World Trade Organization (“WTO”). Generally, these trade agreements have positive effects on trade liberalization and benefit our business by reducing or eliminating the duties and/or quotas assessed on products manufactured in a particular country.
 
In addition, all of our import operations are subject to tariffs and quotas set by governments through mutual agreements or bilateral actions. Countries in which our products are manufactured or imported may from time to time impose new or additional quotas, duties, tariffs or other restrictions on our imports or adversely modify existing restrictions.
 
Our business was not materially affected by the elimination of quotas on textile and apparel imports by WTO member countries at the end of 2004 from developing countries which historically have lower labor costs, including China, because the U.S. and other WTO members re-imposed “safeguard” quotas on specific categories of products from China. We also receive a small portion of our products from Vietnam, which is not a member of the WTO, and we therefore are still subject to quotas for products imported from Vietnam.
 
We believe we are in substantial compliance with all U.S. and foreign regulations that apply to our business.
 
THE SPIEGEL BANKRUPTCY
 
 
As part of the Spiegel group, Eddie Bauer, Inc. was one of three principal merchant divisions, along with Spiegel Catalog, Inc., which primarily offered private-label and branded apparel and home merchandise through catalogs, and Newport News, Inc., a direct marketer of moderately priced women’s fashions and home furnishings.


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Spiegel’s principal source of liquidity was FCNB, its special-purpose bank that offered private-label credit cards imprinted with an Eddie Bauer, Newport News or Spiegel logo to qualifying customers as well as MasterCardtm and Visatm bankcards to the general public. A principal source of liquidity for the Spiegel group was FCNB’s ability to sell substantially all of the private-label credit card and bankcard receivables to securitization vehicles, which in turn financed their purchase of the receivables by selling asset-backed securities to investors. In the ordinary course of business, the securitization vehicles returned a significant portion of the proceeds of collections on the receivables to FCNB in exchange for the deposit of additional receivables. FCNB used these proceeds to reimburse the merchant divisions for charges made with the private-label credit cards.
 
On March 17, 2003, Spiegel, together with 19 of its subsidiaries and affiliates, including Eddie Bauer, Inc., filed petitions for relief under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court of the Southern District of New York. We collectively refer to the entities party to the bankruptcy proceedings as the “Debtors.” FCNB, Spiegel Acceptance Corporation (“SAC”) and Financial Services Acceptance Corporation (“FSAC”) were not Debtors. The bankruptcy court confirmed the Amended Joint Plan of Reorganization relating to the bankruptcy, which we call the Plan of Reorganization, on May 25, 2005, and the Plan of Reorganization became effective on June 21, 2005.
 
 
During 2001 and 2002, net sales declined at Spiegel’s three merchant divisions, including Eddie Bauer, Inc. In addition, as a result of FCNB’s expansion of credit to high risk, low-credit score customers beginning in 1999, the performance of the credit card receivables declined significantly. These events led to lower liquidity and contributed to the noncompliance by Spiegel and its affiliates with certain financial and other covenants under their financing arrangements.
 
In May 2002, FCNB entered into an agreement with the Office of the Comptroller of the Currency, or the OCC, which required FCNB to comply with certain requirements and restrictions regarding its bankcard business, and in November 2002 the OCC approved a disposition plan for FCNB. As a result of continued declines in the performance and credit quality of the receivables, in March 2003 early amortization (or “pay-out”) events occurred under some of the securitizations, which caused, through cross-default provisions, pay-out events on the other securitizations. As a result, substantially all monthly excess cash flow from the securitizations was diverted to repay principal to investors in the securitization vehicles on an accelerated basis, rather than to pay the cash to FCNB upon deposit of new receivables. Accordingly, the Debtors lost a significant source of liquidity to fund their operations and FCNB was precluded from continuing to securitize new credit card receivables.
 
In March 2003, the merchant divisions ceased honoring the private-label credit cards issued to their customers by FCNB, FCNB discontinued charging privileges on all MasterCardtm and Visatm bankcards issued by FCNB to its customers, and FCNB began the liquidation process required by the OCC. The liquidation of FCNB contributed significantly to our decreased revenues in 2003.
 
Also in March 2003, the SEC commenced a civil proceeding against Spiegel alleging, among other things, that Spiegel’s public disclosures violated the Securities Exchange Act of 1934, as amended, or the Exchange Act. Spiegel entered into a consent and stipulation with the SEC resolving, in part, the claims asserted in the SEC action. Spiegel also consented to the entry of a partial final judgment pursuant to which it agreed, among other things, to the entry of a permanent injunction enjoining any conduct in violation of the Exchange Act and to the appointment of an independent examiner to review its financial records and to report on its financial condition and financial accounting. As part of the settlement, Spiegel neither admitted nor denied the allegations in the SEC’s complaint.
 
In view of the foregoing, Spiegel’s ongoing liquidity crisis, and various additional lawsuits that were filed against Spiegel and certain of its subsidiaries and affiliates, the Debtors concluded that it was in the best interests of their creditors, stockholders and other parties-in-interest for the Debtors to seek protection under the Bankruptcy Code.


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On June 21, 2005, the Plan of Reorganization became effective and:
 
  •  Eddie Bauer Holdings, Inc. was formed as a new holding company to serve as the parent company for Eddie Bauer, Inc. and its subsidiaries;
 
  •  Spiegel transferred to Eddie Bauer Holdings 100% of its ownership interest in Eddie Bauer, Inc., FSAC, SAC, Eddie Bauer Fulfillment Services, Inc. (“EBFS”), and Eddie Bauer Customer Services Inc. (“EBCS”), in exchange for Eddie Bauer Holdings issuance of 30 million shares of common stock to certain unsecured creditors of the Debtors;
 
  •  Eddie Bauer Holdings contributed to Eddie Bauer, Inc. its shares in EBFS and EBCS such that these entities became wholly-owned subsidiaries of Eddie Bauer, Inc.;
 
  •  Eddie Bauer Information Technology, LLC, or EBIT, was formed as a wholly-owned subsidiary of Eddie Bauer, Inc., and Spiegel Management Group, after having transferred all of its assets that did not comprise or support its information services to Spiegel, Inc., merged with and into EBIT;
 
  •  in order to take advantage of tax net operating losses (“NOLs”) available to Eddie Bauer Holdings from FSAC and SAC, we included ownership limitations on our newly issued common stock in our certificate of incorporation and bylaws;
 
  •  we agreed to use commercially reasonable best efforts to become a reporting company under the Exchange Act and cause, as soon as reasonably practicable, our common stock to be quoted on the Nasdaq National Market;
 
  •  we and our U.S. subsidiaries entered into a $300 million senior secured term loan agreement that is secured by a first lien on certain of our real estate assets and trademarks and a second lien on other U.S. assets and a $150 million working capital facility that replaced a debtor-in-possession facility and that is secured by a first lien on our U.S. inventory and U.S. accounts receivables balances and a second lien on all other U.S. assets (other than our real estate). See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sources of Liquidity”; and
 
  •  we issued a nonrecourse promissory obligation to a liquidating trust established for the benefit of the creditors of Spiegel, pursuant to which we are obligated to pay the creditors’ trust 90% of proceeds (as defined in the obligation) received by SAC and FSAC in respect of securitization interests held by either entity in certain pre-petition securitization transactions to which Spiegel and its subsidiaries were a party.
 
Item 1A.   Risk Factors
 
Any of the risks discussed below, as well as any of the other risks described in this Form 10-K, could materially affect our business, financial condition, results of operations and cash flows.  
 
 
 
The retail apparel industry is highly competitive. We compete with a variety of retailers, including national department store chains, national and international specialty apparel chains, outdoor specialty stores, apparel catalog businesses, sportswear marketers and online apparel businesses that sell similar lines of merchandise. Our outlet stores compete with the outlet stores of other specialty retailers as well as with other value-oriented apparel chains and national department store chains.
 
Competition in the retail industry is primarily based on:
 
  •  brand recognition;


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  •  the selection, availability, quality and fit of products;
 
  •  the ability to anticipate and react to changing customer demands and fashion trends in a timely manner;
 
  •  price;
 
  •  effectiveness of marketing and advertising; and
 
  •  effectiveness of customer service.
 
Our competitors may be able to adapt to changes in customer requirements more quickly, devote greater resources to the design, sourcing, distribution, marketing and sale of their products, generate greater national brand recognition or adopt more aggressive pricing policies than we can. If we are unable to overcome these potential competitive disadvantages or effectively place our products relative to our competition, our business and results of operations will suffer.
 
 
The specialty retail apparel industry is heavily dependent on discretionary consumer spending patterns. Our business is sensitive to numerous factors that affect discretionary consumer income, including adverse general economic conditions, changes in employment trends and levels of unemployment, increases in interest rates, weather, acts of war, terrorist or political events, a significant rise in energy prices or other events or actions that may lead to a decrease in consumer confidence or a reduction in discretionary income. In addition, increased fuel costs may discourage customers from driving to our retail and outlet locations, reducing store traffic and possibly sales. Declines in consumer spending on apparel and accessories, especially for extended periods, could have a material adverse effect on our business, financial condition and results of operations.
 
 
Trade restrictions, including increased tariffs or quotas, embargoes, safeguards and customs restrictions against apparel items, as well as U.S., Canadian or foreign labor strikes, work stoppages or boycotts could increase the cost or reduce the supply of apparel available to us or may require us to modify our current business practices, any of which could hurt our business, financial condition and results of operations. Under the World Trade Organization Agreement, effective January 1, 2005, the U.S. and other WTO member countries removed quotas on goods from WTO members, which resulted in an import surge from China. In response, the U.S. in May 2005 imposed safeguard quotas on seven categories of goods and apparel imported from China, and may impose additional quotas. In fiscal 2006, our largest country of import was China with 31% of total imports, of which 12% were from Hong Kong. The extent of this impact, if any, and the possible effect on our sourcing patterns and costs, cannot be determined at this time. We also cannot predict whether any of the countries in which our merchandise is currently manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the U.S., Canadian and foreign governments, nor can we predict the likelihood, type or effect of any such restrictions.
 
 
Many retailers in the apparel industry, including Eddie  Bauer, who are positioned between the high-end luxury segment and the low-end discount segment have been under increasing pressure to reduce prices of their products as a result of increased competition, the increased outsourcing of product manufacturing to countries with lower labor costs, trade liberalization, consolidation among retailers and lower barriers to entry for manufacturers and retailers. This trend is of extra significance to us since, as part of our strategy to revitalize our brand as a premium quality brand, we have added some higher priced items to our product offering. If we are unable to resist the trend towards lower prices, or are unable to sell our higher-priced products, our business, financial condition and results of operations could suffer materially.


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The retail apparel industry is highly seasonal. We generate our highest levels of sales during the fourth quarter, particularly during the November through December Holiday periods, and we typically experience higher sales of men’s products and accessories in June for Father’s Day. Our profitability depends, to a significant degree, on the sales generated during these peak periods. Any decrease in sales or margins during these periods, whether as a result of economic conditions, poor weather or other factors, could have a material adverse effect on our company.
 
 
The apparel industry is characterized by rapidly changing customer preferences and quickly emerging and dissipating trends. If we continue to fail to effectively gauge the direction of customer preferences and anticipate trends, our product offerings may be met with poor customer reception and require substantial discounts to sell. We typically place orders with our vendors approximately six months prior to the initial sale date. Due to this lead time, we have a very limited ability to respond to changes in customer preferences between our order date and initial sale date. If we are unable to successfully identify changes in customer preferences and anticipate customer demand from season to season, or if customer preferences shift away from our line of product offerings, we could continue to experience lower sales, excess inventories, higher mark-downs and decreased earnings. In addition, we will incur additional costs if we need to redesign our product offerings. The occurrence of any of these events may also have a negative effect on our brand name if customers believe we are unable to offer relevant styles. We may respond by further increasing mark-downs or introducing marketing promotions, which would further decrease our gross margins and net income.
 
Risks Relating to Our Business
 
 
Our net merchandise sales have declined during the last several fiscal years, from $1.6 billion in fiscal 2000 to $1.0 billion in fiscal 2006. In addition, comparable store sales have also decreased in 23 of the 28 quarters since the beginning of fiscal 2000. Our customer database has also decreased, from approximately 8.9 million customers at the end of fiscal 2000 to approximately 8.0 million customers as of December 30, 2006. As we discuss in “Item 1. Business — Our Business Turnaround,” we have taken, and intend to take, several strategic, operational and management actions designed to reconnect with our customers and revitalize Eddie Bauer as a premium quality brand. However, we cannot assure you that the changes we have made, or the additional actions we are taking or intend to take, will be successful. For example:
 
  •  our attempt to revitalize the brand by offering a more current and updated look may result in confusion among existing customers;
 
  •  our desire to attract additional female customers may result in the loss of existing male customers;
 
  •  our desire to attract new customers with more current and updated product offerings may result in the loss of some existing customers;
 
  •  our addition of higher priced classifications may drive away existing customers and may not attract new customers;
 
  •  our efforts to increase traffic and sales in our retail stores may not be cost effective; or
 
  •  our marketing efforts to promote our revitalized brand may not be effective.
 
If we cannot successfully revitalize the Eddie Bauer brand, or if the revitalization takes longer than anticipated, our business and our financial condition and results of operations will be adversely impacted. The results of the Fall/Holiday 2005 and the first three quarters of fiscal 2006 did not meet management


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expectations and indicated that our customers did not respond positively to all of the changes we made to our product offerings in our 2005 Fall/Holiday line. Compared to the same quarter in the prior year, net merchandise sales for the third and fourth quarters of fiscal 2005 were down $18.3 million and $29.5 million, respectively, or approximately 8.2% and 7.6%, respectively, and comparable store sales declined by 4.3% and 7.1%, respectively. Results for the first three quarters of fiscal 2006 had declines in net merchandise sales of $26.0 million, $17.8 million and $5.4 million, respectively, or approximately 12.6%, 7.7% and 2.7%, respectively. Comparable store sales also declined approximately 10.0%, 5.9% and 1.5% in the first, second and third quarters of fiscal 2006 compared to the same periods in the prior year. The decrease in net merchandise sales and a $77.6 million increase in impairment charges, resulted in an increase in our operating loss of $141.8 million for fiscal 2006 compared with the prior year. If customer purchases continue to lag behind our expectations, we may continue to experience decreased net merchandise sales, negative comparable store sales and higher operating losses.
 
 
As a result of our involvement in the Spiegel bankruptcy proceedings, we were required to take actions that we might not otherwise have taken as a stand-alone company, including:
 
  •  distributing a significant portion of our cash flow and the proceeds of the $300 million senior secured term loan to the creditors of Spiegel, instead of reinvesting that capital in our business and infrastructure during the bankruptcy process;
 
  •  borrowing significant amounts (including $300 million under our senior secured loan and amounts from time to time under our senior secured credit facility of up to $150 million) and as a result becoming subject to the restrictions and limitations imposed by the lenders under our financing facilities;
 
  •  limiting capital expenditures and investment into the infrastructure and growth of our company;
 
  •  focusing on short term cash flow and operating income rather than long term sustainability of our company;
 
  •  assuming ongoing obligations, equal to approximately $17 million, associated with Spiegel’s former pension and other retirement plans;
 
  •  assuming the obligations of Spiegel and its subsidiaries to indemnify officers or employees for liability associated with their service;
 
  •  selling and subsequently leasing back our corporate headquarters;
 
  •  allocating substantial management resources to participating in the bankruptcy proceedings; and
 
  •  inheriting facilities that were not optimally suited for our operations and, as a result, having to sell, streamline, consolidate or relocate some of these facilities.
 
We have been operating as a stand-alone entity for a limited period of time and face additional costs and risks as a result. We must continue to streamline the back-end distribution and logistics operations we inherited and reduce costs throughout our organization. We are still in the process of integrating our personnel, systems and operations, and we must do so while being subject to the constraints imposed on us as a result of the bankruptcy process. If we are unable to do so successfully, our business, financial condition and results of operations could be harmed.
 
 
Our senior management team has devoted substantial efforts to guide the company through the bankruptcy reorganization and its subsequent emergence. We anticipate that management will need to continue to dedicate a substantial portion of time to establishing an adequate operating and public company infrastructure in the near term since Eddie Bauer has not been an independent company since 1971. If management’s attention is


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diverted too much from operational issues facing our business as a result of infrastructure or post-bankruptcy related responsibilities, management may not be able to devote sufficient time to revitalize the brand and our results of operations may suffer.
 
 
Most of the members of our senior management team have been in place for less than three years. Our chief executive officer resigned in February 2007 and we are currently operating with an interim chief executive officer until we hire a replacement. Additionally, our general counsel has been in this position with us for approximately two years, our chief merchandising officer and head of design joined us in the Summer of 2004 and we are currently operating without a permanent chief financial officer. In addition, several other key positions are open, such as chief operating officer, chief marketing officer, senior vice president of human resources and vice president of direct. Our success will depend to a significant extent on our ability to attract qualified individuals to our leadership team and to retain the services of members of our senior management team in the long term through attractive incentive arrangements. Competition for qualified personnel is intense. We may not be able to retain current employees or attract new employees due to uncertainty relating to our business as a result of our recent emergence from bankruptcy, uncertainty concerning our pursuit of strategic alternatives and the recent stockholder vote regarding the proposed merger. The loss, for any reason, of the services of these individuals or the failure to attract and retain additional members of our management team could have a material adverse effect on us.
 
Our success also depends on our ability to hire, motivate and retain other qualified associates who reflect and enhance our customer-service oriented culture, including our store managers, sales associates and staff at our call centers. If we are unable to hire and keep enough qualified associates, especially during our peak season, our customer service levels and our business, financial condition and results of operations may be hurt.
 
We have determined that we have material weaknesses in our internal control over financial reporting. Our disclosure controls and procedures and internal control over financial reporting may not be effective in future periods, as a result of existing or subsequently identified material weaknesses in internal control over financial reporting.
 
We will not be subject to the SEC rules adopted pursuant to Section 404 of the Sarbanes-Oxley Act requiring public companies to include a report of management on the company’s internal control over financial reporting until our annual report on Form 10-K for our fiscal year ending December 29, 2007. Accordingly, management has not performed the assessment required by Section 404 and the SEC’s rules and regulations implementing such section. “Internal control over financial reporting” is the process designed by a company’s senior management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
 
However, in preparing our financial statements as a stand-alone company since June 21, 2005, management identified several material weaknesses in our internal control over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, that adversely affects a company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
 
Subsequent to our original Form 10 filing in December 2005, which was withdrawn on January 25, 2006, we identified several additional errors in our financial statements. In January 2007 we publicly announced that in the course of preparing our fiscal 2006 financial statements, we identified errors in our tax accounting for 2005 and prior years relating to the determination of deferred tax assets and goodwill on our balance sheet arising from the treatment of leasehold improvements. The errors announced in January 2007 were ultimately determined to be immaterial and have been corrected in the fiscal 2006 financial statements contained in this Form 10-K (see Note 4 (cc) to our annual financial statements included herein). Both sets of errors originally


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went undetected due to insufficient technical in-house expertise necessary to provide a sufficiently rigorous review.
 
Areas in which weaknesses have been identified include the lack of sufficient controls to ensure adequate analysis and documentation regarding the application of numerous “fresh-start” accounting adjustments, including valuation of tangible and intangible assets and leases and assumption of employee benefit plan liabilities. In addition, a number of issues arose related to accounting for income taxes, including the development of the tax provision, accounting for NOLs and related valuation allowances, and identification and classification of deferred tax assets and liabilities. Several clerical and technical accounting errors, applicable to prior periods, were also identified pertaining to accounting for landlord incentives and deferred rent liability, hedge accounting for interest rate swaps and classification of activity in the cash flows statement. In addition, our reliance upon manual closing and reconciliation systems and a lack of timely and sufficient financial statement account reconciliation and analysis have been identified as material weaknesses. As of December 30, 2006, staffing with adequate technical expertise was not in place to support our ongoing accounting and reporting requirements for a public reporting company. We expect that the challenges associated with recruiting appropriately qualified personnel and implementing improved processes and procedures will take approximately six to 12 months and may be further complicated by our difficulties in hiring senior and middle management employees. As a result, we do not expect to be in a position to report that such weaknesses will be remediated before the end of 2007.
 
In conjunction with our preparation work for compliance with Section 404 of the Sarbanes-Oxley Act, management has identified control deficiencies pertaining to the security administration of various automated business applications which could potentially impact internal control over financial reporting. These relate primarily to granting and tracking access to our accounting and merchandising systems. Management is still in the process of assessing, evaluating and testing these deficiencies. If these issues are not remediated in a timely manner, these deficiencies, along with other deficiencies that may be identified during the remainder of our review and testing of internal control over financial reporting, may collectively be considered a material weakness.
 
Accordingly, management has concluded that our internal control over financial reporting was not effective as of and for the periods ended December 30, 2006, December 31, 2005 and July 2, 2005 (the fresh-start balance sheet date). To address the material weaknesses, we performed additional analysis and other post-closing procedures and retained additional external resources with extensive public company reporting expertise in order to prepare our consolidated financial statements in accordance with generally accepted accounting principles in the U.S.
 
We will need to continue to divert significant resources to address our currently known weaknesses. If we are unable to adequately remediate our currently known weaknesses or if we identify additional weaknesses, investors could lose confidence in the accuracy and reliability of our financial statements, which would cause the market price of our stock to decline and could lead to stockholder litigation.
 
 
The growth of sales in our stores is significantly dependent on our ability to operate stores in desirable locations with capital investments and lease costs that allow us to earn a reasonable return. Desirable locations and configurations may not be available to us at all or at reasonable costs.
 
Our success will also depend on our ability to improve the profitability of our retail stores, which will require us to:
 
  •  offer relevant products to our customers;
 
  •  avoid construction delays and cost overruns in connection with the build-out of new stores;
 
  •  close underperforming stores in a rational manner, such as upon their natural lease expirations;
 
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  •  generate sufficient average sales per square foot in the stores we wish to keep open, to prevent a landlord exercising its contractual right to terminate the lease early if the store does not perform well.
 
 
Substantially all of our store locations are leased from landlords in regional malls and lifestyle centers and in metropolitan areas. As a result, each year, a portion of the locations under lease is due for renewal or renegotiation. In addition, we close a certain number of our store locations and lease new locations each year. Landlords typically evaluate the creditworthiness of a tenant and the expected sales volume of the store location in connection with the negotiation of lease terms. Continued weakening of our financial performance or financial profile, including our sales per square foot, or potential covenant defaults on our debt instruments could ultimately lead landlords to conclude that we do not meet their criteria for risk and return, and result in our inability to negotiate leases on reasonable terms or at all. In addition, we must be able to renew our existing store leases on terms that meet our financial targets. Due to the need to terminate or renegotiate a number of leases during the bankruptcy proceeding, our relationships with significant landlords may have been damaged, which may result in additional difficulty in leasing appropriate space. Our failure to secure favorable lease terms generally and upon renewal could hurt our business, financial condition and results of operations.
 
 
Many of our stores are located in shopping malls. Sales at these stores are derived, in part, from the volume of traffic in those malls. Our stores benefit from the ability of the malls’ “anchor” tenants, generally large department stores, and other area attractions to generate customer traffic in the vicinity of our stores and the continuing popularity of the malls as shopping destinations. Traffic in malls where we have stores may be adversely affected by regional economic downturns, the closing of anchor tenants and competition from non-mall retailers and other malls where we do not have stores. In addition, a decline in the desirability of the shopping environment of a particular mall, or a decline in the popularity of mall shopping generally among our customers, would hurt our business, financial condition and results of operations.
 
 
The success of our catalogs is a key factor in our efforts to revitalize our brand, as we believe the catalogs reinforce our brand image and drive sales across the retail and direct channels. If we are unable to continue to attract customers to our catalogs by providing them with appealing and extensive product offerings, our business, financial condition and results of operations may suffer.
 
Factors that may impact our ability to maintain and grow our catalog sales include:
 
  •  customer acceptance of our catalog presentations;
 
  •  increases in paper and printing costs, postage rates and other costs relating to our catalog mailings;
 
  •  a failure in the timing of catalog deliveries;
 
  •  the implementation of government-mandated return policies that would require us to pay for all returns;
 
  •  our inability to adequately replenish our customer database, which has decreased in each of the last several years, primarily due to the loss of customers who were private-label credit card holders in connection with the liquidation of FCNB; and
 
  •  the accuracy, breadth and depth of the information contained in our customer database so we can correctly analyze our mailing lists and maximize our customer targeting efforts.
 
In addition, catalog sales may decline as a result of customers switching from catalog purchases to Internet purchases. Our catalog sales may also be affected since, unlike some of our catalog competitors, we collect a sales tax on catalog sales.


