Background

The Company is a New York corporation incorporated on April 10, 1935. On December 18, 2006, the Company entered into an Agreement and Plan of Merger and Reorganization, as amended, with Fred Merger Corp., a wholly-owned subsidiary of the Company, and FOH Holdings. On January 28, 2008, the Company consummated its merger with FOH Holdings. As a result, FOH Holdings is now a wholly-owned subsidiary of the Company. FOH Holdings is the parent company of Frederick's of Hollywood, Inc. Following the merger, the Company changed its name from Movie Star, Inc. to Frederick's of Hollywood Group Inc.

In connection with the merger, the Company:

• issued to the FOH Holdings Stockholders an aggregate of 11,844,591 shares of common stock in exchange for all of FOH Holdings' outstanding common stock, of which 2,368,916 shares (representing 20% of the shares of common stock issued to the FOH Holdings Stockholders) were deposited into escrow for 18 months following the closing of the merger, subject to extension under certain circumstances, to cover any indemnification claims that we may bring for certain matters, including breaches of FOH Holdings' covenants, representations and

warranties in the merger agreement. Similarly, 618,283 treasury shares of common stock (representing 7.5% of the aggregate number of issued and outstanding shares of common stock immediately prior to the closing of the merger) were deposited into escrow for 18 months following the closing of the merger, subject to certain conditions, to cover any indemnification claims that may be brought by the FOH Holdings Stockholders against us;

• raised $20 million of gross proceeds through (i) the issuance of an aggregate of 752,473 shares of common stock upon exercise by our shareholders of non-transferable subscription rights to purchase shares of common stock (the "Rights Offering") and (ii) the issuance of an aggregate of 4,929,345 shares of common stock not subscribed for by our shareholders in the Rights Offering that were purchased on an equal basis by Fursa and Tokarz Investments, who acted as standby purchasers (the "Standby Purchase"). As sole consideration for their commitments in connection with the Standby Purchase, we issued warrants to the standby purchasers representing the right to purchase an aggregate of 596,591 shares of common stock;

• issued an aggregate of 3,629,325 shares of Series A 7.5% Convertible Preferred Stock to Fursa in exchange for a $7.5 million portion of the debt owed by FOH Holdings and its subsidiaries; and

• issued to Performance Enhancement Partners, LLC (of which our Executive Chairman is the sole member) and our Chief Financial Officer 50,000 and 24,194 shares of common stock, respectively, under the 2000 Performance Equity Plan in accordance with the terms of their respective consulting and employment agreements. The Chief Executive Officer and certain other employees of FOH Holdings also were issued an aggregate of 290,006 shares of restricted common stock in accordance with the terms of the merger agreement and their respective equity incentive agreements.

Overview

We are primarily a retailer of women's intimate apparel and related products through mall-based specialty stores in the United States, which we refer to as "Stores," and mail order catalogs and the Internet, which we refer to collectively as "Direct." We also design, manufacture, source, distribute and sell women's intimate apparel to mass merchandisers, specialty and department stores, discount retailers, national and regional chains and direct mail catalog marketers throughout the United States and Canada.

We conduct our business through two operating divisions: the multi-channel retail division and the wholesale division. Our business reporting segments are retail and wholesale. We believe this method of segment reporting reflects both the way our business segments are managed and the way each segment's performance is evaluated. The retail segment includes our Frederick's of Hollywood Stores and Direct operations. The wholesale segment includes our wholesale operations in the U.S. and Canada.

Financial information about the retail segment for the year ended July 26, 2008 and July 28, 2007 and about the wholesale segment from January 28, 2008 (the closing date of the merger) through July 26, 2008 is included in the consolidated financial statements contained herein.

