SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C.  20549




FORM
10-K







[X]
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
fiscal year ended January 2, 2010





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


For the
transition period from __________ to _____________





Commission
File Number 1-11681





FOOTSTAR, INC.(Exact
      name of registrant as specified in its
charter)





Delaware
            22-3439443(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer Identification No.)933
      MacArthur Blvd.,
              Mahwah,
      New Jersey
            07430(Address
      of principal executive offices)
            (Zip
      Code)





Registrant’s
telephone number, including area code: (201)
934-2000





Securities
registered pursuant to Section 12(b) of the Act:





None





Securities
registered pursuant to Section 12(g) of the Act:





Common Stock (par value $.01 per
      share)(Title
      of Class)








Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. ̈ Yes þ No





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act ̈ Yes þ No





Indicate
by check mark whether the registrant (1) has 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) has been subject to such filing requirements for
the past 90 days.þ
Yes  ̈
No




1
 Table of Contents





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in the definitive proxy statement incorporated by
reference in Part III of this Form 10-K, or any amendment to this Form 10-K.
[  ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See definitions of large accelerated filer, accelerated
filer and smaller reporting company in Rule 12b-2 of the Exchange Act (Check
one):





Large
      accelerated filer  ̈
            Accelerated
      filer   ̈Non-accelerated
      filer   ̈
            Smaller
      Reporting Company þ(do
      not check if a smaller reporting company)





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). ̈ Yes þ No





For the
purpose of reporting the following market value of the registrant’s common stock
held by non-affiliates, the common stock held by the directors and executive
officers of the registrant have been excluded. The aggregate market value of
common stock held by non-affiliates of the registrant as of July 4, 2009, was
approximately $19.8 million based on the closing price on July 2, 2009 of $0.97
per share.





Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court.  þ
Yes  ̈ No





Number of
shares outstanding of common stock, par value $.01 per share, as of March 12,
2010:  21,575,404.





Documents
Incorporated by Reference





Information
required by Part III that is not provided in this report will be in either
Footstar, Inc.’s Proxy Statement for the 2010 Annual Meeting of Shareholders or
an amendment to this report, one of which will be filed within 120 days after
the end of the registrant’s fiscal year, and is  incorporated herein
by reference.




2
 Table of Contents


FOOTSTAR,
INC.
 ANNUAL
REPORT ON FORM 10-K
  TABLEOF CONTENTS
  PART I
              
              4Introductory Note
              4Item 1.
              Business
              5General
              5Employees
              5Executive Officers of the Registrant
              5Available Information
              5Item 1A
              Risk Factors
              6Item 1B.
              Unresolved Staff Comments
              8Item 2.
              Properties
              8Item 3.
              Legal Proceedings
              9Item 4.
              (Removed and Reserved)
              9PART II
              
              9Item 5.
              Market for the Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities
              9Item 6.
              Selected Financial Data
              12Item 7.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              12Item 7A.
              Quantitative and Qualitative Disclosures About Market
      Risk
              19Item 8.
              Financial Statements and Supplementary
    Data
              19Item 9.
              Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure
              19Item 9A.
              Controls and Procedures
              19Item 9B.
              Other Information
              20PART III
              
              22Item 10.
              Directors, Executive Officers and Corporate
      Governance
              22Item 11.
              Executive Compensation
              22Item 12.
              Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
              22Item 13.
              Certain Relationships and Related Transactions, and
      Director Independence
              22Item 14.
              Principal Accounting Fees and Services
              22PART IV
              
              23Item 15.
              Exhibits, Financial Statement Schedules
              23
 
