**Exhibit 99.1**

On May 31, 2006, Spirit Finance Corporation (“SpiritFinance”) acquired 178 real estate properties from SKO Group Holding Corp.(“SKO”) for $815.3 million (the “Property Acquisition”).  In conjunctionwith the Property Acquisition, Spirit Finance entered into long-term triple-netmaster lease agreements with two wholly-owned subsidiaries of SKO, ShopKoStores Operating Co., LLC (“ShopKo”) and Pamida Stores Operating Co.,LLC.  The master leases with these two SKO subsidiaries were initially cross-defaulted. As of December 29, 2006, the cross-default provisions were removed from themaster leases in accordance with the terms of the master leases. Subsequent to the Property Acquisition, SKO changed its name to SpecialtyRetail Shops Holding Corp. (“Specialty Retail”) and transferred the ownershipof Pamida Stores Operating Co., LLC to an affiliate of Specialty Retail.

At June 30, 2007, the ShopKo master lease wasguaranteed by its indirect parent company, Specialty Retail.  ShopKo isrequired to furnish Spirit Finance various financial statements and otherfinancial information under its master lease agreement.  Due to theconcentration of the ShopKo tenant in relation to Spirit Finance’s total assetsat June 30, 2007, included in this exhibit are the unaudited financialstatements of Specialty Retail and subsidiaries (f/k/a SKO Group Holding Corp.and subsidiaries) as of May 5, 2007 and February 3, 2007 and for the 13 weeksended May 5, 2007 and April 29, 2006, provided to Spirit Finance by SKO inaccordance with the terms of the master lease agreement.  These financial statements should be read inconjunction with the audited financial statements of Specialty Retail andsubsidiaries as of February 3, 2007 and January 28, 2006, and therelated consolidated statements of operations, shareholders’ equity and cashflows for the fifty-three weeks ended February 3, 2007 (Successor), the fourweeks ended January 28, 2006 (Successor), the forty-eight weeks endedDecember 31, 2005 (Predecessor), and the fifty-two weeks endedJanuary 29, 2005 (Predecessor), included in Spirit Finance’s Form 10-K/Adated May 7, 2007.

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**SPECIALTY RETAIL SHOPSHOLDING CORP. AND SUBSIDIARIES**

**TABLEOF CONTENTS**

 
|                                                                                                                     | ** ** | **Page** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|                                                                                                                |       |     |       |
| Condensed Consolidated  Statements of Operations for the 13 Weeks Ended May 5, 2007 and April 29,  2006 (Unaudited) |       | 1        |       |
|                                                                                                                |       |     |       |
| Condensed Consolidated  Balance Sheets as of May 5, 2007, February 3, 2007 and April 29, 2006  (Unaudited)          |       | 2        |       |
|                                                                                                                |       |     |       |
| Condensed Consolidated  Statements of Cash Flows for the 13 Weeks Ended May 5, 2007 and April 29,  2006 (Unaudited) |       | 3        |       |
|                                                                                                                |       |     |       |
| Condensed Consolidated  Statement of Shareholders’ Equity for the 13 Weeks Ended May 5, 2007  (Unaudited)      |       | 4        |       |
|                                                                                                                |       |     |       |
| Notes to Condensed Consolidated Financial Statements (Unaudited)                                                    |       | 5 - 16   |       |

 

 

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** **

**SPECIALTYRETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS (UNAUDITED)FOR THE THIRTEEN WEEKS ENDED MAY 5, 2007 AND APRIL 29, 2006**
| **(In thousands)**                              | ** ** |
|------------------------------------------------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **May 5, 2007** | ** ** | **April 29, 2006** | ** ** |
| ** **                                           | ** ** | **(13 weeks)** | ** ** | **(13 weeks)** | ** ** |
|                                                 |       |   |   |   |   |
| REVENUES:                                            |       |   |   |   |   |
| Net sales                                            |       | $ | 499,029 |   | $ | 504,617 |   |
| Licensed department rentals and other income         |       | 3,159 |   | 3,072 |   |
| Total revenues                                       |       | 502,188 |   | 507,689 |   |
|                                                 |       |   |   |   |   |
| COSTS  AND EXPENSES:                                 |       |   |   |   |   |
| Cost of sales (before depreciation and amortization) |       | 361,273 |   | 366,731 |   |
| Selling, general and administrative expenses         |       | 130,997 |   | 115,970 |   |
| Depreciation and amortization expenses               |       | 1,201 |   | 6,803 |   |
|                                                 |       |   |   |   |   |
| Total costs and expenses                             |       | 493,471 |   | 489,504 |   |
|                                                 |       |   |   |   |   |
| EARNINGS  FROM OPERATIONS                            |       | 8,717 |   | 18,185 |   |
|                                                 |       |   |   |   |   |
| INTEREST  EXPENSE                                    |       | 4,212 |   | 23,167 |   |
|                                                 |       |   |   |   |   |
| INCOME  (LOSS) BEFORE INCOME TAXES                   |       | 4,505 |   | (4,982 | ) |
|                                                 |       |   |   |   |   |
| INCOME  TAX (BENEFIT) PROVISION                      |       | 1,802 |   | (1,993 | ) |
|                                                 |       |   |   |   |   |
| INCOME  (LOSS) FROM CONTINUING OPERATIONS            |       | 2,703 |   | (2,989 | ) |
|                                                 |       |   |   |   |   |
| INCOME  (LOSS) FROM DISCONTINUED OPERATIONS          |       | — |   | (1,782 | ) |
|                                                 |       |   |   |   |   |
| NET  INCOME (LOSS)                                   |       | $ | 2,703 |   | $ | (4,771 | ) |

 

See notes to condensedconsolidated financial statements.