Fiscal 2009 Initiatives

Throughout fiscal year 2008, we have operated under challenging macroeconomic conditions, which have had a negative impact on our revenues, gross margins and earnings. These conditions have continued into the first quarter of fiscal year 2009 and we believe that they will continue during the remainder of fiscal year 2009. Our efforts are focused on implementing changes in our business strategy described below that we believe over time will both increase revenues and reduce costs. We expect that some of these initiatives will have an immediate impact on our operating results while

others may take more time. We cannot be certain that these initiatives will produce positive operating results in fiscal 2009. These key initiatives include:

• Reducing operating expenses. While the macroeconomic environment continues to present challenges to both our retail and wholesale divisions, following the consummation of the merger, we have taken and are continuing to take a number of actions to reduce operating expenses, which include reducing personnel through the elimination of executive and support positions, decreasing the use of outside consultants, and consolidating employee benefits and insurance.

• Consolidating Functions. During fiscal year 2008, the wholesale division accounted for approximately 6% of the dollar value of our retail division's merchandise purchases. Our objective is to continue to vertically integrate our retail and wholesale operations in order to derive additional margin benefits. To this end, we have been evaluating our entire organization to determine where we can improve operational efficiencies and have begun to consolidate both companies' merchandising and design, distribution, information technology and finance functions. We also have been transitioning manufacturing support functions to our new manufacturing facility in the Philippines.

• Continuing to reduce catalog circulation. As a result of rising costs, we have continued to reduce Frederick's of Hollywood's annual catalog circulation from approximately 26.3 million in fiscal year 2006 to approximately 20.4 million in fiscal year 2007 to approximately 18.7 million in fiscal year 2008. Since we have reduced catalog circulation, we are endeavoring to expand our Internet customer base through various methods, including partnering with Internet search engines and participating in affiliate programs. Following an unsuccessful transition earlier this fiscal year to a new web platform, we have focused our efforts on replacing our website with a state-of-the-art e-commerce system hosted by a third-party service provider, which we expect will be operational in early calendar year 2009. We believe our upgraded and enhanced website, combined with improved customer acquisition and retention capabilities, will enable www.fredericks.com to provide customers with an enhanced pleasurable online shopping experience for intimate apparel and related products.

• Reducing planned store openings. Following the consummation of the merger in January 2008, we had anticipated that we would open, relocate and/or remodel approximately 40 to 50 new stores over three years. However, due to uncertain economic conditions and our poor operating performance in fiscal year 2008, we have revised our retail store expansion plans for fiscal year 2009 to include only three store openings and one store remodeling. We also expect to close two stores. We continuously evaluate our longer-term store expansion plans and intend to make appropriate adjustments as business conditions permit.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.

Management believes that the application of accounting policies, and the estimates inherently required by the policies, are reasonable. These accounting policies and estimates are constantly re-evaluated, and adjustments are made when facts and circumstances dictate a change. Historically, management has found the application of accounting policies to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates.

Our accounting policies are more fully described in Note 2 to the consolidated financial statements contained elsewhere in this report. Management has identified certain critical accounting policies that are described below.

The Company's most significant areas of estimation and assumption are:

• determination of the appropriate amount and timing of markdowns to clear unproductive or slow-moving retail inventory and overall inventory obsolescence;

• determination of appropriate levels of reserves for accounts receivable allowances and sales discounts;

• estimation of future cash flows used to assess the recoverability of long-lived assets, including trademarks and goodwill;

• estimation of expected customer merchandise returns; and

• estimation of the net deferred income tax asset valuation allowance.

