UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 1, 2006
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

LINENS HOLDING CO.
LINENS ‘N THINGS, INC.
LINENS ‘N THINGS CENTER, INC.
(Exact names of registrants as specified in their charters)

 

6 Brighton Road, Clifton, New Jersey 07015
(Address of principal executive offices) (Zip Code)

(973) 778-1300
(Registrants’ telephone number, including area code)

Indicate by check mark whether the registrants (1) have 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) have been subject to such filing requirements for the past 90 days:

Yes  o   No  þ

Indicate by check mark whether the registrants are large accelerated filers, accelerated filers, or non-accelerated filers. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o     Accelerated Filer o     Non-accelerated filer þ

Indicate by check mark whether the registrants are a shell company (as defined in Rule 12b-2 of the Act):

Yes  o   No  þ

As of July 31, 2006, there were 13,043,000 shares of Linens Holding Co. common stock, $0.01 par value, outstanding, 1,000 shares of Linens ‘n Things, Inc. common stock, $0.01 par value, outstanding and 100 shares of Linens ‘n Things Center, Inc., common stock, no par value, outstanding.

INDEX

				Page No.
Explanatory Note and Forward-Looking Statements				3
Part I.		Financial Information
Item 1.		Financial Statements
		Condensed Consolidated Statements of Operations (Unaudited) for the Thirteen Weeks Ended July 1, 2006 (Successor Entity) and July 2, 2005 (Predecessor Entity)		4
		Condensed Consolidated Statements of Operations (Unaudited) for the period February 14 to July 1, 2006 (Successor Entity); the period January 1 to February 13, 2006 (Predecessor Entity); and the Twenty-Six Weeks Ended July 2, 2005 (Predecessor Entity)		5
		Condensed Consolidated Balance Sheets (Unaudited) as of July 1, 2006 (Successor Entity); December 31, 2005 (Predecessor Entity); and July 2, 2005 (Predecessor Entity)		6
		Condensed Consolidated Statements of Cash Flows (Unaudited) for the period February 14 to July 1, 2006 (Successor Entity); the period January 1 to February 13, 2006 (Predecessor Entity); and the Twenty-Six Weeks Ended July 2, 2005 (Predecessor Entity)		7
		Notes to Condensed Consolidated Financial Statements (Unaudited)		8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operation		35
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		45
Item 4.		Controls and Procedures		45
Part II.		Other Information
Item 1.		Legal Proceedings		47
Item 1A.		Risk Factors		47
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		56
Item 6.		Exhibits		56
		Signatures		57

 

2

EXPLANATORY NOTE

On November 7, 2005, Linens Merger Sub Co. was formed by affiliates of Apollo Management, L.P., and National Realty & Development Corp. and Silver Point Capital Fund Investments LLC (collectively, the “Sponsors”) to serve as a holding company.  On February 14, 2006, Linens Merger Sub Co. merged with and into Linens ‘n Things, Inc. in the merger described in Note 1 to the Condensed Consolidated Financial Statements included in this report (the “Merger”), and Linens ‘n Things, Inc., as the surviving corporation, became a wholly-owned subsidiary of Linens Holding Co. (the “Company”).  The merger was financed in part by the issuance of $650 million aggregate principal amount of Senior Secured Floating Rate Notes (the “Notes”) due 2014 of Linens ‘n Things, Inc. and Linens ‘n Things Center, Inc., a wholly owned subsidiary of Linens ‘n Things, Inc.  The Notes are guaranteed by the Company and each of its domestic subsidiaries (other than Linens ‘n Things, Inc. and Linens ‘n Things Center, Inc.).  This report also contains the condensed consolidated financial statements of the Company’s predecessor entity, Linens ‘n Things, Inc. and Subsidiaries, as of July 2, 2005 and December 31, 2005, and for the thirteen and twenty-six weeks ended July 2, 2005 and the period January 1 to February 13, 2006.  The accompanying Condensed Consolidated Financial Statements are those of Linens Holding Co. and its subsidiaries.  The Company has not presented separate financial statements for Linens ‘n Things, Inc. and its subsidiaries or Linens ‘n Things Center, Inc. and its subsidiaries (collectively, the issuers as described in Note 14) because management has determined that the differences in such financial statements are minor.  Unless the context requires otherwise, “we,” “us,” “our,” or the “Company” refer to Linens Holding Co. and its subsidiaries and, for periods prior to February 14, 2006, our predecessor and its subsidiaries.

FORWARD-LOOKING STATEMENTS

This report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) with respect to our financial condition, results of operations and business that is not historical information.  All statements, other than statements of historical fact, included in this report are forward-looking statements.  In particular, statements that the Company makes relating to its overall volume trends, industry forces, margin trends, anticipated capital expenditures and its strategies are forward-looking statements.  When used in this document, the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “plan,” and similar expressions, as well as future or conditional verbs such as “will,” “should,” “would” and “could,” are intended to identify forward-looking statements.

These statements are based on assumptions and assessments made by the Company’s management in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes to be appropriate.  The Company believes there is a reasonable basis for our expectations and beliefs, but they are inherently uncertain, we may not realize our expectations and our beliefs may not prove correct.  Any forward-looking statements are not guarantees of the Company’s future performance and are subject to risks and uncertainties that could cause actual results, developments and business decisions to differ materially from those described or implied by any such forward-looking statements.  The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Such factors include, without limitation: general economic conditions; changes in the retailing environment and consumer spending habits; inclement weather and natural disasters; competition from existing and potential competitors; the amount of merchandise markdowns; loss or retirement of key members of management; increases in the costs of borrowings and unavailability of additional debt or equity capital; impact of our substantial indebtedness on our operating income and our ability to grow; the cost of labor; labor disputes; increased healthcare benefit costs; other costs and expenses; and other important factors that could cause actual results to differ materially from those described or implied by the forward-looking statements contained in this report.  See Item 1A, “Risk Factors,” included in Part II of this report.

