Summary of FREDERICK'S OF HOLLYWOOD GROUP INC /NY/

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
When used in this Form 10-Q of Frederick's of Hollywood Group Inc. and in our future filings with the Securities and Exchange Commission ("SEC"), the words or phrases "will likely result," "management expects" or "we expect," "will continue," "is anticipated," "estimated" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Readers are cautioned not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made. We have no obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.
Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These risks are included in "Item 1:
Business," "Item 1A: Risk Factors" and "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Form 10-K for the fiscal year ended July 26, 2008. In assessing forward-looking statements contained herein, readers are urged to carefully read those statements. Among the factors that could cause actual results to differ materially are:
competition; business conditions and industry growth; rapidly changing consumer preferences and trends; general economic conditions; large variations in sales volume with significant customers; addition or loss of significant customers; continued compliance with government regulations; loss of key personnel; labor practices; product development; management of growth; increases of costs of operations or inability to meet efficiency or cost reduction objectives; timing of orders and deliveries of products; and foreign government regulations and risks of doing business abroad.
Corporate History
Frederick's of Hollywood Group Inc. (formerly, Movie Star, Inc.) (the "Company") is a New York corporation incorporated on April 10, 1935. On January 28, 2008, the Company consummated its merger with FOH Holdings, Inc., a privately-held Delaware corporation ("FOH Holdings"). As a result of the transaction, FOH Holdings became a wholly-owned subsidiary of the Company. FOH Holdings is the parent company of Frederick's of Hollywood, Inc. Upon consummation of the merger, the Company changed its name from Movie Star, Inc. to Frederick's of Hollywood Group Inc. and its trading symbol on the NYSE Alternext US (formerly, the American Stock Exchange) was changed to "FOH." The merger was accounted for as a reverse acquisition, which means that for accounting and financial reporting purposes, the Company was treated as the acquired company, and FOH Holdings was treated as the acquiring company. The historical financial information presented for the 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.
Immediately prior to the merger, we completed a one-for-two reverse stock split of our outstanding common stock. All share and per share data referred to in this Form 10-Q has been retroactively restated to reflect the reverse stock split.
Unless otherwise indicated, as used in this Form 10-Q:
• "Movie Star, Inc." or "Movie Star" refers to the business, operations and financial results of Movie Star, Inc. prior to the closing of the merger;

• "FOH Holdings" or "Frederick's of Hollywood" refers to the business, operations and financial results of FOH Holdings, Inc., a privately-held Delaware corporation, prior to the closing of the merger and after the merger, as the context requires; and

• the "Company," "we," "our" or "us" refers to the operations and financial results of Frederick's of Hollywood Group Inc., together with FOH Holdings, Inc. and its subsidiaries on a consolidated basis after the closing of the merger.

Overview
As a merged company, we conduct our business through two operating divisions, which represent two distinct business reporting segments: the multi-channel retail division and the wholesale division. We believe this method of segment reporting reflects both the way our business segments are managed and the way each segment's performance is

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evaluated. The retail segment includes our Frederick's of Hollywood retail stores, catalog and e-commerce website operations. The wholesale segment includes our wholesale operations in the United States and Canada.
Through our multi-channel retail division, we sell women's intimate apparel and related products under our proprietary Frederick's of Hollywood® brand exclusively through our mall-based specialty retail stores in the United States, which we refer to as "Stores," and through our catalog and website at www.fredericks.com, which we refer to collectively as "Direct." As of October 25, 2008, we operated 134 Frederick's of Hollywood stores nationwide.
Through our wholesale division, we 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.
Financial information about the retail segment for the three months ended October 25, 2008 and October 27, 2007 and about the wholesale segment for the three months ended October 25, 2008 is included in the consolidated financial statements contained herein.
Fiscal 2009 Initiatives
Throughout fiscal year 2008, we operated under challenging macroeconomic conditions, which have had a negative impact on our revenues, gross margins and earnings. These conditions 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. Since the consummation of the merger, other than store personnel, we have terminated approximately 15% of our domestic employees and have transitioned certain manufacturing support functions previously performed by some of these employees to our facility in the Philippines. This net reduction in workforce has resulted in an annualized net salary savings of approximately $3.8 million.

• Consolidating Functions. During fiscal year 2008, the wholesale division accounted for approximately 6% of the dollar value of our retail division's merchandise purchases. We will continue to vertically integrate our retail and wholesale operations when complementary 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 manufacturing facility in the Philippines.

• Continuing to reduce catalog circulation. As a result of rising paper, production and mailing 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. Through improved analysis and monitoring of our customer base, we are continuing to reduce catalog circulation by targeting a more defined customer. Accordingly, we expect to further reduce catalog circulation by approximately 3% in fiscal year 2009. We are also 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 to a new web platform during fiscal year 2008, 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

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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 when the leases expire. 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 our audited consolidated financial statements and accompanying notes for the year ended July 26, 2008 included in our Annual Report on Form 10-K filed with the SEC on October 24, 2008. Management has identified certain critical accounting policies that are described below.
Our 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;

• estimation of the net deferred income tax asset valuation allowance; and

• estimation of deferred catalog costs and the amount of future benefit to be derived from the catalogs.