** **

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**SPECIALTYRETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCESHEETS (UNAUDITED)AS OF MAY 5, 2007, FEBRUARY 3, 2007 AND APRIL 29, 2006**
| **(In thousands)**                                                               | ** ** |
|---------------------------------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **May 5,  2007** | ** ** | **February 3,  2007** | ** ** | **April 29,  2006** | ** ** |
|                                                                                  |       |   |   |   |   |   |   |
| **ASSETS**                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                                  |       |   |   |   |   |   |   |
| CURRENT  ASSETS:                                                                      |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                             |       | $ | 16,679 |   | $ | 15,131 |   | $ | 16,267 |   |
| Receivables (net of allowance for losses of $1,098, $1,095 and $1,417,  respectively) |       | 44,282 |   | 47,468 |   | 44,889 |   |
| Merchandise inventories                                                               |       | 369,385 |   | 353,674 |   | 378,190 |   |
| Other current assets                                                                  |       | 13,986 |   | 12,782 |   | 8,097 |   |
| Current assets of discontinued operations                                             |       | — |   | — |   | 209,558 |   |
|                                                                                  |       |   |   |   |   |   |   |
| Total current assets                                                                  |       | 444,332 |   | 429,055 |   | 657,001 |   |
|                                                                                  |       |   |   |   |   |   |   |
| PROPERTY  AND EQUIPMENT — Net                                                    |       | 30,039 |   | 29,980 |   | 747,502 |   |
|                                                                                  |       |   |   |   |   |   |   |
| INTANGIBLE  ASSETS — Net                                                         |       | 637 |   | 527 |   | 29,605 |   |
|                                                                                  |       |   |   |   |   |   |   |
| DEFERRED  INCOME TAXES                                                                |       | 59,668 |   | 55,768 |   | 9,665 |   |
|                                                                                  |       |   |   |   |   |   |   |
| DEBT  ISSUANCE COSTS                                                                  |       | 7,888 |   | 7,913 |   | 33,750 |   |
|                                                                                  |       |   |   |   |   |   |   |
| OTHER  ASSETS                                                                         |       | 6,194 |   | 6,005 |   | 5,666 |   |
|                                                                                  |       |   |   |   |   |   |   |
| NON-CURRENT  ASSETS OF DISCONTINUED OPERATIONS                                        |       | — |   | — |   | 123,353 |   |
|                                                                                  |       |   |   |   |   |   |   |
| TOTAL  ASSETS                                                                         |       | $ | 548,758 |   | $ | 529,248 |   | $ | 1,606,542 |   |
|                                                                                  |       |   |   |   |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                        |       |   |   |   |   |   |   |
|                                                                                  |       |   |   |   |   |   |   |
| CURRENT  LIABILITIES:                                                                 |       |   |   |   |   |   |   |
| Short-term debt                                                                       |       | $ | — |   | $ | — |   | $ | 51,414 |   |
| Accounts payable — trade                                                         |       | 185,362 |   | 165,384 |   | 174,041 |   |
| Accrued compensation and related taxes                                                |       | 16,566 |   | 21,336 |   | 14,120 |   |
| Deferred taxes and other accrued liabilities                                          |       | 81,719 |   | 111,470 |   | 70,438 |   |
| Accrued income and other taxes                                                        |       | 16,041 |   | 25,745 |   | 20,800 |   |
| Current portion of long-term debt and capital lease obligations                       |       | 2,560 |   | 2,494 |   | 5,665 |   |
| Current liabilities of discontinued operations                                        |       | — |   | — |   | 141,355 |   |
|                                                                                  |       |   |   |   |   |   |   |
| Total current liabilities                                                             |       | 302,248 |   | 326,429 |   | 477,833 |   |
|                                                                                  |       |   |   |   |   |   |   |
| LONG-TERM  DEBT AND CAPITAL LEASE OBLIGATIONS — Less current portion             |       | 159,884 |   | 122,080 |   | 905,815 |   |
|                                                                                  |       |   |   |   |   |   |   |
| OTHER  LONG-TERM OBLIGATIONS                                                          |       | 52,432 |   | 49,296 |   | 23,813 |   |
|                                                                                  |       |   |   |   |   |   |   |
| NON-CURRENT  LIABILITIES OF DISCONTINUED OPERATIONS                                   |       | — |   | — |   | 157,112 |   |
|                                                                                  |       |   |   |   |   |   |   |
| COMMITMENTS  & CONTINGENCIES (Notes 3, 5 and 12)                                  |       | — |   | — |   | — |   |
|                                                                                  |       |   |   |   |   |   |   |
| SHAREHOLDERS’  EQUITY:                                                           |       |   |   |   |   |   |   |
| Common stock (par value $0.001: 1,000 shares authorized, issued and  outstanding)     |       | — |   | — |   | — |   |
| Additional paid-in capital                                                            |       | 22,648 |   | 22,600 |   | 55,000 |   |
| Retained earnings (deficit)                                                           |       | 11,546 |   | 8,843 |   | (13,031 | ) |
|                                                                                  |       |   |   |   |   |   |   |
| Shareholders’ equity                                                             |       | 34,194 |   | 31,443 |   | 41,969 |   |
|                                                                                  |       |   |   |   |   |   |   |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                      |       | $ | 548,758 |   | $ | 529,248 |   | $ | 1,606,542 |   |

 

Seenotes to condensed consolidated financial statements.

 

 

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**SPECIALTYRETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS (UNAUDITED)FOR THE THIRTEEN WEEKS ENDED MAY 5, 2007 AND APRIL 29, 2006**
| **(In thousands)**                                                                                           | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                        | ** ** | **May 5, 2007** | ** ** | **April 29, 2006** | ** ** |
| ** **                                                                                                        | ** ** | **(13 weeks)** | ** ** | **(13 weeks)** | ** ** |
|                                                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                                            |       |   |   |   |   |
| Net income (loss)                                                                                                 |       | $ | 2,703 |   | $ | (4,771 | ) |
| Loss from discontinued operations                                                                                 |       | — |   | (1,782 | ) |
| Income (loss) from continuing operations                                                                          |       | 2,703 |   | (2,989 | ) |
| Adjustments to reconcile income (loss) from continuing operations  to net cash provided by operating  activities: |       |   |   |   |   |
| Depreciation and amortization                                                                                     |       | 1,201 |   | 6,803 |   |
| Amortization of deferred financing costs                                                                          |       | 534 |   | 3,999 |   |
| Gain on the sale of property and equipment                                                                        |       | (504 | ) | — |   |
| Stock compensation expense                                                                                        |       | 48 |   | — |   |
| Change in assets and liabilities :                                                                                |       |   |   |   |   |
| Receivables                                                                                                       |       | 3,186 |   | 8,667 |   |
| Merchandise inventories                                                                                           |       | (15,711 | ) | (8,210 | ) |
| Other current assets                                                                                              |       | (1,203 | ) | (57 | ) |
| Other assets                                                                                                      |       | — |   | 509 |   |
| Accounts payable and accrued liabilities                                                                          |       | 814 |   | (34,548 | ) |
| Other long-term obligations                                                                                       |       | (764 | ) | 7,893 |   |
|                                                                                                              |       |   |   |   |   |
| Net cash used in operating activities of continuing operations                                                    |       | (9,696 | ) | (17,933 | ) |
| Net cash used in operating activities of discontinued operations                                                  |       | — |   | (12,411 | ) |
|                                                                                                              |       |   |   |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                                            |       |   |   |   |   |
| Capital expenditures                                                                                              |       | (1,432 | ) | (75 | ) |
| Proceeds from the sale of property and equipment                                                                  |       | 504 |   | 420 |   |
| Payments for pharmacy customer lists                                                                              |       | (128 | ) | — |   |
|                                                                                                              |       |   |   |   |   |
| Net cash (used in) provided by investing activities of continuing  operations                                     |       | (1,056 | ) | 345 |   |
| Net cash used in investing activities of discontinued operations                                                  |       | — |   | (21 | ) |
|                                                                                                              |       |   |   |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                                            |       |   |   |   |   |
| Borrowings under revolving credit facilities                                                                      |       | 38,763 |   | 23,556 |   |
| Repayment of other debt and capital lease obligations                                                             |       | (956 | ) | (2,313 | ) |
| Borrowings of LT debt — net                                                                                  |       | 63 |   | — |   |
| Repayment of Note to Pamida                                                                                       |       | (25,061 | ) | — |   |
| Payment of financing costs                                                                                        |       | (509 | ) | — |   |
|                                                                                                              |       |   |   |   |   |
| Net cash provided by financing activities of continuing operations                                                |       | 12,300 |   | 21,243 |   |
| Net cash provided by financing activities of discontinued operations                                              |       | — |   | 9,059 |   |
|                                                                                                              |       |   |   |   |   |
| CASH  AND CASH EQUIVALENTS — Beginning of period                                                             |       | 15,131 |   | 15,985 |   |
| Net  cash used by discontinued operations                                                                         |       | — |   | (3,373 | ) |
| Net  increase in cash and cash equivalents                                                                        |       | 1,548 |   | 3,655 |   |
| CASH  AND CASH EQUIVALENTS — End of period                                                                   |       | $ | 16,679 |   | $ | 16,267 |   |

