UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark) One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2006

 

or

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

Commission file numbers:      333-135646-12
001-12381
333-135646-11

 

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 x      No o

 

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 x

 

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

Yes o      No x

 

As of October 31, 2006, there were 13,053,000 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 September 30, 2006 (Successor Entity) and October 1, 2005 (Predecessor Entity)	4
	Condensed Consolidated Statements of Operations (Unaudited) for the period February 14 to September 30, 2006 (Successor Entity); the period January 1 to February 13, 2006 (Predecessor Entity); and the Thirty-nine Weeks Ended October 1, 2005 (Predecessor Entity)	5
	Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2006 (Successor Entity); December 31, 2005 (Predecessor Entity); and October 1, 2005 (Predecessor Entity)	6
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the period February 14 to September 30, 2006 (Successor Entity); the period January 1 to February 13, 2006 (Predecessor Entity); and the Thirty-nine Weeks Ended October 1, 2005 (Predecessor Entity)	7
	Notes to Unaudited Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	51
Item 4.	Controls and Procedures	51
Part II.	Other Information
Item 1.	Legal Proceedings	53
Item 1A.	Risk Factors	53
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53
Item 6.	Exhibits	53
	Signatures	54

 

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 Unaudited 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 October 1, 2005 and December 31, 2005, and for the thirteen and thirty-nine weeks ended October 1, 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 15) 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.

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
		September 30, 2006					October 1, 2005
		(Successor Entity)					(Predecessor Entity)
Net sales		$	658,155				$	629,268
Cost of sales, including buying and distribution costs		388,579					370,953
Gross profit		269,576					258,315
Selling, general and administrative expenses		287,752					255,508
Operating (loss) income		(18,176		)			2,807
Interest income		(18		)			(54		)
Interest expense		23,572					1,216
Interest expense, net		23,554					1,162
(Loss) income before (benefit) provision for income taxes		(41,730		)			1,645
(Benefit) provision for income taxes		(14,355		)			621
Net (loss) income		$	(27,375	)			$	1,024

 

See accompanying Notes to Unaudited 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 September 30,  2006					January 1 to  February 13,  2006			Thirty-nine Weeks Ended October 1, 2005
		(Successor Entity)					(Predecessor Entity)			(Predecessor Entity)
Net sales		$	1,577,583				$	284,971		$	1,773,531
Cost of sales, including buying and distribution costs		951,007					180,675			1,041,880
Gross profit		626,576					104,296			731,651
Selling, general and administrative expenses		705,705					174,138			743,364
Operating loss		(79,129		)			(69,842		)	(11,713		)
Interest income		(137		)			(668		)	(678		)
Interest expense		55,404					—			3,301
Interest expense (income), net		55,267					(668		)	2,623
Loss before benefit for income taxes		(134,396		)			(69,174		)	(14,336		)
Benefit for income taxes		(50,322		)			(21,270		)	(5,354		)
Net loss		$	(84,074	)			$	(47,904	)	$	(8,982	)

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

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LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)(Unaudited)

		Successor Entity					Predecessor Entity
		September 30,  2006					December 31,  2005			October 1,  2005
Assets
Current assets:
Cash and cash equivalents		$	11,394				$	158,158		$	37,608
Accounts receivable		33,886					43,561			50,369
Inventories		999,316					787,283			863,100
Prepaid expenses and other current assets		66,788					17,425			41,587
Current deferred taxes		11,146					2,033			834
Total current assets		1,122,530					1,008,460			993,498
Property and equipment, net of accumulated depreciation of $74,339, $464,496 and $446,362 at September 30, 2006, December 31, 2005 and October 1, 2005, respectively		572,500					612,247			601,261
Identifiable intangible assets, net		155,361					1,301			1,352
Goodwill		277,152					18,126			18,126
Deferred financing cost and other noncurrent assets, net		35,218					10,700			11,799
Total assets		$	2,162,761				$	1,650,834		$	1,626,036
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	331,667				$	267,582		$	279,411
Accrued expenses and other current liabilities		155,136					199,024			167,685
Current deferred taxes		—					4,401			3,917
Short-term borrowings		225,934					—			30,000
Total current liabilities		712,737					471,007			481,013
Senior secured notes and other long-term debt, net of current portion		652,028					2,076			2,094
Noncurrent deferred income taxes		180,862					54,416			65,780
Other long-term liabilities		48,512					273,472			272,697
Total liabilities		1,594,139					800,971			821,584
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 45,628,964 shares issued and 45,369,460 shares outstanding at October 1, 2005		—					457			456
Common stock of Successor Entity, $0.01 par value; 15,000,000 shares authorized; 13,053,000 shares issued and outstanding at September 30, 2006		131					—			—
Additional paid-in capital		651,636					376,730			376,156
Retained (deficit) earnings		(84,074		)			476,896			431,932
Accumulated other comprehensive income		929					3,287			3,300
Treasury stock of Predecessor Entity, at cost; 263,979 shares at December 31, 2005; and 259,504 shares at October 1, 2005		—					(7,507		)	(7,392		)
Total shareholders’ equity		568,622					849,863			804,452
Total liabilities and shareholders’ equity		$	2,162,761				$	1,650,834		$	1,626,036

 