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The success of our websites is subject to risks and uncertainties associated with the Internet, including changing customer preferences and buying trends relating to Internet usage, changes in required technology interfaces, increasing costs of placing advertisements and keywords online, website downtime and other technical failures, changes in applicable U.S. and foreign regulation, security breaches and consumer privacy concerns. Our failure to successfully respond to these risks and uncertainties might hurt our website sales and damage our brand’s reputation. Internet sales may also be affected since, unlike some of our online competitors, we collect a sales tax on Internet sales.
 
 
Our collection and processing of transactions through our sales channels require us to receive and store a large volume of personally identifiable data. This type of data is subject to legislation and regulation in various jurisdictions. Our business, financial condition and results of operations could be adversely affected if the laws and regulations are expanded, implemented or interpreted to require changes to our business practices and methods of data collection.
 
As personal and legal issues relating to privacy and data protection become more sensitive, we may become exposed to potential liabilities with respect to the data we collect, manage and process, and may incur legal costs if our information security policies and procedures are not effective or if we are required to defend our methods of collection, processing and storage of personal data. Future investigations, lawsuits or adverse publicity relating to our methods of handling personal data could adversely affect our business, financial condition and results of operations due to the costs and negative market reaction to such developments.
 
 
The sale of casual sportswear and accessories involves the risk of injury to consumers. If the use of any of our products causes, or is alleged to have caused, an injury we may become subject to claims or lawsuits relating to such matters. Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertion that our products caused injury or death could adversely affect our reputation with existing and potential customers and our corporate and brand image. Moreover, claims or liabilities of this sort might not be covered by our insurance or by any rights of indemnity or contribution that we may have against others. We maintain product liability insurance in an amount that we believe to be adequate. However, we cannot be sure that we will not incur claims or liabilities for which we are not insured or that exceed the amount of our insurance coverage.
 
Under certain circumstances, we may be required to recall products, leading to a material adverse effect on our business. Even if a situation does not necessitate a recall, product liability claims might be asserted against us. A product liability judgment against us or a product recall could have a material adverse effect on our business, consolidated financial condition, results of operations or liquidity.
 
 
We are currently a party to licensing agreements with third parties for the manufacture, distribution and sale of merchandise carrying the Eddie Bauer brand name. These third-party licensees may not perform under the terms of the licensing agreements. In addition, some of our licensing agreements will expire by their terms over the next several years. We cannot assure that we will be successful in negotiating and entering into either extensions of existing agreements or new licensing agreements with suitable third parties on economically favorable terms. In addition, any downturn in the business or reputation of our licensees could in turn reduce sales of our licensed products. While our licensees are responsible for all quality control procedures on our licensed products, we cannot assure that our reputation will not be harmed as a result of any product liability claim in the future. Any such claim could divert management attention and result in significant costs to us.


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The occurrence of any one or more of these events could adversely affect our Eddie Bauer brand revitalization initiatives and thus our business, operating results and financial condition.
 
Further, our licensing arrangements provide us with relatively high margins because we incur relatively few expenses in connection with them. As a result, any decrease in our royalty revenue will adversely affect our net income directly.
 
 
In 2006, on a purchase value basis, we sourced approximately 84% of our products through EBI. Our sourcing agreement with EBI is on a commission basis and is automatically renewed each year unless terminated by either party upon one year written notice. If the agreement with EBI were terminated or if the terms of the agreement were modified substantially and we did not find an appropriate replacement in a timely manner and on reasonable terms, or if we were unable to transition the EBI functions in-house in a cost-effective manner, we could experience shortages or delays in receipt of our merchandise, higher costs and quality control issues. Any of these events could have a material adverse effect on our business, financial condition and results of operations. In addition, some of our competitors may perform all or a larger portion of their sourcing functions in-house, and, as a result, have lower sourcing costs than we do.
 
 
We use independent vendors to manufacture our products and depend on these vendors to maintain adequate financial resources, secure a sufficient supply of raw materials and maintain manufacturing capacity to meet our pricing, quality and demand requirements. We do not maintain long-term contracts with our vendors. If we are unable to locate quality vendors and foster stable relationships with them, this could have a material adverse effect on our business, financial condition and results of operations. In addition, as vendors receive increased orders from us and/or other retailers, we may experience delays in receiving our products or quality control issues. We also anticipate reducing the number of vendors and countries from which we source, which may make it more difficult to meet our performance, quality and cost requirements and will cause us to become more dependent upon a smaller number of vendors.
 
Importing from foreign suppliers also requires us to order products in advance to account for transportation time. We currently order products approximately six months prior to the time the product is available to our customers. We may have to hold goods in inventory and sell them at lower margins if we overestimate customer demand or if customer preferences change. If we underestimate customer demand, we may miss sales opportunities. In addition, this lead time also makes it difficult for us to adjust to changes in customer preferences subsequent to our orders. Finally, if quality control inspectors detect a defect, delivery of our products may be delayed, which could have a material adverse effect on our business, financial condition and results of operations.
 
Our business is also subject to a variety of other risks generally associated with doing business abroad, such as political and financial instability, currency and exchange risks, disruption of imports by labor disputes and local business practices, health concerns regarding infectious diseases in countries in which our merchandise is produced, adverse weather conditions or natural disasters, acts of war or terrorism in the U.S. or worldwide, to the extent these acts affect the production, shipment, receipt of or demand for merchandise. Our future performance will be subject to these factors, which are beyond our control, and these factors could materially hurt our business, financial condition and results of operations.
 
 
Energy prices have risen substantially over the past few years and may continue to rise due to tight supplies, political unrest in oil producing regions or other factors. If our shipping or sourcing partners pass these increases on to us, our costs of goods will increase. If we are unable to increase our product and


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shipping prices, as applicable, to cover these additional costs, our operating results and financial condition will be adversely impacted.
 
 
We rely on third parties for each step of our transportation delivery chain to deliver our products on time. If any step in the chain becomes unavailable or is delayed, we would have to find a replacement. We may incur additional costs and could experience a delay in delivering our products to our stores and to our customers. We have experienced such issues in the past. For example, we began receiving overseas shipments into the ports of Tacoma/Seattle because we experienced lengthy delays using the port of Los Angeles. In addition, in 2002, a West Coast longshoremen’s strike significantly delayed delivery of our products to our distribution center in Groveport, Ohio. Also, from time to time labor disputes regarding pilots employed by UPS have occurred, which have threatened our ability to deliver expedited packages in the event of a work stoppage. Finally, inclement weather, other natural disasters or acts of terrorism may cause unexpected delays in our transportation delivery chain. Any inability to deliver products on time could undermine customer confidence in us and have a material adverse effect on our business, financial condition and results of operations.
 
 
As part of the Spiegel bankruptcy process, we transitioned our back-end operations, including our information technology systems, logistics and distribution and customer call centers, to support our business on a stand-alone basis. The systems, networks, facilities and other infrastructure associated with these back-end functions were originally designed to support multiple Spiegel merchant divisions, and we continue to be in the process of streamlining these operations to make them more appropriate for our business as a stand-alone entity. In addition, some of these systems, particularly relating to information technology, are dated and are an amalgamation of multiple applications, rather than one overarching state-of -the-art system. If we are unable to effectively streamline these systems and update them where necessary, this could have a material adverse effect on our business, financial condition and results of operations.
 
In addition, any significant interruption in our back-end operations resulting from systems failures, associate grievances, natural disasters, inclement weather, accidents or other unforeseen events could lead to delays or other lapses in service relating to the distribution of merchandise to our stores and to our customers, or in the processing of returns from our customers. If our current back-end operations cannot handle a significant increase in transaction volume, we may experience inaccuracy in processing orders or delays in delivering orders. Any delays or lapses in service could have a material adverse effect on our business, financial condition and results of operations.
 
 
We provide our joint venture partners in Germany and Japan with access to our designs, sourcing network, marketing materials, catalog photography, page layouts and general operational knowledge. We do not directly manage or control the sales, marketing or operational aspects of our joint venture partners. Our financial condition and results of operations may be adversely affected by our joint venture partners’ inability to market and sell merchandise and operate the joint venture effectively and in a manner consistent with our business plans. We also are subject to foreign currency exchange risk as our joint ventures submit payment to us in their respective local currencies and we convert to U.S. dollars at a daily rate upon payment. Our Eddie Bauer Germany joint venture has experienced weakness in its retail stores operation and in January 2007 made the decision to close all of its retail stores. It is anticipated that all Eddie Bauer Germany retail stores will be closed by August 2007. We anticipate recording equity losses of approximately $2.5 million in the first quarter of fiscal 2007 related to our proportionate share of the store closing costs.


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We use many trademarks and product designs in our business. As appropriate, we rely on the trademark and copyright laws to protect these designs even if not formally registered as marks, copyrights or designs. We believe these trademarks and product designs are important to our competitive position and success. Third parties may sue us for alleged infringement of their proprietary rights. The party claiming infringement might have greater resources than we do to pursue its claims, and we could be forced to incur substantial costs and devote significant management resources to defend the litigation. Moreover, if the party claiming infringement were to prevail, we could be forced to discontinue the use of the related trademark, patent or design and/or pay significant damages, or to enter into expensive royalty or licensing arrangements with the prevailing party, assuming these royalty or licensing arrangements are available at all on an economically feasible basis, which they may not be.
 
Additionally, we may experience difficulty in effectively limiting unauthorized use of our trademarks and product designs worldwide. Unauthorized use of our trademarks or other proprietary rights may cause significant damage to our brand name and our ability to effectively represent ourselves to our agents, suppliers, vendors, licensees and/or customers. While we intend to enforce our trademark and other proprietary rights, there can be no assurance that we are adequately protected in all countries or that we will prevail when defending our trademark and proprietary rights.
 
 
While our Global Labor Practices Program and our vendor operating guidelines promote ethical business practices, we do not control our independent vendors or their business practices. Accordingly, we cannot guarantee their compliance with our guidelines.
 
Violation of labor or other laws by our vendors, or the divergence of a vendor’s labor practices from those generally accepted as ethical in the U.S. could materially hurt our business, financial condition and results of operations if, as a result of such violation, we were to incur substantial liability or attract negative publicity damaging to our reputation. Our business might also be harmed if we ceased our relationship with that vendor and were unable to find another vendor to produce goods on equally favorable terms.
 
 
Our business is adversely affected by unseasonal weather conditions. Sales of our outerwear and sweaters are dependent in part on the weather and may decline in years in which weather conditions do not favor the use of these products. Further, sales of our Spring and Summer products, which traditionally consist of lighter clothing, are adversely impacted by cool or wet weather. In addition, severe weather events, such as hurricanes, blizzards and floods typically lead to temporarily reduced traffic at malls where most of our stores are located. Severe weather events have and will continue to impact our ability to supply our stores from our central distribution facility, deliver orders to our customers and staff our stores and call centers. Periods of unseasonably warm weather in the Fall or Winter or unseasonably cold or wet weather in the Spring or severe weather events could have a material adverse effect on our results of operations and financial condition.
 
 
 
We anticipate that we will not be able to meet the financial covenants contained in our senior secured term loan agreement during 2007, possibly as early as the first quarter of 2007. As a result, we will be required to refinance our existing secured loan agreement or obtain waivers to applicable covenants. We have engaged J.P. Morgan Securities Inc., JPMorgan Chase Bank, N.A. and Goldman Sachs Credit Partners L.P. as


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arrangers and are in active discussions with the arrangers to refinance our existing secured term loan with proceeds from a new term loan and junior capital, and we expect to complete the transaction in April 2007. However, we have not entered into any definitive arrangements to amend and restate the existing secured term loan agreement and cannot give any assurance that we will successfully complete the refinancing. In connection with this refinancing, we will also request an amendment to our revolving credit facility. If we are unable to successfully complete the refinancing of our secured debt or amend the revolving credit facility we will likely breach the financial covenants in our term loan agreement and may not be able to satisfy our obligations thereunder. As a result, our outstanding obligations under the existing secured term loan agreement could be accelerated and become immediately due and payable. In addition, an event of default would occur under our revolving credit facility and amounts thereunder could also become immediately due and payable. We would then be required to search for alternative financing, which may not be available on acceptable terms, if at all. If we are not able to refinance our existing secured term loan agreement on favorable terms, existing stockholders may suffer dilution and we may become subject to more stringent covenants that could further restrict our flexibility and ability to invest in our brand and infrastructure. In addition, if we are not able to refinance our existing secured term loan agreement, the lenders under our current loan agreements would be entitled to exercise remedies, including foreclosure on our assets that serve as collateral under the facilities (real estate, trademarks, inventory, account receivables and potentially all other assets). In that event, those lenders would be entitled to be repaid in full from the proceeds of the liquidations of those assets, which could result in our assets being entirely or severely diminished, which would materially and adversely affect the price of our common stock. Alternatively, we may choose to file for bankruptcy protection, which would also materially and adversely affect the price of our common stock.
 
 
Due to the fact that we anticipate not being able to meet the financial covenants contained in our senior secured term loan agreement during 2007, our independent registered public accountants have included an explanatory paragraph in their report for our fiscal year ended December 30, 2006 with respect to our ability to continue as a going concern. This explanatory paragraph and any future breach of the financial covenants, if not cured or waived within the required period of time, would result in a violation of the covenants governing our existing term loan agreement and our revolving credit facility and may negatively affect our stock price and our capital-raising efforts. Any such breach of our loan covenants could result in the loss of our ability to borrow additional funds under our revolving credit facility and the acceleration of amounts due under our loan agreements. We are in active discussions with our revolving credit facility lenders regarding a waiver of this default, but we cannot give any assurance that we will be able to obtain the waiver. In addition, the inclusion of the explanatory paragraph regarding our ability to continue as a going concern gives the counterparty in one of our material contracts regarding our private label credit card program the right to immediately terminate such contract. We have received a waiver under this contract from the counterparty which provides us until May 31, 2007 to provide an updated report from our independent registered public accountants without an explanatory paragraph with respect to our ability to continue as a going concern. Our consolidated financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. If we became unable to continue as a going concern, we would have to liquidate our assets and we might receive significantly less than the values at which they are carried on our consolidated financial statements. A termination of one or more of our material contracts could result in additional costs and may negatively impact our results of operations and financial condition.
 
 
In connection with our emergence from bankruptcy we issued a non-recourse promissory obligation to a liquidating trust established for the benefit of the creditors of Spiegel, pursuant to which we are obligated to pay the creditors’ trust 90% of any proceeds (as defined in the obligation) received by SAC and FSAC in respect of securitization interests held by either entity in certain pre-petition securitization transactions to


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which Spiegel and its subsidiaries were a party. As a result of this arrangement, we are taxed on 100% of the proceeds we receive from SAC and FSAC in respect of the securitization interest, but are only entitled to retain 10% of the amounts received. As a result, to the extent that we receive proceeds, the arrangement reduces the amount of net operating loss carryforwards that are available to offset income from other sources. In addition, if our net operating loss carryforwards become unavailable or are limited in the future, including through a change of control, the amount of taxes due on the 100% of proceeds we receive likely would exceed the 10% of proceeds we are entitled to retain and would reduce our cash flow.
 
 
Our financial statements reflect the adoption of fresh start accounting under American Institute of Certified Public Accountants Statement of Position 90-7, or SOP 90-7. Fresh start accounting principles provided, among other things, that we determined the reorganization value of our company and allocated such reorganization value to the fair value of our tangible assets, finite-lived intangible assets and indefinite-lived intangible assets in accordance with the provisions of Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”) as of our emergence from bankruptcy. An independent third party appraisal firm was engaged to assist us in determining our reorganization value. As of our fresh start reporting date, we recorded goodwill and trademark intangible assets of $220.5 million and $225.0 million, respectively.
 
Although we allocated our reorganization value among our assets in accordance with SFAS No. 141, our allocations were based on estimates and assumptions that may not be realized and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. If these results are not achieved, the resulting values could be materially different from our estimates, which could cause us to write down the value of our assets and record impairment charges which could make our earnings volatile. During the fourth quarter of 2005, in conjunction with our annual impairment reviews as required under SFAS No. 142, we recognized an impairment loss of $40.0 million related to our trademarks. The decline in the fair value of our trademarks between our fresh start reporting date and December 31, 2005 was due principally to decreases in our projected revenues. Additionally, in the third quarter of fiscal 2006 we completed impairment tests for our indefinite-lived intangible assets, including our goodwill and trademarks. As a result we recorded an impairment charge of $117.6 million related to our goodwill. The decline in our fair value since our fresh start reporting date was due principally to the lower than projected revenues and gross margins.
 
We could experience additional impairment charges in future periods if our assumptions and projections within our long-range plans are not achieved.
 
 
In connection with the Plan of Reorganization, we and our subsidiaries entered into a $300 million senior secured term loan agreement and a $150 million senior secured revolving credit facility. As a result, we have, and will continue to have, a substantial amount of debt. We anticipate that the covenants and restrictions governing our existing term loan agreement will be substantially incorporated into the amendment and restatement of the agreement that we are negotiating to refinance our existing term loan. Our level of debt:
 
  •  requires us to use a substantial portion of our cash flow from operations to pay interest and principal on our debt (currently 50% of our excess cash flow must be used to reduce our outstanding obligations under the senior secured term loan on an annual basis), which reduces our funds available for working capital, capital expenditures and other general corporate purposes, and may also prevent us from taking advantage of business opportunities as they arise or successfully carrying out expansion plans, if any;
 
  •  may result in higher interest expense if interest rates increase on our floating rate borrowings;


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  •  limits our flexibility in planning for or reacting to, and heighten our vulnerability to, changes or downturns in our business, the industry or in the general economy; and
 
  •  limits our ability to pay future dividends.
 
In addition, the terms of our debt contain various restrictive covenants that limit our ability to, among other things:
 
  •  incur additional debt;
 
  •  grant liens;
 
  •  dispose of certain property;
 
  •  make certain capital expenditures; and
 
  •  engage in sale-leaseback transactions and transactions with affiliates.
 
We are also required to meet a fixed charge coverage ratio and a leverage ratio under our term loan and, if certain availability thresholds are not met, a fixed charge coverage ratio under our revolving credit facility. These restrictions and covenants inhibit our operational flexibility and restrict or prohibit our ability to take actions that could be beneficial to our company and our stockholders. This may place us at a competitive disadvantage to our competitors who may not be subject to similar restrictions.
 
 
The success of our business depends, in part, upon our ability to increase sales at our existing stores. Our comparable store sales have fluctuated over most quarters in the past three years, and we expect that they will continue to do so in the future. Since fiscal 2002, our quarterly comparable store sales have ranged from a decrease of 17.1% in the first quarter of fiscal 2002 to an increase of 4.6% in the fourth quarter of fiscal 2006. Various factors affect our comparable store sales, including the number of stores we open and close in any period, the general retail sales environment, changes in our merchandise, competition, customer preferences, current economic conditions, energy prices, the timing of our releases of new merchandise and promotional events, the success of our marketing programs, the approach and timing of mark-down strategies, weather conditions and the overlapping of existing store sales by new stores in existing markets.
 
Our ability to maintain and improve our comparable store sales results depends in large part on improving our forecasting of customer demand and preferences and adjusting our inventory levels accordingly, increasing the number of transactions in each store, selecting effective marketing techniques, providing an appropriate mix of merchandise for our broad and diverse customer base and using more effective pricing strategies. Any failure to meet the comparable store sales expectations of investors and securities analysts in one or more future periods could significantly reduce the market price of our common stock.
 
 
 
While our common stock is currently quoted on the Nasdaq Global Market, we cannot assure that an active market for our common stock will develop or, if any such market does develop, that it will continue to exist. In addition, the market price for our common stock may be highly volatile. Our common stock was issued under the Plan of Reorganization to holders of pre-petition claims, some of whom may prefer to liquidate their investment rather than to hold it on a long-term basis. In addition, the information we are providing in this document and other public filings and announcements may be received negatively by our stockholders or by investors who have been trading in our stock and may cause them to sell their shares, which may cause the price of our common stock to decline. In addition, it is possible that investors who have been trading in our stock have been engaging in short-selling, which could further cause the price of our common stock to decline.


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The trading price of our common stock could also fluctuate due to the factors discussed in this “Risk Factors” section. The trading market for our common stock also may be influenced by the research and reports that industry or securities analysts publish about us or our industry. While there can be no assurance that any analysts will elect to cover our company, in the event that one or more of the analysts who may cover us in the future were to publish an unfavorable research report or to downgrade our stock, our stock price likely would decline. If we were to receive no analyst coverage or if one or more of analysts who may elect to cover our company were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
 
In addition, the stock market in general has experienced extreme price and volume fluctuations. These broad market and industry factors may decrease the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. Litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
 
 
We have operated as a public company for a limited period of time. As a public company subject to the reporting requirements of the Exchange Act and the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, we are required, among other things, to file periodic reports relating to our business and financial condition. In addition, beginning with our annual report for the year ending December 29, 2007, Section 404 of Sarbanes-Oxley will require us to include a report with our annual report on Form 10-K that must include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of that fiscal year and disclosure of any material weaknesses in internal control that we have identified. Additionally, our independent registered public accounting firm will be required to issue a report on management’s assessment of our internal control over financial reporting and their evaluation of the operating effectiveness of our internal control. Our assessment requires us to make subjective judgments and our independent registered public accounting firm may not agree with our assessment.
 
Achieving compliance with Section 404 within the prescribed period will require us to incur significant costs and expend significant time and management resources. If we are unable to complete the work necessary for our management to issue its management report in a timely manner, or if we are unable to complete any work required for our management to be able to conclude that our internal control over financial reporting is operating effectively, we and our independent registered public accounting firm would be unable to conclude that our internal control over financial reporting is effective as of December 29, 2007. As a result, investors could lose confidence in our reported financial information or public filings, which could have an adverse effect on the trading price of our stock or lead to stockholders litigation. In addition, our independent registered public accounting firm may not agree with our management’s assessment or conclude that our internal control over financial reporting is operating effectively. The new laws, rules and regulations may also make it more difficult for us to attract and retain qualified independent members of our board of directors and qualified executive officers.
 
 
Provisions in our certificate of incorporation, bylaws and Senior Officer Change in Control Compensation Benefits Plan, as well as Delaware corporate law, may have the effect of delaying, deferring or preventing a change in control. These provisions include:
 
  •  our ability to issue “blank check” preferred stock;
 
  •  provisions restricting stockholders from calling a special meeting of stockholders;


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  •  provisions that set forth advance notice procedures for meetings of stockholders; and
 
  •  payments of certain bonus and severance amounts to covered employees in certain circumstances.
 
In addition, under our certificate of incorporation, a person or entity who seeks to acquire 4.75% or more of our outstanding common stock, or a person or entity who already is a direct or indirect 4.75% stockholder and wishes to increase its ownership, may not acquire such shares unless it has obtained the prior written consent of our board of directors until such time as these restrictions lapse, which will be January 4, 2009 at the latest. Our board may deny any such proposed transaction if it determines in its reasonable assessment that the proposed transaction could jeopardize realization of the full benefits of unrestricted use of our net operating loss carryovers.
 
In accordance with our certificate of incorporation, any transaction in violation of these ownership restrictions will be void so that a purported transferee will not have any ownership rights with respect to any shares acquired in excess of these ownership restrictions. Therefore, a purported transferee will not be entitled to any rights as a stockholder, including voting, dividend or distribution rights, with respect to any excess shares. In addition, Eddie Bauer has the right to demand any purported transferee of excess shares to transfer to an agent of our designation its excess shares for resale by the agent or, if the excess shares have already been sold by the purported transferee, to transfer to the agent any proceeds from the sale by the purported transferee of such excess shares. We have set up procedures that instruct our transfer agent not to transfer, without our written approval, any shares on our books and records if such transfer would violate these ownership restrictions.
 
These provisions may make it more difficult for other persons or entities, without the approval of our board of directors, to make a tender offer or otherwise acquire substantial amounts of our common stock, or to launch other takeover attempts that a stockholder might consider to be in such stockholder’s best interest. These provisions also may limit the price that certain investors might be willing to pay in the future for shares of our common stock.
 
 
As of December 30, 2006, we had NOLs of approximately $540 million for federal income tax purposes. Under Section 382 of the Internal Revenue Code, if a corporation undergoes an “ownership change,” the corporation’s ability to use its pre-change NOLs and other pre-change tax attributes to offset its post-change income may be limited. An ownership change is generally defined as a greater than 50% change in its equity ownership by value over a three-year period. We may experience an ownership change in the future as a result of subsequent shifts in our stock ownership, including as a result of any conversion of notes into shares of our common stock pursuant to the currently contemplated offering of convertible notes. If we were to trigger an ownership change in the future, our ability to use any NOLs existing at that time could be limited.
 