 

See notes to condensedconsolidated financial statements.

** **

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**SPECIALTYRETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTOF SHAREHOLDERS’ EQUITY (UNAUDITED)FOR THE THIRTEEN WEEKS ENDED MAY 5, 2007**
| **(In thousands)**             | ** ** |
|-------------------------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Total** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
|                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| BALANCE—February 3,  2007 |       | 1 |   | $ | — |   | $ | 22,600 |   | $ | 8,843 |   | 1 |   | $ | 31,443 |   |
|                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock  compensation expense         |       |   |   |   |   | 48 |   |   |   |   |   | 48 |   |
|                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                          |       | — |   | — |   | — |   | 2,703 |   | — |   | 2,703 |   |
|                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| BALANCE—May 5, 2007            |       | 1 |   | $ | — |   | $ | 22,648 |   | $ | 11,546 |   | 1 |   | $ | 34,194 |   |

 

Seenotes to consolidated financial statements.

 

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** **

**SPECIALTY RETAIL SHOPS HOLDING CORP. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

**1.**                      ORGANIZATION, BASIS OF PRESENTATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

***Organization***—Specialty Retail Shops Holding Corp.,formerly known as SKO Group Holding Corp. (the “Company”), was incorporated byan investment fund affiliated with Sun Capital Partners, Inc. (“Sun Capital”)in December 2005 for the purpose of acquiring all of the outstandingshares of common stock of ShopKo Stores, Inc. (the “Predecessor”). The Companyis a wholly-owned subsidiary of SKO Group Holding LLC, (the “Parent”), which isowned by an affiliate of Sun Capital and other co-investors. OnDecember 28, 2005, the Company acquired all of the issued and outstandingshares of the Predecessor (the “Acquisition”).

For the majority of the yearended February 3, 2007, the Company had two wholly-owned operatingsubsidiaries, ShopKo Holding Company, Inc. (“ShopKo”) and Pamida HoldingCompany, Inc. (“Pamida”), which are engaged in providing general merchandiseand retail health services through two separate, distinct retail formats(ShopKo stores and Pamida stores). ShopKo stores are operated in the Midwest,Western and Pacific Northwest states in mid-sized to larger cities; whilePamida stores are operated in Midwest, North Central and Rocky Mountain statesin small, rural communities.

Prior to the close ofbusiness on February 3, 2007, the Company distributed as a dividend all of theshares of Pamida to the Parent, which subsequently contributed the shares to anew holding company, Pamida Brands Holding, LLC.  The operations of Pamida have beenreclassified to be reported in these financial statements as a discontinuedoperation in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets.*

The Company also has awholly-owned real estate subsidiary which owns certain real properties whichare leased to ShopKo or held for sale as of May 5, 2007.

***Interim FinancialStatements -***TheCompany operates on a 52/53-week fiscal year basis.  The 2007 fiscal year (52 weeks) will end onFebruary 2, 2008 and the 2006 fiscal year (53 weeks) ended February 3,2007.  The accompanying consolidatedfinancial statements have been prepared by the Company without audit.  However, the foregoing financial statementsreflect all adjustments (which include only normal recurring adjustments) whichare, in the opinion of Company Management, necessary to present fairly the consolidatedfinancial position of the Company as of May 5, 2007 and April 29, 2006, and theresults of operations for the then ended 13 week periods.

These interim results arenot necessarily indicative of the results of the fiscal years as a wholebecause the operations of the Company are highly seasonal.  The fourth fiscal quarter has historicallycontributed a significant part of the Company’s earnings due to the Christmasselling season.

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted. The Company’s fiscal 2006 audited financial statements contain a summaryof significant accounting policies and include the consolidated financialstatements and the notes thereto.  Thesame accounting policies are followed in the preparation of the interim reportswith the exception of the adoption of FIN 48 as discussed below and in Note4.  The accompanying unaudited condensedconsolidated financial statements should be read in conjunction with theCompany’s audited consolidated financial statements and notes thereto for thefiscal year ended February 3, 2007.  The 

5

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Company’s consolidatedfinancial statements for the fiscal year ended February 3, 2007 were includedin the Form 10-K/A filed by Spirit Finance Corporation on May 7, 2007.

***Reclassifications —***Certain prior year amounts have been reclassified to conformwith current period presentation.

***Recently Issued AccountingStandards —***In June 2006, the Financial AccountingStandards Board (“FASB”) issued Interpretation No. 48 (FIN 48), *Accounting for Uncertainty in Income Taxes*,an interpretation of SFAS No. 109, *Accountingfor Income Taxes*. FIN 48 provides guidance relative to therecognition, de-recognition and measurement of tax positions for financialstatement purposes.  Effective February4, 2007, the Company has adopted the provisions of FIN 48 and there was nomaterial effect on the financial statements. As a result, there was nocumulative effect related to adopting FIN 48. However, certain amounts havebeen reclassified in the statement of financial position in order to complywith the requirements of the statement (see Note 4).

In September 2006,the FASB issued SFAS No. 157, *Fair ValueMeasurements*. SFAS No. 157 provides guidance for, among otherthings, the definition of fair value and the methods used to measure fairvalue. The provisions of SFAS No. 157 are effective for fiscal years beginningafter November 15, 2007. The Company is currently in the process of evaluatingthe impact, if any, of adopting SFAS No. 157 on its financial statements.