Accounts Receivable/Allowance for Doubtful Accounts and Sales Discounts - Our accounts receivable is net of allowance for doubtful accounts and sales discounts. An allowance for doubtful accounts is determined through the analysis of the aging of accounts receivable at the date of the financial statements. An assessment of the accounts receivable is made based on historical trends and an evaluation of the impact of economic conditions. This amount is not significant, primarily due to our history of minimal bad debts. An allowance for sales discounts is based on discounts relating to open invoices where trade discounts have been extended to customers, costs associated with potential returns of products, as well as allowable customer markdowns and operational charge backs, net of expected recoveries. These allowances are included as a reduction to net sales and are part of the provision for allowances included in accounts receivable. The foregoing results from seasonal negotiations and historic deduction trends, net of expected recoveries and the evaluation of current market conditions. As of July 26, 2008 and July 28, 2007, accounts receivable was net of allowances of $979,000 and $0, respectively. This allowance is the result of the addition of the wholesale division in connection with the merger. The wholesale accounts receivable as of July 26, 2008, net of the $979,000 allowance, was $5,027,000. Management believes its allowance for doubtful accounts and sales discounts are appropriate, and actual results should not differ materially from those determined using necessary estimates. However, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. If market conditions were to worsen, management may take actions to increase customer incentive offerings, possibly resulting in an incremental allowance at the time the incentive is offered.

Merchandise Inventories - Retail store inventories are valued at the lower of cost or market using the retail inventory first-in, first-out ("FIFO") method, and wholesale, catalog and Internet inventories are valued at the lower of cost or market, on an average cost basis that approximates the FIFO method. Freight costs are included in inventory and vendor promotional allowances are recorded as a reduction in inventory cost. These inventory methods inherently require management judgments and estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuations as well as gross margins. Markdowns are recorded when the sales value of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise, and fashion trends. Additionally, we accrue for planned but unexecuted markdowns. If actual market conditions are less favorable than those projected by management, additional inventory reserves may be required. Historically, management has found its inventory reserves to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates. Inventory reserves were $1,312,000 at July 26, 2008, and $238,000 at July 28, 2007. This increase was due to the addition of the wholesale inventory in connection with the merger. The wholesale inventory was $8,966,000, net of a $1,075,000 reserve.

Deferred Catalog Costs - Deferred catalog costs represent direct-response advertising that is capitalized and amortized over its expected period of future benefit. Direct-response advertising consists primarily of product catalogs of FOH Holdings' mail order subsidiary. The capitalized costs of the advertising are amortized over the expected revenue stream following the mailing of the respective catalog, which is generally six months. The realizability of the deferred catalog costs are also evaluated as of each balance sheet date by comparing the capitalized costs for each catalog, on a catalog by catalog basis, to the probable remaining future net revenues. Direct-response advertising costs of $2,297,000 and $2,409,000 are included in prepaid expenses and other current assets in the accompanying consolidated balance sheets at July 26, 2008 and July 28, 2007, respectively. Management believes that they have appropriately determined the expected period of future benefit as of the date of its consolidated financial statements; however, should actual sales results differ from expected sales, deferred catalog costs may be written off on an accelerated basis.

Impairment of Long-Lived Assets - We review long-lived assets, including property and equipment and our amortizable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on undiscounted cash flows. If long-lived assets are impaired, an impairment loss is recognized and is measured as the amount by which the carrying value exceeds the estimated fair value of the assets. No impairment was recorded for the years ended July 26, 2008 and July 28, 2007.

Goodwill and Intangible Assets - We have certain intangible assets and goodwill. Intangible assets consist of trademarks, principally the Frederick's of Hollywood trade name, customer relationships, and domain names recognized in accordance with purchase accounting. We have determined the trademarks and domain names to have indefinite lives. Financial Accounting Standards Board ("FASB") Statement No. 142, Goodwill and Other Intangible Assets, requires us to not amortize goodwill and certain other indefinite life intangible assets, but to test those intangible assets for impairment annually and between annual tests when circumstances or events have occurred that may indicate a potential impairment has occurred. We conducted our annual impairment evaluations of goodwill and indefinite life intangibles as of July 26, 2008 and July 28, 2007. Based on these evaluations, no impairment was recorded for the years ended July 26, 2008 and July 28, 2007.

Income Taxes - Income taxes are accounted for under an asset and liability approach that requires the recognition of deferred income tax assets and liabilities for the expected future consequences of events that have been recognized in our financial statements and income tax returns. We provide a valuation allowance for deferred income tax assets when it is considered more likely than not that all or a portion of such deferred income tax assets will not be realized. Due to the merger, we underwent a change in control under
Section 382 of the Internal Revenue Code and, therefore, our net operating loss carryforwards may be limited.