3

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PART I — FINANCIAL INFORMATION

Item 1.                          Financial Statements

LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands) (Unaudited)

		Thirteen Weeks Ended
		July 1, 2006			July 2, 2005
		(Successor Entity)			(Predecessor Entity)
Net sales		$	611,583		$	573,317
Cost of sales, including buying and distribution costs		373,265			336,374
Gross profit		238,318			236,943
Selling, general and administrative expenses		280,287			245,702
Operating loss		(41,969		)	(8,759		)
Interest income		(33		)	(129		)
Interest expense		21,845			867
Interest expense, net		21,812			738
Loss before benefit for income taxes		(63,781		)	(9,497		)
Benefit for income taxes		(24,654		)	(3,565		)
Net loss		$	(39,127	)	$	(5,932	)

 

See accompanying Notes to Condensed Consolidated Financial Statements

4

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands) (Unaudited)

		February 14 to July 1, 2006			January 1 to February 13, 2006			Twenty-Six Weeks Ended July 2, 2005
		(Successor Entity)			(Predecessor Entity)			(Predecessor Entity)
Net sales		$	919,428		$	284,971		$	1,144,263
Cost of sales, including buying and distribution costs		562,333			180,675			670,927
Gross profit		357,095			104,296			473,336
Selling, general and administrative expenses		418,048			174,138			487,856
Operating loss		(60,953		)	(69,842		)	(14,520		)
Interest income		(119		)	(668		)	(624		)
Interest expense		31,832			—			2,085
Interest expense (income), net		31,713			(668		)	1,461
Loss before benefit for income taxes		(92,666		)	(69,174		)	(15,981		)
Benefit for income taxes		(35,967		)	(21,270		)	(5,975		)
Net loss		$	(56,699	)	$	(47,904	)	$	(10,006	)

 

See accompanying Notes to Condensed Consolidated Financial Statements

5

 

LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)(Unaudited)

 

		Successor Entity			Predecessor Entity
		July 1, 2006			December 31, 2005			July 2, 2005
Assets
Current assets:
Cash and cash equivalents		$	13,494		$	158,158		$	22,193
Accounts receivable		39,695			43,561			34,250
Inventories		854,823			787,283			799,077
Prepaid expenses and other current assets		74,658			17,425			38,890
Current deferred taxes		5,599			2,033			1,620
Total current assets		988,269			1,008,460			896,030
Property and equipment, net of accumulated depreciation of $44,147, $464,496 and $424,928 at July 1, 2006, December 31, 2005 and July 2, 2005, respectively		590,781			612,247			586,743
Identifiable intangible assets, net		157,887			1,301			1,391
Goodwill		277,315			18,126			18,126
Deferred financing cost and other noncurrent assets, net		35,364			10,700			11,621
Total assets		$	2,049,616		$	1,650,834		$	1,513,911
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	235,805		$	267,582		$	244,842
Accrued expenses and other current liabilities		179,492			199,024			137,566
Current deferred taxes		—			4,401			—
Short-term borrowings		155,070			—			—
Total current liabilities		570,367			471,007			382,408
Senior secured notes and other long-term debt, net of current portion		652,044			2,076			2,108
Deferred income taxes and other long-term liabilities		231,854			327,888			328,806
Total liabilities		1,454,265			800,971			713,322
Shareholders’ equity:
Preferred stock of Predecessor Entity, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding		—			—			—
Common stock of Predecessor Entity, $0.01 par value; 135,000,000 shares authorized; 45,653,954 shares issued and 45,389,975 shares outstanding at December 31, 2005; and 45,540,958 shares issued and 45,283,393 shares outstanding at July 2, 2005		—			457			455
Common stock of Successor Entity, $0.01 par value; 15,000,000 shares authorized; 13,043,000 shares issued and outstanding at July 1, 2006		130			—			—
Additional paid-in capital		649,966			376,730			374,538
Retained (deficit) earnings		(56,699		)	476,896			430,908
Accumulated other comprehensive income		1,954			3,287			2,047
Treasury stock of Predecessor Entity, at cost; 263,979 shares at December 31, 2005; and 257,565 shares at July 2, 2005		—			(7,507		)	(7,359		)
Total shareholders’ equity		595,351			849,863			800,589
Total liabilities and shareholders’ equity		$	2,049,616		$	1,650,834		$	1,513,911

 

See accompanying Notes to Condensed Consolidated Financial Statements

6

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) (Unaudited)

 

		Successor Entity			Predecessor Entity
		February 14 to July 1, 2006			January 1 to February 13, 2006			Twenty-Six Weeks Ended July 2, 2005
Cash flows from operating activities:
Net loss		$	(56,699	)	$	(47,904	)	$	(10,006	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		46,816			12,642			43,675
Deferred income taxes		(22,424		)	(6,646		)	(3,105		)
Share-based compensation		2,328			12,484			489
Loss on disposal of assets		73			—			339
Changes in assets and liabilities, net of effect of acquisition:
Decrease (increase) in accounts receivable		6,231			(2,240		)	(8,533		)
Increase in inventories		(33,433		)	(31,886		)	(85,260		)
Increase in prepaid expenses and other current assets		(45,410		)	(12,153		)	(46		)
Decrease (increase) in identifiable intangible assets, net, goodwill, deferred financing cost and other noncurrent assets, net		2,586			9,623			(2,152		)
(Decrease) increase in accounts payable		(39,817		)	7,244			(345		)
Decrease in accrued expenses and other liabilities, net		(12,205		)	(6,310		)	(65,306		)
Net cash used in operating activities		(151,954		)	(65,146		)	(130,250		)
Cash flows from investing activities:
Acquisition of the Company, net of cash acquired(1)		(1,205,502		)	—			—
Additions to property and equipment		(25,222		)	(7,776		)	(52,841		)
Net cash used in investing activities		(1,230,724		)	(7,776		)	(52,841		)
Cash flows from financing activities:
Issuance of common stock to Linens Investors LLC and others		650,150			—			—
Issuance of floating rate notes		650,000			—			—
Financing and direct acquisition costs		(59,254		)	—			—
Issuance of common stock under stock incentive plans		—			—			1,769
Federal tax benefit from common stock issued under stock incentive plans		—			4,298			144
Increase in short-term borrowings		155,070			—			—
Decrease (increase) in treasury stock		—			674			(97		)
Net cash provided by financing activities		1,395,966			4,972			1,816
Effect of exchange rate changes on cash and cash equivalents		206			125			(541		)
Net increase (decrease) in cash and cash equivalents		13,494			(67,825		)	(181,816		)
Cash and cash equivalents at beginning of period		—			158,158			204,009
Cash and cash equivalents at end of period		$	13,494		$	90,333		$	22,193
Cash paid during the year for:
Interest (net of amounts capitalized)(2)		$	14,031		$	135		$	2,000
Income taxes		$	25,500		$	57		$	30,476