In September 2006,the FASB issued SFAS No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans*(anamendment of FASB Statements No. 87, 88, 106, and 132R). SFAS No. 158 requiresan employer to recognize the funded status of its defined benefit pension andpostretirement plans on its statement of financial position and to recognize asa component of other comprehensive income, net of taxes, the gains or lossesand prior service credits that arise during the period but are not recognizedas components of net periodic benefit costs. The recognition requirements ofSFAS No. 158 are effective for the Company’s fiscal year ending February 2,2008.  SFAS No. 158 also requires themeasurement date coincide with the Company’s fiscal year end.  The change in measurement date is effectivefor fiscal years ending after December 15, 2008.  The Company is currently evaluating theimpact of adopting SFAS No. 158 on its financial statements.

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*.  SFAS No. 159 permits entities to choose tomeasure many financial instruments and certain other items at fair value.  The provisions of SFAS No. 159 are effectivefor fiscal years beginning after November 15, 2007.  The Company is currently in the process ofevaluating the impact, if any, of adopting SFAS No. 159 on its financialstatements.

In June 2006, the EITF Task Force reached a consensus on Issue No. 06-3(“EITF 06-3”),**“Disclosure Requirements for Taxes Assessedby a Governmental Authority on Revenue-Producing Transactions.”  The consensus allows an entity tochoose between two acceptable alternatives based on their accounting policiesfor transactions in which the entity collects taxes on behalf of a governmentalauthority, such as sales taxes.  Underthe gross method, taxes collected are accounted for as a component of salesrevenue with an offsetting expense. Conversely, the net method allows a reduction to sales revenue.  Entities should disclose the method selectedpursuant to APR No. 22, “Disclosure of Accounting Policies.”  If such taxes are reported gross and aresignificant, entities should disclose the amount of those taxes.  The guidance should be applied to financialreports through retrospective application for all periods presented, if amountsare significant, for interim and annual reporting beginning after December 15,2006.  The Company adopted the guidanceduring the first quarter of fiscal 2007 and consistent with its historicalaccounting policies the Company has presented sales net of tax collected.

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**2.**                      THE ACQUISITION

The Company acquired the Predecessor pursuantto an Agreement and Plan of Merger, dated as of October 18, 2005, asamended (the “Merger Agreement”). Pursuant to the Merger Agreement, each issuedand outstanding share of the Predecessor’s common stock was converted into theright to receive $29.07 in cash and all options to acquire shares of thePredecessor were cancelled in exchange for a cash payment. Includingtransaction costs of $5.0 million, the total consideration paid to existingcommon share and option holders was $905.5 million. The Acquisition wasfinanced with cash on hand, a capital contribution of $55.0 million fromthe Parent funded by investments from an affiliate of Sun Capital and theco-investors, and borrowings under the new senior secured asset-backedrevolving credit and bridge loan facilities (see Note 8). The Acquisitionoccurred simultaneously with (i) the closing of the financing transactions andequity contribution described above, (ii) the redemption of $94.3 millionprincipal amount of the Predecessor’s outstanding 9.25% senior unsecured notes,(iii) the redemption of $46.7 million in outstanding mortgage notespayable, and (iv) the termination of the Predecessor’s revolving creditfacility. In connection with the early redemption of the senior unsecured notesand mortgage notes, the Company paid a pre-payment premium to noteholdersaggregating $33.7 million.

The Acquisition was accounted for as apurchase in accordance with the provisions of SFAS No. 141, *Business Combinations*. Accordingly, the total acquisitioncost was allocated to the respective assets and liabilities based upon theirestimated fair values on the date of the Acquisition. At the date ofAcquisition, the appraised fair market value of net assets acquired exceededthe purchase price; therefore, no goodwill is reflected in the consolidatedbalance sheet. In accordance with SFAS No. 141, the excess of estimated fairmarket value of net assets acquired over purchase price was allocated toeligible non-current assets. At January 28, 2006, the consolidated financialstatements reflected the preliminary purchase price allocation.  In accordance with SFAS No. 141, thepreliminary purchase price allocation is subject to additional adjustmentduring an allocation period (which is generally within one year after theacquisition) as additional information on asset and liability valuationsbecomes available.  During the fourthquarter of fiscal 2006, the Company finalized its preliminary purchase priceallocation to adjust the fair values of the real estate assets sold during theperiod (see Note 3) to the amounts realized upon sale, and to reflect theestimated income tax consequences of the sale-leaseback transaction.  Upon the final purchase price allocation, theexcess of the fair market value of the net assets acquired was allocated toacquired non-current assets, reducing acquired non-current assets to zero.  The remaining excess, in the amount of $4.0million, was recognized in accordance with SFAS No. 141 as an extraordinarygain in the Company’s statement of operations for fiscal 2006.

The purchase price allocation, inclusive ofthe Acquisition financing activities, is as follows (in millions):

| Cash and cash equivalents             |   | $       | 21.2   |   |
|---------------------------------------|--------|---------|--------|--------|
| Receivables                           |   | 66.8    |   |
| Merchandise  inventories              |   | 543.3   |   |
| Other current  assets                 |   | 6.4     |   |
| Property and  equipment               |   | 871.9   |   |
| Net deferred  income tax assets       |   | 42.1    |   |
| Debt issuance  costs and other assets |   | 47.9    |   |
|                                  |   |    |   |
| Total assets  acquired                |   | 1,599.6 |   |

 

7

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| Current liabilities                                         |   | 490.6   |   |
|-------------------------------------------------------------|--------|---------|--------|
| Acquisition debt  including the cost of acquisition         |   | 924.6   |   |
| Other long-term  debt and capital lease obligations assumed |   | 125.4   |   |
|                                                        |   |    |   |
| Total liabilities assumed                                   |   | 1,540.6 |   |
|                                                        |   |    |   |
| Equity  contribution                                        |   | 55.0    |   |
|                                                        |   |    |   |
| Extraordinary gain on acquisition  of business              |   | $       | 4.0    |   |
|                                                             |        |         |        |  |

 

The Company has established reserves foremployee severance costs of $6.2 million and for store exit costs of$8.4 million resulting from decisions directly related to the Acquisition.As of May 5, 2007, the Company had made payments of $5.3 million with respectto employee severance and $0.6 million with respect to store exit costs. TheCompany expects that the actions necessary to complete the employee severanceand store exits will be completed within one year.

**3.**                      SALE-LEASEBACK TRANSACTIONS

On May 31, 2006, the Companyconsummated a sale-leaseback transaction pursuant to which the Companytransferred the ownership of 112 ShopKo and 66 Pamida properties (including twocorporate headquarters, three distribution centers, the centralized opticalfacility and five ground lease properties) to a subsidiary of Spirit FinanceCorporation (“Spirit”) for approximately $815.3 million, of which $727.5million was attributed to the ShopKo properties. In addition, ShopKo enteredinto a master lease with Spirit whereby ShopKo is leasing back the propertiesfrom Spirit for an initial term of 20 years. At the end of the initial leaseterm, ShopKo will have the option to renew the lease term of any individualproperty for two additional ten-year terms. The master lease provides for baserents for ShopKo of approximately $66.4 million with an escalation provisionevery three years at the lesser of 6% or 1.25 times the product of the baserent and the change in the consumer price index.  ShopKo, as tenant, is responsible for thepayment of all operating expenses of the properties, including insurance,taxes, utilities, and other maintenance expenses.  At May 5, 2007, ShopKo is not liable for anyof Pamida’s obligations under its master lease arrangement with Spirit.