 
 3
 Table of Contents
  PARTI
  INTRODUCTORYNOTE
  Footstar,
Inc., which may be referred to as “Footstar”, the “Company”, “we”, or “our” is
filing this Annual Report on Form 10-K for its fiscal year ended January 2,
2010.
  The
Company is a holding company, incorporated under the laws of the State of
Delaware in 1996 and operated its businesses through its subsidiaries primarily
as a retailer selling family footwear through licensed footwear departments in
discount chains and wholesale arrangements since 1961.
  Until
December 31, 2008, the Company had operated licensed footwear departments in
discount chains since 1961, and was the only major operator of licensed footwear
departments in the United States.  The Company had operated licensed
footwear departments in various Kmart Corporation (“Kmart”)
stores.  The Company also had supplied certain retail stores,
including Rite Aid Corporation (“Rite Aid”), with family footwear on a wholesale
basis.
  As of
January 3, 2009, the Company no longer operates licensed footwear departments in
Kmart stores and in Rite Aid stores.
  Substantially
all of the Company’s business operations consisted of running licensed footwear
departments in Kmart stores pursuant to that certain Amended and Restated Master
Agreement dated as of August 24, 2005 by and between Kmart, Sears Holding
Corporation (“Sears”) and the Company (the “Kmart Master Agreement”), as amended
by that certain Master Agreement Amendment, dated as of April 3, 2008, by and
among the Company, Kmart, certain affiliates of Kmart and Sears (the “Kmart
Master Agreement Amendment” and, collectively with the Kmart Master Agreement,
the “Kmart Agreement”). The Kmart Agreement expired by its terms on December 31,
2008.
  In May
2008 the Board of Directors determined that it is in the best interests of the
Company and its shareholders to liquidate and ultimately dissolve after the
expiration of the Kmart Agreement in December 2008 (and other miscellaneous
contracts through the end of such term) and to sell and/or dispose of any of the
Company’s other remaining assets, including its property in Mahwah, New Jersey,
which contains its corporate headquarters building, improvements and 21 acres of
underlying land (“collectively, the “Mahwah Real Estate”). In May 2008, the
Board of Directors approved the Plan of Complete Liquidation of Footstar, Inc.
(the “Original Plan”), which provided for the complete liquidation and ultimate
dissolution of the Company on expiration of the Kmart Agreement on December 31,
2008.
  The Board
amended the Original Plan on March 5, 2009.  The Amended Plan of
Complete Dissolution and Liquidation of Footstar, Inc. (the “Plan of
Dissolution”)  reflects technical and legal changes to the Original
Plan consistent with Delaware corporate law and is intended to modify, supersede
and replace the Original Plan in order to more efficiently facilitate the
liquidation and dissolution of the Company in the best interests of
shareholders.  The Plan of Dissolution provides for the complete,
voluntary liquidation of the Company by providing for the sale of its remaining
assets and the wind-down of the Company’s business as described in the Plan of
Dissolution and for distributions of available cash to shareholders as
determined by the Board of Directors (the “Dissolution”).
  The Plan
of Dissolution was approved by shareholders at a special meeting on May 5,
2009.  Also on May 5, 2009, the Company filed a certificate of
dissolution with the Secretary of State of Delaware, which commenced a
three-year statutory liquidation process. The Company began implementing the
Plan of Dissolution immediately following its approval, and adopted the
liquidation basis of accounting effective May 6, 2009.
  4
 Table of Contents
  Since the
Company’s emergence from bankruptcy on February 7, 2006, the Board of Directors
has declared special cash distributions totaling $9.85 per common share.
Specifically, the Board of Directors has declared cash distributions to
shareholders in the following amounts and on the following dates: $5.00 per
common share on March 27, 2007; $1.00 per common share on May 9, 2008; $1.00 per
common share on January 8, 2009; $2.00 per common share on April 20, 2009; $.40
per common share on August 18, 2009; $.35 per common share on December 1, 2009
and $.10 per common share on February 24, 2010.
  On
February 24, 2010, the Company announced it anticipates it will not make any
further distributions until the monetization of the Mahwah Real
Estate.
  See Item
1A, “Risk Factors”, beginning at page 6, concerning certain other matters in
connection with future events, circumstances and uncertainties that may impact
the Plan of Dissolution and the timing and amounts of any distributions made to
shareholders under the Plan of Dissolution.
  ITEM1.  BUSINESS
  GENERAL
  Not
applicable.
  EMPLOYEES
  As of
March 15, 2010, the Company had five employees, including one officer, to assist
in the liquidation process.
  EXECUTIVEOFFICERS OF THE REGISTRANT
  The
following information sets forth the name, age and business experience during
the past five years of the current executive officer of the
Company:
  Jonathan
M. Couchman, 40, was appointed Chief Financial Officer effective August 11,
2009. Mr. Couchman became President and Chief Executive Officer of Footstar
effective January 1, 2009.  Prior to that, on December 9, 2008 Mr.
Couchman became Chief Wind-Down Officer of the Company.  He was
appointed Chairman of the Board of Footstar on February 7, 2006. He is the
Managing Member of Couchman Capital LLC, which is the investment manager of
Couchman Investments LP and Couchman International Ltd., private partnerships
established in 2001. Couchman Capital LLC is also the general partner of
Couchman Partners LP, a private investment partnership established in 2001. In
addition, Mr. Couchman is the President of Couchman Advisors, Inc., a management
advisory company. He is a member of the CFA Institute and the New York Society
of Security Analysts and holds a Bachelor of Science in Finance from the
California State University at Chico.
  AVAILABLEINFORMATION
  You may
read any materials filed by us with the Securities and Exchange Commission (the
“Commission” or the “SEC”), including our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), at the SEC’s Public
Reference Room at 100 F Street, NE, Washington, DC  20549, and you may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet web
site, www.sec.gov, which contains reports, proxy and information statements and
other information which we file electronically with the SEC.
  5
 Table of Contents
  A copy of
Footstar’s Corporate Governance Guidelines and its Code of Conduct and
Compliance Program are posted on the Corporate Governance section of the
Company’s website, www.footstar.com, and are available in print to any
shareholder who requests copies by contacting Jonathan Couchman, President,
Chief Executive Officer and Chief Financial Officer, at the Company’s principal
executive office set forth above.
  ITEM1A.  RISK
FACTORS
  The
matters discussed in this Annual Report on Form 10-K include forward-looking
statements that involve significant risks and uncertainties and that are made in
reliance upon the safe harbor provisions of Section 27A of the Securities Act
and Section 21E of the Exchange Act.  These statements may be
identified by the use of words, such as: “anticipate,” “estimates,” “should,”
“expect,” “project,” “intend,” “plan,” “believe” and other words and terms of
similar meaning, in connection with any discussion of our financial statements,
business, results of operations, liquidity, future operating or financial
performance and other future events and circumstances.  These
statements are neither promises nor guarantees. A number of important risks and
uncertainties, including those identified below and those factors included in
this Annual Report on Form 10-K under Item 7, “Recent Events”, beginning on page
12, each of which is a risk factor and is incorporated into this Item 1A by
reference, as well as risks and uncertainties discussed elsewhere in this Form
10-K, could cause our actual results to differ materially from those expressed
or implied in our forward-looking statements. In addition to the
above-referenced statements and factors which are set forth elsewhere in our
Annual Report on Form 10-K and incorporated herein by reference, we set forth
the following risks and uncertainties related to our business.
  Adverse
U.S. economic conditions and the current turmoil in the U.S. capital and credit
markets could limit demand for the Company’s corporate headquarters building,
improvements and, thus, we may not be able to timely sell our corporate
headquarters or on acceptable terms.
  The
economy in the United States is currently experiencing unprecedented
disruptions, including increased levels of unemployment, the failure and near
failure of a number of large financial institutions, reduced liquidity and
increased credit risk premiums for a number of market
participants.  Economic conditions may be affected by numerous
factors, including inflation and employment levels, energy prices, recessionary
concerns, changes in currency exchange rates, the availability of debt and
interest rate fluctuations.  At this time, it is unclear whether, and
to what extent, the actions taken by the U.S. government, including the passage
of the Emergency Stabilization Act of 2008, the Troubled Assets Relief Program,
the American Recovery and Reinvestment Act of 2009 and other measures currently
being implemented or contemplated will mitigate the effects of the
crisis.  The current turmoil in the capital and credit markets could
limit demand for our owned Mahwah Real Estate, which contains our corporate
headquarters building, improvements and 21 acres of underlying land which we
have been marketing since March 2007.  At this time we cannot predict
the extent or duration of any negative impact that the current disruptions in
the U.S. economy will have on our ability to sell the Mahwah Real Estate or on