Effect of New Accounting Standards - See Note 2 to our consolidated financial statements for a discussion of recent accounting developments and their impact on our consolidated financial statements contained elsewhere in this report.

Results of Operations

As a result of the merger being accounted for as a reverse acquisition in which the Company was treated as the acquired company, and FOH Holdings was treated as the acquiring company, Movie Star's historical financial results are not included in the financial statements presented in this Form 10-K and the historical financial statements reflect only FOH Holdings' consolidated financial statements. Therefore, the historical financial information for periods and dates prior to January 28, 2008 is that of FOH Holdings and its subsidiaries and for periods subsequent to January 28, 2008 is that of the merged company.

Management considers certain key indicators when reviewing our results of operations and liquidity and capital resources. Because the results of operations for both our retail and wholesale divisions are subject to seasonal variations, retail sales are reviewed against comparable store sales for

the similar period in the prior year and wholesale sales are reviewed in conjunction with our backlog of orders to determine the total position for the year. When reviewing sales, a material factor that we consider is the gross profit percentage. We also consider our selling, general and administrative expenses as a key indicator in evaluating our financial performance. Inventory, accounts receivable and our outstanding borrowings are the main indicators we consider when we review our liquidity and capital resources, particularly the size and age of the inventory and accounts receivable. We review all of our key indicators against the prior year and our operating projections in order to evaluate our operating performance and financial condition.

The following table shows each specified item as a dollar amount and as a percentage of net sales in each fiscal period, and should be read in conjunction with the consolidated financial statements included elsewhere in this report (in thousands, except for percentages, which percentages may not add due to rounding):

                                                                          Year Ended
                                           July 26, 2008(1)              July 28, 2007               July 29, 2006

Net sales                               $ 182,233        100.0 %     $ 155,238        100.0 %    $ 136,705        100.0 %
Cost of goods sold, buying and
occupancy                                 115,306         63.3 %        90,201         58.1 %       80,102         58.6 %

Gross profit                               66,927         36.7 %        65,037         41.9 %       56,603         41.4 %
Selling, general and administrative
expenses                                   80,108         44.0 %        61,996         39.9 %       57,579         42.1 %

Operating income (loss)                   (13,181 )       (7.2 )%        3,041          2.0 %         (976 )        (.7 )%
Interest expense, net                       2,048          1.1 %         2,093          1.3 %        2,422          1.8 %

Income (loss) from continuing
operations before income tax
provision                                 (15,229 )       (8.4 )%          948           .6 %       (3,398 )       (2.5 )%
Income tax provision                          154           .1 %           548           .4 %          127           .1 %

Income (loss) from continuing
operations                                (15,383 )       (8.4 )%          400           .3 %       (3,525 )       (2.6 )%
Discontinued operations, net of tax
provision                                       -            -              41            -            240           .2 %

Net income (loss)                         (15,383 )       (8.4 )%          441           .3 %       (3,285 )       (2.4 )%

Less: Preferred stock dividends               281                            -                           -

Net income (loss) available to common
shareholders                            $ (15,664 )                  $     441                   $  (3,285 )

(1) Reflects the merged entity as of January 28, 2008. See Note 1 to the consolidated financial statements contained elsewhere in this report.

Fiscal Year 2008 Compared to Fiscal Year 2007

Net Sales

Net sales for the year ended July 26, 2008 increased to $182,233,000 as compared
to $155,238,000 for the year ended July 28, 2007, and were comprised of retail
and wholesale sales as follows (in thousands):


                                              Year Ended
                                        July 26,      July 28,
                      Net Sales:          2008          2007

                      Retail            $ 153,748     $ 155,238
                      Wholesale            28,485             -

                      Total net sales   $ 182,233     $ 155,238

The increase in net sales resulted from the addition of $28,485,000 of net sales generated from January 28, 2008 through July 26, 2008 by the wholesale division following the consummation of the merger. The increase was partially offset by a decrease in retail sales of $1,490,000, which was primarily due to a weak retail environment and an unsuccessful transition to a new web platform, partially offset by the contribution from new stores.