The Spirit sale-leasebacktransaction was accounted for in accordance with the provisions of SFAS Nos. 13and 98, *Accounting for Leases.*Of the 112 ShopKoproperties in the transaction, 108 of the properties (with aggregate proceeds of$705.6 million) were treated as property sales in accordance with SFAS No. 98.Of the 108 properties accounted for as property sales, all of the leasebacksqualified as an operating lease in accordance with SFAS No. 13. The remainingfour leasebacks did not qualify for sale-leaseback accounting under SFAS No.98, due to the leaseback containing certain elements of continuing involvementon the part of the seller-lessee. The proceeds from the sale of these fourproperties, which aggregated approximately $21.9 million, have been accountedfor as a financing by the Company.  Thenature of the Company’s continuing involvement could change in the future atwhich time the property will be accounted for as a sale with the relatedreduction in long term debt.

The proceeds from the Spiritsale-leaseback transaction (net of selling costs of approximately $18 million)were used to repay the outstanding borrowings under the Real Estate facilityand for general corporate purposes.

On January 29, 2007, theCompany consummated a sale-leaseback transaction pursuant to which the Companytransferred the ownership of seven ShopKo retail store properties to SovereignInvestment Company (“Sovereign”) and various entities controlled by AtlasInvestments (“Atlas”) for approximately $75.5 million.  In addition, the Company entered intoseparate lease agreements whereby the Company is leasing back the propertiesfrom Sovereign or Atlas for an initial term of 20 years. At 

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the end of the initial lease term, the Company willhave the option to renew the lease term of any individual property for fouradditional five-year terms. The leases provide for base rents of approximately$5.7 million, with an escalation provision every three years at the lesser of6% or 1.25 times the product of the base rent and the change in the consumerprice index.  ShopKo, as tenant, isresponsible for the payment of all operating expenses of the properties,including insurance, taxes, utilities, and other maintenance expenses.

The Sovereign sale-leasebacktransaction was accounted for in accordance with the provisions of SFAS Nos. 13and 98, *Accounting for Leases.*All 7 of theproperties were treated as property sales in accordance with SFAS No. 98, andall of the leasebacks qualified as an operating lease in accordance with SFASNo. 13.

**4.**                      INCOME TAXES

Prior to January 28, 2006,the Company effected a legal entity restructuring of certain wholly-ownedsubsidiaries, whereby the Company’s owned real property was segregated in asubsidiary which the Company has subsequently sold to a third party in asale-leaseback transaction.  Inaccordance with SFAS No. 109, a deferred tax asset had been recognized atJanuary 28, 2006 for the excess of the tax basis over the financial reportingbasis of the investment in the Company’s subsidiary that was reversed uponconsummation of the transaction described in Note 3. The valuation allowance atJanuary 28, 2006 adjusted deferred tax assets to an amount management believedwas more likely than not to be realized. Upon consummation of the restructuring and sale-leaseback transaction infiscal 2006, and completion of the purchase price allocation, the relatedvaluation allowance was reversed through purchase accounting.  The Company has determined no valuationallowance is required on other deferred tax assets.

The Company and itsqualifying domestic subsidiaries are included in a consolidated federal incometax return and certain state income tax returns of the Company.  For the 13 weeks ended April 29, 2006, theprovision for income taxes for the Company was determined on a separate returnbasis in accordance with the terms of a tax sharing agreement with Pamida andpayments for use of any current federal and state income benefits will be madeto Pamida (see Note 5).

In July 2006, the FASBissued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”(“FIN 48”).  FIN 48 is an interpretationof FASB Statement No. 109. “Accounting for Income Taxes,” and it seeks toreduce the diversity in practice associated with certain aspects of measurementand recognition in accounting for income taxes. In addition, FIN 48 providesguidance on recognition, classification, interest and penalties, and accountingin interim periods and requires expanded disclosure with respect to theuncertainty in income taxes.

Effective February 4, 2007,the Company has adopted the provisions of FIN 48 and there was no materialeffect on the financial statements. As a result, there was no cumulative effectrelated to adopting FIN 48. Amounts previously reflected as accrued income andother taxes are recorded as deferred income taxes or other long-termobligations in the current period.

The total amount ofunrecognized tax benefits as of the date of adoption was $29.5 millionexclusive of interest and penalties. Approximately $25.3 million (net of federal and state tax benefits)would affect the effective tax rate if recognized.  There were no significant changes in componentsof the liability in the first quarter of 2007. Approximately $0.6 million of unrecognized tax benefits relate to itemsthat are affected by the expected settlement of state audits within the nexttwelve months.

The Company’s policy is torecognize potential accrued interest and penalties related to unrecognized taxbenefits in income tax expense.  To theextent interest and penalties are not assessed with respect to uncertain taxpositions, amounts accrued will be reduced and reflected as a reduction of theoverall tax

 

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provision. Accrued interestand penalties of approximately $2.2 million were recorded in accrued incometaxes as of February 4, 2007.

Federal and state taxauthorities periodically audit the Company’s income tax returns. These auditsinclude questions regarding its tax filing positions, including the timing andamount of deductions and the allocation of income among various taxjurisdictions. In evaluating the exposures associated with its various taxfiling positions, the Company records reserves for probable exposures. A numberof years may elapse before a particular matter, for which the Company hasestablished a reserve, is audited by taxing authorities and fullyresolved.  The Company’s federal incometax return for 2003 through 2006 and tax returns in certain state jurisdictionsfor 1997 through 2006 remain subject to examination by taxing authorities.