 
We may issue securities in the future and may do so in a manner that results in substantial dilution for our stockholders. In addition, we may issue debt or equity from time to time that ranks in preference to our common stock in the event of a liquidation or winding up or that is secured by an interest in some or all of our assets, including the currently planned issuance of junior capital as part of our refinancing efforts. Sales of common stock by existing stockholders in the public market, our issuances of new securities or debt, or the expectation that any of these events might occur could materially and adversely affect the market price of our common stock.
 
 
We do not anticipate paying dividends on our common stock for the foreseeable future. Our ability to pay dividends depends on our receipt of cash dividends from our subsidiaries because we are a holding company. The terms of certain of our outstanding indebtedness prohibit us from paying dividends. Accordingly, investors


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must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.
 
Item 1B.   Unresolved Staff Comments
 
Not Applicable.
 
Item 2.   Properties
 
The following is an overview of key facilities in our business. We believe all of our facilities are suitable and adequate for our current and anticipated operations.
 
 
We lease our corporate headquarters in Redmond, Washington pursuant to an agreement entered into with Microsoft Corporation in August 2004 to lease the property for a three-year period. Microsoft has informed us that we will not be able to renew our lease. We have executed a lease with Lincoln Square Office, LLC to lease approximately 230,000 square feet in Bellevue, Washington, for a term of 15 years. We anticipate occupying the space in the Summer of 2007 and will incur substantial moving costs in 2007.
 
 
All of our retail and outlet stores are located in leased facilities. Our retail stores are generally located in regional malls, lifestyle centers and in metropolitan areas. We also have retail stores in smaller markets where we believe a concentration of our target customers exists. Our outlet stores are located predominantly in outlet centers, value strip centers and “destination” outlet areas. Our retail stores average approximately 6,900 gross square feet, while our outlet stores average approximately 7,500 gross square feet. In most cases, our retail and outlet store leases have ten-year terms. Some of our retail store leases allow us the one time right to terminate the lease three to five years after the commencement of the lease if previously agreed upon sales thresholds are not achieved. Our current leases expire at various dates, with more than 17% expiring between 2006 and 2008. Our store leases normally provide for base rent and the payment of a percentage of sales as additional rent when certain sales thresholds are reached. Under our store leases, we are typically responsible for maintenance and common area charges, real estate taxes and certain other expenses.
 
Most of our lease arrangements provide for tenant allowances from developers, pursuant to which we are reimbursed by the developer or landlord for a portion of costs incurred in connection with building out or making alterations and improvements to the leased space.
 
As of December 30, 2006, we had 243 U.S. retail stores located in 47 states and 36 retail stores located in Canada. We had more than ten retail stores located in each of the following states: California (15), Illinois (15), Texas (14) and Washington (11). As of December 30, 2006, we had 115 U.S. outlet stores located in 34 states, with 14 outlet stores in California. In fiscal 2007, we intend to open approximately 22 additional retail stores in the aggregate in the United States and Canada. We closed 29 retail stores in January 2007 and do not expect to close any additional retail stores during fiscal 2007. During the same period, we also expect to open approximately 11 additional outlet stores in the United States and close one outlet store, which was closed in January 2007. We intend, as a part of our normal-course operations, to continue to open new retail stores in advantageous locations and close underperforming retail stores upon natural expiration of store leases.


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Our wholly-owned subsidiary, Eddie Bauer Fulfillment Services, or EBFS, supports our U.S. distribution, fulfillment and inbound/outbound transportation requirements. EBFS operates our two main facilities in Groveport, Ohio, and Vaughan, Ontario, Canada.
 
Groveport Facility.  EBFS owns our facility in Groveport, Ohio, which consists of approximately 2.2 million square feet. This facility handles logistics and distribution for our U.S. retail, U.S. outlet and direct operations, including direct-to-consumer ship and return services, purchasing of non-merchandise inventory and services, processing of non-merchandise supply accounts payable, and shipping and transportation coordination.
 
Vaughan, Ontario Facility.  Our facility in Vaughan, Ontario, consists of approximately 97,200 square feet and provides distribution services for our Canadian retail stores. The lease is scheduled to expire in April 2008.
 
 
Our primary customer contact center is located in Saint John, New Brunswick, Canada, with a secondary center located within our Groveport facility. The Saint John center supported approximately 2.4 million customer calls (3.2 customer contacts) in fiscal 2006. The center has 326 seats in approximately 37,815 square feet and its lease expires in May 2011. The Groveport customer contact center has 83 seats and occupies approximately 15,000 square feet within the Groveport facility.
 
 
We own our approximately 50,000 square foot information technology facility, which is located in Westmont, Illinois. This facility houses all of our systems and network services, including those related to product development, merchandising, marketing, planning, store operations, sourcing, finance, accounting, call centers, Internet, inventory and order fulfillment.
 
Item 3.   Legal Proceedings
 
 
On March 17, 2003, Spiegel, Inc., together with 19 of its subsidiaries and affiliates, including Eddie Bauer, Inc., filed petitions for relief under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court of the Southern District of New York. The debtor subsidiaries were Eddie Bauer, Inc., Newport News, Inc., Spiegel Catalog, Inc., Distribution Fulfillment Services, Inc. (now known as EBFS), Spiegel Group Teleservices, Inc. (now known as EBCS), Spiegel Group Teleservices-Canada, Inc., Spiegel Management Group, Inc. and their respective subsidiaries. The Plan of Reorganization was confirmed by order of the bankruptcy court on May 25, 2005 and became effective on June 21, 2005. See “Item 1. Business — The Spiegel Bankruptcy.”
 
Also in March 2003, the SEC commenced a civil proceeding against Spiegel alleging, among other things, that Spiegel’s public disclosures violated the Exchange Act. Spiegel entered into a consent and stipulation with the SEC resolving, in part, the claims asserted in the SEC action. Spiegel also consented to the entry of a partial final judgment pursuant to which it agreed, among other things, to the entry of a permanent injunction enjoining any conduct in violation of the Exchange Act and to the appointment of an independent examiner to review its financial records and to report on its financial condition and financial accounting. As part of the settlement, Spiegel neither admitted nor denied the allegations of the SEC’s complaint.


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On or about June 15, 2006, a class action was filed against Eddie Bauer, Inc. in Los Angeles Superior Court in the State of California in an action entitled Tara Hill v. Eddie Bauer, Inc., alleging, among other things, that Eddie Bauer, Inc. (1) did not provide plaintiffs with adequate wage statements; (2) did not reimburse plaintiffs for business-related expenses; (3) forced plaintiffs to buy Eddie Bauer clothing; (4) did not timely pay plaintiffs at the cessation of employment; and (5) improperly required the plaintiffs to work during rest and meal periods without compensation. Based on these allegations, plaintiffs assert various causes of action, including those under the California Labor Code and California Business and Professions Code. Although we cannot predict with assurance the outcome of any litigation, we believe that plaintiffs’ claims are without merit and are vigorously defending this case. No date has yet been set for class certification hearing or trial. Plaintiffs have until May 7, 2007 to file a motion for class certification.
 
Between November 17, 2006 and November 22, 2006, three purported class action complaints were filed by putative stockholders of Eddie Bauer in the Superior Court of the State of Washington in and for King County against Eddie Bauer and its Board of Directors. The complaints allege, among other things, that the Board of Directors breached its fiduciary duties in connection with the proposed merger with an affiliate of Sun Capital Partners and Golden Gate Capital and that the consideration to have been paid to holders of Eddie Bauer’s common stock was inadequate. The complaints sought, among other things, to enjoin the consummation of the merger, that certain sections of the merger agreement should have been enjoined and rescinded and attorneys’ fees. An order of dismissal without prejudice with respect to one of the complaints was entered on December 7, 2006. Eddie Bauer and the Board of Directors believe that the complaints are without merit and intend to defend the lawsuits vigorously. As the adoption of the merger agreement was not approved by our stockholders and the merger agreement was terminated, although we cannot predict with assurance, we do not believe that this litigation will have a material impact on our financial condition or results of operations.
 
In the ordinary course of business, we may be subject from time to time to various proceedings, lawsuits, disputes or claims. These actions may involve commercial, intellectual property, product liability, labor and employment related claims and other matters. Although we cannot predict with assurance the outcome of any litigation, we do not believe there are currently any such actions that would have a material impact on our financial condition or results of operations.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year ended December 30, 2006.


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Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities
 
 
From June 3, 2005 through October 11, 2006, our common stock was traded over-the-counter. Since October 12, 2006, Eddie Bauer’s common stock has been traded on The NASDAQ Global Market under the trading symbol “EBHI.” The following table sets forth, for the periods indicated, the high and low sales prices per share for the Eddie Bauer common stock as quoted on the OTC Bulletin Board or reported by The NASDAQ Global Market, as applicable:
 
                 
    High     Low  
 
Fiscal 2005
               
June 3, 2005 through July 1, 2005
  $ 28.40     $ 27.00  
Third Quarter Ended September 30, 2005
  $ 31.50     $ 22.75  
Fourth Quarter Ended December 31, 2005
  $ 25.00     $ 11.50  
Fiscal 2006
               
First Quarter Ended March 31, 2006
  $ 16.00     $ 11.75  
Second Quarter Ended July 1, 2006
  $ 15.00     $ 6.00  
Third Quarter Ended September 30, 2006
  $ 15.00     $ 8.30  
Fourth Quarter Ended December 30, 2006
  $ 11.00     $ 6.88  
 
 
As of March 28, 2007, there were 30,309,931 shares of Eddie Bauer common stock outstanding. As of December 30, 2006 our common stock was held by approximately 552 holders of record.
 
 
We do not anticipate paying any dividends on our common stock in the foreseeable future. In addition, covenants in our term loan agreement and revolving credit facility restrict our ability to pay dividends and may prohibit the payment of dividends and certain other payments.
 
 
The information called for by this Item is contained in Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters.


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The following performance graph shows the percentage change in cumulative total return to a holder of Eddie Bauer common stock (NASDAQ:EBHI) compared with the cumulative total return, assuming dividend reinvestment, of the NASDAQ Composite Index and the industry peer group indicated below, during the period from June 3, 2005 through December 29, 2006. The Company paid no cash dividends during the periods presented.
 
 
(PERFORMANCE GRAPH)
Peer Group:  Chico’s FAS, Inc. (NYSE:CHS)
The Gap, Inc. (NYSE: GPS)
Limited Brands, Inc. (NYSE:LTD)
AnnTaylor Stores Corporation (NYSE:ANN)
Coldwater Creek Inc. (NASDAQ:CWTR)
The Talbots, Inc. (NYSE:TLB)
 
(F)   Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Purchases of Equity Securities
 
On June 21, 2005, in connection with the Plan of Reorganization, we issued 30,000,000 shares of our common stock to certain holders of pre-petition claims. We received no cash consideration for the issuance of our common stock.
 
Section 1145 of the Bankruptcy Code exempts the original issuance of securities under a plan of reorganization (as well as subsequent distributions by the distribution agent) from registration under the Securities Act of 1933, as amended, or Securities Act, and state securities laws. Under Section 1145, the issuance of securities pursuant to a plan of reorganization is exempt from registration if three principal requirements are satisfied: (i) the securities must be issued under a plan of reorganization by a debtor, its successor or an affiliate participating in a joint plan with the debtor; (ii) the recipients of the securities must hold a claim against the debtor or such affiliate, an interest in the debtor or such affiliate, or a claim for an administrative expense against the debtor or such affiliate and (iii) the securities must be issued entirely in exchange for the recipient’s claim against or interest in the debtor or such affiliate or “principally” in such exchange and “partly” for cash or property. We believe that the issuances of the shares of our common stock pursuant to the Plan of Reorganization satisfied the requirements of Section 1145 of the Bankruptcy Code and, therefore, were exempt from registration under the Securities Act and state securities laws.


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On July 18, 2006, several directors and current and former officers received a total of 21,503 shares of common stock in connection with a scheduled settlement date of July 1, 2006 for shares of common stock underlying restricted stock units granted to them on November 3, 2005. On October 2, 2006, an additional officer received 7,475 shares of common stock in connection with the settlement date of July 1, 2006 for shares of common stock underlying restricted stock units granted to him on November 3, 2005. On December 20, 2006 current and former officers received 289,269 shares of common stock in connection with the settlement date for shares of common stock underlying restricted stock units granted to them on November 3, 2005. The shares of common stock were issued to the officers and directors pursuant to the 2005 Stock Incentive Plan adopted by the Board of Directors in November 2005 prior to our registration under the Securities Exchange Act of 1934, as amended, in accordance with the exemption from registration provided by Rule 701 promulgated under the Securities Act of 1933, as amended.
 
 
Item 6.   Selected Financial Data
 
 
   The Bankruptcy
 
On March 17, 2003, Spiegel and the other Debtors, including Eddie Bauer, Inc., our principal operating subsidiary, filed petitions for relief under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court of the Southern District of New York. The bankruptcy court confirmed the Plan of Reorganization on May 25, 2005, it became effective on June 21, 2005 (“Effective Date”), and on that date the Debtors emerged from bankruptcy.
 
Pursuant to the Plan of Reorganization, Eddie Bauer Holdings, Inc. (“Eddie Bauer”) was formed as a new holding company and, in exchange for Eddie Bauer issuing shares of common stock to certain unsecured creditors of the Debtors, Spiegel transferred to Eddie Bauer 100% of its ownership interest in:
 
  •  Eddie Bauer, Inc., including its subsidiaries;
 
  •  FSAC and SAC, which are two non-operating subsidiaries that hold securitization interests in certain pre-petition securitization transactions to which Spiegel and its subsidiaries (including FSAC and SAC, as applicable) were a party;
 
  •  DFS (now known as EBFS), which historically has provided catalog and retail distribution services for us; and
 
  •  SGTS (now known as EBCS), which has an office in Saint John, Canada, and which historically provided call center support for us (“Saint John”).
 
Eddie Bauer then contributed to Eddie Bauer, Inc. its shares in EBFS and EBCS such that these entities became wholly-owned subsidiaries of Eddie Bauer, Inc. In addition, EBIT was formed as a wholly-owned subsidiary of Eddie Bauer, Inc. and Spiegel Management Group, after having transferred to Spiegel all of its assets that did not comprise or support its information technology operation (the “IT Group”), merged with and into EBIT, with the result that the IT Group became part of EBIT.
 
   Predecessor and Successor Entities
 
We refer to the entities prior to emergence from bankruptcy as the “Predecessor” and to the emerged entities as the “Successor.” The Predecessor consists of Eddie Bauer, Inc., EBFS, the IT Group and Saint John. The Successor consists of Eddie Bauer, Eddie Bauer, Inc., FSAC, SAC, EBFS, EBCS, EBIT and the obligations associated with Spiegel’s former pension and other post-retirement plans that were assumed by Eddie Bauer.
 
Our historical financial statements for periods prior to July 2, 2005 were prepared on a combined, carve-out basis and reflect the financial results of the Predecessor. Our consolidated financial statements for periods as of and subsequent to July 2, 2005 reflect the financial results of the Successor.


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The Predecessor’s results of operations for periods prior to our emergence from bankruptcy are not comparable to the Successor’s results of operations for periods after our emergence from bankruptcy.  The primary differences include:
 
Reorganization costs and expenses, net:  In accordance with Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code (“SOP 90-7”), our financial statements prior to July 2, 2005 reflect our revenues, expenses, realized gains and losses, and provisions for losses resulting from the reorganization separately as “reorganization costs and expenses, net” in our combined statements of operations. In addition, all pre-petition liabilities subject to compromise have been segregated in our combined balance sheets and have been classified as “liabilities subject to compromise” and our cash flows related to our reorganization have been separately reflected in our combined statements of cash flows. Our results of operations for periods subsequent to July 2, 2005 will no longer include reorganization expenses related to our bankruptcy proceedings.
 
Revenue from Spiegel-affiliated parties:  For periods until December 2004, our historical combined results of operations included intercompany revenues from Spiegel affiliates, primarily Newport News and Spiegel Catalog. These intercompany revenues resulted from these and other Spiegel affiliates using the distribution services of EBFS, the call center support of Saint John and the information technology services of the IT Group. We reflected these intercompany revenues in our combined statements of operations as “revenue from Spiegel-affiliated parties” until Spiegel sold these entities in June and July 2004, respectively. Subsequent to Spiegel’s sales of Newport News and Spiegel Catalog, we billed these services to the former affiliates under transition services agreements and we reflected these billings as “other revenues” in our combined statements of operations. These services ended in December 2004. Our financial results for periods subsequent to December 2004 do not reflect intercompany revenues or revenues under transition services agreements from these former Spiegel affiliates.
 
Allocations of certain costs of Spiegel:  In accordance with the carve-out accounting provisions of Staff Accounting Bulleting (“SAB”) Topic 1.B, Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions or Lesser Business Components of Another Entity, our historical combined financial statements for periods prior to July 2, 2005 included allocations of certain costs of Spiegel in order to present our results of operations on a stand-alone basis. As our historical results of operations included allocations of certain costs of Spiegel, they may not be indicative of our results of operations had we been a separate, stand-alone entity for those periods, nor may they be indicative of our future results. Our results of operations for periods subsequent to July 2, 2005 no longer include allocated management fees from Spiegel, but instead include the additional expenses associated with being a stand-alone, public company.
 
Expenses of EBFS, Saint John and the IT Group:  The Predecessor’s historical combined results of operations included the expenses of EBFS, Saint John and the IT Group. As discussed above, these groups supported not only our operations, but also the operations of other Spiegel affiliates, primarily Newport News and Spiegel Catalog. During 2003, it was decided, with the approval of the bankruptcy court, to consolidate the three distribution facilities of EBFS into two facilities because of excess capacity at the distribution centers. The sale of one of EBFS’s distribution facilities in Columbus, Ohio, was completed in 2004. As a result of this consolidation and down-sizing efforts of our call center support and IT Group functions, our results of operations since 2004 reflect lower expenses associated with the operations of EBFS, Saint John and the IT Group as compared with prior periods. In order to further improve our gross margins and profitability, we intend to focus additional efforts on optimizing and improving the efficiency of these operations.
 
Discontinuation of Eddie Bauer Home — In February 2005 we announced our plan to discontinue operating our “Eddie Bauer Home” concept. As such, we have reflected the historical results of the Eddie Bauer Home group within discontinued operations in our financial statements. All Eddie Bauer Home store locations were closed by September 2005.


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Although we emerged from bankruptcy on June 21, 2005, in accordance with SOP 90-7, we have applied the accounting and reporting requirements of “fresh start” accounting to the Successor effective July 2, 2005. We chose the date of July 2, 2005 because it corresponded with the end of our second quarter of fiscal 2005 and applying fresh start accounting as of June 21, 2005 versus July 2, 2005 would not have resulted in a material difference to our results of operations or financial condition. Pursuant to the principles of fresh start accounting, we determined the reorganization value of our company and allocated such reorganization value to the fair value of our tangible assets, finite-lived intangible assets and indefinite-lived intangible assets in accordance with the provisions of Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”).
 
 
For fiscal 2005, the results of the Successor for the six months ended December 31, 2005 and the results of the Predecessor for the six months ended July 2, 2005 have been combined for convenience of discussion since separate presentation and discussions of the Predecessor and Successor periods would not be meaningful in terms of operating results or comparisons to other periods. We refer to the combined results collectively as fiscal 2005. As a result of applying fresh start accounting, the Successor’s results of operations for periods after our emergence from bankruptcy are not comparable to the Predecessor’s results of operations for periods prior to our emergence from bankruptcy, and therefore, the combined results for fiscal 2005 should not be taken as indicative of our historical or future results.
 
 
We assess the performance of our business using various financial and operating measures, which primarily include:
 
  •  Net merchandise sales — Net merchandise sales include sales of merchandise from our retail and outlet stores, catalogs and websites, less discounts and sales return allowances. Upon the sale of a gift card or gift certificate, we defer the revenue and record a liability. We reduce the liability and record merchandise sales when the gift card or gift certificate is redeemed by the customer. A significant percentage of our customers make purchases through more than one sales channel.
 
  •  Comparable store sales — Comparable store sales include net merchandise sales from retail and outlet stores that have been open for one complete fiscal year. We exclude new store locations from our comparable store sales until they have been in operation for one complete fiscal year. Similarly, stores that are expanded or down-sized by more than 30% are also excluded from our comparable store base until they have been in operation in their new configuration for one complete fiscal year. Stores that are closed for more than 10 consecutive days are also excluded from our comparable store base. Comparable store sales do not include net sales from our catalogs and websites.
 
  •  Average sales per square foot — Average sales per square foot is determined on an annual basis by dividing net merchandise sales from our retail and outlet stores for the fiscal year by the monthly average of the gross square feet during such fiscal year. References to square feet represent gross square feet and not net selling space.
 
  •  Other revenues — Other revenues include revenues associated with the royalties we receive from licensing agreements for the use of the Eddie Bauer trademark, royalties we receive from our international joint ventures and shipping revenues from shipments to customers from our direct channel. Other revenues also included services we billed to former Spiegel-affiliated entities under transition services agreements after Spiegel’s sale of these entities in June and July 2004 through December 2004.
 
  •  Revenue from Spiegel-affiliated parties — Revenue from Spiegel-affiliated parties included intercompany revenues from Spiegel affiliates, which were primarily Newport News and Spiegel Catalog, prior to Spiegel’s sale of these entities in June and July of 2004. These intercompany revenues resulted from these and other Spiegel affiliates’ using the distribution services of EBFS, the call center support of Saint John and the information technology services of the IT Group.


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  •  Gross margin — Gross margin is equal to our net merchandise sales less our costs of sales. We include in our costs of sales the direct cost of purchased merchandise, inbound freight, inventory write downs, design, buying and production costs and occupancy costs related to store operations and warehouses. Costs of sales also include the amortization expenses associated with our finite-lived intangible assets. As noted below, our warehousing and distribution expenses (excluding occupancy costs related to our warehouses) and shipping costs are included in selling, general and administrative expenses and are therefore excluded from our calculation of gross margin and gross margin percentage. As a result, our gross margin and gross margin percentages may not be comparable to those of other retailers.
 
During September 2006, we launched a full-scale customer loyalty program. Prior to that time, we had a limited pilot customer loyalty program which we launched in mid-2004. Under the program, a customer earns points based upon merchandise purchases. Accumulated points are then converted into rewards certificates after reaching a specified threshold. The rewards certificates can be used towards the purchase of our products and in limited cases, can be used to purchase non-Eddie Bauer merchandise or services (e.g., travel awards, specialty services). Both accumulated points and issued rewards certificates expire after a stated period of time. We record costs of sales expense and a liability for earned certificates. The liability is recorded net of an estimated breakage amount, or the amount of rewards certificates estimated to go unredeemed. We reduce the liability when a reward certificate is redeemed by the customer. Program costs, including marketing, printing and administration of the program, are reflected within selling, general and administrative expenses.
 
  •  Gross margin %  — Gross margin % is calculated as our gross margin as a percentage of our net merchandise sales.
 
  •  Impairment of indefinite-lived intangible assets — These expenses include impairment charges related to our goodwill and trademarks.
 
  •  Selling, general and administrative (“SG&A”) — These expenses include all operating expenses not included within costs of sales, such as store expenses other than occupancy costs, administrative expenses, marketing and advertising expenses, catalog production and mailing costs, warehousing and distribution expenses (excluding occupancy costs related to our warehouses, which are reflected in costs of sales), call center expenses, shipping costs associated with our catalog and Internet sales and depreciation and amortization of our non-store related property and equipment and computer software costs. Selling, general and administrative expenses also include gift card breakage related to gift cards purchased, which is the estimated amount of gift cards and gift certificates that will go unredeemed. We record a liability associated with the sale of gift cards and gift certificates. We reduce the liability and record revenue when the gift card or gift certificate is redeemed by the customer. Gift card breakage is recorded as a reduction to selling, general and administrative expenses for amounts when redemption is determined to be remote, based upon historical breakage percentages.
 
  •  Interest expense — Interest expense for periods prior to July 2, 2005 represent interest charged by our former parent, Spiegel, on our intercompany borrowings. Interest expense for periods subsequent to July 2, 2005 includes interest on our senior secured revolving credit facility and interest on our senior secured term loan, which was amended in April 2006, both of which we entered into upon our emergence from bankruptcy.
 
  •  Other income (expense) — Other income (expense) primarily includes interest earned on our cash and cash equivalents, gains or losses on our derivative instruments not designated in hedging relationships, and the net accretion on the financing receivables and liabilities associated with our securitization interests.
 
  •  Equity in earnings (losses) of foreign joint ventures — This includes our proportionate share of the earnings or losses of our joint ventures in Germany and Japan. We own a 30% interest in Eddie Bauer Japan, Inc. and a 40% interest in Eddie Bauer GmbH & Co. We account for these investments under the equity method of accounting as we do not control these entities.