(1)          In connection with the Merger, net cash settlements of approximately $20.0 million and $4.4 million for stock options and restricted stock units, respectively, are included in “Acquisition of the Company, net of cash acquired.”

(2)          Excludes $36,653 of deferred financing costs incurred in connection with the Merger.  Such costs are being charged-off to interest expense over the life of the related financing commitments.

See accompanying Notes to Condensed Consolidated Financial Statements

7

 

LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Acquisition of Linens ’n Things, Inc. by Linens Holding Co.

On November 8, 2005, Linens Merger Sub Co. and its parent company, Linens Holding Co. (the “Company”), entered into an Agreement and Plan of Merger with Linens ’n Things, Inc. governing a merger (the “Merger”) pursuant to which each share of common stock of Linens ’n Things, Inc. (other than shares held in treasury or owned by Linens Merger Sub Co., its parent company or any affiliate of Linens Merger Sub Co. and other than shares held by stockholders who properly demanded and perfected appraisal rights) would be converted into the right to receive $28.00 in cash, without interest, for aggregate consideration of approximately $1.3 billion. The Merger was structured as a reverse subsidiary merger, and on February 14, 2006 Linens Merger Sub Co. was merged with and into Linens ’n Things, Inc., with Linens ’n Things, Inc. as the surviving corporation.  As the surviving corporation in the Merger, Linens ’n Things, Inc. assumed by operation of law all of the rights and obligations of Linens Merger Sub Co., including $650 million aggregate principal amount of Senior Secured Floating Rate Notes (the “Notes”) due 2014 of Linens ’n Things, Inc. and Linens ’n Things Center, Inc. (collectively, the “Issuers”) and the related indenture. Linens ’n Things Center, Inc., a direct wholly owned subsidiary of Linens ’n Things, Inc., is a co-issuer of the Notes.

Affiliates of Apollo Management, L.P., National Realty & Development Corp. and Silver Point Capital Fund Investments LLC (the “Sponsors”) collectively contributed approximately $648 million as equity to Linens Merger Sub Co. immediately prior to the Merger.

The Sponsors financed the purchase of Linens ’n Things, Inc. and paid related fees and expenses through the offering of the Notes, the equity investment described above and excess cash on hand at Linens ’n Things, Inc.  Linens ’n Things, Inc. did not draw on its new asset-based revolving credit facility at closing.

These transactions, including the Merger and payment of any costs related to these transactions, are collectively referred to herein as the “Transactions.”  In connection with the Transactions, Linens ’n Things, Inc. incurred significant indebtedness and became highly leveraged.

Immediately following the Merger, Linens ’n Things, Inc. became a wholly owned subsidiary of Linens Holding Co.  Linens Holding Co. is an entity that was formed in connection with the Transactions and has no assets or liabilities other than the shares of Linens Merger Sub Co. and its rights and obligations under and in connection with the merger agreement with Linens ’n Things, Inc. and the equity commitment letters and debt financing commitment letters provided in connection with the Transactions.

The closing of the Merger occurred simultaneously with:

·      the closing of the Note offering;

·      the closing of Linens ’n Things, Inc.’s new $600 million asset-based revolving credit facility;

·      the termination of Linens ’n Things, Inc.’s existing $250 million unsecured revolving credit facility and CAD $40 million unsecured credit facility agreements; and

·      the equity investments described above.

The consummation of the Notes offering was conditioned upon the consummation of the Merger, the closing of Linens ’n Things, Inc.’s new asset-based revolving credit facility and the equity investments described above, all of which were completed on February 14, 2006.

The Notes bear interest at a per annum rate equal to LIBOR plus 5.625%, which is paid every three months on January 15, April 15, July 15 and October 15, commencing April 15, 2006.  The interest rate on the Notes is reset quarterly.  The Notes mature on January 15, 2014.

On July 7, 2006 the Issuers entered into a Zero Cost Interest Rate Collar Hedge to mitigate the interest risk associated with the LIBOR component of the interest rate on the Notes.  The hedge is based on the average LIBOR rate with an upper strike rate at 6.51% and a lower strike rate at 4.45%, payable and reset on the quarterly dates

8

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

stipulated in the Notes with a termination date of January 15, 2008.  Simultaneously, the Issuers purchased a one-year Forward-Starting Cap, with the first reset date to begin on January 11, 2008, based on the average LIBOR rate with a strike rate of 6.51%, payable quarterly on the dates stipulated in the Notes.  The Issuers paid a premium of $700,000 to purchase the Forward-Starting Cap.