**5.     RELATED PARTY TRANSACTIONS**

***Management Agreement —***TheCompany and an affiliate of Sun Capital (the “Manager”) are parties to aten-year management services agreement (the “Management Agreement”), wherebythe Manager provides the Company with financial and management consultingservices.  For the services to berendered by the Manager, the Company shall pay the Manager an annual fee of$3.0 million, plus reimbursement of out of-pocket expenses.  Payment of the annual fee may be limited bycertain covenants in the Revolving Credit Facility (see Note 8).  The covenant restrictions provide for thequarterly payment of $375,000 plus out-of-pocket expenses (not to exceed $1.0million) as long as certain availability thresholds are met.  The remaining $1.5 million is payable only ifcertain cash flows are attained. Included in selling, general and administrative expenses for the Companyfor thirteen weeks ended May 5, 2007 and April 29, 2006 are $0.75 million and$0.75 million, respectively,******of feesincurred in connection with the Management Agreement.  On May 4, 2007, the Company paid $1.5 millionin management fees included in other accrued liabilities related to fiscal 2006as it met the availability thresholds test. In addition, the Management Agreement also provides that, upon theoccurrence of certain events (including and without limitation to refinancings,restructurings, equity or debt offerings, acquisitions, mergers anddivestitures), the Company shall pay to the Manager a fee for its consultingservices equal to 1% of the aggregate consideration paid to or by the Companyin connection with such event.  During fiscal2006, in connection with the sale-leaseback transactions, the Company paid tothe Manager and an affiliate of the co-investors an aggregate fee of $5.7million in fiscal 2006 in accordance with the terms of the ManagementAgreement.  Of the total fee, $4.4million was paid to the Manager, an affiliate of Sun Capital, and $1.3 millionwas paid to Manchester Securities Corp and Elliott Associates, L.P.. (“Manchester/Elliott”).  During fiscal 2005 in connection with theAcquisition and related financings, the Company paid to the Manager and affiliatesof the co-investors an aggregate fee of $17.1 million in accordance with theterms of the Management Agreement.  Ofthe total fee, $12.0 million was paid to an affiliate of Sun Capital, $3.4million was paid to Manchester/Elliott and $1.7 million was paid to KLA-Shopko,LLC (“KLA”).  Sun Capital,Manchester/Elliott, and KLA or their respective affiliates own 70%, 20%, and10%, respectively, of the Parent.

On February 28, 2007, the Company amended and restatedthe Management Agreement for the primary purpose of eliminating Pamida as aparty to the agreement.  The amended andrestated Management Agreement is based on significantly comparable terms to theprior agreement, except the prior agreement annual fee was $4.0 million, 75% ofwhich was allocated to ShopKo

***Real Estate Advisory Services Agreement***—OnMarch 21, 2006, the Company entered into a one-year agreement with KLAwhereby KLA will provide advisory and other services to the Company in relationto the Company’s real estate assets (the “Real Estate Advisory Agreement”). Forthe services to be rendered by KLA, the Company agreed to pay to KLA anadvisory fee of $1.2 million, plus out-of-pocket expenses, during thetwelve month period ending on March 21, 2007. To the extent KLA 

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provided material services in connection with the sale of any of theCompany’s real estate assets, KLA was entitled to receive a fee of 0.5% of thegross sale price of such assets. To the extent KLA provided material servicesin connection with any financing or refinancing arrangements with respect tothe Company’s real estate assets, KLA was entitled to receive a fee of 0.25% ofthe gross amount of such financing up to $700 million, and 0.75% of theexcess, if any, of any financing over that amount.  Pursuant to this agreement, KLA received feesrelated to the sale-leaseback transactions in the amount of $4.4 million duringthe Company’s 2006 fiscal year.  The RealEstate Advisory Agreement terminated as of March 21, 2007.

***PamidaHolding Company, Inc. (“Pamida”) Tax Sharing Agreement***—OnJanuary 31, 2007, the Company entered into a tax sharing agreement with Pamidawhereby the Company and Pamida Holding agreed upon an equitable method fordetermining the share of consolidated federal tax burdens and benefitsattributable to each company for the taxable year 2006 and any adjustments toprior years’ consolidated federal income tax returns commencing with thetaxable year beginning on February 2, 2003. Pamida agreed to pay an amount equal to its tax liability if it had beenfiling on a standalone basis.  TheCompany agreed to pay Pamida an amount equal to the difference between theamount of the liability actually paid less its tax liability if it had beenfiling on a standalone basis.  At May 5,2007, the Company had a payable in the amount of $7.4 million****due to Pamida related to this agreement.  Effective with the transaction discussed inNote 10, Pamida will be a separate filer for the determination of federal,state and local income taxes.

***PamidaStores Operating Co., LLC Master Transition Services Agreement and DistributionServices Agreement***—On April 1, 2006, the Company’ssubsidiary, ShopKo Stores Operating Co., LLC, (“ShopKo Operating”) entered intoa two year Master Transition Services Agreement (the “TSA”) with Pamida StoresOperating Co., LLC (“Pamida Operating”) in conjunction with a corporateorganizational change, for the provision of certain services, benefit programsand products during a transition period during which Pamida Operating assemblesor acquires internal resources, staff and systems to provide internally suchservice and functions for its own benefit. The scope and nature of the services includes information systems, humanresource services, including payroll and benefits, pharmacy third partyadministration services and insurance services, distribution services and otherservices.  Effective February 4, 2007,ShopKo Operating and Pamida Operating entered into a separate DistributionServices Agreement (the “DSA”) that covers all warehousing and distributionservices previously covered under the Master Transition ServicesAgreement.  ShopKo Operating receives afee from Pamida Operating for these services. Included as a reduction to cost of sales for the 13 weeks ended May 5,2007 is $1.6 million of fees received under the DSA agreement.  Included as a reduction to selling, generaland administrative expenses for the 13 weeks ended May 5, 2007 and April 29,2006 is $0.7 million and $0.5 million, respectively, of fees also receivedunder the TSA agreement.

***SubordinatedPromissory Note***—On February 2, 2007, Pamida Operatingmade a pre-payment of $30 million to ShopKo Operating for services under theTSA and DSA and ShopKo Operating signed a Subordinated Promissory Note (the “PamidaNote”) in the same amount payable to Pamida in fifteen payments of $2 millionon the last day of each month beginning February 28, 2007 and ending April 30,2008, subject to set-off rights as set forth in the TSA and DSA.  Interest accrues on a daily basis at the rateof 4.93% per annum on the unpaid principal amount and Pamida Operating has theoption to call the Pamida Note in certain circumstances.  The Pamida Note is subordinated to ShopKoOperating’s senior secured debt.  TheNote was called by Pamida May 2, 2007. During the quarter, the Company paid $25.1 million of the Pamida Note toPamida.  The remaining balance of $4.9million will be paid once Pamida has issued certain standby letters of creditrequired by the TSA.

***Affiliate Participation in Revolving Credit Facility***— An affiliate of Sun Capital owns a 16.7% interest in Revolver B commitmentsin the amount of $5.1 million and $5.3 million at May 5, 2007 and April 29,2006, respectively, for which it received a closing fee from the Revolver Blender in the 

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amount of $35,000 and $367,000 for the 13 weeks ended May 5, 2007 andApril 29, 2006, respectively.  Interestexpense incurred by the Company on outstanding borrowings related to theaffiliate’s commitments was $101,000 and $29,000 during the 13 weeks ended May5, 2007 and April 29, 2006,respectively.