acceptable terms.
  We
may not be able to settle all of our obligations to creditors.
  We have
current obligations to creditors. Our estimate of ultimate distributions to our
shareholders takes into account all of our known obligations and our best
estimate of the amount reasonably required to satisfy such obligations. As part
of our dissolution process, we will attempt to settle those obligations with our
creditors. We cannot assure you that we will be able to settle all of these
obligations or that they can be settled for the amounts we have estimated for
purposes of calculating the likely distribution to shareholders. If we are
unable to reach agreement with a creditor relating to an obligation, that
creditor may bring a lawsuit against us. Amounts required to settle obligations
or defend lawsuits in excess of the estimated amounts will result in
distributions to shareholders that are smaller than those that we presently
estimate or may eliminate distributions entirely.
  6
 Table of Contents
  We
will continue to incur claims, liabilities and expenses, which will reduce the
amount available for distribution to shareholders.
  We
continue to incur claims, liabilities and expenses (such as salaries and
benefits, directors’ and officers’ insurance, payroll and local taxes,
facilities costs, legal, accounting and consulting fees and miscellaneous office
expenses) as we wind up. These expenses will reduce the amount ultimately
available for distribution to our shareholders.
  Each
shareholder may be liable to our creditors for an amount up to the amount
distributed to such shareholder by us if our reserves for payments to creditors
are inadequate.
  Even
though we are a dissolved corporation, as required by Delaware law, we will
continue to exist as a non-operating entity for at least three years after the
Dissolution became effective, which was on May 5, 2009, or for such longer
period as the Delaware Court of Chancery directs, for the purpose of prosecuting
and defending lawsuits, settling and closing our business, disposing of our
property, discharging our liabilities and distributing to our shareholders any
remaining assets. Under applicable Delaware law, in the event we do not resolve
all claims against the Company, each of our shareholders could be held liable
for payment to our creditors up to the amount distributed to such shareholder in
the liquidation. In such event, a shareholder could be required to return up to
all amounts received as distributions pursuant to the Plan of Dissolution and
ultimately could receive nothing under the Plan of Dissolution. Moreover, even
though a shareholder has paid taxes on amounts previously received, a repayment
of all or a portion of such amount will not result in a recalculation of the
gain or loss on the liquidation. Instead, a shareholder’s repayment will
generally be deductible as a capital loss in the year in which the contingent
liability is paid, and such capital loss cannot be carried back to offset any
liquidation gain recognized earlier. We cannot assure you that any contingency
reserve that we plan to establish will be adequate to cover all expenses and
liabilities.
  Although
we intend to seek relief from the SEC of certain of our public company reporting
requirements, we cannot assure you that we will be successful in obtaining such
relief.
  We intend
to seek relief from the SEC of certain of our public company reporting
requirements. If we are able to obtain such relief from the SEC, we will
continue to file current reports on Form 8-K to disclose material events
relating to our liquidation, along with any other reports that the SEC may
require, though we will no longer file annual and quarterly reports with the
SEC. If we are unable to obtain relief, we will continue to file annual and
quarterly reports with the SEC which will require us to continue to incur
significant accounting, legal and other administrative costs in connection with
preparing, reviewing and filing with the SEC.
  Shareholders
may not be able to recognize a loss for federal income tax purposes until they
receive a final distribution from us, which may be three years or more after our
Dissolution.
  As a
result of our liquidation, for federal income tax purposes, shareholders will
recognize gain or loss equal to the difference between (1) the sum of the amount
of cash and the aggregate fair market value of any property distributed to them
(reduced by any liability assumed or subject to which it is taken), and (2)
their tax basis in their shares of our common stock. A shareholder’s tax basis
in our shares will depend upon various factors, including the shareholder’s cost
and the amount and nature of any distributions received with respect thereto. A
shareholder generally may recognize a loss only when he, she or it has received
a final distribution from us, which may be as much as three years (or up to ten
years if the Company elects to comply with Section 281(b) of the Delaware
General Corporation Law) after our Dissolution. However, if we are unable to
sell the Mahwah Real Estate prior to the third anniversary of the filing of the
certificate of dissolution, we may transfer such property into a liquidating
trust, in which event we may make a final distribution after the third
anniversary of the filing of the certificate of dissolution.
  7
 Table of Contents
  We
do not currently expect to generate any material revenues or operating income as
an independent company.
  Following
the termination of the Kmart Agreement on December 31, 2008, we have not
generated any meaningful revenues.  We will endeavor to operate the
Company on a scaled back basis.  However, we will continue to incur
costs to maintain our ongoing administrative operations and continued corporate
existence as well as costs to wind-down our business, without corresponding
revenues.
  We
likely will be unable to realize the benefits of our net operating loss
carryforwards.
  As
discussed above under “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Critical Accounting Estimates – Deferred
Tax Assets,” we currently have significant deferred tax assets resulting from
net operating loss carryforwards.  Our ability to use these tax
benefits in future years depends upon the amount of our otherwise taxable
income, among many other factors and conditions.  We will lose the
benefit of these net operating loss carryforwards upon completion of the plan of
liquidation and dissolution and could lose them under many other
circumstances.
  Also, if
we underwent an ownership change, we or a successor might be unable to use all
or a significant portion of our net operating loss to offset taxable
income.  In order to avoid an adverse impact on our ability to utilize
our net operating losses for federal income tax purposes, we had earlier amended
our certificate of incorporation in February 2006 to include certain
restrictions on the transfer of our stock when we emerged from bankruptcy. These
restrictions were intended to prevent an ownership change within the meaning of
Section 382 of the Internal Revenue Code from occurring.  These
restrictions expired on December 31, 2008.  On February 4, 2009, we
amended our Rights Agreement to continue to prevent a possible ownership change
but we can provide no assurances that an ownership change will not occur, which
may eliminate our ability to utilize our net operating losses.
  For
accounting purposes, we cannot currently conclude that it is more likely than
not that certain deferred tax assets, including our net operating losses, will
be realized and, as a result, we have recorded a non-cash valuation allowance
equal to our net deferred tax asset.
  ITEM1B.  UNRESOLVED STAFF
COMMENTS
  None.
  ITEM2.     PROPERTIES
  As of
January 3, 2009, we no longer operated licensed footwear
departments.
  Our
corporate headquarters is located in 129,000 square feet of office space in
Mahwah, New Jersey.
  8
 Table of Contents
  In
connection with the wind-down of our business, we are actively pursuing the sale
of our Mahwah Real Estate.
  In
connection with the Company’s discontinued operations in 1995, the Company
entered into a sub-lease formerly occupied by its Thom McAn stores. The lease
expires effective February 1, 2014. The obligation under the sublease is $3.1
million, although the Company believes that there has been a novation of its
obligations under such lease and may in the future bring litigation to have a
court finally determine such issue. If we are unable to resolve this matter
prior to the conclusion of our statutory dissolution period on May 6, 2012, we
may be required to fund a Liquidating Trust with $1.5 million (the obligation
amount from May 2012 through February 2014) until such time as the matter is
concluded.
  ITEM3.      LEGAL
PROCEEDINGS
  The
Company is involved in various and routine litigation matters, which arise
through the normal course of business.  Management believes that the
resolution of these matters will not have a material adverse effect on the final
liquidation of the Company.  While it firmly maintains that all
pending claims are meritless, the Company will continue to expend costs as it
vigorously defends against these claims.
  ITEM4.     (REMOVED AND
RESERVED)
  None.
  PARTII
  ITEM5.     MARKET FOR THE REGISTRANT’S
COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
  Our
common stock, FTAR.OB, is quoted on the OTCBB and on the Pink Sheets
LLC.  Prices shown below reflect the quarterly high and low bid
quotations for the common stock as reported on the OTCBB System.  The
over-the-counter market quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission may not necessarily reflect actual transactions
and have not been adjusted for dividends.  As of March 9, 2010, there
were 1,986 shareholders of record (not including the number of persons or
entities holding stock in nominee or street name through various banks and
brokerage firms).
  Information
concerning the high and low closing bid quotations of our common stock is set
forth below:
  HIGH
                