The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior basis by the Company and by each of the Company’s direct and indirect subsidiaries (other than the Issuers) that guarantee Linens ’n Things, Inc.’s new asset-based revolving credit facility except for its Canadian subsidiaries (collectively, the “Note Guarantors”).

All obligations under the Notes, and the guarantees of those obligations, are secured, by first-priority liens, subject to permitted liens, on all of the Company’s, the Issuers’ and the Note Guarantors’ equipment, intellectual property rights and related general intangibles and the capital stock of the Issuers and certain of the subsidiaries.

The lien on capital stock may be released under certain circumstances.  As a result of the filing of a registration statement on Form S-4 with the SEC with respect to the Notes, the Issuers and the Note Guarantors became subject to applicable SEC rules with respect to information required to be included in the prospectus in the registration statement.  To the extent that the securities of any Issuer or Guarantor constitute collateral for the Notes and the value of the securities equals or exceeds 20% of the principal amount, or $130.0 million of the Notes, separate financial statements of the Issuer or Guarantor would be required under these SEC rules to be included in the Company’s SEC filings.  The indenture that governs the Notes provides, however, with respect to any direct or indirect subsidiary of Linens ‘n Things, Inc., that the securities of the subsidiary are released from the lien on capital stock on the date that the lien triggers this separate financial statement requirement.  Accordingly, for any subsidiary with securities that equal or exceed the 20% threshold, the lien on the capital stock securing the Notes has been released with respect to those securities.  The lien on the capital stock of Linens ‘n Things, Inc. remains in place.

The Notes and guarantees are also secured by second-priority liens, subject to permitted liens, on all of the Issuers’ and the Note Guarantors’ inventory, accounts receivable, cash, securities and other general intangibles.

If the Issuers sell certain assets or experiences specific kinds of changes in control, the Issuers must offer to repurchase the Notes.  The Issuers may, at their option, redeem the Notes at any time on or after January 15, 2008 at pre-determined prices.  Prior to January 15, 2008, the Issuers may, at their option, redeem up to 35% of the Notes with the proceeds of certain sales of its equity or of its subsidiaries.  Prior to January 15, 2008, the Issuers may, at their option, redeem the Notes at a price equal to 100% of the principal amount of the Notes plus a “make-whole” premium amount which cannot be quantified as it is dependent on factors that are not yet determinable.

Linens ‘n Things, Inc.’s new asset-based revolving credit facility (the “Credit Facility”) provides senior secured financing of up to $600 million, subject to a borrowing base.  The borrowing base is a formula based on certain eligible inventory and receivables, minus certain reserves.  A portion of the Credit Facility, not to exceed $40 million, is also available to Linens ’n Things Canada Corp. subject to the Canadian borrowing base.  The Credit Facility requires the Company to comply with financial ratio maintenance covenants if the excess availability under the Credit Facility, at any time, does not exceed $75 million and also contains certain customary affirmative covenants and events of default.  The principal amount outstanding of the loans under the Credit Facility, plus interest accrued and unpaid thereon, will be due and payable in full at maturity, five years from February 14, 2006, the date of closing of the Transactions.

All obligations under the Credit Facility are unconditionally guaranteed by the Company and certain of its existing and future domestic subsidiaries.  All obligations under the Credit Facility, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the assets of the borrowers, consisting of Linens ‘n Things, Inc., Linens ‘n Things Center, Inc. and Linens ‘n Things Canada Corp. (collectively, the “Borrowers”), and the subsidiary guarantors, including: (i) a first-priority security interest in inventory, accounts receivable, cash, securities and other general intangibles; and (ii) a second-priority security interest in equipment, intellectual property rights and related general intangibles and all of the capital stock of Linens ‘n Things, Inc. and the capital stock of certain subsidiaries.

Borrowings under the Credit Facility bear interest at a rate equal to, at the Borrowers’ option, either (a) an alternate base rate determined by reference to the higher of (1) the base rate in effect on such day and (2) the federal funds effective rate plus 0.50% or (b) a LIBOR rate, with respect to any Eurodollar borrowing, determined by reference to

9

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, in each case plus an applicable margin.  The initial applicable margin for borrowings under the Credit Facility is 0% with respect to alternate base rate borrowings and 1.50% with respect to LIBOR borrowings.  After the delivery of the financial statements for the first full fiscal quarter after the closing date, the applicable margin for borrowings under the Credit Facility will be subject to adjustment based on the excess availability under the Credit Facility.  In addition to paying interest on outstanding principal under the Credit Facility, the Borrowers are required to pay a commitment fee, initially 0.375% per annum, in respect of the unutilized commitments thereunder.  After the delivery of financial statements for the first full fiscal quarter after the closing date, the commitment fee will be subject to adjustment based on the excess availability under the Credit Facility.  The Borrowers must also pay customary letter of credit fees and agency fees.  The Borrowers initiated borrowings under its Credit Facility on February 23, 2006 to meet its operational working capital needs.

As a result of the Merger, all of Linens ’n Things, Inc.’s issued and outstanding capital stock was acquired by Linens Holding Co.  At such time, investment funds associated with or designated by the Sponsors acquired approximately 99.7% of the common stock of Linens Holding Co. through an investment vehicle controlled by Apollo Management V, L.P., or one of its affiliates, and Robert J. DiNicola, the new Chairman and Chief Executive Officer of Linens ’n Things, Inc., acquired the remaining 0.3% at the same price paid by the sponsors.

Upon consummation of the Transactions, Linens ’n Things, Inc. delisted its shares of common stock from the New York Stock Exchange (the “NYSE”) and deregistered under Section 12 of the Securities Exchange Act of 1934.  The last day of trading on the NYSE was February 14, 2006.