**6.**                 PROPERTYAND EQUIPMENT

Propertyand equipment as of May 5, 2007 and April 29, 2006 includes(in thousands):

|                                                | ** ** | **May 5,  2007** | ** ** | **April 29,  2006** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|
| Property and equipment — at cost:         |       |                  |       |                     |       |
| Land                                           |       | $                     | 52         |                     | $          | 254,251 |   |
| Buildings                                      |       | 172                   |       | 468,356                  |       |
| Equipment                                      |       | 18,259                |       | 21,695                   |       |
| Leasehold improvements                         |       | 9,994                 |       | 3,103                    |       |
| Property under construction                    |       | —                |       | 1,040                    |       |
| Property under capital leases                  |       | 6,810                 |       | 4,114                    |       |
|                                           |       |                  |       |                     |       |
| Total property and equipment                   |       | 35,287                |       | 752,559                  |       |
|                                           |       |                  |       |                     |       |
| Less accumulated depreciation and amortization |       | (5,248                | )          | (5,057                   | )          |
|                                           |       |                  |       |                     |       |
| Property  and equipment — net             |       | $                     | 30,039     |                     | $          | 747,502 |   |

 

Propertyand equipment balances as of April 29, 2006 reflected the Company’s preliminarypurchase price allocation recorded at the time of the Acquisition.  As of May 5, 2007, the decrease in propertyis primarily due to two sale-leaseback transactions (see Note 3) as well as thefinalization of the Company’s purchase price allocation (see Note 2).

**7.**                      INTANGIBLE ASSETS

Intangible assets as of May5, 2007 and April 29, 2006 are as follows (in thousands):

|                                | ** ** | **May 5,  2007** | ** ** | **April 29,  2006** | ** ** |
|--------------------------------|------------|-----------------------|------------|--------------------------|------------|
| Intangible assets:             |       |                  |       |                     |       |
| Customer relationships         |       | $                     | 1,944      |                     | $          | 19,152 |   |
| Indefinite lived tradenames    |       | —                |       | 10,853                   |       |
| Other                          |       | —                |       | 450                      |       |
|                           |       |                  |       |                     |       |
| Total intangible assets        |       | 1,944                 |       | 30,455                   |       |
|                           |       |                  |       |                     |       |
| Less accumulated  amortization |       | (1,307                | )          | (850                     | )          |
|                           |       |                  |       |                     |       |
| Intangible assets—net     |       | $                     | 637        |                     | $          | 29,605 |   |

 

Intangible assets at April29, 2006 reflected the Company’s preliminary purchase price allocation recordedat the time of the Acquisition.  Asdiscussed in Note 2, acquired non-current assets (including acquired intangibleassets) were reduced to zero as part of the finalization of the purchaseaccounting in fiscal 2006.

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**8.**                      DEBT

The components of the Company’s debt as of May 5, 2007 and April 29, 2006 are asfollows (in thousands):

|                                                                              | ** ** | **May 5,  2007** | ** ** | **April 29,  2006** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|
|                                                                         |       |                  |       |                     |       |
| Revolving credit  facility                                                   |       | $                     | 87,786     |                     | $          | 256,514 |   |
| Real estate  facility                                                        |       | —                |       | 654,487                  |       |
| Senior unsecured  notes, 9.25% due March 15, 2022                       |       | 5,669                 |       | 5,667                    |       |
| Mortgages and  other obligations                                             |       | 21,078                |       | 570                      |       |
| Capital lease  obligations                                                   |       | 47,911                |       | 45,656                   |       |
|                                                                         |       |                  |       |                     |       |
|                                                                         |       | 162,444               |       | 962,894                  |       |
|                                                                         |       |                  |       |                     |       |
| Less—current  portion of long-term debt and capital lease obligations   |       | 2,560                 |       | 5,665                    |       |
| Less—portion of  revolving credit facility presented as short-term debt |       | —                |       | 51,414                   |       |
|                                                                         |       |                  |       |                     |       |
| Long-term debt and  capital lease obligations                                |       | $                     | 159,884    |                     | $          | 905,815 |   |

 

***Revolving Credit Facility***— At the time of theAcquisition, the Company obtained a new senior secured asset-based revolvingcredit facility (the “Revolving Credit Facility”). On February 28, 2007, theCompany amended and restated its revolving credit facility for the primarypurpose of eliminating Pamida as a co-borrower under the agreement.  The Revolving Credit Facility, whichterminates on December 28, 2010, provides revolving credit loans of up to$442.5 million. The Revolving Credit Facility consists of two components,Revolver A and Revolver B, both of which are subject to borrowing basecalculations based primarily on a percentage of inventory and accountsreceivable. Revolver B loans are deemed to be the first loans made and the lastloans repaid.  Interest for both RevolverA and B is payable monthly. The Revolving Credit Facility is essentiallysecured by all the assets of the Company, excluding real property andequipment. The Revolving Credit Facility limits the number of store closings,payment of dividends, incurring new indebtedness, repurchase of common stock,capital expenditures and transactions with affiliates, including payment ofmanagement fees, and also requires the Company to meet certain financialperformance covenants. The Company was in compliance with all covenants as ofMay 5, 2007.

Revolver A has maximum available borrowings and letters of credit up to$400.0 million. The total outstanding letters of credit is limited to$145.5 million. Borrowings bear interest at a variable rate based on acertain formula (7.5% and 6.5% at May 5, 2007 and April 29, 2006,respectively). At May 5, 2007 and April 29, 2006 there were borrowings of $57.2million and $224.7 million under Revolver A, respectively with $222.5 millionand $85.9 million of additional borrowings available, respectively.

Revolver B has maximum available borrowings up to $42.5 million. Borrowingsbear interest at a variable rate based on a certain formula (8.8% and 11.2% atMay 5, 2007 and April 29, 2006, respectively). At May 5, 2007 and April 29,2006 there were borrowings of $30.6 million and $31.8 million respectivelyunder Revolver B with no additional borrowings available.

The Company issues documentary letters of credit during the ordinarycourse of business as required by certain foreign vendors, as well as stand-byletters of credit as required by certain insurers and other parties. As of May5, 2007 and April 29, 2006, the Company had outstanding stand-by letters ofcredit 

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of $25.0 million and $26.9 million, respectively, and outstandingdocumentary letters of credit of $3.7 million and $3.6 million, respectively.

***Real Estate Facility***— On January 27, 2006,the Company, utilizing special purpose subsidiaries formed to hold its realestate assets, obtained $655.3 million in private placement mortgagefinancing (the “Real Estate Facility”). The full amount of the Real EstateFacility was borrowed on January 27, 2006. In connection with the sale-leaseback transaction described in Note 3,on May 31, 2006, the Company repaid all borrowings and retired the Real EstateFacility.

***Senior Unsecured Notes***—Inconnection with the Acquisition, and pursuant to a cash tender offer commencedin June 2005, approximately $94.3 million (principal amount) of thePredecessor Company’s senior unsecured notes were repaid on December 28,2005.

***Mortgage and Other Obligations***—In connection withthe sale-leaseback transaction described in Note 3, the Company recognized$21.9 million of the proceeds received in the sale-leaseback as financingobligations, pursuant to the requirements of SFAS No. 98, due to the Company’scontinuing involvement with four properties. The nature of the Company’s continuing involvement could change in thefuture at which time the property will be accounted for as a sale with therelated reduction in long term debt.