                
                
                LOW2008First
      Quarter
                
                $
                4.70
                
                
                $
                4.25Second
      Quarter
                
                $
                5.35
                
                
                $
                4.10Third
      Quarter
                
                $
                4.09
                
                
                $
                3.40Fourth
      Quarter
                
                $
                3.64
                
                
                $
                2.80
  HIGH
                
                
                
                LOW2009First
      Quarter
                
                $
                3.55
                
                
                $
                1.81Second
      Quarter
                
                $
                2.94
                
                
                $
                0.06Third
      Quarter
                
                $
                1.10
                
                
                $
                0.70Fourth
      Quarter
                
                $
                0.99
                
                
                $
                0.41
  9
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 From 2007
through January 2, 2010, the Company’s Board of Directors declared and paid cash
distributions to shareholders in the amount of $9.75 per common share or $207.1
million.
 
 On
February 24, 2010, the Company announced that its Board of Directors declared a
liquidating cash distribution to stockholders in the amount of $.10 per common
share. The Company recorded the distribution effective the date the declaration
was made by the Board of Directors. The liquidating cash distribution totaling
$2.2 million was paid on March 12, 2010 to the holders of record at the close of
business on March 8, 2010.
 
 On
February 24, 2010, the Company announced it anticipates it will not make any
further distributions until the monetization of the Mahwah Real
Estate.
  On
February 4, 2009, the Company entered into Amendment No. 2 (“Amendment No. 2”)
to its Rights Agreement, dated as of March 8, 1999, as amended as of May 31,
2002 (as amended, the “Rights Agreement”), between it and Mellon Investor
Services LLC, a New Jersey limited liability company (formerly ChaseMellon
Shareholder Services, L.L.C.), as Rights Agent, pursuant to which the terms of
the outstanding preferred share purchase rights were amended.
  The
Rights Agreement was amended by Amendment No. 2 in order to protect shareholder
value by attempting to prevent a possible limitation on the Company’s ability to
use its U.S. net operating loss carryovers. The Company has experienced
significant losses in the United States, and under the Internal Revenue Code of
1986, as amended (the “Code”), and rules and regulations promulgated by the
Internal Revenue Service, the Company may “carry forward” these losses in
certain circumstances to offset any current and future taxable income and thus
reduce federal income tax liability, subject to certain requirements and
restrictions. To the extent that the net operating losses do not otherwise
become limited, the Company believes that it may be able to utilize a portion of
such losses and, therefore, these net operating losses could be a substantial
asset to the Company. The use of such losses, however, is not assured and under
many circumstances may be unlikely. For example, if the Company experiences an
“ownership change” as defined in Section 382 of the Code, the Company’s ability
to use the net operating losses could be severely limited. See “Item 7.
Management’s Discussion and Analysis of Financial Conditions – Factors to
Consider – We likely will be unable to realize the benefits of our net operating
loss carryforwards.”
  We plan
to sell or liquidate any remaining assets and pay all of our known and
undisputed liabilities and obligations. We intend to establish a contingency
reserve to cover any unknown, disputed or contingent liabilities and intend to
distribute remaining amounts to shareholders as and when our Board of Directors
deems appropriate. We also intend to distribute remaining liquidation proceeds
as promptly as practicable following the sale or liquidation of our remaining
assets, subject to payment or provisions for the payment of known obligations
and, if necessary or appropriate, establishing a contingency reserve. It is
possible that unanticipated lawsuits or other claims will be asserted against
us, which could result in certain distributions to our shareholders being
delayed until the resolution of any such lawsuit or other claim and such period
could extend over multiple years.
  Because
of the uncertainties as to the ultimate settlement amount of our remaining
liabilities and expenditures we will face during liquidation, we are not able to
predict with precision or certainty specific amounts, or timing, of future
liquidation distributions. At the present time, we are not able to predict with
certainty whether sales proceeds from our remaining assets will differ
materially from amounts recorded for those assets on our statement of net assets
at January 2, 2010. To the extent that the value of our assets is less than we
anticipate, or the amount of our liabilities or the amounts that we expend
during liquidation are greater than we anticipate, our shareholders could
receive less than we currently estimate.
  10
 Table of Contents
  Please
refer to “Introductory Note”, above, and Item 7, “Management’s Discussion
and Analysis of Financial Conditions and Results of Operations,” below, in
connection with the wind-down of the Company’s businesses in connection with the
termination of the Kmart Agreement.
  EQUITY COMPENSATION PLAN
INFORMATION
  (a)
              (b)
              (c)Plan category
              Number
      of
                securities
      to be
                issued
      upon exercise
                of
      outstanding options,
                warrants and rights
              Weighted-average
                exercise
      price of
                outstanding
      options,
                warrants and rights
              Number
      of securities
                remaining
      available
                for
      future issuance
                under
      equity compensation
                plans
      (excluding securities
                reflected
      in column (a))Equity
      compensation
                plans approved by security holders (1)
              546,394
              $15
              1,621,873Equity
      compensation
                plans not approved  by security holders (2)
              101,215
              $32
              1,752,442Total
              647,609
              $15
              3,374,315
 
 (1)
              The
      1996 Incentive Compensation Plan includes 1,621,873 shares available for
      issuance other than upon the exercise of an option or other
      right.
 (2)
              The
      2000 Equity Incentive Plan includes 1,752,442 shares available for
      issuance other than upon the exercise of an option or other
      right.
 
 Our 2000
Equity Incentive Plan was adopted by the Board and became effective on March 10,
2000.  The plan provides for grants of stock options and other stock
based awards to our full-time employees other than to any individual who would
be a named executive officer in the proxy statement to be filed with the SEC in
connection with the annual meeting for the applicable
year.  Participants in the plan may be granted stock options, stock
appreciation rights, restricted stock, deferred stock, bonus stock, dividend
equivalents, or other stock based awards, performance awards or annual incentive
awards.  All stock option grants have an exercise price per share no
less than the fair market value per share of common stock on the grant date and
may have a term of no longer than ten years from grant date.  For
further information concerning the plan, see Note 13 to the Consolidated
Financial Statements.
  On May 5,
2009, the Company de-registered all of the securities registered under the 1996
Incentive Compensation Plan and the 2000 Equity Incentive Plan that remain
unsold as of this date. The Company has no plans to make additional grants under
any of these plans.
 