Total fees and expenses related to the Transactions were approximately $107 million, consisting of approximately $48 million of pre-merger transaction cost incurred by the Company’s predecessor entity, Linens ‘n Things, Inc., $23 million of direct acquisition costs of the Company and $36 million of deferred financing costs.  Such fees include commitment, placement, financial advisory and other transaction fees as well as legal, accounting and other professional fees.  The direct acquisition costs were included in the purchase price and is a component of goodwill.  Deferred financing costs of approximately $11 million relates to the asset-based revolving credit facility, which are amortized over five years on a straight-line basis, and $25 million relates to the Notes, which are amortized over eight years using the effective interest method.

The acquisition of Linens ’n Things, Inc. is being accounted for as a business combination using the purchase method of accounting, whereby the purchase price (including liabilities assumed) was allocated to the assets acquired based on their estimated fair market values at the date of acquisition.  Independent third-party appraisers were engaged to assist management and perform valuations of certain of the tangible and intangible assets acquired.

The Company has allocated the purchase price based on the appraisal associated with the valuation of certain assets and liabilities.  The Company does not believe that the appraisal or its estimate of certain contingencies will materially modify the preliminary purchase price allocation.

As a result of the consummation of the Transactions, a new entity (“successor entity”) was formed with an effective date of February 14, 2006, consisting of Linens Holding Co. and Subsidiaries.  The condensed consolidated financial statements for the successor entity as of July 1, 2006, and for the 13-week period ended July 1, 2006 and for the period February 14 to July 1, 2006 show the operations of the successor entity, Linens Holding Co. and Subsidiaries.  The condensed consolidated financial statements presented as of July 2, 2005 and December 31, 2005, and for the thirteen-week and twenty-six-week periods ended July 2, 2005 and for the period January 1 to February 13, 2006 are shown under the “predecessor entity” caption, consisting of Linens ’n Things, Inc. and Subsidiaries.

As a result of the consummation of the Transactions, the condensed consolidated financial statements for the period after February 13, 2006 are presented on a different basis than that for the periods before February 14, 2006 as a result of the application of purchase accounting as of February 14, 2006 and therefore are not comparable.

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

A reconciliation of the preliminary purchase price adjustments recorded in connection with the Transactions is presented below (in thousands):

		Predecessor Entity						Successor Entity
		February 13, 2006			Transaction Adjustments			February 14, 2006
Assets
Current assets:
Cash and cash equivalents		$	90,333		$	(15,701	)	$	74,632
Accounts receivable		45,833			—			45,833
Inventories		819,600			—			819,600
Prepaid expenses and other current assets		29,499			—			29,499
Current deferred taxes		132			—			132
Total current assets		985,397			(15,701		)	969,696
Property and equipment, net		607,787			(57		)	607,730
Identifiable intangible assets, net		1,276			159,742			161,018
Goodwill		18,126			259,309			277,435
Deferred financing cost and other noncurrent assets, net		1,079			36,172			37,251
Total assets		$	1,613,665		$	439,465		$	2,053,130
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	274,997		$	—		$	274,997
Accrued expenses and other current liabilities		195,467			39,388		(1)	234,855
Current deferred taxes		8,176			—			8,176
Total current liabilities		478,640			39,388			518,028
Senior secured notes and other long-term debt, net of current portion		2,068			650,000			652,068
Deferred income taxes and other long-term liabilities		312,549			(77,128		)(2)	235,421
Total liabilities		793,257			612,260			1,405,517
Shareholders’ equity		820,408			(172,795		)	647,613
Total liabilities and shareholders’ equity		$	1,613,665		$	439,465		$	2,053,130

(1)          Represents an accrual for unpaid transaction expenses.

(2)          Consists of the following purchase accounting adjustments:

Unfavorable leases		$	20,000
Deferred rents		(250,020		)
Deferred income taxes		152,892
		$	(77,128	)

 

As presented in the above table, the Company’s assets and liabilities were adjusted to fair value as of the closing date of the Transactions, and the excess of the total purchase price over the fair value of the Company’s net assets was allocated to goodwill.  The following table presents an analysis of the change in goodwill.

(1)            The predecessor entity goodwill has been written-off in purchase accounting.

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

The unaudited pro forma results of operations provided below for the twenty-six weeks ended July 1, 2006 and July 2, 2005 are presented as though the Transactions had occurred at the beginning of the periods presented, after giving effect to purchase accounting adjustments relating to depreciation and amortization of the revalued assets, interest expense associated with the Notes and the Credit Facility and other acquisition-related adjustments in connection with the Transactions.  The pro forma results of operations are not necessarily indicative of the combined results that would have occurred had the Transactions been consummated at the beginning of the periods presented, nor are they necessarily indicative of future operating results.

		Thirteen Weeks Ended						Twenty-Six Weeks Ended
		July 1, 2006			July 2, 2005			July 1, 2006			July 2, 2005
(In Thousands)
Net sales		$	611,583		$	573,317		$	1,204,399		$	1,144,263
Loss before benefit for income taxes		$	(63,781	)	$	(41,660	)	$	(133,177	)	$	(79,225	)
Net loss		$	(39,127	)	$	(25,648	)	$	(81,029	)	$	(48,775	)

 

2. Basis of Presentation

The accompanying Condensed Consolidated Financial Statements are unaudited.  In the opinion of management, the accompanying Condensed Consolidated Financial Statements contain all adjustments to present fairly the financial position of successor entity Linens Holding Co. and Subsidiaries and predecessor entity Linens ’n Things, Inc. and Subsidiaries, as of July 1, 2006 and July 2, 2005 and the results of operations for the respective periods then ended and cash flows for the respective periods then ended as presented in the unaudited statements.  The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Because of the seasonality of the specialty retailing business, operating results of the Company on a quarterly or interim basis may not be indicative of operating results for the full year.

These Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements for the fiscal year ended December 31, 2005 included in the Company’s predecessor entity’s Annual Report on Form 10-K Equivalent for Linens ’n Things, Inc. posted on the Linens ’n Things, Inc. website on March 21, 2006 under “Noteholder Information.”  All significant intercompany accounts and transactions have been eliminated.