**9.**                      BENEFIT PLANS

***Stock-based Compensation Plans***—Duringfiscal 2006, the Company adopted a stock option plan which provides for thegranting of non-qualified stock options to various officers, directors andaffiliates of ShopKo. The options granted under the plan have a term of tenyears and generally vest over five years. A summary of information related to the subsidiary stock options grantedis as follows:

| Shares  Outstanding | ** ** | **Reserved for  Option Grant** | ** ** | **Stock Options  Granted** | ** ** | **Price Range** | ** **  | **Weighted  Average  Exercise Price** | ** ** | **Fair Value  At Grant** | ** ** |
|---------------------|------------|------------------------------------------|------------|---------------------------------|------------|----------------------|-------------|--------------------------------------------|------------|------------------------------------|------------|
| 10,000,000          |       | 700,000                                  |       | 577,500                         |       | $                    | 4.35-$26.71 |                                       | $          | 7.33                               |       | $ | 2.11 |   |
|                     |            |                                          |            |                                 |            |                      |             |                                            |            |                                    |            |  |  |  |

 

Stock-basedcompensation expense of $48,000 was recognized under SFAS No. 123R for the 13weeks ended May 5, 2007.  There were nostock options issued in the 13 week period ended May 5, 2007.  As of May 5, 2007, there was $0.8 million oftotal unrecognized compensation cost related to non-vested share-basedcompensation plans, which is expected to be recognized over a weighted averageperiod of approximately 5 years. The Company has used an estimated forfeiturerate of 25%.  The fair value of theoptions granted was estimated using the Black-Scholes option pricing modelbased on the estimated market value of the respective subsidiaries at the grantdate and the weighted average assumptions specific to the underlying optionsgranted in fiscal 2006, as follows:

| Risk-free interest rate       |   | 5.0  | %      |
|-------------------------------|--------|------|--------|
| Expected  volatility          |   | 32.7 | %      |
| Dividend yield                |   | 0.0  | %      |
| Expected option life  (years) |   | 6.5  |   |

 

***Defined Contribution******Plan***—Substantially all employees of the Companyare covered by a defined contribution plan. The plan provides for anemployer matching contribution equal to 100% of the first three percent and 50%of the next 2% of compensation contributed by participating employees. Employermatching contributions were $1.6 million for the 13 weeks ended May 5, 2007,and $1.6 million for the 13 weeks ended April 29, 2006.

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***Other Benefits***—TheCompany also provides certain supplemental retirement and postretirementbenefits, other than pensions. Costs associated with these benefits are accruedduring the employee’s service period. The annual cost and accumulated benefitobligation associated with these benefits are not material.

**10.**               DISCONTINUED OPERATIONS

Prior to February 3, 2007,the Company distributed all of the shares of Pamida Holding Company to theParent, which subsequently contributed the shares to a new holding company,Pamida Brands Holding, LLC.  Inaccordance with SFAS No. 144, the Company has reflected the operations ofPamida as a discontinued operation for the 13 weeks ended April 29, 2006.  The table below presents the significantcomponents of Pamida’s operating results included in income from discontinuedoperations.

| (In Thousands)                  | ** ** | **April 29,  2006  (13 Weeks)** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| Revenues                             |       | $                                         | 183,225    |   |
|                                 |       |                                      |       |
| Income before  income taxes          |       | (2,970                                    | )          |
| Income tax  expense                  |       | (1,188                                    | )          |
| Income from  discontinued operations |       | (1,782                                    | )          |
|                                      |            |                                           |            |  |

 

The assets and liabilities of Pamidareflected as discontinued operations in the consolidated balance sheet as ofApril 29, 2006 are shown below.  Noassets or liabilities of Pamida are included in the consolidated balance sheetas of May 5, 2007.

 

| (In Thousands)                           | ** ** | **April 29,  2006** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|
| Cash and cash  equivalents                    |       | $                        | 6,696      |   |
| Receivables,  less allowances                 |       | 12,085                   |       |
| Merchandise  inventories                      |       | 188,779                  |       |
| Other current  assets                         |       | 1,998                    |       |
| Total current assets                          |       | 209,558                  |       |
|                                          |       |                     |       |
| Other assets and  deferred charges            |       | 1,171                    |       |
| Intangible  assets — net                 |       | 2,489                    |       |
| Debt issuance  costs                          |       | 5,676                    |       |
| Net property and  equipment                   |       | 101,379                  |       |
| Deferred income  taxes                        |       | 12,638                   |       |
| Total non-current assets                      |       | 123,353                  |       |
|                                          |       |                     |       |
| Short term debt                               |       | 22,035                   |       |
| Accounts payable  — trade                |       | 66,657                   |       |
| Accrued  compensation and related taxes       |       | 5,703                    |       |
| Deferred taxes  and other accrued liabilities |       | 37,188                   |       |
| Accrued income  and other taxes               |       | 6,244                    |       |
| Current portion  of long-term obligations     |       | 3,528                    |       |
| Total current liabilities                     |       | 141,355                  |       |
|                                          |       |                     |       |
| Real estate loan                              |       | 103,341                  |       |
| Capital lease  obligations — long term   |       | 21,337                   |       |
| Other long-term  obligations                  |       | 32,434                   |       |
| Total  non-current liabilities                |       | 157,112                  |       |
|                                               |            |                          |            |  |

 

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**11.**               LITIGATION

In the normal course ofbusiness, the Company has been named as a defendant in various lawsuits. Someof these lawsuits involve claims for substantial amounts. Although the ultimateoutcome of these lawsuits cannot be ascertained at this time, it is the opinionof management, after consultation with counsel, that the resolution of suchsuits will not have a material adverse effect on the consolidated financialstatements of the Company.

**12.    RELATED PARTY GUARANTEES**

As of May 5, 2007, the Company is a guarantor orco-obligor of certain obligations of its former subsidiary, Pamida StoresOperating Co., LLC.  The guarantees orco-obligations consist of:

| (in millions)    | ** ** | **Total** | ** ** |
|-----------------------|------------|-----------|------------|
| Lease  co-obligations |       | $         | 13.1       |   |
| Performance guarantee |       | 5.2       |       |
|                       |            |           |            |  |

 

The lease co-obligations relate to a distribution facility in Lebanon,IN in which the Company remains secondarily liable if Pamida, the primaryobligor, defaults.  The performanceguarantee relates to shared self-insured worker’s compensations, generalliability, employee benefit plans and other claims incurred under commoninsurance policies.  The basis forpossible payments under the guarantees or co-obligations is always thenon-performance of the primary obligor (Pamida) under a contractual agreement.

**13.    SUBSEQUENT EVENT**

On May 14, 2007, the Company paid a dividend in theamount of $55 million to shareholders of record.  The dividend was financed with additionalborrowings under the Revolving Credit Facility.

******

 

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