 Recent Sales of Unregistered
Securities
  We did
not make any unregistered sales of our common stock during the 2009 fiscal
year.
  Issuer Purchases of Equity
Securities
  We did
not repurchase any shares of our common stock during the twelve months ended
January 2, 2010.
  11
 Table of Contents
  ITEM6.     SELECTED FINANCIAL
DATA
  Not
applicable.
 
 ITEM7.     MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
  FORWARD-LOOKING
STATEMENTS
  This
report contains forward-looking statements made in reliance upon the safe harbor
provisions of Section 27A of the Securities Act, and Section 21E of the Exchange
Act.  These statements may be identified by the use of words such as
“anticipate,” “estimates,” “should,” “expect,” “project,” “intend,” “plan,”
“believe” and other words and terms of similar meaning, in connection with any
discussion of our financial statements, business, results of operations,
liquidity, future operating or financial performance and other future events and
circumstances. Factors that could affect our forward-looking statements include,
among other things:
  ·
              the
      impact of any dividends or any other special distributions to shareholders
      on the Company’s future cash requirements and liquidity needs, both in
      connection with the wind-down of the  Company’s operations and
      all contingencies;
  ·
              under
      the Plan of Dissolution, the Company’s remaining assets would be disposed
      of, known liabilities would be paid or provided for and reserves would be
      established for contingent liabilities, with only any remaining assets
      available for ultimate
distribution;
  ·
              uncertainties
      exist as to the disposition value of our remaining assets as well as the
      amount of our liabilities and obligations, and, in connection with the
      Plan of Dissolution,  there can be no assurance as to the amount
      of any cash or other property that may potentially be distributed to
      shareholders or the timing of any
distributions;
  ·
              we
      do not expect to be able to fully realize the benefits of our net
      operating loss carry forwards; and
  ·
              the
      difficulty of selling the Company’s Mahwah Real Estate on satisfactory
      terms, taking into account the current decline in the economic conditions
      and the current disruption in the capital and credit
    markets.
  Because
the information in this Annual Report on Form 10-K is based solely on data
currently available, it is subject to change and should not be viewed as
providing any assurance regarding our future operations or performance. Actual
results, operations, performance, events, plans and expectations may differ
materially from our current projections, estimates and expectations and the
differences may be material, individually or in the aggregate, to our financial
condition, results of operations, liquidity and
prospects.  Additionally, we do not plan to update any of our forward
looking statements based on changes in assumptions, changes in results or other
events subsequent to the date of this Annual Report on Form 10-K, other than as
included in any future required SEC filings, or as may otherwise be legally
required.
  RECENT
EVENTS
  On
February 24, 2010, the Company announced that its Board of Directors declared a
liquidating cash distribution to shareholders in the amount of $.10 per common
share. The Company recorded the distribution effective the date the declaration
was made by the Board of Directors. The liquidating cash distribution totaling
$2.2million was paid on March 12, 2010 to the holders of record at the close of
business on March 8, 2010.
  12
 Table of Contents
  On
February 24, 2010, the Company announced it anticipates it will not make any
further distributions until the monetization of the Mahwah Real
Estate.
  As of
February 8, 2010, the Company’s letters of credit obligation decreased by $1.0
million resulting in the release by Bank of America of $1.1 million in cash
collateral.
  Following
shareholder approval of the Plan of Dissolution on May 5, 2009 and the filing of
a certificate of dissolution with the Delaware Secretary of State that day, the
Plan of Dissolution took effect.  Since May 5, 2009, pursuant to the
Plan of Dissolution our activities have been limited to actions we deem
necessary or appropriate to accomplish, among other things, the
following:
  ·
              remaining
      in existence as a non-operating entity for at least three years following
      the filing of the certificate of dissolution on May 5, 2009, as required
      under Delaware law;
  ·
              completing
      the sale or liquidation of the Company’s remaining assets that are held
      for sale, principally consisting of the Mahwah Real Estate, which may
      include, without limitation, entering into commercial leases to enhance or
      facilitate the disposition of real estate, if
  advisable;
  ·
              the
      adoption by the Company of the liquidation basis of accounting effective
      May 6, 2009;
  ·
              collecting,
      or providing for the collection of debts and other claims owing to the
      Company;
  ·
              paying,
      or providing for the payment of, our debts and liabilities, including both
      known liabilities and those that are contingent, conditional, unmatured or
      unknown, in accordance with Delaware
law;
  ·
              winding
      up our remaining business activities and withdrawing from any jurisdiction
      in which we remain qualified to do
business;
  ·
              complying
      with the SEC’s filing requirements for so long as we are required to do
      so;
  ·
              making
      ongoing tax and other regulatory filings;
and
  ·
              preparing
      to make, and making, distributions to our shareholders of any liquidation
      proceeds that may be available for such
  distributions.
  Under
Delaware law, our Board of Directors may take such actions as it deems necessary
or appropriate in furtherance of the Dissolution and the winding up of the
Company’s affairs.
  OVERVIEW
  The
following points highlight the Company’s operations, cash flows and financial
position for the year ended January 2, 2010:
 
 ·
              In
      2009, the Company’s Board of Directors declared and paid cash
      distributions in the amount of $3.75 per common
  share
 
 ·
              As
      of January 2, 2010, the Company had $9.8 million of cash and cash
      equivalents
  13
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  RESULTS
OF OPERATIONS
  The
following discussion and analysis should be read in conjunction with and is
qualified in its entirety by our Consolidated Financial Statements and the Notes
thereto that appear elsewhere in this report.
  FOR
THE PERIOD JANUARY 4, 2009 TO MAY 5, 2009 VERSUS THE YEAR ENDED JANUARY 3, 2009
(GOING CONCERN BASIS)
  (in
      millions)
              
              For
      the period January 4, 2009 to May 5, 2009
              
              
              For
      the year ended January 3, 2009Net
      Sales
              
              $
              --
              
              
              $
              580.0Liquidation
      of Inventory
              
              
              2.5
              
              
              
              54.2Total
      Revenues
              
              
              2.5
              
              
              
              634.2Gross
      Profit on Net Sales
              
              
              --
              
              
              
              183.3Loss
      on Liquidation of  Inventory
              
              
              --
              
              
              
              (4.9
              )Total
      Gross Profit
              
              
              2.5
              
              
              
              178.4SG&A
      Expenses
              
              
              6.5
              
              
              
              146.8Depreciation/Amortization
              
              
              --
              
              
              
              4.5Loss
      on Impairment of Long- Lived Asset
              
              
              --
              
              
              
              10.8Gain
      on Cancellation of Retiree Benefit Plan
              
              
              --
              
              
              
              (22.3
              )Gain
      on Sale of Intangible Assets
              
              
              --
              
              
              
              (10.5
              )Gain
      on Expiration of Kmart Agreement
              
              
              --
              
              
              