Certain prior period amounts have been reclassified to conform with the current period’s presentation.

The accompanying Condensed Consolidated Financial Statements are those of Linens Holding Co. and its subsidiaries.  The Company has not presented separate financial statements for Linens ‘n Things, Inc. and its subsidiaries or Linens ‘n Things Center, Inc. and its subsidiaries (collectively, the issuers as described in Note 14) because management has determined that the differences in such financial statements are minor.

3. Stock-based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123 (Revised 2004)”), requiring the recognition of compensation cost for all equity classified awards granted, modified or settled after the effective date and for the unvested portion of awards outstanding as of the effective date using the fair-value measurement method.  SFAS No. 123 (Revised 2004) revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”

The Company recognizes the cost of all time-based employee stock options on a straight-line attribution basis and the cost of all performance-based employee stock options on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans” over their respective vesting periods, net of estimated forfeitures.  The Company has selected the modified prospective method of transition; accordingly, prior periods have not been restated.  Prior to

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

adopting SFAS No. 123 (Revised 2004), the Company applied the recognition and measurement principles of APB Opinion No. 25 and related interpretations.  All employee stock options were granted at or above the grant date market price.  Accordingly, the Company did not recognize compensation expense for stock option grants.  Restricted stock units granted at fair market value at the date of grant are amortized over specified vesting periods in the accompanying Condensed Consolidated Financial Statements.

Share-based Compensation Plans—Predecessor Entity

Prior to the completion of the Merger, the Company granted stock options and restricted stock units for a fixed number of shares to employees and directors under share-based compensation plans.  The exercise prices of the stock options were equal to the fair market value of the underlying shares at the date of grant.  Compensation expense for restricted stock awards was measured at fair value on the date of grant based on the number of shares granted and the quoted market price of the Company’s common stock.  Such value was recognized as expense over the vesting period of the award adjusted for actual forfeitures.

Upon completion of the Merger and in accordance with the terms of the stock plans, all of the outstanding stock options became fully vested and immediately exercisable.  Each option was exercised, equal to the excess of $28.00 over the underlying stock option exercise price, less applicable withholding taxes.  Each restricted stock unit award was exercised at $28.00 in cash, without interest, less applicable withholding taxes.

The following is a summary of activity under the stock option plans that were in effect upon adoption of SFAS 123 (Revised 2004) through the effective date of the Merger, when all of the stock options and restricted stock units were exercised:

		Predecessor Entity
Plan		Outstanding at January 1, 2006			Exercised			Outstanding at February 14, 2006
Stock options
1996 Plan		1,151,673			1,151,673			—
Directors’ Plan		48,800			48,800			—
2000 Plan		1,463,796			1,463,796			—
Broad-based Equity Plan		1,470,638			1,470,638			—
2004 Plan		1,246,690			1,246,690			—
New Hire Authorization		450,000			450,000			—
Total options outstanding		5,831,597			5,831,597			—
Weighted average exercise price per option		$	25.20		$	25.20		—
Weighted average remaining contractual term per option		4.6 years						—
Options exercisable at period end:
Number of options								—
Weighted average exercise price								—
Weighted average remaining contractual term								—
Restricted stock units
2000 Plan		7,500			7,500
Broad-based Equity Plan		9,850			9,850			—
2004 Plan		118,066			118,066			—
New Hire Authorization		20,000			20,000			—
Total units outstanding		155,416			155,416			—
Weighted average fair market value per unit at date of award		$	25.71		$	25.71		—
Weighted average remaining contractual term for restrictions		2.9 years

 

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

The 2004 Stock Award and Incentive Plan (the “2004 Plan”) provided for the granting of options, restricted stock unit grants and other stock-based awards (collectively, “awards”) to key employees and non-employee directors.  The 2004 Plan replaced both the Company’s 2000 Stock Award and Incentive Plan (the “2000 Plan”) and the Broad-Based Equity Plan.  The 2000 Plan replaced both the Company’s 1996 Incentive Compensation Plan (the “1996 Plan”) and the 1996 Non-Employee Directors’ Stock Plan (the “Directors’ Plan”).  Therefore, no future awards were made under the 2000 Plan, the Broad-Based Equity Plan, the 1996 Plan or the Directors’ Plan (collectively, the “Prior Plans”), although outstanding awards under the Prior Plans continued to be in effect.  The New Hire Authorization provided for the granting of awards as an inducement to a person being retained for employment by the Company.

Under the 2004 Plan, an aggregate of 4,000,000 shares (plus any shares under outstanding awards under the Prior Plans which become available for further grants) was authorized for issuance of awards.  Under the New Hire Authorization, an aggregate of 500,000 shares was authorized.

Stock options under the 2004 Plan and the New Hire Authorization were granted with exercise prices at the fair market value of the underlying shares at the date of grant.  The right to exercise options generally commenced one to five years after the grant date, and the options expired between five to ten years after the grant date. Restrictions on restricted stock unit grants lapsed over vesting periods of up to five years.

There were no share-based grants during the period January 1, 2006 to February 14, 2006 (predecessor entity).  The weighted-average grant date fair value of options and restricted stock units granted during the thirteen weeks ended July 2, 2005 was $9.77 and $24.25, respectively.  The weighted-average grant date fair value of options and restricted stock units granted during the twenty-six weeks ended July 2, 2005 was $9.98 and $24.05, respectively.

The total intrinsic value of each stock option and restricted stock unit exercised due to the Merger was approximately $20.0 million and $4.4 million, respectively, for the period January 1, 2006 to February 14, 2006 (predecessor entity).  The total intrinsic value of stock options exercised during the thirteen and twenty-six weeks ended July 2, 2005 was approximately $73,000 and $422,000, respectively.  The total intrinsic value of restricted stock units converted into common stock was approximately $352,000 during both the thirteen and twenty-six weeks ended July 2, 2005.