See accompanying Notes to Unaudited 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 September 30, 2006					January 1 to February 13, 2006			Thirty-nine Weeks Ended October 1, 2005
Cash flows from operating activities:
Net loss		$	(84,074	)			$	(47,904	)	$	(8,982	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		80,215					12,642			66,216
Deferred income taxes		(33,546		)			(6,646		)	782
Share-based compensation		3,363					12,484			818
Amortization of deferred financing charges		2,725					43			559
Loss on sale and disposals of property and equipment		416					—			625
Loss on fixed asset impairment writedown		—					—			1,452
Changes in assets and liabilities, net of effect of acquisition:
Decrease (increase) in accounts receivable		12,047					(2,240		)	(24,476		)
Increase in inventories		(177,910		)			(31,886		)	(145,922		)
Increase in prepaid expenses and other current assets		(37,579		)			(12,153		)	(4,204		)
Decrease (increase) in identifiable intangible assets, goodwill, deferred financing cost and other noncurrent assets, net		398					9,580			(2,886		)
Increase in accounts payable		56,077					7,244			32,815
Decrease in accrued expenses and other liabilities, net		(33,878		)			(6,310		)	(28,123		)
Net cash used in operating activities		(211,746		)			(65,146		)	(111,326		)
Cash flows from investing activities:
Acquisition of the Company, net of cash acquired(1)		(1,205,502		)			—			—
Additions to property and equipment		(41,138		)			(7,776		)	(88,994		)
Proceeds from sale of property and equipment		3,100					—			—
Net cash used in investing activities		(1,243,540		)			(7,776		)	(88,994		)
Cash flows from financing activities:
Issuance of common stock to Linens Investors LLC and others		650,650					—			—
Issuance of floating rate notes		650,000					—			—
Financing and direct acquisition costs		(59,254		)			—			—
Premium paid for derivative financial instrument		(700		)			—			—
Issuance of common stock under stock incentive plans							—			3,081
Federal tax benefit from common stock issued under stock incentive plans		—					4,298			447
Increase in short-term borrowings		225,934					—			30,000
Decrease (increase) in treasury stock		—					674			(130		)
Net cash provided by financing activities		1,466,630					4,972			33,398
Effect of exchange rate changes on cash and cash equivalents		50					125			521
Net increase (decrease) in cash and cash equivalents		11,394					(67,825		)	(166,401		)
Cash and cash equivalents at beginning of period		—					158,158			204,009
Cash and cash equivalents at end of period		$	11,394				$	90,333		$	37,608
Cash paid during the year for:
Interest (net of amounts capitalized)(2)		$	35,397				$	135		$	3,249
Income taxes		$	38,629				$	57		$	32,062
Non-cash transaction:
Unrealized loss on hedge arrangements		$	898				$	—		$	—

 

(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 $37,106 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 Unaudited Condensed Consolidated Financial Statement

7

LINENS HOLDING CO. AND SUBSIDIARIES (AND PREDECESSOR)
NOTES TO UNAUDITED 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 agreement (the “Collar Agreement”) to hedge the cash flows associated with the LIBOR component of the interest rate on the Notes.  On July 7, 2006 the Issuers also purchased a one-year forward-starting interest rate cap agreement (the “Cap Agreement”) which takes effect on

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

January 15, 2008 (see Note 12 to the Unaudited Condensed Consolidated Financial Statements for disclosures regarding these derivatives).

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 and effectiveness 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 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 experience 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 the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain

9

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

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 of September 30, 2006 the applicable margin for borrowings under the Credit Facility and the commitment fee in respect of the unutilized commitments thereunder remained at the initial levels established.

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 $108 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 $37 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 credit facility, which are amortized over five years on a straight-line basis, and $26 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 September 30, 2006, and for the 13-week period ended September 30, 2006 and for the period February 14 to September 30, 2006 show the operations of the successor entity, Linens Holding Co. and Subsidiaries.  The condensed consolidated financial statements presented as of October 1, 2005 and December 31, 2005, and for the thirteen-week and thirty-nine-week periods ended October 1, 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 UNAUDITED 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
Noncurrent deferred income taxes		42,094			152,892					194,986
Other long-term liabilities		270,455			(230,020)		(2)			40,435
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		)
		$	(230,020	)

 

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.

(in thousands)		Amount
Balance at October 1, 2005 and December 31, 2005 (predecessor entity)		$	18,126	(1)
Purchase accounting adjustments from preliminary allocation		259,309
Balance at February 14, 2006 (successor entity)		277,435
Pre-existing tax adjustments		(250		)
Pre-existing book adjustments, net		(618		)
Other – foreign currency translation		585
Balance at September 30, 2006 (successor entity)		$	277,152

(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 UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, cont’d

The unaudited pro forma results of operations provided below for the thirteen weeks and thirty-nine weeks ended September 30, 2006 and October 1, 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						Thirty-nine Weeks Ended
(In Thousands)		September 30, 2006			October 1, 2005			September 30, 2006			October 1, 2005
Net sales		$	658,155		$	629,268		$	1,862,554		$	1,773,531
Loss before benefit for income taxes		$	(41,730	)	$	(31,739	)	$	(174,907	)	$	(110,964	)
Net loss		$	(27,375	)	$	(19,861	)	$	(108,404	)	$	(69,432	)

 

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 September 30, 2006 and October 1, 2005 and the results of operations 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 to 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 15) 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 UNAUDITED 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 UNAUDITED 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 October 1, 2005 was $8.12 and $25.73, respectively.  The weighted-average grant date fair value of options and restricted stock units granted during the thirty-nine weeks ended October 1, 2005 was $8.44 and $25.37, 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 thirty-nine weeks ended October 1, 2005 was approximately $0.8 million and $1.2 million, respectively.  The total intrinsic value of restricted stock units converted into common stock during the thirteen and thirty-nine weeks ended October 1, 2005 was approximately $6,000 and $358,000, respectively.

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 and thirty-nine weeks ended October 1, 2005 was approximately $0.4 million and $1.5 million, respectively.  The total fair value of restricted stock units vested during the thirteen and thirty-nine weeks ended October 1, 2005 was approximately $6,000 and $358,000, respectively.

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