              (5.0
              )Operating
      Profit / (Loss)
              
              $
              (4.0
              )
              
              $
              54.1
 
 Due
to the shortened time period during 2009 as a result of the adoption of the
liquidation basis of accounting effective May 6, 2009, these numbers are not
comparable.
  NET
SALES
  Due to
the expiration of the Kmart Agreement at the end of 2008, there were no net
sales for the period January 4, 2009 to May 5, 2009. Net Sales for the Company
were $580.0 million in 2008.
  LIQUIDATION
OF INVENTORY
  Liquidation
of inventory for the period January 4, 2009 to May 5, 2009 of $2.5 million
represents the amount received from Kmart relating to the resolution of the
disputed amounts of the liquidation of the inventory on hand as of December 31,
2008.  On December 31, 2008, the Company sold the remaining inventory
on hand in the Kmart and Rite Aid stores for $54.2 million.
  GROSS
PROFIT
  For the
period January 4, 2009 to May 5, 2009, the Company had gross profit of $2.5
million. Gross profit was $178.4 million in 2008.
  14
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  SG&A
EXPENSES
  Store
operating, selling, general and administrative expenses for the period January
4, 2009 to May 5, 2009 of $6.5 million primarily represents costs associated
with the wind-down of the Company, including compensation and benefits ($4.3
million), facility costs ($0.6 million), professional fees ($1.1 million) and
other miscellaneous costs ($0.5 million). Selling, general and administrative
were $146.8 million in 2008.
  DEPRECIATION/AMORTIZATION
  All of
the Company’s assets were fully depreciated as of January 3, 2009, with the
exception of the Mahwah Real Estate, which has been accounted for as an asset
held for resale, and reflected at its estimated fair market value and therefore
no depreciation expense was recorded for the period January 4, 2009 to May 5,
2009. The Company had depreciation and amortization expense of $4.5 million in
2008.
  LOSS
ON IMPAIRMENT OF LONG-LIVED ASSET
  During
fiscal 2008, the Company recorded an impairment charge of $10.8 million to
reduce the carrying amount of its corporate headquarters to its fair value of
$6.2 million and has recorded the asset as held for sale.  The Company
used significant other observable inputs to determine fair value, less costs to
dispose of the property of approximately $0.3 million, in accordance with ASC
Topic 360, “Property, Plant, & Equipment”. The impairment was caused by the
significant decrease in the real estate market during 2008, along with the
Company’s decision to market the building to financial buyers in addition to the
user owner community as the Company had previously.
  GAIN
ON CANCELLATION OF RETIREE BENEFIT PLAN
  In
connection with the previously announced anticipated wind-down of the Company’s
business at the end of fiscal 2008, the Company terminated its retiree medical
and retiree life insurance plan for all active employees who had been eligible
to participate in such plan and for all retiree participants effective June 6,
2008. As a result of this termination, during the second quarter of 2008, the
Company eliminated its accumulated postretirement benefit obligation of
approximately $14.6 million and its unamortized net gain and prior service costs
included in accumulated other comprehensive income of $7.7 million, and recorded
a gain of approximately $22.3 million.
  GAIN
ON SALE OF INTANGIBLE ASSETS
  Under the
terms of the IP Purchase Agreement, the Company sold to Sears Brands
substantially all of the Company’s intellectual property, including the
intellectual property related to the Company’s Kmart business, for a purchase
price of approximately $13.0 million. The Company recognized the gain of $10.5
million at the expiration of the Kmart Agreement on December 31,
2008.
  GAIN
ON EXPIRATION OF KMART AGREEMENT
  Kmart had
a claim against us in the amount of $11,000 for each store that was an existing
store, as defined in the Kmart Agreement, on August 25, 2005, which was disposed
of, closed or converted to another retail format and such claim was generally
payable by us to Kmart at the time of store closing, disposal or
conversion.  However, upon the expiration of the Kmart Agreement all
such claims not yet due and payable were waived for any remaining stores. As
such, the Company recorded a gain on the elimination of the amount due under
Kmart Settlement of $5.0 million.
  15
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  OPERATING
PROFIT
  Operating
loss decreased to ($4.0) million in the period January 4, 2009 to May 5, 2009
compared with operating profit of $54.1 million in 2008.
  LIQUIDITY
AND CAPITAL RESOURCES
  The
Company also has and continues to incur additional liquidation costs and
professional fees in connection with the wind-down of its business. The Company
intends to fund such cash requirements through current balances in cash and cash
equivalents. At January 2, 2010, we had cash and cash equivalents of
approximately $9.8 million.
  From 2007
through January 2, 2010, the Company’s Board of Directors declared and paid cash
distributions to shareholders in the amount of $9.75 per common share or $207.1
million.
 