The following is a summary of the activity for nonvested stock option grants and restricted stock unit awards as of February 14, 2006 and the changes for the period January 1, 2006 to February 14, 2006:

 

		Predecessor Entity
		Stock Options					Restricted Stock Units
		Options		Fair Value(1)			Units		Fair Value(1)
Nonvested at January 1, 2006		1,064,620		$	10.59		155,416		$	25.71
Grants		—		$	—		—		$	—
Vested(2)		(1,060,940	)	$	10.59		(155,416	)	$	25.71
Cancelled		(3,680	)	$	11.12		—		$	—
Nonvested at February 14, 2006		—		$	—		—		$	—

(1)          Represents the weighted-average grant date fair value per share-based unit, using the Black-Scholes option-pricing model for stock options and the average high/low market price of the Company’s common stock for restricted stock units.

(2)          All of the share-based units became immediately vested on the date of the Merger.

The total fair value of stock options and restricted stock units vested during the period from January 1, 2006 to February 14, 2006 (predecessor entity) was approximately $11.2 million and $4.0 million, respectively.  The total fair value of stock options vested during the thirteen-week and twenty-six week periods ended July 2, 2005 was

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

 approximately $0.7 million and $1.1 million, respectively.  The total fair value of restricted stock units vested was approximately $0.4 million during both the thirteen and twenty-six weeks ended July 2, 2005.

As of December 31, 2005, there was approximately $9.3 million and $3.2 million of total unrecognized compensation cost related to stock option grants and restricted stock unit awards, respectively, under the stock-based compensation plans.  The consummation of the Merger accelerated the recognition of compensation cost, and, accordingly, all of this cost was included in selling, general and administrative expense in the Condensed Consolidated Statements of Operations in the period from January 1, 2006 to February 13, 2006 (predecessor entity).

The compensation cost that has been charged against income for restricted stock unit grants was approximately $0.3 million and $0.5 million for the thirteen weeks and twenty-six weeks ended July 2, 2005.  No compensation cost was recognized for stock option grants for the thirteen weeks and twenty-six weeks ended July 2, 2005.

Share-based Compensation Plans—Successor Entity

On February 14, 2006, the board of directors (the “Board”) and stockholders of Linens Holding Co. adopted the Linens Holding Co. Stock Option Plan (the “Plan”). The Plan provides employees or directors of the Company or its subsidiaries who are in a position to contribute to the long-term success of these entities, with options to acquire shares in the Company to aid in attracting, retaining and motivating persons of outstanding ability.  The Plan was amended in March 2006 to increase the number of shares of common stock, par value $0.01 per share, of Linens Holding (the “Common Stock”) available for issuance under the Plan to 1,157,298 shares.

As of July 1, 2006, 805,446 stock options were outstanding as detailed below:

 

		Number of Stock Options Granted
Grants under the Linens Holding Co. Stock Option Plan (1)		717,446
Grants approved by the Board and not included in the Plan (2)(3)		43,000
Grants not included in the Plan to members of the Board in accordance with the Director Compensation Policy (4)		45,000
		805,446

(1)          The stock options granted under the Plan to each optionee are equally divided between a “Time Option” and a “Performance Option,” as those terms are defined in the standard form of option grant letter.  The stock options have an exercise price of $50.00 per share, the estimated fair market value of the underlying shares at the date of grant, and expire seven years after the date of grant.  Time Options become vested and exercisable in four equal installments on either (1) each of February 14, 2007, February 14, 2008, February 14, 2009, and February 14, 2010 with respect to 697,446 options initially granted March 27, 2006 or (2) on each of the first four anniversaries of the date of grant.  With respect to Performance Options and as provided for and defined in the standard form of grant letter, the stock options become vested and exercisable in two equal installments from a measurement date if, on such measurement date, the value per share equals or exceeds a target stock price.

(2)          On March 23, 2006, the Board approved a grant to Robert J. DiNicola, the Chairman and Chief Executive Officer of Linens ‘n Things, Inc., of a non-qualified stock option to purchase 40,000 shares of Common Stock outside of the Plan.  These stock options also have an exercise price of $50.00 per share and are fully vested and immediately exercisable on the date of grant.

(3)          On May 11, 2006, the Board approved a grant to F. David Coder, the Executive Vice President Store Operations of Linens ‘n Things, Inc., of a non-qualified stock option to purchase 3,000 shares of Common Stock outside of the Plan.  These stock options also have an exercise price of $50.00 per share and are fully vested and immediately exercisable on the date of grant.

(4)          On June 13, 2006, the Board adopted a policy for director compensation (the “Director Compensation Policy”) with retroactive effect to April 1, 2006.  Pursuant to the Director Compensation Policy, the Board Chairman and each non-employee director, upon first election or appointment to the Board, will receive a grant of non-qualified stock options to purchase a minimum of 5,000 shares of Common Stock outside of the Plan.  In accordance with the Director Compensation Policy, the Board also approved a grant of a non-qualified stock option to purchase 5,000 shares of Common Stock to each of eight Board members appointed to the Board in March 2006.  These stock options have an exercise price of $50.00 per share and are fully vested and immediately exercisable on the date of grant.  On June 15, 2006 an additional grant of a non-qualified stock option to purchase 5,000 shares of Common Stock was approved upon the appointment of the Company’s ninth and final Board member.  These stock options have an exercise price of $50.00 per share and are fully vested and immediately exercisable on the date of grant.