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  •  Gain on discharge of liabilities — In conjunction with our emergence from bankruptcy, we recognized a net gain of $107.6 million for the six months ended July 2, 2005 associated with the discharge of our liabilities in accordance with the Plan of Reorganization.
 
  •  Reorganization costs and expenses, net — In accordance with SOP 90-7, our financial statements prior to our emergence from bankruptcy reflect our revenues, expenses, realized gains and losses, and provisions for losses resulting from the reorganization separately as “reorganization costs and expenses, net” in our combined statements of operations.
 
  •  Discontinuation of Eddie Bauer Home — In February 2005 we announced our plan to discontinue operating our “Eddie Bauer Home” concept. As such, we have reflected the historical results of the Eddie Bauer Home group within discontinued operations in our financial statements. All Eddie Bauer Home store locations were closed by September 2005.
 
SELECTED HISTORICAL FINANCIAL INFORMATION
 
The following tables set forth selected historical financial and other information for the Predecessor and Successor entities as of the dates and for the periods indicated. Financial information for periods prior to July 2, 2005 relates to the Predecessor and financial information for periods as of and subsequent to July 2, 2005 relates to the Successor. Because of our emergence from bankruptcy and our corresponding adoption of fresh start accounting and for the reasons stated above in “— Predecessor and Successor Entities”, our financial information for any period prior to July 2, 2005 will not be comparable to financial information for periods after that date.
 
Our selected historical balance sheet information as of December 30, 2006, December 31, 2005, July 2, 2005 (the date we adopted fresh start accounting), January 1, 2005 and January 3, 2004 is derived from our audited consolidated and combined balance sheets. Our selected historical statement of operations information for the fiscal year ended December 30, 2006, the six months ended December 31, 2005, the six months ended July 2, 2005 and fiscal years ended January 1, 2005, January 3, 2004, and December 28, 2002 are derived from our audited consolidated and combined statements of operations. Our selected historical balance sheet information as of December 28, 2002 is derived from our unaudited financial statements.
 
For all periods presented, income from continuing operations excludes the results of our discontinued Eddie Bauer Home business unit. The results of operations of this business unit are presented separately as discontinued operations, net of tax.
 
The following financial information should be read in conjunction with our financial statements and related notes included elsewhere in this registration statement, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
                                                         
          Successor
    Predecessor
                         
          Six Months
    Six Months
                         
          Ended
    Ended
                         
    Successor
    December 31,
    July 2,
    Combined
    Predecessor
    Predecessor
    Predecessor
 
    2006     2005     2005     2005     2004     2003     2002  
    ($ in thousands, except per share data)  
 
Statement of Operations Information:
                                                       
Net sales and other revenues
  $ 1,013,447     $ 593,711     $ 465,723     $ 1,059,434     $ 1,120,761     $ 1,243,927     $ 1,374,204  
Revenue from Spiegel-affiliated parties
                            37,154       73,288       97,748  
                                                         
Total revenues
    1,013,447       593,711       465,723       1,059,434       1,157,915       1,317,215       1,471,952  


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          Successor
    Predecessor
                         
          Six Months
    Six Months
                         
          Ended
    Ended
                         
    Successor
    December 31,
    July 2,
    Combined
    Predecessor
    Predecessor
    Predecessor
 
    2006     2005     2005     2005     2004     2003     2002  
    ($ in thousands, except per share data)  
 
Costs of sales, including buying and occupancy
    603,171       337,318       259,536       596,854       604,864       695,872       797,037  
Impairment of indefinite-lived intangible assets(a)
    117,584       40,000             40,000                    
Selling, general and administrative expenses
    411,300       214,125       185,225       399,350       452,603       531,101       619,003  
                                                         
Total operating expenses
    1,132,055       591,443       444,761       1,036,204       1,057,467       1,226,973       1,416,040  
Operating income (loss)
    (118,608 )     2,268       20,962       23,230       100,448       90,242       55,912  
Interest expense
    26,928       11,064       761       11,825       316       2,513       18,952  
Other income
    3,031       1,919             1,919                    
Equity in earnings (losses) of foreign joint ventures
    (3,413 )     174       (95 )     79       3,590       1,606       (281 )
                                                         
Income (loss) from continuing operations before reorganization items and income tax expense
    (145,918 )     (6,703 )     20,106       13,403       103,722       89,335       36,679  
Gain on discharge of liabilities(b)
                (107,559 )     (107,559 )                  
Reorganization costs and expenses, net
                13,686       13,686       26,871       91,022        
                                                         
Income (loss) from continuing operations before income tax expense (benefit)
    (145,918 )     (6,703 )     113,979       107,276       76,851       (1,687 )     36,679  
Income tax expense (c)
    65,531       14,645       50,402       65,047       36,080       4,803       14,425  
                                                         
Income (loss) from continuing operations
    (211,449 )     (21,348 )     63,577       42,229       40,771       (6,490 )     22,254  
Income (loss) from discontinued operations, net of tax
    (534 )     (1,440 )     (2,661 )     (4,101 )     2,893       6,171       8,075  
                                                         
Net income (loss)
  $ (211,983 )   $ (22,788 )   $ 60,916     $ 38,128     $ 43,664     $ (319 )   $ 30,329  
                                                         
Basic and Diluted Earnings Per Share Information(d):
                                                       
Loss from continuing operations per share
  $ (7.04 )   $ (0.71 )     n/a       n/a       n/a       n/a       n/a  
Loss from discontinued operations per share
  $ (0.02 )   $ (0.05 )     n/a       n/a       n/a       n/a       n/a  
Net loss per share
  $ (7.06 )   $ (0.76 )     n/a       n/a       n/a       n/a       n/a  
Weighted average shares used to complete basic and diluted earnings per share
    30,012,896       29,995,092       n/a       n/a       n/a       n/a       n/a  

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          Successor
    Predecessor
                         
          Six Months
    Six Months
                         
          Ended
    Ended
                         
    Successor
    December 31,
    July 2,
    Combined
    Predecessor
    Predecessor
    Predecessor
 
    2006     2005     2005     2005     2004     2003     2002  
    ($ in thousands, except per share data)  
 
Operating Information — Unaudited(e):
                                                       
Percentage increase (decrease) in comparable store sales(f)
    (2.0 )%     (6.0 )%     3.4 %     (2.2 )%     (1.7 )%     (5.3 )%     (12.9 )%
Average sales per square foot
  $ 256       n/a       n/a     $ 256     $ 252     $ 245     $ 247  
Number of retail stores(g):
                                                       
Open at beginning of period
    292       279       304       304       330       399       432  
Opened during the period
    16       16             16       7       1       7  
Closed during the period
    29       3       25       28       33       70       40  
Open at the end of the period
    279       292       279       292       304       330       399  
Number of outlet stores(g):
                                                       
Open at beginning of period
    108       103       101       101       103       102       99  
Opened during the period
    8       5       3       8       2       2       4  
Closed during the period
    1             1       1       4       1       1  
Open at the end of the period
    115       108       103       108       101       103       102  
Total store square footage at end of period (in thousands)
    2,752       2,897       n/a       2,897       2,960       3,220       3,775  
Gross margin
  $ 353,517     $ 228,161     $ 176,478     $ 404,639     $ 442,875     $ 478,170     $ 506,586  
Gross margin %
    37.0 %     40.3 %     40.5 %     40.4 %     42.3 %     40.7 %     38.9 %
Capital expenditures
  $ 45,814     $ 30,214     $ 8,641     $ 38,855     $ 13,906     $ 6,313     $ 24,967  
Depreciation and amortization
  $ 55,494     $ 26,589     $ 16,171     $ 42,760     $ 41,142     $ 57,339     $ 71,360  
 
                                                 
    Successor
    Successor
    Successor
    Predecessor
    Predecessor
    Predecessor
 
    As of
    As of
    As of
    As of
    As of
    As of
 
    December 30,
    December 31,
    July 2,
    January 1,
    January 3,
    December 28,
 
    2006     2005     2005     2005     2004     2002  
    ($ in thousands)  
 
Balance Sheet Information:
                                               
Working capital
  $ 105,067     $ 107,297     $ 115,087     $ 112,577     $ 12,805     $ (208,529 )
Goodwill
  $ 114,765     $ 220,481     $ 220,481     $ 76,601     $ 76,601     $ 76,601  
Trademarks
  $ 185,000     $ 185,000     $ 225,000     $ 58,756     $ 58,756     $ 58,756  
Total assets
  $ 855,910     $ 1,153,236     $ 1,186,005     $ 591,975     $ 643,137     $ 850,912  
Due to (from) Spiegel
                    $ (37,751 )   $ 90,688     $ 300,129  
Total long-term debt(h)
  $ 274,500     $ 298,500     $ 300,000                    
Stockholders’ equity
  $ 346,641     $ 545,020     $ 564,900     $ 292,391     $ 248,013     $ 246,638  
 
 
(a) In conjunction with our impairment tests of indefinite-lived intangible assets, we recorded an impairment charge of $40 million related to our trademarks during the fourth quarter of 2005 and an impairment charge of $117.6 million related to our goodwill during the third quarter of 2006. See Note 7 to our annual financial statements for more detailed descriptions of the impairment tests performed.
 
(b) In accordance with SOP 90-7, we recorded a net gain of $107.6 million related to the discharge of our liabilities upon our emergence from bankruptcy for the six months ended July 2, 2005.
 
(c) We recorded income tax expense associated with increases to our tax valuation allowance of $71.3 million and $15.3 million during fiscal 2006 and 2005, respectively. See further discussion in Note 15 to our annual financial statements for more detailed descriptions of our tax valuation allowance changes.

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(d) On June 21, 2005, in connection with the Effective Date of the Plan of Reorganization, we issued 30,000,000 shares of our common stock to certain unsecured creditors of the Debtors. Accordingly, earnings per share data have been included for periods subsequent to July 2, 2005. No earnings per share data have been presented for periods prior to July 2, 2005 because there were no shares outstanding for the combined entity.
 
(e) Represents unaudited financial measures used by our management to assess the performance of our business.
 
(f) Represents increase (decrease) over respective prior year period.
 
(g) Retail and outlet store count data excludes stores related to our discontinued Eddie Bauer Home business.
 
(h) Includes current portion of long-term debt, which totaled $8.0 million as of December 30, 2006, $24.0 million as of December 31, 2005 and $3.0 million as of July 2, 2005.
 
 
The following table sets forth our historical unaudited quarterly comparable sales data (compared to sales of the same quarter the prior year):
 
                                             
Fiscal 2006   Fiscal 2005   Fiscal 2004
Q4   Q3   Q2   Q1   Q4   Q3   Q2   Q1   Q4   Q3   Q2   Q1
 
4.6%
  (1.5)%   (5.9)%   (10.0)%   (7.1)%   (4.3)%   3.7%   3.0%   2.0%   (3.9)%   (6.0)%   (0.9)%
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The information in this Management’s Discussion and Analysis contains certain forward-looking statements, which reflect our current view with respect to future events and financial performance. Any such forward-looking statements are subject to risks and uncertainties that could cause our actual results of operations to differ materially from historical results or current expectations. This discussion and analysis should be read in conjunction with our consolidated and combined financial statements and the related notes included elsewhere in this document.
 
 
 
Eddie Bauer is a specialty retailer that sells casual sportswear and accessories for the modern outdoor lifestyle. Our primary target customers are women and men who are 30-54 years old with an average annual household income of $75,000. Eddie Bauer is a nationally recognized brand that we believe stands for high quality, innovation, style and customer service. Founded in 1920, Eddie Bauer has an established reputation in the outerwear market and was ranked as the number three outerwear brand in a survey conducted by Women’s Wear Daily in July 2006.
 
In June 2005, we emerged from bankruptcy as a stand-alone company for the first time in 34 years. We are committed to turning our business around and revitalizing Eddie Bauer as a premium quality brand, both by continuing to implement initiatives that we commenced over the past several years and by actively changing initiatives that are not performing up to our expectations.
 
We sell our products through two interdependent sales channels that share product sourcing, design and marketing resources:
 
  •  retail, which consists of our Eddie Bauer stores and our Eddie Bauer Outlet stores located in the United States and Canada; and
 
  •  direct, which consists of our Eddie Bauer catalogs and our websites www.eddiebauer.com and www.eddiebaueroutlet.com.
 
We aim to offer our customers a seamless retail experience and structure our operations to reflect that goal. Customers can purchase our products through either of our sales channels and return or exchange our


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products at any of our stores, regardless of the channel of purchase. Our U.S. stores also offer a direct phone connection to our customer call centers that allows an in-store customer to order for home delivery a particular size, color or item that may not be available in the store.
 
As of December 30, 2006, we operated 394 stores, consisting of 279 retail stores and 115 outlet stores in the U.S. and Canada. During 2006, we had 33.7 million visits to our two websites and circulation of approximately 80.8 million catalogs.
 
In addition, we are minority participants in joint venture operations in Japan and Germany. As of December 30, 2006, Eddie Bauer Japan operated 40 retail stores and nine outlet stores, distributed 11 major catalogs annually and operated a website located at www.eddiebauer.co.jp and Eddie Bauer Germany operated seven retail stores and two outlet stores, distributed six major catalogs annually and operated a website located at www.eddiebauer.de. As a result of weak retail sales due partially to a continued poor apparel retail market in Germany, in January 2007 Eddie Bauer Germany made the decision to close all of its retail stores. We anticipate that all Eddie Bauer Germany retail stores will be closed by August 2007. Eddie Bauer Germany will continue to sell its products through its catalogs, website and outlet stores. We also license the Eddie Bauer name to various consumer product manufacturers and other retailers whose products complement our modern outdoor lifestyle brand image.
 
We design and source almost all of our clothing and accessories that we sell through our stores and direct sales channel. Although we do not manufacture any of our products, each of our vendors must comply with our Global Labor Practices Program that includes prohibitions against forced labor, child labor, harassment and abuse. Our sourcing and logistics infrastructure is designed to provide the timely distribution of products to our customers and stores, and our customer call center is designed to deliver a consistently high level of customer service.
 
 
Compared to the prior year, net merchandise sales for fiscal 2006 were down $44.8 million, or approximately 4.5%, and comparable store sales declined by 2.0%. Our gross margin and gross margin percentage for fiscal 2006 were $353.5 million and 37.0%, down from $404.6 million and 40.4% in the prior year. The $44.8 million decrease in net merchandise sales and an increase in impairment charges resulted in an increase in our operating loss of $141.8 million for fiscal 2006, versus the prior year period. The decline in retail sales during fiscal 2006, as well as sales in our direct channel, was primarily a continuation into the first three quarters of 2006 of poor customer reaction to the significant changes in the merchandise collection introduced in the fall of fiscal 2005. During fiscal 2006, we recognized a $117.6 million impairment charge related to our goodwill versus a $40.0 million impairment charge related to trademarks during fiscal 2005.
 
As discussed above, we introduced our new 2006 Fall/Holiday collection which began arriving in our stores in the third quarter of 2006. Our fourth fiscal quarter was the first full quarter to reflect the results of our 2006 Fall/Holiday collection. Net merchandise sales for the fourth quarter of 2006 increased $4.4 million, or approximately 1.2%, compared to the prior year quarter. After experiencing negative comparable sales for the past five quarters, beginning with the third quarter of 2005, comparable stores sales increased 4.6% during the fourth quarter. Our gross margin and gross margin percentage for the fourth fiscal quarter of 2006 were $164.4 million and 45.0%, compared to $161.8 million and 44.8% in the prior year quarter.
 
Recent Developments and Initiatives
 
 
We are currently in active discussions to refinance our existing term loan, which totaled $275 million as of December 30, 2006, as a result of our expectation that we would not meet certain loan covenants during 2007, possibly as early as the first quarter of 2007. We are working with our financial advisors and potential lenders on a refinancing package that would include a new term loan and junior capital. We expect to complete the financing transaction in April 2007. Proceeds from the new financing transaction would be utilized to pay-off our existing senior secured term loan. See further discussion below within “Management’s


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Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”.
 
 
On November 13, 2006, we announced that we had entered into a merger agreement with Eddie B Holding Corp., a company owned by affiliates of Sun Capital Partners, Inc. and Golden Gate Capital. Under the terms of the merger agreement, all of the Company’s outstanding shares of common stock were to be converted into the right to receive $9.25 per share in cash upon closing of the transaction. On February 8, 2007, at a special meeting of our stockholders to vote on the transaction, an insufficient number of shares were voted in favor of approving the proposed sale. Following this stockholder vote, on February 8, 2007 we terminated the merger agreement. As a result, Eddie Bauer will continue to operate as a stand-alone publicly traded company. We intend to continue to operate the business and implement initiatives in substantial conformance with our previously announced plans.
 
 
We are committed to turning our business around and revitalizing Eddie Bauer, by continuing to implement previously announced initiatives and by actively changing initiatives that are not performing up to our expectations. Although we believe our strategies will help stabilize our business in the long term, this process comes with significant risks and challenges and will take time. As a result, even if we are successful, we do not expect to see improvements in our results of operations in the near term.
 
 
Our primary focus with the 2006 Fall/Holiday line has been to re-align the offering with the needs and preferences of our 30-54 year-old core customers, including:
 
  •  re-setting the styling, fit and construction of our products, while leveraging Eddie Bauer’s unique outdoor heritage as a point of differentiation,
 
  •  returning to a color palette that emphasizes Eddie Bauer’s tradition of rich, textured and natural colors inspired by the outdoors,
 
  •  increasing emphasis on down outerwear and accessories as we seek to capitalize on our past success in these classifications as well as our reputation as one of the world’s most recognized outerwear brands, and
 
  •  modifying pricing in certain areas to improve the price/value equation for our customers.
 
In 2006, we made significant changes in the fabric, materials and fit in our pant business in both Men’s and Women’s categories aimed at improving the appeal and functionality of our line. We ran a promotion in September 2006 to publicize these changes. Customer reactions to these changes and promotional efforts were favorable with sales in these categories tracking above the previous year’s disappointing results. Product with similarly revised construction and fit will be introduced gradually in our Eddie Bauer Outlet stores over the course of 2007. The 2006 Fall/Holiday collection reflected a move to more traditional colors in our basic offerings unlike our 2005 Fall/Holiday merchandise that featured a non-traditional color scheme.
 
To support the 2006 Fall/Holiday products, we redirected our catalog and store merchandising to present more product-specific marketing, including a product-focused advertising campaign that we launched in the November and December issues of key magazines that we believe reach our core customers. In addition, we placed a stronger emphasis on gift giving in our marketing efforts. We believe that the reduced emphasis on wardrobing (i.e., presentation of products as unified outfits) in the 2006 Fall/Holiday sales materials and displays has contributed to improved customer response, particularly in the Men’s categories where this approach was emphasized. In addition, our recent catalogs have featured a model group that is more age appropriate for our target demographics and a greater emphasis on individual product images to enhance the ability of customers to evaluate fit and finish. Customer response to the 2006 Fall/Holiday line has been


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encouraging, as evidenced by increases in comparable store sales of 4.6% and 9.5% in the fourth quarter of 2006 and the first quarter of 2007 (through March 10, 2007) and an increase in sales in our direct channel in the first quarter of 2007 (through March 10, 2007) of 12.9%, when compared to the same period in 2006. These results reinforce our belief that we are on the correct path.
 
 
On September 6, 2006, we launched our first full-scale customer loyalty program, Eddie Bauer Friends, for Eddie Bauer customers based on the results of a limited pilot program that we had tested since mid-2004. Customers may enroll in the program via our stores, catalog call centers or at www.eddiebauerfriends.com. The loyalty program allows customers in the United States to accrue points that may be redeemed for Eddie Bauer rewards certificates or used toward acquiring special Eddie Bauer merchandise at www.eddiebauerfriends.com. For every dollar spent on Eddie Bauer products, a member of the loyalty program receives loyalty points. Members who hold Eddie Bauer credit cards are eligible for bonus points and are also eligible to participate in exclusive online auctions for special items, such as outdoor vacations, resort getaways, electronics, day spa retreats and more, using their points. The full terms and conditions of the loyalty program are available at www.eddiebauerfriends.com. As of December 30, 2006, approximately 851,000 customers have enrolled in our loyalty program.
 
We intend to evaluate the performance of the program on an on-going basis. We believe that the program will be a valuable tool in driving customer purchases and fostering customer loyalty while facilitating our ability to track and market to our customers.
 
 
During fiscal 2006, we opened 16 new retail stores and eight new outlet stores, including five retail stores and one outlet store opening during the fourth quarter. We closed 29 retail and one outlet store during fiscal 2006, of which one retail store was closed during the fourth quarter. All new retail stores, with the exception of one temporary lease for a new store in Canada, opened during fiscal 2006 were within 15% of our model store size of 5,500 square feet. In fiscal 2007, we intend to open approximately 22 new retail stores and 11 new outlet stores and expect to close approximately 29 retail stores and one outlet store, which were all closed during the first quarter of 2007. We financed the opening of the new stores and intend to finance additional store openings through cash provided by operations and our revolving credit facility. We estimate that capital expenditures to open a store will approximate $0.9 million and $0.5 million per store for retail and outlet stores, respectively. In substantially all instances, this capital investment is funded partially by the landlords of leased sites. The portion funded by landlords typically ranges from 25% to 50%. The number of stores we ultimately open during any given year will depend on our ability to obtain suitable locations on favorable terms, our working capital, general economic conditions, and the terms of our debt agreements. In addition to closing under-performing stores and opening new stores, our strategy includes right-sizing our existing stores, mainly through down-sizing. In addition, during the first half of 2007, we expect to complete the build-out of our office space at our new leased headquarters currently under construction in Bellevue, Washington, in anticipation of our relocation planned for summer of 2007.
 
 
To increase our profitability and generate cash for future growth, we will need to increase our net sales in our stores and through our direct channel. Comparable store sales for the quarter-to-date period through March 10, 2007 increased 9.5% and sales in our direct channel increased 12.9%. The sales improvements seen during the first quarter of 2007, however, may not be indicative of future sales increases. Improvement in our gross margins and profitability also depends upon our ability to source our products at cost effective prices, control our transportation and energy costs and reduce our need for inventory mark-downs. Additionally, our ability to control store occupancy and buying costs and efficiently manage our back-end operations and fixed costs will also impact our future gross margins and profitability. Despite our strategy to design products that appeal to our target customers, changes in customer preferences or demand or lack of customer response to these designs could result in increased costs and lower margins if we are again required to increase our


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inventory markdowns or redesign our product offerings. We anticipate continuing our loyalty program as discussed above during 2007, which will result in higher cost of sales and put pressure on our gross margin during fiscal 2007. Additionally, our results for the first quarter of 2007 will be negatively impacted by a $5 million charge related to the expense reimbursement we were required to pay as a result of the previously mentioned termination of our merger agreement, professional fees related to the proposed sale, a charge of approximately $5 million related to severance costs associated with the resignation of our Chief Executive Officer (“CEO”) and a non-cash charge of approximately $3 million related to the accelerated vesting of our resigned CEO’s stock options and RSUs. In the event we are successful in our turnaround initiatives, we expect that it may take approximately 12 to 18 months before our operating results would improve significantly from the current levels.
 
 
We must stabilize our business and revitalize Eddie Bauer as a premium quality brand while addressing general trends we face in the apparel industry. We believe the key marketplace factors affecting us include:
 
  •  Constantly shifting consumer style preferences, such as the general shift in the U.S. towards more casual apparel and a shift towards consumers being more willing to purchase either premium apparel at higher prices or value apparel with lower prices, and being less willing to purchase mid-priced apparel;
 
  •  The maturation and fragmentation of the apparel industry by channel of distribution, age, gender, price points and classification, as well as the increase in brand proliferation, especially with the growth of private label brands;
 
  •  Increased competition due to fewer barriers to entry;
 
  •  The increased availability of quality, global low-cost sourcing for apparel due to the elimination of import quotas in the U.S., which puts deflationary pressures on pricing and further lowers barriers to entry;
 
  •  Retail sales of apparel is seasonal in nature, i.e., revenues, the related expenses and profits are typically higher during the fourth quarter of the calendar year, driven by significant holiday purchases; and
 
  •  In the international markets in which we participate through our joint ventures (Japan and Germany), Germany has experienced a deteriorating retail environment while Japan continues to experience a fairly robust retail environment.
 
 
The following is a discussion of our results of operations for fiscal 2006, 2005 and 2004. Our historical results for periods prior to July 2, 2005 are not comparable with our results for periods subsequent to July 2, 2005 for several reasons.  As discussed above, we applied the fresh start reporting requirements of SOP 90-7 effective July 2, 2005. For fiscal 2005, the results of the Successor for the six months ended December 31, 2005 and the results of the Predecessor for the six months ended July 2, 2005 have been combined for convenience of discussion since separate presentation and discussions of the Predecessor and Successor periods would not be meaningful in terms of operating results or comparisons to other periods. We refer to the combined results collectively as fiscal 2005. Additionally, as mentioned above, in February 2005 we announced our plan to discontinue operating our “Eddie Bauer Home” concept.