 On
February 24, 2010, the Company announced that its Board of Directors declared a
$.10 per share liquidating cash distribution to shareholders of record as of
March 8, 2010. The distribution totaling $2.2 million was paid on March 12, 2010
from current balances in cash and cash equivalents.
  On
February 24, 2010, the Company announced it anticipates it will not make any
further distributions until the monetization of the Mahwah Real
Estate.
  Factors
that could affect our short and long term liquidity relate primarily to the
final wind-down of the businesses and include, among other things, the payment
of any further dividends or distributions, our ability to sell our Mahwah Real
Estate or on acceptable terms, and managing costs associated with the
management, liquidation and dissolution of the Company.
  The Board
of Directors approved an amendment to the Plan of Dissolution on March 5, 2009
which amendment is intended to modify, supersede and replace the Original Plan
in order to more efficiently facilitate the liquidation and dissolution of the
Company in the best interests of shareholders.  The Plan, as amended,
provides for the complete liquidation of the Company by providing for the sale
of its remaining assets and the wind-down of the Company’s business as described
therein and for distributions of available cash to shareholders as determined by
the Board of Directors.
  Although
we cannot reasonably assess the impact of all of these or other uncertainties,
we believe that our cash will be sufficient to fund our working capital needs
and anticipated expenses for at least the next twelve months.
  As of
February 27, 2009, the Company has received proceeds of $55.3 million in
connection with the sale of inventory to Kmart pursuant to the Kmart Agreement.
In addition, the Company received proceeds of $1.3 million in connection with
the sale of its remaining Rite-Aid inventory.
  We plan
to sell or liquidate any remaining assets and pay all of our known and
undisputed liabilities and obligations. We may then establish, if necessary or
appropriate, a contingency reserve to cover any unknown, disputed or contingent
liabilities and intend to distribute remaining amounts to shareholders as and
when our Board of Directors deems appropriate. Any sales of our assets will be
made in private or public transactions and on such terms as are approved by our
Board of Directors.
  We may
establish a reserve, referred to as the Contingency Reserve, in an amount
determined by our Board of Directors to be sufficient to satisfy potential
liabilities, expenses, and obligations. The net balance, if any, of any
Contingency Reserve remaining after payment, provision, or discharge of all of
our liabilities, expenses, and obligations will also be distributed to our
shareholders pro rata.
  16
 Table of Contents
  AMENDED
CREDIT FACILITY
  As of
January 1, 2009, the Amended Credit Facility dated May 9, 2008, between the
Company and Bank of America, N.A., was terminated.
  In the
past, we have entered into standby letters of credit to secure certain
obligations, including insurance programs and duties related to the import of
our merchandise.  As of January 2, 2010, we had standby letters of
credit which were cash collateralized at 103% of face value, plus a reserve for
future fees (the “L/C Cash Collateral”) totaling $3.8 million, with Bank of
America as issuing bank.  Accordingly, Bank of America has been
granted a first priority security interest and lien upon the L/C Cash
Collateral.  Amounts held in the L/C Cash Collateral will be refunded
to the Company as letters of credit are reduced, terminated or expire. As of
February 8, 2010, the Company’s letters of credit obligation decreased by $1.0
million resulting in the release by Bank of America of $1.1 million in cash
collateral.
  CRITICAL
ACCOUNTING ESTIMATES
  Management’s
Discussion and Analysis of Financial Condition and Results of Operations is
based in part upon the Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America.
  Our
discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting estimates that require management to make judgments and estimates
that are subject to varying degrees of uncertainty.  We believe that
investors need to be aware of these estimates and how they impact our financial
statements as a whole, as well as our related discussion and analysis presented
herein.  While we believe that these accounting estimates are based on
sound measurement criteria, actual future events can and often do result in
outcomes that can be materially different from these estimates or
forecasts.
  The
critical accounting estimates and related risks described in the Company’s
Annual Report on Form 10-K for fiscal year ended January 2, 2010 (the “2009
Annual Report”) are those that depend most heavily on these judgments and
estimates including the following.
  Impairment
of Long-Lived Assets
  Factors
that management must estimate when performing impairment tests include, among
other items, possible liquidation of our business. Actual results may differ
materially from these estimates and, as a result, the fair values may be
adjusted in the future.
  During
fiscal 2008, the Company recorded an impairment charge of $10.8 million to
reduce the carrying amount of its corporate headquarters to $6.2 million and has
recorded the asset as held for sale. The value is based on unobservable inputs
including real estate broker estimate and property assessment.
  Insurance
and Self-Insurance Liabilities
  Prior to
2008 we were primarily self-insured for medical costs, as our deductible under
third party coverage was $250,000 per claim.  We establish accruals
for our insurance programs based on available claims data and historical trends
and experience, as well as loss development factors prepared by third party
actuaries.  Loss development factors are estimates based on our actual
historical data and other retail industry data.  Commencing in 2008,
the Company was no longer self-insured for medical costs.
  17
 Table of Contents
  We
evaluate the accrual and the underlying assumptions for workers’ compensation
claims and for medical costs quarterly and make adjustments as needed based on
third party actuarial assessments.  The ultimate cost of these claims
may be greater than or less than the established accrual.  While we
believe that the recorded amounts are adequate, there can be no assurance that
changes to management’s estimates will not occur due to limitations inherent in
the estimating process.  In the event we determine the accruals should
be increased or reduced, we record such adjustments in the period in which such
determination is made.
  The
accrued obligation for these self-insurance programs was approximately $1.9
million at the end of fiscal year 2009 and $1.8 million at the end of fiscal
year 2008.  Because loss development factors are estimates at a point
in time, should unknown claim issues, such as adverse medical costs, occur,
develop or become realized over the course of the claim, actual claim payments
could materially differ from our accrued obligation.
  Deferred
Tax Assets
  We
currently have significant deferred tax assets resulting from net operating loss
carryforwards and temporary differences, which is available to reduce taxable
income in future periods subject to many conditions and contingencies (and use
against taxable income after 2009 will not be possible if the Company has no
operating income or if the Company liquidates and dissolves).
  As of
January 2, 2010 we have recorded a net deferred tax asset of $51.2 million and a
related valuation allowance of $51.2 million.  In connection with the
preparation of our fiscal years 2009 and 2008 consolidated financial statements,
we reviewed the valuation of our deferred tax assets based on objective positive
evidence, such as projections of our future taxable earnings along with negative
evidence, such as operational uncertainties, no taxable income in carryback
period, and liquidation of our business.  For accounting purposes, we
cannot rely on anticipated long-term future profits to utilize our deferred tax
assets.  As a result, we could not conclude that it is more likely
than not that certain deferred tax assets will be realized and have recorded a
non-cash valuation allowance on our net deferred tax asset.
  Effective
December 31, 2006 the Company adopted FASB ASC Topic 740 “Income Taxes”. The
interpretation contains a two step approach to recognizing and measuring
uncertain tax positions accounted for in accordance with FASB Topic No. 740. The
first step is to evaluate the tax position for recognition by determining if the
weight of available evidence indicates it is more likely than not that the
position will be sustained on audit, including resolution of related appeals or
litigation processes, if any. The second step is to measure the tax benefit as
the largest amount which is more than 50% likely of being realized upon ultimate
resolution. In implementing FASB Topic 740, the Company evaluated individual tax
benefits using these evaluation methods and made judgments on how to
disaggregate its various tax positions and then analyzed the tax
positions.  At the adoption date of December 31, 2006, January 3, 2009
and January 2, 2010, the Company did not have any unrecognized tax
benefits.
  IMPACT
OF RECENTLY ISSUED ACCOUNTING STANDARDS
  In June
2009, the Financial Accounting Standards Board (“FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168 – “The FASB
Accounting Standards ASC Topic and the Hierarchy of Generally Accepted
Accounting Principles a replacement of FASB Statement No.
162”.  (“SFAS NO. 168”).  SFAS No. 168 made the FASB
Accounting Standards Codification (the “ASC”) the single source of U.S.
Generally Accepted Accounting Policies (“U.S. GAAP”) used by nongovernmental
entities in the preparation of financial statements, except for rules and
interpretive releases of the SEC under authority of federal securities laws
which are sources of authoritative accounting guidance for SEC
registrants.  The ASC is meant to simplify user access to all
authoritative accounting guidance by reorganizing U.S. GAAP pronouncements into
roughly 90 accounting topics within a consistent structure: its purpose in not
to create new accounting and reporting guidance.  The ASC superseded
all existing non-SEC accounting and reporting standards and was effective for
the Company beginning July 1, 2009.  Following SFAS No. 168, the Board
will not issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issues Task Force Abstracts; instead, it will issue Accounting
Standards Updates.  The FASB will not consider Accounting Standards
Updates (“ASU”) as authoritative in their own right; these updates will serve
only to update the ASC topic, provide background information about the guidance,
and provide the bases for conclusions on the change(s) in the ASC.  In
the description of ASC and ASU that follows, references relate to ASC or ASU
topics and their descriptive titles, as appropriate.
  18
 Table of Contents
  Effective
January 1, 2008, the Company adopted FASB ASC Topic 820, “Fair Value Measurement
and Disclosure,” which defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles and expands disclosure
about fair value measurements.  The Company uses the following methods
for determining fair value in accordance with FASB ASC Topic 820.  For
assets and liabilities that are measured using quoted prices in active markets
for the identical asset or liability, the total fair value is the published
market price per unit multiplied by the number of units held without
consideration of transaction costs (Level 1).  Assets and liabilities
that are measured using significant other observable inputs are valued by
reference to similar assets or liabilities, such as quoted prices for similar
assets or liabilities, quoted prices in markets that are not active, or other
inputs that are observable or can be corroborated by observable market data
(Level 2).  For all remaining assets and liabilities for which there
are no significant observable inputs, fair value is derived using an assessment
of various discount rates, default risk, credit quality and the overall capital
market liquidity (Level 3).
  ITEM7A.  QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
  Not
applicable.
 