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 October 25, 2008 and July 26, 2008, accounts receivable was net of allowances of $1,054,000 and $979,000, respectively. 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

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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 $1,242,000 at October 25, 2008, and $1,312,000 at July 26, 2008.
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 $2,406,000 and $2,297,000 are included in prepaid expenses and other current assets in the accompanying consolidated balance sheets at October 25, 2008 and July 26, 2008, 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 three months ended October 25, 2008 and October 27, 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. No impairment was recorded for the three months ended October 25, 2008 and October 27, 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 4 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-Q 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.

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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):

                                                                       Three Months Ended
                                                      October 25, 2008(1)                 October 27, 2007
Net sales                                         $    42,565           100.0 %       $  37,187          100.0 %
Cost of goods sold, buying and occupancy               27,887            65.5 %          21,849           58.8 %

Gross profit                                           14,678            34.5 %          15,338           41.2 %
Selling, general and administrative expenses           19,375            45.5 %          18,639           50.1 %

Operating loss                                         (4,697 )         (11.0 )%         (3,301 )         (8.9 )%
Interest expense, net                                     428             1.0 %             626            1.7 %

Loss before income tax provision                       (5,125 )         (12.0 )%         (3,927 )        (10.6 )%
Income tax provision                                       20               - %               -              - %

Net loss                                               (5,145 )         (12.0 )%         (3,927 )        (10.6 )%

Less: Preferred stock dividends                           141                                 -

Net loss available to common shareholders         $    (5,286 )                       $  (3,927 )

(1) Reflects the merged entity. See Note 2 to the consolidated financial statements contained elsewhere in this report.

Net Sales
   Net sales for the three months ended October 25, 2008 increased to
$42,565,000 as compared to $37,187,000 for the three months ended October 27,
2007, and were comprised of retail and wholesale sales as follows (in
thousands):

                                                                Three Months Ended
                                                         October 25,          October 27,          Increase/(decrease)
                                                            2008                 2007                from prior year
Net Sales:
Retail Stores                                           $      21,211        $      24,055        $              (2,844 )
Retail Direct (catalog and internet)                           11,918               13,132                       (1,214 )

Total Retail                                                   33,129               37,187                       (4,058 )
Total Wholesale                                                 9,436                    -                        9,436

Total net sales                                         $      42,565        $      37,187        $               5,378

The increase in net sales resulted from the addition of $9,436,000 of net sales from the wholesale division following the consummation of the merger. This increase was partially offset by a decrease in retail net sales of $4,058,000 to $33,129,000 for the three months ended October 25, 2008 from $37,187,000 for the three months ended October 27, 2007. This decrease was primarily due to a decrease in consumer spending resulting from the challenging macroeconomic environment. In addition:
• Total store sales decreased by $2,844,000 or 11.8% for the three months ended October 25, 2008 compared to the three months ended October 27, 2007.

• Comparable store sales decreased by $2,859,000 or 12.7% for the three months ended October 25, 2008 compared to the three months ended October 27, 2007. Comparable store sales are defined as net sales for stores that have been open for one complete year.

• Direct sales, which are comprised of sales from our catalog and website operations, decreased by $1,214,000 or 9.2% for the three months ended October 25, 2008 compared to the three months ended

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October 27, 2007. In the prior year, sales were negatively impacted by an unsuccessful transition to a new web platform.

The wholesale division's net sales by customer for the three months ended October 25, 2008, which are included in total net sales, and for the three months ended October 27, 2007, which are not included in total net sales and are provided for comparative purposes only, were as follows ($ in thousands):

                                     Three months ended          Three months ended
                Customer              October 25, 2008            October 27, 2007
        Walmart                    $    1,494         15.9 %   $     7,786        50.8 %
        All other U.S. customers        7,344         77.8 %         7,271        47.4 %

        Total U.S. customers            8,838         93.7 %        15,057        98.2 %
        Canada                            598          6.3 %           283         1.8 %

        Total                      $    9,436        100.0 %   $    15,340       100.0 %

(1) Information provided for comparative purposes only.

The wholesale division's backlog of open orders by customer as of October 25, 2008 and October 27, 2007 was as follows ($ in thousands):

                Customer             October 25, 2008          October 27, 2007(1)
        Walmart                    $   8,228        42.1 %   $    23,099         67.3 %
        All other U.S. customers      11,012        56.4 %        10,849         31.6 %

        Total U.S.                    19,240        98.5 %        33,948         98.9 %
        Canada                           302         1.5 %           357          1.1 %

        Total                      $  19,542       100.0 %   $    34,305        100.0 %

The backlog of orders was $19,542,000 as of October 25, 2008 and $34,305,000 as of October 27, 2007. Orders are booked upon receipt. Our open order position with Walmart as of October 25, 2008 was $8,228,000 as compared to $23,099,000 at October 27, 2007. This reduction is the result of Walmart shifting its focus to product categories that differ from the main product categories that we historically have presented to Walmart and that Walmart historically has purchased from us. We are working closely with Walmart to develop new products to accommodate these business changes and appeal to their customers. Gross Profit
The gross margin (gross profit as a percentage of net sales) for the three months ended October 25, 2008 was 34.5% as compared to 41.2% for the three months ended October 27, 2007. The decrease was partially due to the lower gross margin for the wholesale division, which was approximately 27.9% for the three months ended October 25, 2008. For comparative purposes only, the gross margin for the wholesale division for the three months ended October 27, 2007 was 28.0%. The gross margin for the retail division also decreased for three months . . .