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Fiscal 2006 Compared to Fiscal 2005
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Retail & outlet store sales:
                       
Comparable store sales
  $ 559,549     $ 570,838     $ (11,289 )
Non-comparable store sales
    140,595       162,325       (21,730 )
                         
Total retail & outlet store sales
    700,144       733,163       (33,019 )
Direct sales
    256,463       268,135       (11,672 )
Other merchandise sales
    81       195       (114 )
                         
Net Merchandise Sales
    956,688       1,001,493       (44,805 )
Shipping revenues
    34,022       35,726       (1,704 )
Licensing revenues
    15,707       15,300       407  
Foreign royalty revenues
    6,626       6,100       526  
Other revenues
    404       815       (411 )
                         
Net sales and other revenues
    1,013,447       1,059,434       (45,987 )
                         
Percentage increase (decrease) in comparable store sales
    (2.0 )%     (2.2 )%     n/a  
Number of retail stores:
                       
Open at beginning of period
    292       304       n/a  
Opened during the period
    16       16       n/a  
Closed during the period
    29       28       n/a  
Open at the end of the period
    279       292       n/a  
Number of outlet stores:
                       
Open at beginning of period
    108       101       n/a  
Opened during the period
    8       8       n/a  
Closed during the period
    1       1       n/a  
Open at the end of the period
    115       108       n/a  
 
Net merchandise sales declined $44.8 million, or 4.5%, in fiscal 2006 from fiscal 2005. During fiscal 2006, we experienced declines in both our retail store sales and our direct sales. Comparable store sales during fiscal 2006 declined 2.0%, or $11.3 million. Non-comparable store sales, which includes sales associated with new, closed and non-comparable remodeled stores, declined $21.7 million, or 1.3%, primarily due to fewer stores open during fiscal 2006 (394 total stores at the end of fiscal 2006 as compared to 400 total stores at the end of fiscal 2005). The decline in net merchandise sales occurred in the first three fiscal quarters of 2006 as a result of the continuation of poor customer response to the significant changes in the merchandise collection first introduced in the fall of fiscal 2005. As of result of the poor sales performance, management took actions to design, source and merchandise products intended to re-capture the interest of our core customer and reverse the downward sales trends. These actions, which began during the fourth quarter of 2005, were undertaken after the poor customer response became clear and the initiatives continued to be implemented through mid-2006 culminating in the introduction of our 2006 Fall/Holiday products beginning during the third quarter as discussed above. Improved customer response to this collection resulted in net merchandise sales during the fourth fiscal quarter of 2006 increasing $4.4 million compared to the fourth quarter of fiscal 2005. Net merchandise sales in our retail stores and direct channel were flat with the prior year quarter, while net merchandise sales in our outlet stores increased $4.5 million. Our comparable store sales for the fourth quarter, including our retail and outlet stores, increased 4.6%.


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    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Net Merchandise Sales
  $ 956,688     $ 1,001,493     $ (44,805 )
Cost of sales, including buying and occupancy
  $ 603,171     $ 596,854     $ 6,317  
Gross margin
  $ 353,517     $ 404,639     $ (51,122 )
Gross margin as a % of net merchandise sales
    37.0 %     40.4 %     (3.4 )%
 
Our gross margin for fiscal 2006 was $353.5 million, a decrease of $51.1 million, or 12.6%, from our fiscal 2005 gross margin of $404.6 million. As noted above in “Financial Operations Overview”, our warehousing and distribution expenses (excluding occupancy costs related to our warehouses) and shipping costs are included in selling, general and administrative expenses. As a result, our gross margin and gross margin percentages may not be comparable to those of other retailers. Our warehousing and distribution expenses reflected in selling, general and administrative expenses for fiscal 2006 and 2005 were $32.5 million and $37.3 million, respectively. Our shipping costs reflected in selling, general and administrative expenses for fiscal 2006 and 2005 were $22.3 million and $21.6 million, respectively.
 
The $6.3 million increase in our costs of sales during fiscal 2006 versus the prior year primarily reflected increases of $8.8 million, $4.5 million and $1.8 million in our occupancy costs, intangible amortization expense, and buying costs, respectively. These increases were partially offset by an $8.6 million decline in our merchandise costs. The $8.8 million increase in our occupancy expenses resulted primarily from an approximately $3.2 million increase in our rent expense and an approximately $6.1 million increase in the amortization of our leasehold improvements, which included higher amortization expenses associated with the fair value adjustments we recorded to our leasehold improvements as of our fresh start accounting date. The $4.5 million increase in our intangible amortization resulted from the intangible assets related to our customer lists and licensing agreements that we recorded in conjunction with our fresh start accounting effective July 2, 2005. Prior to that date, we did not have any intangible assets that were amortized. Our buying costs increased as a result of higher payroll and employee benefit related expenses. The $8.6 million decline in our merchandise costs resulted primarily from the decrease in our merchandise sales in fiscal 2006 versus fiscal 2005.
 
Our gross margin percentage declined to 37.0% in fiscal 2006, down from 40.4% in fiscal 2005. The 3.4 percentage point decline in our gross margin percentage was due primarily to increases in our occupancy costs discussed above, which resulted in a 1.6 percentage point decline in our gross margin percentage as a result of lower net merchandise sales in which to absorb our fixed store related costs. Additionally, our merchandise margins decreased 1.1 percentage points as a result of higher markdowns and the customer loyalty program we introduced during the second half of 2006. Lastly, the increases in our intangible amortization expense and buying costs resulted in declines of 0.5 and 0.3 percentage points, respectively, in our gross margin percentage versus fiscal 2005.
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Selling, general and administrative expenses (SG&A)
  $ 411,300     $ 399,350     $ 11,950  
SG&A as a % of net merchandise sales
    43.0 %     39.9 %     3.1 %
 
SG&A expenses for fiscal 2006 were $411.3 million, representing an increase of $12.0 million, or 3.0% from the prior year. SG&A expenses as a percentage of net merchandise sales for fiscal 2006 were 43.0%, up from 39.9% in the prior year, which reflected both the spreading of our SG&A over our declining merchandise sales and increased expenses as described below. The increase in SG&A expenses for fiscal 2006 versus the


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prior year primarily resulted from: (i) professional service fees and legal costs of approximately $6.1 million, which included incremental costs related to being a stand-alone company and our exploration of strategic alternatives; (ii) $3.3 million of merger-related expenses; (iii) higher payroll and employee benefits related expenses of approximately $4.3 million; (iv) increased stock compensation expenses of $6.6 million as fiscal 2006 included twelve months of expense versus two months during fiscal 2005; and (v) higher depreciation and amortization of approximately $3.2 million. These increases were partially offset by: (i) an $8.4 million reduction in advertising expenses, including catalog production costs (fewer catalogs produced in fiscal 2006 versus fiscal 2005) and direct mail circulation costs; (ii) an approximately $5.9 million decrease in warehousing and distribution expenses due to consolidation of our distribution facilities; (iii) an approximately $4.9 million reduction in incentive compensation costs; and (iv) an increase of approximately $2.3 million of SG&A costs capitalized into inventory due primarily to higher levels of inventory at the end of fiscal 2006 compared to fiscal 2005. Additionally, fiscal 2005 included $6.2 million of credits associated with adjustments related to pre-bankruptcy petition claims and one-time refund credits. Gift card breakage reduced SG&A expenses for fiscal 2006 and 2005 by $2.3 million and $3.1 million, respectively. The reduction in gift card breakage in fiscal 2006 compared to 2005 was primarily due to fewer gift cards purchased.
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Impairment of indefinite-lived intangible assets
  $ 117,584     $ 40,000     $ 77,584  
 
Our adoption of fresh start reporting effective July 2, 2005 resulted in the recording of indefinite-lived intangible asset values of $221 million and $225 million for goodwill and trademarks, respectively.
 
During the fourth quarter of fiscal 2005, we completed our annual impairment tests for both goodwill and trademarks in accordance with SFAS No. 142, which resulted in a pretax impairment charge totaling $40 million related to trademarks. The fair value of our trademarks as of the fourth quarter of fiscal 2005 was estimated to be $185 million and was determined using the discounted present value of estimated future cash flows, which included a long-term growth rate of 3.5% and a discount rate of 16%. The decline in the fair value of our trademarks since July 2, 2005 was due principally to decreases in projected revenues. The annual impairment review of our goodwill balance as of the fourth quarter of fiscal 2005 was completed using the two-step approach prescribed in SFAS No. 142 and resulted in no impairment charge.
 
As a result of interactions with our investment bankers, preliminary indications of interest received from various third parties during our publicly announced process of evaluating various strategic alternatives, and the significant decline in our common stock price during the third quarter of 2006, we determined that it was more likely than not that the fair value of our enterprise was below our carrying value. Accordingly, in accordance with SFAS No. 142, we completed impairment tests for our indefinite-lived intangible assets, including our goodwill and trademarks, during the third quarter of 2006.
 
The fair value of our trademarks during the third quarter of 2006 was determined using the discounted present value of estimated future cash flows, which included a long-term growth rate of 3.5% and a discount rate of 17.5% and was estimated to be $185 million, equal to their net book value. Accordingly, no impairment charge was recorded during the third quarter of 2006 related to our trademarks.
 
Our enterprise value for purposes of our goodwill impairment test during the third quarter of 2006 was estimated primarily using a discounted cash flow model and was further supported by valuations using market comparables and market transactions for other retail companies and our common stock price. The premise of the discounted cash flow model was based upon our internal plans related to the future cash flows of our primary assets. The discounted cash flow valuation used a discount rate of 14.5%, which represented our weighted average cost of capital and an expected growth rate of 3.5%. In order to assess our fair value in its entirety, following the calculation of the discounted cash flows of our primary assets, the book value of our interest-bearing debt was deducted and the fair values of the assets not contributing to the discounted cash


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flows of our primary assets, including our NOL carryforwards, were added to derive the fair value of our total net assets. Upon completion of step one of the goodwill impairment test, our estimated enterprise fair value was less than the carrying value of our net book value and long-term debt. Accordingly, we completed step two of the goodwill impairment test, which included comparing the implied fair value of the company with the carrying amount of goodwill. Upon completion of step two of the goodwill impairment test, we recorded an impairment charge of $117.6 million related to our goodwill. The decline in our fair value since our fresh start reporting date of July 2, 2005 was due principally to lower than projected revenues and gross margins.
 
During the fourth quarter of 2006, we completed our annual impairment tests for both our goodwill and trademarks consistent with the testing performed during the third quarter of 2006. We concluded that our enterprise value and the fair value of our trademarks approximated the values as determined during our impairment tests during the third quarter of 2006 as there were no significant changes in our long-range forecast, discount rate or expected growth rate. Additionally, our results of operations during the fourth quarter of 2006 were consistent with the long-range plan used during our third quarter impairment review. Our estimated enterprise value as of the fourth quarter of 2006 exceeded our net carrying value and accordingly, we concluded that we passed step one of our goodwill impairment test.
 
Our impairment evaluations during the fourth quarter of 2005 and third and fourth quarters of 2006 included reasonable and supportable assumptions and projections and were based on estimates of projected future cash flows. We experienced lower than anticipated sales during the second half of 2005 and the first three quarters of 2006, indicative of a weaker than expected response by our customers to our merchandise collection. The long-range projections used in our impairment evaluations assume that we will successfully introduce merchandise assortments that appeal to our core customer tastes and preferences and respond to future changes in customer style preferences in a timely and effective manner. These estimates of future cash flows are based upon our experience, historical operations of the stores, catalogs and Internet sites, estimates of future profitability and economic conditions. Future estimates of profitability and economic conditions require estimating such factors as sales growth, employment rates and the overall economics of the retail industry for up to twenty years in the future, and are therefore subject to variability, are difficult to predict and in certain cases, beyond our control. The assumptions utilized by management were consistent with those developed in conjunction with our long-range planning process. If the assumptions and projections underlying these evaluations are not achieved, or should we ultimately adopt and pursue different long-range plans, the amount of the impairment could be adversely affected. Accordingly, there can be no assurance that there will not be additional impairment charges in the future based on future events and that the additional charges would not have a material adverse impact on our financial position or results of operations.
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Equity in earnings (losses) of foreign joint ventures
  $ (3,413 )   $ 79     $ (3,492 )
 
Losses of foreign joint ventures for fiscal 2006 of $3.4 million included losses related to Eddie Bauer Germany of $4.2 million and income from Eddie Bauer Japan of $0.8 million. As a result of weak retail sales due partially to a continued poor apparel retail market in Germany, in January 2007 Eddie Bauer Germany made the decision to close all of its retail stores. We anticipate that all Eddie Bauer Germany retail stores will be closed by August 2007. Eddie Bauer Germany will continue to sell its products through its catalogs, website and outlet stores. Equity losses for Eddie Bauer Germany for fiscal 2006 included $0.7 million of losses related to our proportionate share of impairment charges recognized on the write-down of certain of Eddie Bauer Germany’s fixed assets and inventory. Eddie Bauer Germany recorded these impairments during the first quarter of 2007. We reflected these write-downs in our fiscal 2006 equity losses because we determined that these impairments existed as of December 30, 2006. With respect to Eddie Bauer Germany’s fixed assets, we determined that the projected cash flows related to Eddie Bauer Germany’s stores was less than the carrying value of their fixed assets as of December 30, 2006 and accordingly recorded our


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proportionate share of the fixed asset impairment as of December 30, 2006. With respect to Eddie Bauer Germany’s inventory balance, we determined that a permanent write-down of Eddie Bauer Germany’s inventory to its net realizable value was required as of December 30, 2006. We anticipate that additional equity losses of approximately $2.5 million will be recorded during the first quarter of 2007 related to our proportionate share of the closing costs (e.g., severance payments, lease terminations, etc.) of Eddie Bauer Germany’s store closings. Earnings of foreign joint ventures for fiscal 2005 included losses related to Eddie Bauer Germany of $1.0 million and income from Eddie Bauer Japan of $1.1 million.
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Interest expense
  $ 26,928     $ 11,825     $ 15,103  
 
Interest expense increased during fiscal 2006 as compared to the prior year primarily as a result of twelve months of interest on our senior secured term loan that we entered into upon our emergence from bankruptcy in late June of 2005 versus six months of interest during fiscal 2005. See further description of the interest requirements on the term loan and the interest rate swap we entered into in October 2005 within “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” below. Interest expense for fiscal 2006 and 2005 also included $2.1 million and $0.6 million, respectively, of interest expense related to our revolving credit facility. During fiscal 2006 and 2005, we capitalized interest of $0.8 million and $0.3 million, respectively. Our future interest requirements will be impacted by our anticipated term loan refinancing as discussed further below.
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Other income
  $ 3,031     $ 1,919     $ 1,112  
 
Other income for fiscal 2006 included $1.8 million of net accretion income and a $0.5 million net gain associated with the receivables and liabilities associated with our securitization interests and $0.7 million of interest income. Other income for fiscal 2005 included $0.9 million of income associated with the net accretion on the receivables and liabilities associated with our securitization interests, $0.8 million of income associated with derivative income related to our interest rate swap, and $0.2 million of interest income. The increase in net accretion income in fiscal 2006 versus fiscal 2005 resulted from twelve months of accretion versus six months in fiscal 2005 as we recorded the receivables and liabilities related to the securitization interests upon our emergence from bankruptcy. There was no other income reflected during 2006 related to our interest rate swap because we designated the interest rate swap as a cash flow hedge of 50% of our senior secured term loan effective January 1, 2006 and the interest rate swap was determined to be an effective hedge. Accordingly, unrealized gains and losses associated with the hedge are reflected within other comprehensive income during fiscal 2006.
 
 
                         
    Successor
    Combined
       
    Fiscal
    Fiscal
       
    2006     2005     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Income tax expense
  $ 65,531     $ 65,047     $ 484  
Effective tax rate
    n/m       60.6 %     n/a  


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Despite having a pre-tax loss for fiscal 2006, we incurred income tax expense of $65.5 million primarily as a result of increases to our valuation allowance requirements, non-deductible impairment charges related to the goodwill impairment we recognized during the third quarter of 2006 and tax expense associated with the non-deductible interest accretion expense on our securitization interest liability. Our income tax expense for fiscal 2006 included $71.3 million of expense to increase our valuation allowance related to our NOLs, of which $23.5 million was recorded during the second quarter, $52.7 million was recorded during the third quarter of 2006 and $4.9 million was reversed during the fourth quarter of 2006. During the second quarter of 2006, we increased our valuation allowance as we reassessed our long-range plan, which resulted in a decrease in our projected taxable income during 2006 and 2007 and an increase in the projected amounts of NOLs expected to expire unused related to this period. The increase to our valuation allowance during the third quarter resulted from a decrease in the estimated annual amount of NOL utilization allowed under Section 382 of the Internal Revenue Code (“IRC”). As discussed above, during the third quarter of 2006, we performed an updated valuation of our enterprise value and concluded that our enterprise value had declined. Because we expect that further restrictions on the utilization of our NOLs will apply to periods subsequent to January 1, 2008 due to the likelihood of a change in ownership after certain trading restrictions on our common stock are lifted, this decline in enterprise value resulted in a decrease in the amount of expected NOL utilization allowed for the years of 2008 through 2023. The lower NOL utilization during this period resulted in an increase in the estimated amount of NOLs that will expire and go unused. Lastly, during the fourth quarter of 2006, we reversed $4.9 million of valuation allowance as our taxable income during the fourth quarter, principally related to collection of our financing receivables, resulted in higher taxable income and higher NOL utilization than previously estimated.
 
Our combined fiscal 2005 effective tax rate of 60.6% was higher than our U.S. Federal statutory tax rate of 35% primarily due to an increase in our valuation allowance requirements, state income taxes, the higher effective tax rate that we incur on our income generated in Canada, tax expense associated with the accretion on the securitization interest liability and non-deductible reorganization expenses. During the fourth quarter of fiscal 2005, we revised our long range forecast which resulted in a decrease in our estimated taxable income in future years and an increase in the estimated amount of NOLs that may expire and go unused after considering the applicable IRS limitations. These changes resulted in a net $15.3 million increase in our valuation allowance requirement which we recorded during the fourth fiscal quarter of 2005.
 
Fiscal 2005 Compared to Fiscal 2004
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Retail & outlet store sales:
                       
Comparable store sales
  $ 616,335     $ 630,098     $ (13,763 )
Non-comparable store sales
    116,828       135,864       (19,036 )
                         
Total retail & outlet store sales
    733,163       765,962       (32,799 )
Direct sales
    268,135       277,168       (9,033 )
Other merchandise sales
    195       4,609       (4,414 )
                         
Net Merchandise Sales
    1,001,493       1,047,739       (46,246 )


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    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Shipping revenues
    35,726       39,342       (3,616 )
Licensing revenues
    15,300       18,540       (3,240 )
Foreign royalty revenues
    6,100       6,338       (238 )
Other revenues
    815       8,802       (7,987 )
                         
Net sales and other revenues
    1,059,434       1,120,761       (61,327 )
                         
Revenue from Spiegel-affiliated parties
          37,154       (37,154 )
                         
Total revenues
  $ 1,059,434     $ 1,157,915     $ (98,481 )
Percentage increase (decrease) in comparable store sales
    (2.2 )%     (1.7 )%     n/a  
Number of retail stores:
                       
Open at beginning of period
    304       330       n/a  
Opened during the period
    16       7       n/a  
Closed during the period
    28       33       n/a  
Open at the end of the period
    292       304       n/a  
Number of outlet stores:
                       
Open at beginning of period
    101       103       n/a  
Opened during the period
    8       2       n/a  
Closed during the period
    1       4       n/a  
Open at the end of the period
    108       101       n/a  
 
Net merchandise sales declined $46.2 million in fiscal 2005 versus fiscal 2004. The overall decline in merchandise sales from our retail stores was offset by a slight increase in merchandise sales from our outlet stores as we had a larger number of outlet stores open during fiscal 2005 versus the prior year. Merchandise sales from our retail stores declined due to fewer stores open during fiscal 2005 (292 stores at the end of fiscal 2005) versus fiscal 2004 (304 stores at the end of fiscal 2004) and a 2.2%, or $13.8 million, decline in comparable store sales. This decline was primarily due to weak customer demand experienced in the second half of fiscal 2005. Although comparable store sales increased by 3.0% and 3.7% in the first and second quarters of fiscal 2005, respectively, such comparable store sales declined by 4.3% and 7.1% in the third and fourth quarters of fiscal 2005, respectively. Non-comparable store sales, which includes sales associated with new, closed and non-comparable remodeled stores, for fiscal 2005 versus fiscal 2004 declined by $19.0 million. The decline in net merchandise sales in both our stores and direct channel were due to poor customer reaction to the significant changes in the merchandise collection which were first reflected in the August 2005 launch of the Fall/ Holiday 2005 product offering.
 
Shipping revenues in fiscal 2005 declined versus the prior year as a result of the decline in sales in our direct channel. Licensing royalty revenues declined versus the prior year primarily due to renegotiated lower per unit royalty rates with one of our primary licensees and a reduction in qualifying sales. Other revenue during fiscal 2004 included $8.1 million of billings under transition services agreements to Newport News and Spiegel Catalog, subsequent to their sale by Spiegel in mid-2004, for services provided by EBFS, the IT Group and Saint John. These services were no longer provided subsequent to December 2004.
 
Revenue from Spiegel-affiliated parties included intercompany revenues to Spiegel affiliates, primarily Newport News and Spiegel Catalog, for services provided by EBFS, the IT Group and Saint John, prior to Spiegel’s sale of these entities in mid-2004.

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    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Net Merchandise Sales
  $ 1,001,493     $ 1,047,739     $ (46,246 )
Cost of sales, including buying and occupancy
  $ 596,854     $ 604,864     $ (8,010 )
Gross margin
  $ 404,639     $ 442,875     $ (38,236 )
Gross margin as a % of net merchandise sales
    40.4 %     42.3 %     (1.9 )%
 
Our gross margin for fiscal 2005 was $404.6 million, a decrease of $38.2 million, or 8.6%, from our fiscal 2004 gross margin of $442.9 million. As noted above in “Financial Operations Overview”, our warehousing and distribution expenses (excluding occupancy costs related to our warehouses) and shipping costs are included in selling, general and administrative expenses. As a result, our gross margin and gross margin percentages may not be comparable to those of other retailers. Our warehousing and distribution expenses reflected in selling, general and administrative expenses for fiscal 2005 and 2004 were $37.3 million and $34.4 million, respectively. Our shipping costs reflected in selling, general and administrative expenses for fiscal 2005 and 2004 were $21.6 million and $24.5 million, respectively.
 
The $8.0 million decline in our costs of sales during fiscal 2005 versus the prior year included an approximately $18.3 million decline in our merchandise costs, partially offset by increases of $6.5 million and $4.9 million in our occupancy costs and intangible amortization expense, respectively. The decline in our merchandise costs resulted from the decrease in our merchandise sales in fiscal 2005 compared to fiscal 2004. The $6.5 million increase in our occupancy costs included increases of approximately $8 million and $2 million related to our rent expense and leasehold improvement amortization, respectively, which were partially offset by an approximately $2 million decline in our utilities, taxes and insurance expenses. The $4.9 million of intangible amortization resulted from the intangible assets related to our customer lists and licensing agreements that we recorded in conjunction with our fresh start accounting effective July 2, 2005. There was no intangible amortization prior to that date.
 
Our gross margin percentage declined to 40.4% in fiscal 2005 from 42.3% in fiscal 2004. The 1.9 percentage point decline in our gross margin percentage was due primarily to increases in our occupancy costs discussed above, which resulted in a 1.3 percentage point decline in our gross margin percentage as a result of lower net merchandise sales in which to absorb our fixed store related costs. Additionally, the intangible amortization expense recorded during the second half of 2005 resulted in a 0.5 percentage point decline in our gross margin percentage versus the prior year.
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
          (Unaudited)        
    (Unaudited)              
    ($ in thousands)  
 
Selling, general and administrative expenses (SG&A)
  $ 399,350     $ 452,603     $ (53,253 )
SG&A as a % of net merchandise sales
    39.9 %     43.2 %     (3.3 )%
 
SG&A expenses for fiscal 2005 were $399.4 million, representing a decrease of $53.3 million, or 11.8% from the prior year. SG&A expenses as a percentage of net merchandise sales for fiscal 2005 were 39.9%, down from 43.2% in the prior year. The decrease in SG&A expenses for fiscal 2005 versus the prior year primarily resulted from lower variable costs of approximately $34.4 million related to services provided by EBFS, the IT Group and Saint John. During fiscal 2004, these entities provided services to other Spiegel-affiliated entities, primarily Newport News and Spiegel Catalog, in addition to providing services to us. Because Spiegel sold these entities during mid-2004, the variable costs associated with these services declined significantly subsequent to December 2004. We also experienced a corresponding decrease in the intercompany revenues we recorded related to these services (see further discussion above under Revenues). The decline in


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SG&A expenses also included an approximate $11.7 million decrease in brand marketing expense, in response to lower sales in the second half of fiscal 2005. In addition, distribution and information services expenses declined in fiscal 2005 by approximately $9.5 million primarily as a result of lower sales, units and transactions processed in fiscal 2005. Additionally, distribution and information services expenses were reduced as a result of downsizing the operations from the multi-client structure of the Predecessor. Sales-related transportation expenses decreased by approximately $4.1 million as a result of lower direct channel sales and fewer stores open during fiscal 2005 compared to fiscal 2004. These decreases were partially offset by higher corporate standalone costs of $4.4 million, which primarily included incremental costs associated with legal fees and consulting services. Gift card breakage reduced SG&A expenses for fiscal 2005 and 2004 by $3.1 million and $2.6 million, respectively.
 