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

The following is a summary of share-based option activity for the period February 14, 2006 to July 1, 2006:

 

Successor Entity
				Weighted			Weighted Average
				Average			Remaining
				Exercise			Contractual Term
Options		Shares		Price			(years)
Outstanding at February 14, 2006		—		$	—
Options granted		737,446		50.00
Exercised		—		—
Canceled		—		—
Outstanding at April 1, 2006		737,446		$	50.00
Options granted		156,500		50.00
Exercised		—
Canceled		(88,500	)	50.00
Outstanding at July 1, 2006		805,446		$	50.00		6.75
Exercisable at July 1, 2006		88,000		$	50.00		6.75

 

There are no provisions in the Plan for the issuance of restricted stock units.

The weighted-average grant date fair value of options granted during the thirteen week period ended July 1, 2006 was $17.21.  The weighted-average grant date fair value of options granted during the period February 14, 2006 to July 1, 2006 (successor entity) was $17.39.

There were no stock option exercises during the period February 14, 2006 to July 1, 2006 (successor entity).

The following is a summary of the activity for nonvested stock option grants as of July 1, 2006 and the changes for the period February 14, 2006 to July 1, 2006:

 

		Successor Entity Stock Options
		Options		Fair Value(1)
Nonvested at February 14, 2006		—		$	—
Grants		737,446		17.43
Vested		(40,000	)	16.67
Nonvested at April 1, 2006		697,446		$	17.47
Grants		156,500		17.21
Vested		(48,000	)	16.79
Canceled		(88,500	)	17.47
Nonvested at July 1, 2006		717,446		$	17.46

(1)          Represents the weighted-average grant date fair value per option, using the Monte Carlo simulation option-pricing model for Performance Options, and the Black-Scholes option-pricing model for Time Options.

The total fair value of stock options vested during the thirteen-week period ended July 1, 2006 was approximately $0.8 million.  The total fair value of stock options vested during the period February 14, 2006 to July 1, 2006 (successor entity) was approximately $1.5 million.

As of July 1, 2006, there was approximately $11.2 million of total unrecognized compensation cost related to stock option grants both under and outside the Plan.  This cost is expected to be recognized over a remaining weighted-

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

average period of 3.3 years.  The compensation cost that has been charged against income for stock option grants was approximately $1.6 million and $2.3 million for the thirteen weeks ended July 1, 2006 and for the period February 14, 2006 to July 1, 2006 (successor entity), respectively, and was included in selling, general and administrative expense in the Condensed Consolidated Statements of Operations.

Prior to the adoption of SFAS 123 (Revised 2004) the Company used the Black-Scholes option-pricing model for estimating the fair value for all options granted.  Beginning in the first quarter of 2006, the Company, with the assistance of an independent third party, used the Monte Carlo simulation option-pricing model for estimating the fair value of Performance Options and the Black-Scholes option-pricing model for Time Options.  This change was made in order to provide a better estimate of fair value.  The Monte Carlo option-pricing model is particularly useful in the valuation of options with complicated features that make them difficult to value through a straight-forward Black-Scholes-style computation.

Presented below is a comparative summary of valuation assumptions for the indicated periods:

 

		Thirteen Weeks			Thirteen
		Ended			Weeks			February 14 to					Twenty-
		July 1, 2006			Ended			July 1, 2006					Six Weeks
		(Monte Carlo			July 2, 2005			(Monte Carlo			January 1 to		Ended
		Simulation and			(Black-Scholes)			Simulation and			February 13, 2006		July 2, 2005
		Black-Scholes)			(Predecessor			Black-Scholes)			(Black-Scholes)		(Black-Scholes)
Valuation Assumptions:		(Successor Entity)			Entity)			(Successor Entity)			(Predecessor Entity)		(Predecessor Entity)
Weighted-average fair value of options granted		N/A			$	9.77		N/A			No Grants		$	9.98
Weighted-average calculated value of options granted		$	17.21		N/A			$	17.39		No Grants		N/A
Expected volatility		N/A		(1)	39.7		%	N/A		(1)	No Grants		40.0		%
Weighted-average volatility		36.8%		(1)	39.7		%	38.0%		(1)	No Grants		40.0		%
Weighted-average expected term (in years)		3.7			5.0			3.7			No Grants		5.0
Dividend yield		—			—			—			No Grants		—
Weighted-average risk-free interest rate		4.9		%	3.8		%	4.8		%	No Grants		3.9		%
Weighted average expected annual forfeiture		1.4		%	2.6		%	3.9		%	No Grants		2.5		%

(1)          The Company used the average of the historical volatility of each of the component companies included in the Standard & Poors Specialty Retail Index as a substitute for expected volatility.

The Company utilized historical optionee behavioral data to estimate the option exercise and termination rates used in the Black-Scholes option-pricing model prior to the adoption of SFAS 123 (Revised 2004).  The expected term of the options represents the period of time the options were expected to be outstanding based on historical trends.  Expected volatility was based on the historical volatility of the common stock of Linens ‘n Things, Inc. for a period approximating the expected life. The Company has never paid dividends, and, accordingly, the dividend yield is zero.  The risk-free interest rate within the expected term was based on the U.S. Treasury yield curve in effect at the time of grant.

For the period subsequent to the adoption of SFAS 123 (Revised 2004), it is not possible for the Company, a non-public entity, to use Company-specific volatility in determining a reasonable estimate of fair value of options granted.  Accordingly, the Company is required to use an alternative measurement method.  Under the alternative measurement method, a nonpublic entity uses a calculated volatility, determined by applying the historical volatility of an appropriate index of public entities, as an input to the valuation models.  The Company used the Standard & Poors Specialty Retail Index for a period approximating the expected term as this index most closely approximates the Company’s applicable operating industry.  Expected term of share options granted represents the period of time that the option grants are expected to be outstanding.  The Company is not expected to pay dividends, and, accordingly, the dividend yield is zero.  The risk-free interest rate within the expected term was based on the U.S. Treasury yield curve in effect at the time of grant.

17