The wholesale division's net sales by customer, which are included in total net sales for the year ended July 26, 2008, were as follows ($ in thousands):

                                                   Year Ended
                   Customer                      July 26, 2008

                   Walmart                    $ 18,797        66.0 %
                   All other U.S. customers      9,334        32.8 %

                   Total U.S. customers         28,131        98.8 %
                   Canada                          354         1.2 %

                   Total                      $ 28,485       100.0 %

The wholesale division's backlog of open orders by customer as of July 26, 2008 was as follows ($ in thousands):

                 Customer                     As of July 26, 2008

                 Walmart                    $     9,709         39.2 %
                 All other U.S. customers        14,246         57.5 %

                 Total U.S. customers            23,955         96.7 %
                 Canada                             830          3.3 %

                 Total                      $    24,785        100.0 %

The decrease in net sales for the retail division to $153,748,000 for the year ended July 26, 2008 from $155,238,000 for the prior year was the result of the following:

• Comparable store sales decreased by approximately 0.2% for the year ended July 26, 2008, compared to the prior year. Comparable store sales are defined as net sales for stores that have been open for one complete year.

• The overall total store sales increased by $3,583,000 or 3.9% for the year ended July 26, 2008 compared to the prior year.

• Direct sales, which are comprised of sales from our catalog and website operations, decreased by $5,073,000 for the year ended July 26, 2008 compared to the prior year, which was primarily due to a decrease in consumer spending resulting from the challenging retail environment and an unsuccessful transition to a new web platform during fiscal year 2008.

Gross Profit

Gross margin (gross profit as a percentage of net sales) for the year ended July 26, 2008 was 36.7% as compared to 41.9% for the prior year. The primary reason for the decrease was the lower gross margin in the wholesale division, which was approximately 25.1% for the year ended July 26, 2008. The gross margin in the retail division also decreased for year ended July 26, 2008 to 38.9% as compared to 41.9% in the prior year.

The largest contributors to the decrease in gross margin for the retail division were the following:

• Product costs as a percentage of sales increased by 1.2% for the year ended July 26, 2008 as compared to the prior year. The increase was primarily the result of higher markdowns.

• Occupancy costs, which consist of rent, common area maintenance, utilities and real estate taxes, increased by $556,000 or 2.7% for the year ended July 26, 2008, as compared to the prior year. This increase was primarily due to net increases in rents and common area costs, which resulted from the addition of stores in higher-end malls with higher annual rents with the potential for higher sales, and the elimination of stores in lower-end malls that have lower rents and lower sales potential, as well as the renewal of leases at a higher annual cost.

• Buying costs, which are the costs associated with our buying and merchandising teams and their activities, increased by $632,000 or 17.4% for the year ended July 26, 2008 as compared to the prior year. This increase was primarily the result of higher salaries and salary-related costs from additional personnel, as well as higher salaries overall.

• Depreciation increased by $719,000 or 31.3% for the year ended July 26, 2008 as compared to the prior year. This increase is due to increased investment in new and remodeled stores.

Selling, General and Administrative Expenses

Included in selling, general and administrative expenses for the year ended
July 26, 2008 were one-time non-recurring merger related expenses that totaled
$2,241,000. They consisted of the following (in thousands):


                                                                   Year Ended
                                                                  July 26, 2008

 Stock compensation expense                                      $           876
 Audit fees in excess of normal audit costs                                  630
 Bonuses paid in connection with the merger                                  450
 Insurance policies purchased as a requirement of the merger                 285

 Total additional selling, general and administrative expenses   $         2,241

Selling, general and administrative expenses for the year ended July 26, 2008 . . .