 
                                 
    Combined
    Predecessor
             
    Fiscal
    Fiscal
             
    2005     2004     Change        
    (Unaudited)     (Unaudited)              
    ($ in thousands)        
 
Impairment of indefinite-lived intangible assets
  $ 40,000           $ 40,000          
 
Our adoption of fresh start reporting effective July 2, 2005 resulted in the recording of indefinite-lived intangible asset values of $221 million and $225 million for goodwill and trademarks, respectively.
 
During the fourth quarter of fiscal 2005, we completed our annual impairment tests for both goodwill and trademarks in accordance with SFAS No. 142, which resulted in a pretax impairment charge totaling $40.0 million related to our trademarks, which was reflected in impairment of indefinite-lived intangible assets on our statement of operations. The fair value of our trademarks was estimated to be $185.0 million. The fair value of our trademarks was estimated using the discounted present value of estimated future cash flows, which included a long-term growth rate of 3.5% and a discount rate of 16%. As the estimated fair value of $185.0 million was less than our carrying value of $225.0 million, we recorded an impairment charge of $40.0 million during the fourth quarter of fiscal 2005. The decline in the fair value of our trademarks since July 2, 2005 was due principally to decreases in our projected revenues.
 
The annual impairment review of our goodwill balance as of the fourth quarter of fiscal 2005 was completed using the two-step approach prescribed in SFAS No. 142. The first step included a determination of our enterprise value using primarily a discounted cash flow model, which included a long-term growth rate of 3.5% and a discount rate of 13%. The premise of the discounted cash flow model was based upon our internal plans related to the future cash flows of our primary assets. In order to assess our fair value in its entirety, following the calculation of the discounted cash flows of our primary assets, the fair value of our interest-bearing debt was deducted and the fair values of the assets not contributing to the discounted cash flows of our primary assets, including our NOL carryforwards, were added to derive the fair value of our total net assets. Upon completion of step one of the goodwill impairment test, our estimated fair value exceeded the carrying value of our net book value and long-term debt. Accordingly, we were not required to complete step two of the goodwill impairment test.
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Equity in earnings (losses) of foreign joint ventures
  $ 79     $ 3,590     $ (3,511 )
 
The decline in equity in earnings of foreign joint ventures during fiscal 2005 versus the prior year resulted primarily from lower earnings associated with our German joint venture. Our German joint venture experienced weaker retail sales in 2005 due partially to a poor apparel retail market in Germany. During 2005, the German joint venture operated nine retail stores and one outlet store in Germany, which accounted for


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approximately 25% of total revenue of the venture in fiscal 2005, and also operated a direct to consumer catalog business, which accounted for the remainder. Our joint venture in Japan, however, experienced strong sales growth in 2005 and the retail markets in Japan did not exhibit the similar consumer weakness referred to above.
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Interest expense
  $ 11,825     $ 316     $ 11,509  
 
Interest expense increased during fiscal 2005 as a result of our $300 million senior secured term loan that we entered into upon our emergence from bankruptcy, including the impact of the interest rate swap agreement we entered into in October 2005. See further description of the interest requirements on the term loan and the interest rate swap within “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” below. Additionally, interest expense for fiscal 2005 included $0.6 million of interest expense related to our revolving credit facility that was incurred during the six months ended December 31, 2005. Interest expense during fiscal 2004 represented the interest we incurred on our intercompany debt with our former parent, Spiegel.
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)  
 
Other income
  $ 1,919           $ 1,919  
 
Other income for fiscal 2005 included $0.9 million of income associated with the net accretion on the receivables and liabilities associated with our securitization interests, $0.8 million of income associated with derivative income related to our interest rate swap, and $0.2 million of interest income. We recognized no other income during fiscal 2004.
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)        
 
Lease rejections
  $ 2,749     $ (3,708 )   $ 6,457  
Professional service fees
    10,705       23,373       (12,668 )
Asset impairment and other, net
    232       8,254       (8,022 )
Severance and relocation
          2,452       (2,452 )
Interest income
          (3,500 )     3,500  
                         
    $ 13,686     $ 26,871     $ (13,185 )
 
In April 2003, we announced our intent to close 60 under-performing stores as a part of our ongoing reorganization process, which received bankruptcy court approval. We closed 59 of these stores as of January 3, 2004 and the remaining store was closed in the fourth quarter of fiscal 2004. In December 2003, we announced our intent to close an additional 29 under-performing stores as a part of our ongoing reorganization process, which received bankruptcy court approval. We closed these stores during the first quarter of fiscal 2004. The lease rejection costs for fiscal 2005 primarily represented the rejected leases from these store closings. The lease rejection income in fiscal 2004 was due to lease termination agreements and mitigation of lease related claims.


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Professional service fees consisted primarily of financial, legal, real estate and other consulting services directly associated with the reorganization process that were incurred by Spiegel and charged to us.
 
The closure of retail and outlet stores described above, as well as other facilities, resulted in the write off of approximately $0.2 million during fiscal 2005 and $2.0 million in assets in fiscal 2004, respectively, primarily related to leasehold improvements that had no future benefit. We also abandoned certain capital projects due to capital expenditure restrictions, which led to the write-off of approximately $3.3 million in assets in fiscal 2004. In 2003, we recorded a write off of approximately $11.6 million related to our decision to sell a distribution facility. The facility was sold in April 2004, and we recorded an additional loss of $0.5 million. On August 3, 2004, the bankruptcy court approved the sale of our three corporate headquarters office buildings for a total price of $38 million representing a loss on the sale of $2.9 million.
 
Other, net items in fiscal 2004 include miscellaneous claims settlements in our favor.
 
We recorded severance costs of $2.5 million in fiscal 2004 associated with the termination of employees at various locations due to either the closure of locations or the overall reduction in workforce.
 
Interest income in fiscal 2004 is attributable to the accumulation of cash and short-term investments subsequent to the Chapter 11 filing.
 
 
                         
    Combined
    Predecessor
       
    Fiscal
    Fiscal
       
    2005     2004     Change  
    (Unaudited)     (Unaudited)        
    ($ in thousands)        
 
Income tax expense
  $ 65,047     $ 36,080     $ 28,967  
Effective tax rate
    60.6 %     47.0 %     n/a  
 
Our combined fiscal 2005 effective tax rate of 60.6% was higher than our U.S. Federal statutory tax rate of 35% primarily due to an increase in our valuation allowance requirements, state income taxes, the higher effective tax rate that we incur on our income generated in Canada, non-income related tax expense associated with the accretion on the securitization interest liability and non-deductible reorganization expenses. During the fourth quarter of fiscal 2005, we revised our long range forecast which resulted in a decrease in our estimated taxable income in future years and an increase in the estimated amount of NOLs that may expire and go unused after considering the applicable IRS limitations. These changes resulted in a net $15.3 million increase in our valuation allowance requirement during fiscal 2005. Our effective tax rate for fiscal 2004 of 47.0% was higher than our U.S. statutory tax rate primarily due to non-deductible reorganization expenses, state income taxes and the higher effective tax rate that we incur on our income generated in Canada.
 
Liquidity and Capital Resources
 
Cash Flow Analysis
 
Fiscal 2006, Fiscal 2005 and Fiscal 2004
 
                         
    Successor
    Combined
    Predecessor
 
    Fiscal
    Fiscal
    Fiscal
 
    2006     2005     2004  
    (Unaudited)  
    ($ in thousands)  
 
Cash flow data:
                       
Net cash provided by operating activities
  $ 50,424     $ 37,767     $ 94,188  
Net cash (used in) provided by investing activities
  $ (45,452 )   $ (39,179 )   $ 40,685  
Net cash provided by (used in) financing activities
  $ (26,107 )   $ 68,319     $ (133,880 )


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Net cash provided by operating activities for fiscal 2006 totaled $50.4 million, compared to $37.8 million for fiscal 2005 and $94.2 million for fiscal 2004. Cash generated from our operations when excluding non-cash expenses (i.e., depreciation and amortization, non-cash reorganization expenses, losses and impairments of property and equipment, equity in earnings (losses) of joint ventures and deferred income taxes) totaled $35.4 million for fiscal 2006, $33.6 million for fiscal 2005 and $97.8 million for fiscal 2004. The significant decline in fiscal 2005 from fiscal 2004 resulted primarily from reductions in our operating income and higher expenses.
 
Changes in our operating assets and liabilities in 2006 resulted in positive cash from working capital of $14.5 million versus negative cash from working capital of $12.8 million and $3.9 million in fiscal 2005 and 2004, respectively. The cash generated from our working capital of $14.5 million for fiscal 2006 resulted primarily from the $11.5 million of net cash received related to our receivables and liabilities from securitization interests and $10.9 million of cash generated related to our deferred rent obligations primarily resulting from cash received during fiscal 2006 related to construction allowances, which were partially offset by $11.6 million of higher inventory levels at the end of fiscal 2006 versus fiscal 2005. Our $12.8 million use of cash related to our working capital during fiscal 2005 resulted primarily from the settlement of our liabilities subject to compromise of $17.4 million in conjunction with our emergence from bankruptcy, which was partially offset by an increase of $7.5 million in our accounts payable balances as of the end of fiscal 2005 versus the prior year end due to the timing of payments. The use of cash related to our working capital of $3.9 million for fiscal 2004 resulted primarily from an $8.4 million use of cash related to higher inventory levels driven by increased levels of inventory in-transit at the end of fiscal 2004. These uses of cash related to our working capital were partially offset by increases of $6.8 million related to accounts payable balances due to the timing of payments and levels of inventory purchases as of year-end and a $4.0 million reduction in prepaid expenses, primarily related to prepaid rents and retail production costs.
 
Cash generated from discontinued operations was $0.5 million in fiscal 2006, $17.0 million in fiscal 2005 and $0.3 million in fiscal 2004.
 
 
Net cash used in investing activities for fiscal 2006 totaled $45.5 million compared to $39.2 million for fiscal 2005. Net cash provided by investing activities for fiscal 2004 totaled $40.7 million. Our net cash used in investing activities for fiscal 2006 primarily included $45.8 million of capital expenditures related to new store openings and store remodels and capital expenditures related to our IT systems and corporate facilities. Our net cash used in investing activities for fiscal 2005 primarily included $38.9 million of capital expenditures related to our continuing operations, including $30.2 million during the six months ended December 31, 2005. The increase in capital expenditures during the second half of 2005 resulted from new store openings during the second half of 2005 as well as capital expenditures to convert prior Eddie Bauer Home store locations to Eddie Bauer retail store space. Net cash provided by investing activities for 2004 included $36.4 million of proceeds on the sale of our headquarters facilities and $18.9 million of proceeds from the sale of one of our distribution facilities. The sale of both of these facilities was in accordance with the Plan of Reorganization. Partially offsetting the cash generated by the sale of these facilities during fiscal 2004 was $13.9 million of cash used for capital expenditures related to our continuing operations and $0.7 million related to our discontinued operations.
 
 
Net cash used in financing activities for fiscal 2006 totaled $26.1 million, which included $24.0 of payments under our senior term loan. Net cash provided by financing activities for fiscal 2005 totaled $68.3 million and included $65.7 million of a net decrease in the receivable due from Spiegel during the six months ended July 2, 2005 and a net increase in our bank overdrafts totaling $4.2 million. The decrease in the receivable due from Spiegel was primarily due to the Predecessor’s income tax expense associated with the gain on the discharge of liabilities related to the emergence from bankruptcy and application of fresh-start


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reporting. The income tax expense related to this gain was not actually paid or due to be paid. Partially offsetting these sources of cash during 2005 were $1.5 million of repayments of our term loan and $0.2 million of treasury stock repurchased. Net cash used by financing activities for fiscal 2004 totaled $133.9 million and primarily included $133.0 million of cash we paid for the repayment of borrowings to our former parent, Spiegel.
 
 
As of December 30, 2006, we had cash balances of $53.2 million. Our primary source of cash is the cash generated from our operations and borrowings under our revolving credit facility. However, our ability to fund our capital requirements will be greatly reduced if we are no longer in compliance with the covenants under our term loan and cannot amend or obtain waivers to any covenants we violate or refinance the term loan with a new agreement containing less restrictive covenants. In addition, if sales and operating cash flow do not improve from the disappointing levels we experienced during the second half of 2005 and the first three quarters of 2006, we may not have sufficient capital resources to fund our operating plan. If we are unsuccessful in improving operating cash flow or if operating cash flow further deteriorates, we would need to seek additional sources of liquidity through the sale of assets, the assumption of additional debt or the issuance of equity. There can be no assurance that we would be successful in borrowing additional funds at reasonable rates of interest or issuing equity at a favorable valuation. We may from time to time consider these or other various financing alternatives in any event. The covenant relief we obtained as a result of the April 2006 amendment discussed below will expire after the first quarter of 2007, resulting in the reestablishment of the original terms related to the financial covenants. As a result, we anticipate that we will not meet certain of these financial covenants during 2007, possibly as early as the first quarter of 2007. Accordingly, we are in active discussions to refinance our existing senior secured term loan, which we anticipate will be completed in April 2007. See further discussion of the anticipated new financing transaction below. In connection with the refinancing of our term loan, we will also request an amendment to our revolving credit facility.
 
 
On June 21, 2005, Eddie Bauer, Inc. executed a loan and security agreement with Bank of America, N.A., General Electric Capital Corporation and The CIT Group/Business Credit, Inc. The senior secured revolving credit facility is comprised of a revolving line of credit consisting of revolving loans and letters of credit up to $150 million to fund working capital needs.
 
Advances under the revolving credit facility may not exceed a borrowing base equal to various percentages of Eddie Bauer, Inc.’s eligible accounts receivable balances and eligible inventory, less specified reserves. The revolving credit facility is secured by a first lien on Eddie Bauer, Inc.’s inventory and certain accounts receivable balances and by a second lien on all of its other assets other than the Groveport, Ohio facility. The revolving credit facility is guaranteed by Eddie Bauer and certain of its subsidiaries. Our availability under the revolving credit facility was $100.9 million as of December 30, 2006. As of December 30, 2006, we had $12.5 million of letters of credit outstanding and no amounts had been drawn under the revolving credit facility.
 
Borrowings under the revolving credit facility bear interest at:
 
  •  LIBOR plus 1.25% if the average aggregate outstanding (based upon the preceding calendar month) is less than $75 million; or
 
  •  LIBOR plus 1.50% if the average aggregate outstanding is greater than or equal to $75 million.
 
The weighted average interest rate we paid on the outstanding revolving credit facility for fiscal 2006 was 7.2%. In addition, we are required to pay an unused commitment fee of 0.25% per annum on the unused amount, plus a letter of credit fee. The revolving credit facility is scheduled to terminate on June 21, 2010.
 
The agreement requires that at any time the availability under the agreement is less than 10% of the maximum revolver available, we are required to maintain a consolidated fixed charge coverage ratio (as defined therein) of at least 1.25:1.00. The agreement also limits our capital expenditures to $60 million in 2007 and 2008,


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and $70 million in 2009 and 2010. Finally, there are additional covenants that restrict us from entering into certain merger, consolidation and sale transactions outside the normal course of business; from making certain distributions or changes in our capital stock; from entering into certain guarantees; from incurring debt and liens subject to limits specified within the agreement; and other customary covenants. In April 2006, we obtained waivers from the lenders for certain defaults and events of default under the revolving credit facility relating primarily to previously due financial and business reports and, in connection with name changes of two subsidiaries, the perfection of security interests in collateral and notice requirements. As of December 30, 2006, our most recent quarterly compliance reporting date, we were in compliance with the covenants under the facility.
 
 
On June 21, 2005, Eddie Bauer, Inc. entered into a $300 million senior secured term loan agreement with various lenders, with JPMorgan Chase, N.A. as administrative agent. In accordance with the term loan agreement, we are required to repay $0.75 million on a quarterly basis from September 30, 2005 through March 31, 2011, with the remaining balance due upon maturity of the loan on June 21, 2011. As of December 30, 2006, $274.5 million was outstanding under the term loan. The term loan is secured by a first lien on certain of our real estate assets and trademarks and by a second lien on all of our other assets.
 
In April 2006, in view of our expectation that we would not meet certain financial covenants contained in the term loan agreement, and to provide us with additional flexibility to pursue our turnaround strategy, we and the lenders amended certain provisions of the term loan relating primarily to financial covenant ratios and operational covenants (including capital expenditures, permitted collateral sales and store openings/closings). In connection with the term loan amendment, we obtained waivers from the lenders for certain defaults and events of default under the term loan relating primarily to previously due financial and business reports and, in connection with name changes of two subsidiaries, the perfection of security interests in collateral and notice requirements. As a result of the term loan amendment, our interest rates were increased by 1.50% per annum over what the prior agreement required, which rates will be reduced by 0.50% when the term loan balance is reduced below $225 million as a result of asset sales or voluntary prepayments from operating cash flow. The following description gives effect to this amendment.
 
The term loan agreement includes mandatory prepayment provisions, including a requirement that 50% (reduced to 25% if our consolidated leverage ratio on the last day of the relevant fiscal year is not greater than 1.75 to 1.00) of any excess cash flows, as defined in the agreement and measured on an annual basis beginning December 31, 2005, be applied to repayment of the loan. The amounts of such excess cash flows for the fiscal years ended December 30, 2006 and December 31, 2005 were $5.0 million and $21.0 million, respectively. Payment of the $21.0 million of excess cash flow as of December 31, 2005 was made on April 7, 2006. In the event we prepay the term loan with proceeds of a new loan prior to March 31, 2007, we are required under the term loan agreement, as amended, to pay a prepayment premium equal to 1% of the principal amount of such prepayment.
 
In accordance with the amended term loan agreement, interest on the loan is calculated as the greater of the prime rate or the Federal funds effective rate plus one-half of one percent plus 2.50% to 3.25% in the case of base rate loans, or LIBOR plus 3.50% to 4.25% in the case of Eurodollar loans, based upon our corporate credit rating issued from time-to-time by Moody’s and Standard & Poor’s, provided that interest on the loan will be increased by 0.50% until the date that the aggregate principal amount of the loans outstanding is less than $225 million as a result of asset sales or voluntary prepayments from operating cash flow. On December 30, 2006, our interest rate under the amended term loan included a LIBOR rate of 5.35% plus a margin of 4.25%, for a total interest rate of 9.6%. Interest is payable quarterly on the last day of each March, June, September and December for base rate loans; and for Eurodollar loans having an interest period of three months or less, the last day of such interest period, or for Eurodollar loans having an interest period of longer than three months, each day that is three months after the first day of such interest period. The agreement required that we entered into interest rate swap agreements such that at least 50% of the aggregate principal amount of the outstanding loan is subject to either a fixed interest rate or interest rate protection for a period of not less than three years. See below for a discussion of the interest rate swap agreement we entered into in October 2005.


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The financial covenants under the amended term loan include:
 
Our consolidated leverage ratio (as defined therein) calculated on a trailing 12-month basis must be less than:
 
  •  5.25 to 1.00 for the fiscal quarter ending December 31, 2006;
 
  •  4.00 to 1.00 for the fiscal quarter ending March 31, 2007;
 
  •  2.50 to 1.00 for the next three fiscal quarters; and
 
  •  thereafter being reduced on a graduated basis to 1.50 to 1.00 at March 31, 2009.
 
In addition, our consolidated fixed charge coverage ratio (as defined therein) calculated on a trailing 12-month basis must be greater than:
 
  •  0.95 to 1.00 for the fiscal quarter ending December 31, 2006;
 
  •  0.975 to 1.00 for the fiscal quarter ending March 31, 2007; and
 
  •  thereafter increasing to 1.50 to 1.00 for the quarters ending June 30, 2007 through June 30, 2011.
 
In addition to the financial covenants, the agreement limits our capital expenditures (net of landlord contributions) to $36 million in 2006, $45 million in 2007, $60 million in 2008, and $70 million in each of 2009, 2010 and 2011. Finally, there are additional covenants that restrict us from entering into certain merger, consolidation and sale transactions outside the normal course of business; from making certain distributions or changes in our capital stock; from entering into certain guarantees; from incurring debt and liens subject to limits specified within the agreement; and other customary covenants. As of December 30, 2006, our most recent quarterly compliance reporting date, we were in compliance with the covenants under the amended term loan agreement. If our business fails to improve or deteriorates, we may not be able to comply with the financial covenants in the future. Additionally, the covenant relief we obtained as a result of the April 2006 amendment discussed above will expire after the first quarter of 2007 resulting in the reestablishment of the original terms related to the financial covenants.
 
As mentioned above, we are currently in active discussions to refinance our existing term loan, as a result of our expectation that we will not meet certain loan covenants during 2007, possibly as early as the first quarter of 2007. We are working with our financial advisors and potential lenders on a refinancing package that would include a new term loan and junior capital. We expect to complete the financing transaction in April 2007. Proceeds from the new financing transaction would be utilized to pay-off our existing senior secured term loan. We anticipate that the financing transaction will include an approximately $225 million senior secured term loan facility and approximately $75 million of convertible notes. Our financial advisors have advised us that reactions to date from potential lenders in the senior secured term loan refinancing transaction have been positive, and we expect to begin pricing the convertible notes during the week of March 26, 2007.
 
We expect the senior secured term loan, when and if finalized, will include the following terms and conditions:
 
  •  Secured on a first priority basis by our intellectual property, certain owned real estate and the stock of the company and its subsidiaries. The senior secured term loan will have a second priority lien on the collateral that currently secures our existing revolving credit facility.
 
  •  Interest will be payable semi-annually at a variable rate based upon LIBOR plus a stated number of basis points.
 
  •  Principal payments due quarterly at a rate of 1% per year, with the remainder due on the seventh anniversary date.
 
  •  Mandatory prepayment provisions, including: (i) 50% of excess cash flow, with step-downs to 25% and 0% based upon certain leverage ratios, (ii) 100% of net proceeds from asset sales, and (iii) 100% of net proceeds from debt issuances, other than proceeds from our existing revolving credit facility.


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  •  Financial covenants, including but not limited to, (i) a maximum senior secured leverage ratio, (ii) a minimum fixed charge coverage ratio, and (iii) a maximum amount of annual capital expenditures.
 
We expect the convertible notes, when and if finalized, will include the following terms and conditions:
 
  •  Maturity date on the seventh year anniversary of issuance.
 
  •  The notes will be general, unsecured obligations ranking equally in right of payment with existing and future senior unsecured indebtedness and senior in right of payment to any subordinated indebtedness.
 
  •  The notes will be guaranteed by certain of our subsidiaries on a senior unsecured basis.
 
  •  Interest will be payable semi-annually at a fixed rate of interest per year.
 
  •  Holders may convert their notes under certain circumstances, including but not limited to, (i) conversion features based upon our common stock price or the convertible note’s price reaching a certain level for a stated period of time and (ii) following certain corporate transactions that occur prior to the convertible note’s scheduled maturity.
 
Although we anticipate completing the above described financing transaction in April 2007, there can be no assurances that we will complete the financing transaction or complete it as described above or that we will be able to amend our revolving credit facility. If we are not successful in obtaining new financing and paying off of our existing term loan, upon default of the financial covenants, the payment of our existing senior secured term loan could be demanded immediately by the lenders. In addition, an event of default would occur under our revolving credit facility and amounts thereunder could also become due and payable. If such demands were made, we currently have insufficient cash to pay in full our outstanding balance under the term loan.
 
 
In accordance with the requirements of our term loan, in October 2005, we entered into an interest rate swap agreement with a total notional value of $150 million, or 50% of the outstanding amount under our term loan as of that date. The interest rate swap agreement effectively converts 50% of the outstanding amount under our term loan, which is floating-rate debt to a fixed-rate by having us pay fixed-rate amounts in exchange for the receipt of the amount of the floating-rate interest payments. Under the terms of the interest rate swap agreement, a monthly net settlement is made for the difference between the fixed rate of 4.665% and the variable rate based upon the monthly LIBOR rate on the notional amount of the interest rate swap. The interest rate swap agreement terminates in conjunction with the termination of the term loan in June 2011.
 
Upon entering into the interest rate swap agreement, we did not contemporaneously designate the interest rate swap as a cash flow hedge of 50% of our senior term loan. The fair value of the interest rate swap was determined to be $0.8 million as of December 31, 2005 and was recorded in other assets on the consolidated balance sheet with the offset to other income in our statement of operations for the six months ended December 31, 2005. The fair value of the interest rate swap was estimated based upon the present value of the future cash flows of the interest rate swap.
 
We reassessed our hedging strategy and in accordance with SFAS 133, we designated the interest rate swap as a cash flow hedge of 50% of our senior secured term loan effective January 1, 2006. No portion of the interest rate swap was excluded from the assessment of the hedge’s effectiveness. Because all critical terms of the derivative hedging instrument and the hedged forecasted transaction were not identical, the interest rate swap does not qualify for the “shortcut method” as defined in SFAS No. 133. On a quarterly basis, we assess and measure the effectiveness of the cash flow hedge using the hypothetical derivative method. In performing our assessment, as of December 30, 2006, the fair value of the interest rate swap was estimated to be $1.7 million and changes in cash flows of the actual derivative hedging instrument were within 80 to 125 percent of the opposite change in the cash flows of the hypothetical derivative instrument and therefore we concluded that the hedge was highly effective. Accordingly, we recorded the effective portion of the cash flow hedge, which totaled $0.9 million as of December 30, 2006 within other comprehensive income on our balance sheet. No amount of the cash flow hedge was determined to be ineffective.


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Financial Condition
 
 
Our total assets were $855.9 million as of December 30, 2006, down $297.3 million, or 25.8% from December 31, 2005. Current assets as of December 30, 2006 were $308.6 million, down $30.2 million from $338.8 million as of December 31, 2005. The decline in our current assets was driven primarily by a $21.0 million decrease in our cash and cash equivalents (see further discussion above under “Liquidity and Capital Resources — Cash Flow Analysis”) and a $16.9 million decrease in our financing receivables related to securitization interests. These decreases were partially offset by an $11.5 million increase in our inventory levels as of December 30, 2006 versus the prior year end. In total, our financing receivables related to our securitization interests (both current and non-current) decreased $93.4 million, which included cash collections of $115.6 million, partially offset by $17.9 million of accretion income during fiscal 2006 and the $4.4 million fair value adjustment we recorded during the fourth quarter of 2006 (see further discussion in Note 9 of our audited financial statements).
 
Non-current assets as of December 30, 2006 were $547.3 million, down $267.2 million from $814.5 million as of December 31, 2005. The decline in our non-current assets was driven primarily by the $105.7 million decrease in our goodwill balance resulting from the goodwill impairment charge we recorded during the third quarter of 2006; the $76.4 million reduction in our non-current receivables related to our securitization interests (discussed above); as well as the $72.2 million decline in our non-current deferred tax assets resulting primarily from the increases in our tax valuation allowance recorded during fiscal 2006. Additionally, our property and equipment and other intangibles assets decreased from the prior year end as a result depreciation and amortization expenses recorded during fiscal 2006.
 
Our total liabilities were $509.3 million as of December 30, 2006, down $98.9 million, or 16.3%, from December 31, 2005. Current liabilities as of December 30, 2006 were $203.6 million, down $27.9 million from $231.5 million as of December 31, 2005. The decline in our current liabilities was driven by a $15.2 million decrease in our current liabilities related to our securitization note and a $16.0 million decline in the current portion of our long-term debt. These decreases were partially offset by a $4.5 million increase in our accounts payable balance. Our total liabilities (current and non-current) related to our securitization note decreased $84.0 million which included cash payments of $104.0 million, partially offset by $16.1 million of accretion expense during fiscal 2006 and the $3.9 million fair value adjustment we recorded during the fourth quarter of 2006 (see further discussion in Note 9 of our audited financial statements). The current portion of our long-term debt totaled $8.0 million and $24.0 million as of December 30, 2006 and December 31, 2005, respectively. The decline in the current portion of our long-term debt resulted from the decline in the excess cash flow required to be repaid at the end of each year, which totaled $5.0 million and $21.0 million as of December 30, 2006 and December 31, 2005, respectively.
 
Non-current liabilities as of December 30, 2006 were $305.7 million, down $71.1 million from $376.8 million as of December 31, 2005. The decrease in our non-current liabilities resulted primarily from the $68.8 million decrease in our non-current liabilities related to our securitization interests discussed above.
 
Our stockholders’ equity as of December 30, 2006 totaled $346.6 million, down $198.4 million from December 31, 2005, driven primarily by our net loss recorded for fiscal 2006.
 
 
Our primary cash requirements for fiscal 2007 are to fund growth in working capital to support anticipated merchandise sales increases; capital expenditures to open new stores and refurbish existing stores; upgrade and maintain our distribution center and information technology systems and to relocate our corporate headquarters; and to make interest and principal payments on our debt. We anticipate that our capital expenditures for 2007 will be approximately $62 million, of which approximately 64% relates to opening and remodeling of stores in accordance with our plans to realign our stores. Approximately $20 million of the capital expenditures will be funded by our landlords, resulting in net capital expenditures of approximately $42 million.


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Our liquidity levels and the need to fund our cash requirements through the use of our revolving credit facility will be driven by our net sales and profitability levels, changes in our working capital, the timing of our capital expenditures and by higher interest payments as a result of the amendment to our term loan that we executed in April 2006 as discussed above. Cash generated from our net sales and profitability, and somewhat to a lesser extent our changes in working capital, are driven by the seasonality of our business, with a disproportionate amount of net merchandise sales and operating cash flows occurring in the fourth fiscal quarter of each year. Additionally, cash generated from our net sales and profitability are impacted by the levels of and timing of mark-downs that we take in order to drive sales. Seasonality also impacts the levels of our working capital, in that we typically experience higher levels of net accounts receivables and sales driven accrued expenses, such as sales and use taxes, sales allowances, and deferred revenues during the fourth quarter of each year. Conversely, we typically experience a decline in both our net accounts receivable and sales driven accrued expenses during the first and second quarters of each year. Additionally, we normally increase our inventory levels during the third quarter in anticipation of higher sales during the third and fourth quarters.
 
We do not anticipate significant cash requirements for U.S. Federal income tax payments during 2007 due to existing, unutilized NOL carryforwards we assumed when Spiegel transferred ownership of its subsidiaries, FSAC and SAC, to us. We do not anticipate paying any dividends on our common stock in the foreseeable future. In addition, covenants in our term loan agreement and revolving credit facility restrict our ability to pay dividends and may prohibit certain other payments.
 
 
                                         
Contractual Obligations
  Payments Due by Period  
as of December 30, 2006
        Less Than
                After
 
(unless otherwise noted)
  Total     1 Year     1-3 Years     3-5 Years     5 Years  
    ($ in thousands)  
 
Long-term debt obligations(1)
  $ 274,500     $ 8,000     $ 6,000     $ 260,500     $  
Interest on long-term debt(2)
  $ 96,902     $ 24,397     $ 44,888     $ 27,617     $  
Operating lease obligations(3)
  $ 424,584     $ 69,233     $ 118,844     $ 86,823     $ 149,684  
Purchase obligations(4)
  $ 161,580     $ 161,580     $     $     $  
Other contractual obligations(5)
  $ 10,423     $ 7,801     $ 2,484     $ 138     $  
                                         
Total
  $ 967,989     $ 271,011     $ 172,216     $ 375,078     $ 149,684  
                                         
 
 
(1) Includes payments due under our existing senior term loan agreement including excess cash flows required to be repaid as of December 30, 2006, but excluding any mandatory prepayment provisions subsequent to December 30, 2006 discussed above under “— Sources of Liquidity — Senior Secured Term Loan.” See further discussion above related to the financing transaction we anticipate closing in April 2007, which will impact the amounts and timing of principal payments required related to our long-term debt obligations.
 
(2) Represents interest due under our term loan agreement discussed above under “— Sources of Liquidity — Senior Secured Term Loan,” taking into consideration the increase in our interest rate margin as a result of the term loan amendment we executed in April 2006. Interest due also includes the impact of the interest rate swap agreement we entered into in October 2005. Interest payments include the assumption of 50% of the outstanding loan at a fixed rate of 7.415% and 50% of the outstanding loan using implied forward LIBOR rates based upon Eurodollar futures rates. See “— Sources of Liquidity — Interest Rate Swap Agreement” above. See further discussion above related to the financing transaction we anticipate closing in April 2007, which will impact the amounts and timing of interest payments required related to our long-term debt obligations.
 
(3) Includes future minimum lease payments under non-cancelable operating leases for retail stores, corporate headquarters, call center and distribution facilities. Amounts do not include costs for maintenance, common areas or real estate taxes.


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(4) Includes open purchase orders with vendors for merchandise not yet received or recorded on our balance sheet.
 
(5) Includes facility-related contracts, such as utility and telecommunication services; information technology contracts; printing services; and other miscellaneous business agreements.
 
In addition to the above contractual obligations, we had $12.5 million of letters of credit outstanding as of December 30, 2006. See further discussion of our letters of credit under “Off-Balance Sheet Arrangements” below.
 
Other Contractual Obligations
 
 
As discussed above, we entered into a merger agreement with Eddie B Holding Corp., a company owned by affiliates of Sun Capital Partners, Inc. and Golden Gate Capital. At a special meeting of our stockholders on February 8, 2007 to vote on the transaction, an insufficient number of shares were voted in favor of approving our proposed sale. We terminated the merger agreement on February 8, 2007. In accordance with the terms of the merger agreement, we were obligated to reimburse Sun Capital Partners, Inc. and Golden Gate Capital up to $5 million for certain expenses incurred related to the transaction. On February 26, 2007, we paid $5 million to Sun Capital Partners, Inc. and Golden Gate Capital for reimbursement of their expenses.
 
 
On February 9, 2007, we announced that Fabian Mansson resigned from his position as Chief Executive Officer and President of the Company and as a member of the Board of Directors of the Company effective February 9, 2007. We also announced that Howard Gross will serve as Interim Chief Executive Officer of the Company commencing February 9, 2007. Mr. Mansson and the Company have entered into a summary of terms which provides for payments of the amounts that Mr. Mansson is entitled to receive pursuant to the terms of his pre-existing employment agreement entered into in 2005, including the following: (a) accrued but unpaid compensation attributable to earned salary and salary that would have been earned for periods through May 9, 2007, unused earned vacation days and vacation days that would have been earned through May 9, 2007, and any other compensation that has been or would be earned or accrued under any bonus or other benefits plan to May 9, 2007, (b) continued payment of Mr. Mansson’s annual base salary ($980,000) through May 9, 2009, (c) continued participation in life insurance, group health and all other employee welfare benefit plans through May 9, 2009 (or such earlier time as Mr. Mansson obtains equivalent coverages and benefits from a subsequent employer), (d) bonus payments of $980,000 for each of 2007 and 2008 and $346,400 for 2009, (e) full accelerated vesting of all stock options and restricted stock units granted to Mr. Mansson, with such stock options to remain exercisable for the duration for their ten year term, (f) reimbursement of outplacement services, in an amount up to $35,000, and (g) reimbursement of expenses related to Mr. Mansson’s relocation to Sweden, reimbursement of certain expenses related to the sale of his current principal residence in the United States (up to 6% of the sales price of such residence), and reimbursement of closing costs relating to the purchase of a new residence in Sweden (up to 3%), plus a tax-gross-up payment. The Company and Mr. Mansson have agreed that the first six months of base salary payments will be paid in a lump sum on August 10, 2007, in compliance with IRC Section 409A. The confidentiality, non-solicitation and non-competition provisions in Mr. Mansson’s pre-existing employment agreement will remain in full force and effect. In the event that there is a “Change of Control” (as defined in Mr. Mansson’s employment agreement) with respect to the Company within nine months after February 9, 2007, Mr. Mansson is entitled to receive (a) his annual base salary for an additional year, (b) continued participation in life insurance, group health and all other employee welfare benefit plans through May 9, 2010 (or such earlier time as Mr. Mansson


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obtains equivalent coverages and benefits from a subsequent employer), (c) an additional bonus payment of $980,000, and (d) an additional $15,000 on the limit of his reimbursable outplacement services.
 
 
In conjunction with its emergence from bankruptcy, ownership of FSAC and SAC was transferred to Eddie Bauer. FSAC and SAC are special-purpose entities created by Spiegel in prior years to accomplish securitizations of certain credit card receivable portfolios and were not parties to the Chapter 11 bankruptcy filing. As of the date of fresh start accounting, FSAC and SAC each owned a securitization interest (“Securitization Interests”) in subordinated amounts that might arise from post-emergence recoveries in certain pre-petition securitization transactions to which Spiegel and its subsidiaries were a party. In addition, in connection with its emergence from bankruptcy proceedings, Eddie Bauer issued a non-recourse promissory obligation to a liquidating trust (the “Promissory Note”) established for the benefit of the creditors of Spiegel (the “Creditor Trust”) pursuant to which Eddie Bauer is obligated to pay to the Creditor Trust 90% of any proceeds received by FSAC and SAC in respect of these Securitization Interests. This Promissory Note is payable only from the proceeds (if any) received by Eddie Bauer in respect of the Securitization Interests.
 
Fair value of the FSAC receivables as of our fresh start reporting date was determined using the actual amounts received in December 2005 of $19.9 million, of which 90% was paid to the Creditor’s Trust. The majority of these proceeds arose from the required liquidation of the remaining FSAC receivables at that time. The December 2005 payment represented the final payout of the securitization interest and therefore no additional proceeds have been received subsequent to December 2005.
 
Pursuant to a settlement agreement with MBIA Insurance Corporation (a guarantor of payments of the Spiegel Credit Card Master Note Trust, the “Note Trust”), SAC assigned to the MBIA Settlement Trust (the “Settlement Trust”) any rights that SAC had in its seller’s interest, collateral or other interest in the Note Trust as of the effective date. Accordingly, SAC is entitled to receive any residual amount from the Settlement Trust only once the original note holders are paid and certain MBIA expenses and other claims are satisfied. Neither Eddie Bauer nor SAC control, manage or otherwise exert any influence over the operation, financial policies or performance of either the Note Trust or the Settlement Trust. In addition, neither Eddie Bauer nor SAC guarantee or are otherwise committed to assure any performance or financial result of the Note Trust or the Settlement Trust. FSAC is not a party to the Note Trust or Settlement Trust.
 
As of our fresh start reporting date, the fair values of the SAC securitization interest of $130.6 million was determined with the assistance of a valuation specialist by estimating the discounted cash flows expected to be received by SAC. A discount rate of 30% was used, which included a 13% discount rate used to calculate the present value of the estimated collections and a 17% discount was applied to reflect uncertainties associated with risk of collection.
 
During the third quarter of 2006, $74.1 million in cash was received related to the outstanding receivables under the SAC securitization interests. In accordance with the terms of the non-recourse promissory obligation established for the benefit of the creditors of Spiegel, 90% of the cash proceeds, which totaled $66.7 million, were paid to the Creditor Trust during the third quarter. As a result of the cash received, the obligations to the original note holders within the Settlement Trust were settled and certain of the related expenses of MBIA were paid from a portion of the cash proceeds received during the third quarter. The Settlement Trust was not terminated as of September 30, 2006 since not all of the related expenses were paid. The Settlement Trust was terminated during December 2006.
 
Upon the termination of the Settlement Trust, SAC became the sole beneficial owner of the receivables held under the Note Trust and as a result, SAC has a unilateral right to terminate the Note Trust. Accordingly, effective December 2006, consistent with SFAS 140, the Note Trust is no longer accounted for as a qualifying special purpose entity. In conjunction with the termination of the Settlement Trust, the outstanding receivables and related liabilities under the Promissory Note were revalued to their fair values of $46.0 million and $41.4 million, respectively. Additionally, we reclassified the remaining outstanding receivables to financing receivables on our consolidated balance sheet as of December 30, 2006. During the fourth quarter of 2006, we received $41.5 million in cash of which 90%, which totaled $37.3 million, was paid to the Creditor Trust.


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We use a combination of insurance and self-insurance to cover a number of risks, including worker’s compensation, general liability, property and automobile liability and employee-related health care benefits, a portion of which is reimbursed by the employee. Liabilities associated with these risks are estimated in part by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. We believe that we have taken reasonable steps to ensure that we are adequately accrued for costs incurred related to these programs at December 30, 2006.
 
 
As established in the Plan of Reorganization, we assumed the Spiegel pension and other post-retirement plans as of the effective date of our emergence from bankruptcy. Prior to our emergence from bankruptcy, our employees participated in these plans and our combined financial statements reflected the expense (benefit) and liabilities associated with the portion of these plans related only to our employees. Accordingly, the liabilities associated with these plans, in addition to those liabilities related to our employees that were already reflected on our combined balance sheet, have been reflected in our consolidated balance sheet as of and subsequent to July 2, 2005, our fresh start reporting date. Our funding obligations and liabilities under the terms of the plans are determined using certain actuarial assumptions, including a discount rate and an expected long-term rate of return on plan assets. These assumptions are reviewed and updated annually at the end of each third quarter, which is the period in which we have elected to use as our annual measurement date.
 
Effective December 30, 2006, we adopted SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R) (“SFAS 158”). SFAS 158 requires companies to (i) recognize in their statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status, (ii) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year and (iii) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur via reporting them within other comprehensive income. SFAS 158 does not change the amounts recognized in the statement of operations as net periodic benefit cost. SFAS 158, with the exception of the new measurement date requirement, is effective for fiscal year ends ending after December 15, 2006. The new measurement date requirement will be effective for fiscal years ending after December 15, 2008.
 
We assumed a discount rate of 5.75% for our pension obligation and 5.78% for our other post-retirement obligations, as of the September 30, 2006 measurement date based upon an analysis of the Moody’s AA corporate bond rate.
 
Our expected long-term rate of return on plan assets assumption for our pension plan was derived from a study conducted by our actuaries and investment managers. The study included a review of anticipated future long-term performance of individual asset classes and consideration of the appropriate asset allocation strategy given the anticipated requirements of the plan to determine the average rate of earnings expected on the funds invested to provide for the pension plan benefits. While the study gives appropriate consideration to recent fund performance and historical returns, the assumption is primarily a long-term, prospective rate. Based upon the most recent study, we have assumed a long-term return of 8.5% related to our pension assets as of the September 30, 2006 measurement date.
 
As of September 30, 2006, our most recent measurement date, our estimated unfunded pension obligation was approximately $7.6 million and our estimated unfunded obligation related to the assumed post-retirement benefit plans was $8.4 million. Our contributions to the pension and post-retirement plans, including all employees covered by the plans, are estimated to total $2.3 million and $0.7 million, respectively, for fiscal 2007.
 
During 2006, the Pension Protection Act of 2006 was enacted. We do not believe that this regulation will have a material impact on the funding obligations with respect to our pension and other benefit plans.


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As of December 30, 2006, we had $12.5 million in outstanding letters of credit. We had no other off-balance sheet financing arrangements as of December 30, 2006. Letters of credit, primarily merchandise vendor letters of credit, are important to our operations because they allow us to have payment on our behalf guaranteed by a bank which then pays the vendor a given amount of money upon presentation of specific documents demonstrating that merchandise has shipped. We subsequently record the payable to the vendor on our balance sheet at the time of merchandise title transfer. Additionally, we use stand-by letters of credit to support our worker’s compensation insurance and import customs bond programs. We are not aware of any material risks to the availability of our letters of credit.
 
 
Historically, our operations have been seasonal, with a disproportionate amount of net merchandise sales occurring in the fourth fiscal quarter, reflecting increased demand during the year-end holiday selling season. During fiscal 2006, the fourth fiscal quarter accounted for approximately 38% of our net merchandise sales. As a result of this seasonality, any factors negatively affecting us during the fourth fiscal quarter of any year, including adverse weather or unfavorable economic conditions, could have a material adverse effect on our financial condition and results of operations for the entire year. The impact of seasonality on results of operations is more pronounced since the level of certain fixed costs, such as occupancy and overhead expenses, do not vary with sales. Our quarterly results of operations also may fluctuate based upon such factors as the timing of certain holiday seasons, the number and timing of new store openings, the amount of net merchandise sales contributed by new and existing stores, the timing and level of markdowns, store closings, refurbishments and relocations, competitive factors, weather and general economic conditions. Accordingly, results for individual quarters are not necessarily indicative of the results to be expected for the entire fiscal year.
 
 
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities as of the date of the financial statements and revenues and expenses during the periods reported. We base our estimates on historical experience, where applicable and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.
 
There are certain estimates that we believe require significant judgment in the preparation of our financial statements. We consider an accounting estimate to be critical if:
 
  •  It requires us to make assumptions because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate; and
 
  •  Changes in the estimate or different estimates that we could have selected may have had a material impact on our financial condition or results of operations.
 
We have discussed the development and selection of these critical accounting estimates with the Audit Committee of our board of directors and the Audit Committee has reviewed our disclosure related to them, as presented below.
 
The following represents the nature of and rationale for our critical accounting estimates.
 
Revenue recognition
 
 
Merchandise sales.  We recognize revenues and the related costs of sales related to our store sales at the time of sale when the customer pays for the merchandise. For sales in our direct channels, including our


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catalog sales and sales through our Internet sites, revenue and the related costs of sales are recognized when the product is estimated to be received by the customer.
 
Sales returns.  We are required to make estimates of future sales returns related to current period sales.
 
Licensing revenues.  We have licensing arrangements with various consumer product manufacturers and other retailers. In certain cases, our licensing revenues are based upon the net sales of the licensed products and therefore we are reliant on the licensee to provide us with their net sales. At times, the net sales information for the licensed products is not available to us prior to the issuance of our financial statements. In these cases, we are required to make an estimate of our licensing revenues.
 
 
Merchandise sales.  In order to properly state our revenues and related costs of sales related to sales in our direct channels, we defer revenue and costs of sales of goods estimated to be in transit to the customer based on our experience of delivery times of the carrier used.
 
Sales returns.  We base our estimates for future sales returns on historical returns experience, taking into consideration current trends.
 
Licensing revenue.  If net sales of the licensed product are not available, we estimate our licensing revenues based upon historical sales experience for the product and by obtaining estimated net sales data from the licensee.
 
 
Merchandise sales.  Our revenue, costs of sales and gross margin would vary if different assumptions were used as to the estimated goods in-transit to the customer. Our average daily sales from our direct channels for fiscal 2006, 2005, and 2004 were $0.7 million, $0.7 million and $0.8 million, respectively.
 
Sales returns.  Our revenue, costs of sales and gross margin would vary if different assumptions were used to estimate our sales returns. Our allowance for sales returns at the end of fiscal 2006 and 2005 were $15.6 million and $14.6 million, respectively.
 
Licensing revenue.  Our revenue related to our licensing agreements would vary if actual net sales for the licensed products turn out to be different than our estimates. Our licensing revenues for fiscal 2006, 2005 and 2004 were $15.7 million, $15.3 million and $18.5 million, respectively.
 
Inventory valuation
 
 
Inventory valuation.  We carry our inventories at the lower of cost or market. Cost is determined by the weighted average cost method and includes certain overhead and internal freight costs capitalized to inventory. Market is determined based upon the estimated net realizable value, which is generally the estimated selling price of the merchandise. We record reserves against our inventory balance for excess and slow moving inventory that are not expected to be sold at or above cost plus cost of disposal and a normal selling margin. Excess and slow moving inventories are typically disposed of through mark-downs, sales in our outlet stores, or through liquidations.
 
 
Inventory valuation.  We base our estimated inventory reserves on historical experience related to the sale and amount of mark-downs previously taken on similar categories of inventory, as well as taking into consideration the age of the inventory; inventory levels for the product, including additional outstanding purchase orders; and new, similar products expected to be sold.


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Inventory valuation.  Our results of operations in future periods could be negatively impacted if we fail to properly estimate the amount of write down of our inventory values. Our inventory valuation reserves at the end of fiscal 2006 and 2005 were $4.1 million and $5.5 million, respectively.
 
Valuation of long-lived assets
 
 
Fair values of property and equipment.  In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS 144”), we review finite-lived long-lived assets, principally consisting of property and equipment and leasehold improvements at our stores, whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. For assets we intend to hold and use, if the total expected future undiscounted cash flows from the asset group is less than the carrying amount of the asset group, an impairment loss is recognized for the difference between the fair value and the carrying value of the asset group. For assets we plan to dispose of, an impairment loss is recognized if the carrying amount of the assets in the disposal group is more than the fair value, net of the costs of disposal. The impairment tests require us to estimate the undiscounted cash flows and fair value of the asset groups.
 
Fair values of indefinite-lived intangible assets.  We review indefinite-lived intangible assets, consisting of our trademarks and goodwill, based upon the requirements of SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 142 requires us to test our goodwill and trademarks for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would indicate that the intangible asset may be impaired. We perform our annual impairment reviews for goodwill and trademarks during the fourth quarter of each fiscal year. The impairment tests require us to estimate the fair value of our trademarks and our overall business enterprise value.
 
 
Fair values of property and equipment.  When analyzing finite, long-lived assets for potential impairment, significant assumptions are used in determining the undiscounted cash flows of the asset group, including the cash flows attributed to the asset group; future cash flows of the asset group, including estimates of future growth rates; and the period of time in which the assets will be held and used or disposed of. We primarily determine fair values of the asset group using discounted cash flow models. Similar assumptions are used to determine the fair value of the asset group as the assumptions used in the undiscounted cash flow model. In addition, to estimate fair value we are required to estimate the discount rate that incorporates the time value of money and risk inherent in future cash flows.
 
Fair values of indefinite-lived intangible assets.  We estimate the fair value of our trademarks primarily using a discounted cash flow model. We estimate the fair value of our overall business enterprise value using discounted cash flow and market multiple approach models, and also take into consideration our common stock price. Significant assumptions are used when determining the fair values of our trademarks and overall enterprise valuation, including future cash flows of our primary assets; our long-term growth rates; and our weighted average cost of capital. Estimates of future cash flows are based upon our experience, historical operations of the stores, catalogs and Internet sites, estimates of future profitability and economic conditions. Future estimates of profitability and economic conditions require estimating such factors as sales growth, employment rates and the overall economics of the retail industry for up to twenty years in the future, and are therefore subject to variability, are difficult to predict and in certain cases, beyond our control. See further discussion of the impairment tests we performed during fiscal 2005 and fiscal 2006 above under “Results of Operations — Impairment of Indefinite-lived Intangible Assets.”


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Fair values of property and equipment and indefinite-lived intangible assets.  The use of different estimates or assumptions within our undiscounted cash flow models could result in cash flows lower than the current carrying values of our asset groups, thereby requiring us to compare the carrying values of the asset groups to their fair value, which may have not been done using different assumptions. The use of different estimates or assumptions within our discounted cash flow models could result in lower fair values of our property and equipment, trademarks, or overall business enterprise value which may result in the need to record further impairment charges, which may not have been done using different assumptions. Lastly, the use of a different method of determining fair value, other than using discounted cash flow and market multiple approach models, could result in lower or higher fair values.
 
Deferred tax valuation allowances
 
 
Upon our emergence from bankruptcy on June 21, 2005, Spiegel transferred ownership of its subsidiaries, FSAC and SAC, to us. Both FSAC and SAC have significant tax NOLs. We are required to estimate the amount of tax valuation allowances to record against these NOLs based upon our assessment of it being more likely than not that these NOLs will expire or go unused.
 
 
In determining the need for tax valuation allowances against our NOLs, we take into consideration current and past operating performance, projections of future operating results and projected taxable income or loss, length of the carryback and carryforward periods, and any limitations imposed by the IRC Section 382. Section 382 limits NOL utilization based upon an entity’s estimated enterprise value. We estimated our NOLs to be approximately $699 million ($271 million tax affected) as of July 2, 2005, our fresh start reporting date. As a result of Section 382 limitations, we concluded that it was more likely than not that a portion of our state NOLs would expire and go unused. Accordingly, in conjunction with our application of fresh start accounting effective July 2, 2005, a valuation allowance was established for approximately $524 million ($19.8 million tax affected) based upon the estimated state NOLs that would expire and go unused. During 2006, we determined that as of our fresh start reporting date, no state NOLs existed and accordingly we reduced both our gross state NOLs and valuation allowance related to our state NOLs by $19.8 million, thereby resulting in no net impact to our net deferred tax assets or goodwill.
 
During the fourth quarter of fiscal 2005, we revised our long range forecast which resulted in a decrease in estimated taxable income in future years and an increase in the amount of Federal NOLs that may expire and go unused after considering the IRS limitations. These changes resulted in a net $15.3 million increase in the valuation allowance requirement during the six months ended December 31, 2005.
 
During fiscal 2006 we recognized $71.3 million of expense to further increase our valuation allowance related to our NOLs, of which $23.5 million was recorded during the second quarter, $52.7 million was recorded during the third quarter of 2006 and $4.9 million of the valuation allowance was reversed during the fourth quarter of 2006. During the second quarter of 2006, we increased our valuation allowance as we reassessed our long-range plan, which resulted in a decrease in our projected taxable income during 2006 and 2007 and an increase in the projected amounts of NOLs expected to expire unused. The increase to our valuation allowance during the third quarter resulted from a decrease in the estimated annual amount of NOL utilization allowed under the IRC Section 382. As discussed above, during the third quarter of 2006, we performed an updated valuation of our enterprise value and concluded that our enterprise value had declined. We expect that further restrictions on the utilization of our NOLs may apply to periods subsequent to January 1, 2008 due to the possibility of a change in ownership after certain trading restrictions on our common stock are lifted and accordingly, this decline in enterprise value resulted in a decrease in the amount of expected NOL utilization allowed for the years of 2008 through 2023. The lower NOL utilization during this period resulted in an increase in the estimated amount of NOLs that will expire and go unused. Lastly, during the fourth quarter of 2006, we reversed $4.9 million of valuation allowance as our taxable income


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during the fourth quarter, principally related to our financing receivables, resulted in higher taxable income and therefore higher NOL utilization than previously estimated.
 
Our NOLs are estimated to be approximately $540 million ($189 million tax affected) as of December 30, 2006 and expire in 2021 through 2023. Our valuation allowance as of December 30, 2006 totaled $84.8 million and related solely to our Federal NOLs.
 
 
Different assumptions as to our future profitability and taxable income or loss could result in different conclusions as to our need for and the level of our tax valuation allowances related to our NOLs. Additionally, our analysis requires assumptions about the timing and amount of limitations imposed by Section 382 based upon our enterprise value. Different estimates in our enterprise value could result in the need for additional valuation allowances. Changes in ownership upon the lapse of the trading restrictions effective January 1, 2008 and related assumptions may also result in future changes in our valuation allowance requirements. In the future, adjustments to increase the valuation allowance related to the NOLs will increase our provision for income taxes which could be materially impacted as these NOLs are realized or expire unused.
 
Stock based compensation
 
 
We account for our stock based compensation in accordance with SFAS No. 123(R), Share Based Payments (“SFAS 123(R)”), which we adopted with our fresh start accounting date of July 2, 2005. Prior to that date, we had no stock based compensation and accordingly, we were not required to select a transition method upon our adoption of SFAS No. 123(R).
 
 
In order to calculate our stock based compensation expense, with the assistance of a third-party, we use the Black-Scholes option pricing model, which requires the use of subjective assumptions including:
 
Volatility — This is a measure of the amount by which a stock price has fluctuated or is expected to fluctuate. Due to our limited stock price history, expected volatility is based upon historical and implied volatility for other companies in the retail industry. An increase in the expected volatility will increase stock based compensation expense.
 
Risk-free interest rate — This is the U.S. Treasury yield curve in effect as of the grant date having a term equal to the expected term of the option. An increase in the risk-free interest rate will increase stock based compensation expense.
 
Expected term — This is the period of time over which the options granted are expected to remain outstanding and is based on estimated future exercise behavior. An increase in the expected term will increase stock based compensation expense.
 
Dividend yield — This is assumed to be zero as we do not have plans to pay dividends in the foreseeable future. An increase in the dividend yield will decrease stock based compensation expense.
 
Forfeitures  — We estimate forfeitures of stock-based awards based on expected future activity and adjust our forfeiture rate on a quarterly basis as actual forfeitures occur. An increase in forfeitures results in a decrease to stock based compensation expense, which is recognized on a prospective basis over the remaining term of the option grant.
 
 
Different estimates of the above items could result in higher or lower amounts of stock based compensation expense recognized. Our stock based compensation expense for fiscal 2006 and 2005 were $10.2 million and $3.6 million, respectively.


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The rate of inflation over the past several years has not had a significant impact on our sales or profitability.
 
 
See Note 4(cc) to our audited financial statements, which are included in this document, for a discussion of recent accounting pronouncements.
 
 
See Notes 8, 18 and 19 to our audited financial statements, which are included in this document, for a discussion of related party transactions.
 
 
See Note 23 to our audited financial statements, which are included in this document, for a discussion of material events occurring subsequent to December 30, 2006.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
Our primary exposures to market risk relate to interest rates and foreign exchange rates. We use certain derivative financial instruments, primarily interest rate swaps, to manage our interest rate risks. We do not use any derivatives to manage our foreign exchange risks. We do not use derivatives for trading purposes, to generate income or to engage in speculative activity.
 
 
We are exposed to interest rate risk associated with our senior secured revolving credit facility and senior secured term loan, which we amended in April 2006. The senior secured revolving credit facility bears interest at variable rates based on LIBOR plus a spread. As of December 30, 2006, our availability was approximately $100.9 million and no amounts had been drawn under the senior secured revolving credit facility.
 
As of December 30, 2006, the outstanding amount of our senior secured term loan totaled $274.5 million. For periods prior to April 14, 2006, the effective date of the amendment to the senior secured term loan agreement, interest on the loan was calculated based on the prime rate plus 1.75% in the case of a base rate loan, or LIBOR plus 2.75% in the case of Eurodollar loans. For periods after April 14, 2006, the date of effectiveness of the amendment to the senior secured term loan agreement, interest is calculated as the greater of the prime rate or the Federal funds effective rate plus one-half of one percent plus 2.50% to 3.25% in the case of a base rate loan, or LIBOR plus 3.50% to 4.25% in the case of Eurodollar loans, based upon our corporate credit rating issued from time to time by Moody’s and Standard & Poor’s, provided that interest on the term loan will be increased by 0.50% until the date that the aggregate principal amount of the loans outstanding is less than $225 million as a result of asset sales or voluntary prepayments from operating cash flow. As of December 30, 2006, our interest rate under the amended term loan included a LIBOR rate of 5.35% plus a margin of 4.25%, for a total interest rate of 9.6%. See “Item 2. Management’s Discussion and Analysis of Financial Condition — Sources of Liquidity — Senior Secured Term Loan.” The agreement required us to enter into interest rate swap agreements such that at least 50% of the aggregate principal amount of the outstanding loan is subject to either a fixed interest rate or interest rate protection for a period of not less than three years. In October 2005, we entered into an interest rate swap agreement with a total notional value of $150 million, or 50% of the outstanding amount under our term loan as of that date. The interest rate swap agreement effectively converts 50% of the outstanding amount under our term loan, which is floating-rate debt, to a fixed-rate by having us pay fixed-rate amounts in exchange for the receipt of the amount of the floating-rate interest payments. Under the terms of the interest rate swap agreement, a monthly net settlement is made for the difference between the fixed rate of 4.665% and the variable rate based upon the monthly LIBOR rate on the notional amount of the interest rate swap. The fair value of the interest rate


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swap as of December 30, 2006 was $1.7 million. Assuming a 10% increase in interest rates, the fair value of the interest rate swap would be approximately $4.5 million at December 30, 2006. Assuming a 10% decrease in interest rates, the fair value of the interest rate swap would be approximately ($1.1) million at December 30, 2006. The interest rate swap agreement terminates in conjunction with the termination of the senior secured term loan in June 2011.
 
See further discussion above within “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” related to the financing transaction we anticipate closing in April 2007, which will impact the amounts and timing of interest payments required related to our long-term debt obligations.
 
 
Our foreign currency risks relate primarily to stores that we operate in Canada and with our investments in Japan and Germany, for which we apply the equity method of accounting as we do not control these entities. Additionally, we have foreign currency risks associated with the purchase of merchandise from foreign entities. We believe that the potential exposure from foreign currency risks is not material to our financial condition or results of operations.
 
Item 8.   Financial Statements and Supplementary Data
 
Information with respect to this item is set forth under Item 15.


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Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
None.
 
Item 9A.   Controls and Procedures
 
 
The Company’s management, including the Company’s interim Chief Executive Officer and interim Chief Financial Officer, evaluated the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report (the “Evaluation Date”). Based on that evaluation, the interim Chief Executive Officer and interim Chief Financial Officer have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are not adequate and effective to reasonably assure that material information relating to the Company, including its consolidated subsidiaries, would be made known to them by others within those entities. A disclosure control system, no matter how well conceived and implemented, can provide only a reasonable assurance that the objectives of such control system are satisfied. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues have been detected. We have, however, designed into our process safeguards intended to reduce, though not eliminate, this risk.
 
 
This determination results from material weaknesses in our internal control over financial reporting that management identified in early 2006, which led to the restatement of certain financial information included in the original Form 10 Registration Statement filed with the Securities and Exchange Commission in December 2005. The identified weaknesses included several clerical errors and accounting errors, primarily related to the recording of complex “fresh start” accounting adjustments required as a result of Eddie Bauer’s emergence from bankruptcy. Management determined these errors originally went undetected due to insufficient in-house technical expertise necessary to provide sufficiently rigorous review. See “Risk Factors” and “Remediation Plan” in this Annual Report on Form 10-K for a more complete discussion of the material weakness determination. These errors were corrected in our restated financial statements included in our new Form 10 registration statement originally filed in May 2006.
 
In conjunction with our preparation work for compliance with Section 404 of the Sarbanes-Oxley Act, management has identified control deficiencies pertaining to the security administration of various automated business applications which could potentially impact internal control over financial reporting. These relate primarily to granting and tracking access to our accounting and merchandising systems. Management is still in the process of assessing, evaluating and testing these deficiencies. If these issues are not remediated in a timely manner, these deficiencies, along with other deficiencies that may be identified during the remainder of our review and testing of internal control over financial reporting, may collectively be considered a material weakness.
 
In the course of preparing the 2006 financial statements, the Company identified errors related to the tax accounting for 2005 and prior years. The Company undertook a comprehensive review of the matter and has determined that these errors are not material and do not require restatement of previously filed financial statements. The Company determined that it did not properly reconcile the book and tax depreciation on its property and equipment, primarily related to the treatment of tenant improvement allowances granted in connection with the opening of new retail stores. The correction of this error was reported in the 2006 financial statements and resulted in a decrease of net deferred tax assets of approximately $12 million and an increase in goodwill of $12 million.
 
To address the material weaknesses and deficiencies identified to date, we performed additional analysis and other post-closing procedures and retained additional external resources with public company reporting expertise in order to prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States.


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Although we are not required to comply with Section 404 of the Sarbanes-Oxley Act until our annual report for our fiscal year ending December 29, 2007, management and our board of directors are committed to the remediation of our disclosure controls and procedures, including the remediation and continued improvement of our overall system of internal control over financial reporting. Management has developed and is in the process of implementing a remediation plan for each of the identified weaknesses. The plan includes:
 
  •  hiring qualified key accounting and finance personnel with appropriate experience in companies which face similar financial reporting requirements;
 
  •  hiring and integrating additional qualified key accounting and finance personnel with appropriate technical experience; and
 
  •  identifying and implementing additional improvements to the internal control framework to ensure ongoing compliance.
 
Due to the uncertainty created by the exploration of strategic alternatives and then the proposed merger, the Company has encountered difficulties in recruiting for permanent positions for its various financial management roles. Currently the Company is utilizing additional external resources to supplement current staffing. During the fourth quarter 2006, we continued to make progress in addressing the material weaknesses discussed above. The Company has:
 
  •  implemented more rigorous financial closing procedures, including more formal documentation of controls and procedures;
 
  •  expanded the project to remediate control deficiencies related to granting and tracking access to our computerized accounting and merchandising systems;
 
  •  retained additional external resources with public company reporting expertise, as well as specialized experts, to research, analyze and document various accounting, and financial reporting issues and processes associated with the preparation and review of the Company’s consolidated financial statements in accordance with generally accepted accounting principles;
 
  •  engaged specialized resources to fully reconcile the deferred tax asset /liability accounts; and
 
  •  implemented additional in-depth analyses and other post-closing procedures, to validate the financial statements and related disclosures.
 
Management has identified the initial steps necessary to address the material weaknesses and control deficiencies discussed above. The Company has not had the opportunity to test these changes and therefore management is unable to conclude that our disclosure controls and procedures are effective as of the Evaluation Date. The Company intends to continue implementing its review, evaluation and testing of internal controls and remediation efforts to strengthen internal controls over financial reporting during 2007.
 
The Company must comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 as of December 29, 2007. The Company is now actively recruiting for permanent resources to fill their accounting and finance needs. In addition, as the Company continues to evaluate the design and operating effectiveness of it various key controls through its Section 404 activities, additional deficiencies may be identified, which if not remediated in a timely manner, may result in additional weaknesses.
 
We have committed to provide status reports to our independent auditors and our Audit Committee of the Board of Directors on a regular basis throughout 2007. We will need to continue to divert significant resources to address our currently known weaknesses. In addition, due to the high demands for these skill sets in the current job market, we may encounter difficulties in attracting and/or retaining qualified personnel. As a result, we do not expect to be in a position to report that such weaknesses will be fully remediated before the end of 2007.


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Item 10.   Directors and Executive Officers and Corporate Governance
 
Except for the code of ethics information below, the information required for this Item will be included in our Proxy Statement relating to our 2007 annual meeting of stockholders, and is incorporated herein by reference. Our Proxy Statement will be filed within 120 days of December 30, 2006, our fiscal year end.
 
We have adopted a written code of ethics, the “Eddie Bauer Code of Business Conduct and Ethics,” that applies to all our employees, managers, officers, executive officers and the board of directors (including non-employee board members to the extent applicable) (collectively, the “Associates”). The code is posted on our website at http://www.eddiebauer.com. We will disclose any changes in or waivers from our code of ethics applicable to any Associate on our website at http://www.eddiebauer.com or by filing a Form 8-K.
 
Item 11.   Executive Compensation
 
Information required for this section will be included in our Proxy Statement relating to our 2007 annual meeting of stockholders and is incorporated herein by reference. Our Proxy Statement will be filed within 120 days of December 30, 2006, our fiscal year end.
 
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Except for the “Securities Authorized for Issuance Under Equity Compensation Plan” below, the information required for this Item will be included in our Proxy Statement relating to our 2007 annual meeting of stockholders and is incorporated herein by reference. Our Proxy Statement will be filed within 120 days of December 30, 2006, our fiscal year end.
 
 
The following table provides information as of December 30, 2006 about shares of Eddie Bauer common stock that may be issued upon the exercise of options, warrants and rights granted to employees, consultants or members of the board of directors under all of our existing equity compensation plans.
 
                         
                Number of securities
 
    Number of securities
          remaining available for
 
    to be issued
    Weighted-average
    future issuance under
 
    upon exercise of
    exercise price of
    equity compensation plans
 
    outstanding options,
    outstanding options,
    (excluding securities
 
Plan category
  warrants and rights     warrants and rights     reflected in column (a))  
 
Equity compensation plans approved by security holders
                 
Equity compensation plans not approved by security holders(1)
    1,193,908 (2)   $ 23.28 (3)     587,845  
                         
Total
    1,193,908     $ 23.28       587,845  
 
 
(1) Eddie Bauer’s 2005 Stock Incentive Plan. This plan provides for the grant of stock options, restricted shares of common stock and other awards valued by reference to our common stock, which may be granted to our directors, employees and consultants of our company or our affiliates. Shares issued pursuant to awards under the plan may be authorized but unissued common stock, or shares that we have reacquired on the market or by forfeiture of awards. In the event of significant corporate transaction, such as a dissolution or liquidation of Eddie Bauer Holdings, or any corporate separation or division, or similar transaction in which we are not the surviving entity, then all outstanding stock awards under the plan may be assumed, continued, or substituted for by any surviving or acquiring entity (or its parent company), or may be cancelled either with or without consideration for the vested portion of the awards. The terms and conditions of options granted under this plan are to be determined by the board of directors, provided, that the exercise price of an option generally cannot be less than the fair market value of our common stock on


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the date of grant. Unless otherwise provided by the plan administrator, following termination of continuous service stock options granted under this plan generally will remain exercisable, to the extent exercisable at the time of termination, for three months (12 months in the case of death or disability) or until they expire by their terms.
 
(2) Reflects securities issued under the Eddie Bauer 2005 Stock Incentive Plan. Includes stock options to acquire 590,375 shares of common stock at a weighted-average exercise price of $23.28 per share and 603,533 restricted stock units.
 
(3) Reflects the weighted-average exercise price of stock options granted and outstanding under the Eddie Bauer 2005 Stock Incentive Plan as of December 30, 2006.
 
Item 13.   Certain Relationships and Related Transactions and Director Independence
 
Information required for this Item will be included in our Proxy Statement relating to our 2007 annual meeting of stockholders and is incorporated herein by reference. Our Proxy Statement will be filed within 120 days of December 30, 2006, our fiscal year end.
 
Item 14.   Principal Accounting Fees and Services
 
Information required for this Item will be included in our Proxy Statement relating to our 2007 annual meeting of stockholders and is incorporated herein by reference. Our Proxy Statement will be filed within 120 days of December 30, 2006, our fiscal year end.
 
 
Item 15.   Exhibits, Financial Statement Schedules
 
(a) Index to Financial Statements
 
     
    Page
 
Financial Statements
   
Annual Financial Statements
   
Report of Independent Registered Public Accounting Firm
  85
Consolidated Balance Sheets — Successor Entity as of December 30, 2006 and December 31, 2005
  86
Consolidated and Combined Statements of Operations — Successor Entity for the year ended December 30, 2006 and for the six months ended December 31, 2005, Predecessor Entity for the six months ended July 2, 2005 and for the year ended January 1, 2005
  87
Consolidated and Combined Statements of Stockholders’ Equity and Comprehensive Income (Loss) — Successor Entity for the year ended December 30, 2006 and for the six months ended December 31, 2005, Predecessor Entity for the six months ended July 2, 2005 and for the year ended January 1, 2005
  88
Consolidated and Combined Statements of Cash Flows — Successor Entity for the year ended December 30, 2006 and for the six months ended December 31, 2005, Predecessor Entity for the six months ended July 2, 2005 and for the year ended January 1, 2005
  90
Notes to Consolidated and Combined Financial Statements
  92
 
Exhibits required as part of this report are listed in the Exhibit Index.


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Board of Directors and Stockholders Eddie Bauer Holdings, Inc.
 
We have audited the accompanying consolidated balance sheets of Eddie Bauer Holdings, Inc. (“Successor”) as of December 30, 2006 and December 31, 2005 and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for the year ended December 30, 2006 and the six month period ended December 31, 2005. We have also audited the accompanying consolidated and combined statements of operations, stockholders’ equity and comprehensive income, and cash flows of Eddie Bauer Inc. and Related Operations (“Predecessor”) for the six month period ended July 2, 2005, and for the year ended January 1, 2005. In connection with our audits of the consolidated and combined financial statements, we have also audited the accompanying financial statement schedule for the year ended December 30, 2006, each of the six month periods ended December 31, 2005 and July 2, 2005, and for the year ended January 1, 2005. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial statement schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial statement schedule. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated and combined financial statements referred to above present fairly, in all material respects, the financial position of Eddie Bauer Holdings, Inc. at December 30, 2006 and December 31, 2005, and the results of its operations and its cash flows for the year ended December 30, 2006 and the six month period ended December 31, 2005, and the results of operations and cash flows of Eddie Bauer, Inc. and Related Operations for the six month period ended July 2, 2005 and the year ended January 1, 2005 in conformity with accounting principles generally accepted in the United States of America.
 
Also, in our opinion, the financial statement schedule presents fairly, in all material respects, the information set forth therein.
 
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company’s ability to refinance its term loan to avoid an event of default related to the failure of the Company in meeting its financial covenants in one or more future interim periods raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3 and Note 10. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
/s/  BDO Seidman, LLP
 
Seattle, Washington
March 23, 2007
 


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EDDIE BAUER HOLDINGS, INC.
 
CONSOLIDATED BALANCE SHEETS
 
                 
    Successor
    Successor
 
    As of
    As of
 
    December 30,
    December 31,
 
    2006     2005  
    ($ in thousands)  
 
Cash and cash equivalents
  $ 53,174     $ 74,186  
Restricted cash
          825  
Accounts receivable, less allowances for doubtful accounts of $1,274 and $982, respectively
    29,774       32,737  
Current assets of discontinued operations
          498  
Inventories
    153,778       142,302