 ITEM8.     FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
  The
reports of independent registered public accounting firm, the Consolidated
Financial Statements of the Company and the Notes to the Consolidated Financial
Statements called for by this Item 8 are filed as part of this Annual Report. An
index to the Consolidated Financial Statements is provided under Item 15,
“Exhibits”, beginning at page F-1 below.
  ITEM9.     CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
  Not
applicable.
  ITEM9A.  CONTROLS AND
PROCEDURES
  (a)           Disclosure
Controls and Procedures
  The
Company carried out, under the supervision and with the participation of the
Company's management, including its Chief Executive Officer and Treasurer, an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of the end of the fiscal year
covered by this Form 10-K. Based upon that evaluation, the Chief Executive
Officer and Treasurer concluded that, as of January 2, 2010, the design and
operation of the Company's disclosure controls and procedures were effective.
Nonetheless, a control system, no matter how well designed and operated, cannot
provide absolute assurance that the objectives of the control system are met,
and no evaluation of controls can provide absolute assurance that all control
issues have been detected.
  19
 Table of Contents
 
 (b)           Management’s
Annual Report on Internal Control Over Financial Reporting
  The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting as defined in Rule 13a-15(f) under the
Exchange Act. The Company’s internal control over financial reporting consists
of policies and procedures that are designed and operated to provide reasonable
assurance about the reliability of the Company’s financial reporting and its
process for preparing financial statements in accordance with generally accepted
accounting principles (“GAAP”). Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions or
that the degree of compliance with the policies or procedures may
deteriorate.
  As
defined by the Public Company Accounting Oversight Board (“PCAOB”) in Auditing
Standard No. 5, a “material weakness” is defined as “a deficiency, or a
combination of deficiencies, in internal control over financial reporting such
that there is a reasonable possibility that a material misstatement of the
company’s annual or interim financial statements will not be prevented or
detected on a timely basis. The term “significant deficiency” is defined as “a
deficiency, or a combination of deficiencies, in internal control over financial
reporting that is less severe than a material weakness, yet important enough to
merit attention by those responsible for oversight of the company’s financial
reporting.”
  The
Company’s Chief Executive Officer, President and Chief Financial Officer
assessed the effectiveness of the Company’s internal control over financial
reporting as of the Evaluation Date. In making this assessment, management used
the criteria described in Internal Control — Integrated Framework issued by The
Committee of Sponsoring Organizations of the Treadway Commission. Based on the
results of this assessment, management (including our Chief Executive Officer,
President and Chief Financial Officer) concluded that, as of the Evaluation
Date, we had not identified any material weakness in our internal control over
financial reporting and our internal control over financial reporting was
effective.
  This
Annual Report on Form 10-K does not include an attestation report of the
Company's registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
Company's registered public accounting firm pursuant to temporary rules of the
SEC that permit the Company to provide only management's report in this Annual
Report on Form 10-K.
  (c)           Changes
in Internal Control Over Financial Reporting
  We
identified no change in our internal control over financial reporting that
occurred during the quarterly period covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
  ITEM9B.  OTHER
INFORMATION
  On March
15, 2010, the Company issued shares of common stock having an aggregate grant
date fair value of $50,000, or 217,391 shares, to each of Adam Finerman and
Eugene Davis, the Company’s non-employee directors, in lieu of cash compensation
for their service as directors in 2010 to which they would otherwise be
entitled. The Company believes that compensating the non-employee directors in
the form of common stock in lieu of cash better aligns the interests of the
Company and the non-employee directors.
  20
 Table of Contents
  On March
15, 2010, the Company issued shares of common stock having an aggregate grant
date fair value of $500,000, or 2,173,913 shares, to Jonathan M. Couchman, the
Company’s President, Chief Executive Officer and Chief Financial Officer, in
lieu of cash compensation for base salary for Mr. Couchman’s services as
President, Chief Executive Officer and Chief Financial Officer for the twelve
months commencing March 1, 2010. The Company believes that compensating Mr.
Couchman in the form of common stock in lieu of cash better aligns his interests
with those of the Company.
  On March
15, 2010, Mr. Couchman was also awarded a stock option to purchase up to
2,500,000 shares of the Company’s common stock at an exercise price of $0.40 per
share (after giving effect to the liquidating cash dividend of $0.10 paid on
March 12, 2010). On the date of the grant, the closing stock price of the
Company’s stock price was $0.23. The stock option was fully vested at the time
of the grant. The stock option expires upon the earlier of the tenth anniversary
of the grant date and the payment of the final liquidation distribution to the
Company’s shareholders. The Company believes that granting a stock option with
an exercise price substantially above both the estimated liquidation value per
share and market price per share at the time of the grant will further incentive
Mr. Couchman to work to maximize distributions to shareholders.
  21
 Table of Contents
  PARTIII
  ITEM10.   DIRECTORS, EXECUTIVE
OFFICERS AND CORPORATE GOVERNANCE
  Information
required by Part III, Item 10, that is not provided in this report will be
included in either Footstar, Inc.’s Proxy Statement for the 2010 Annual Meeting
of Shareholders or an amendment to this report, one of which will be filed with
the SEC within 120 days after the end of the Company’s fiscal year, and is
incorporated herein by reference.  Certain information required by
this Item 10 concerning executive officers is set forth in Item 1 of this report
under the caption “Executive Officers of the Registrant.”
  ITEM11.   EXECUTIVE
COMPENSATION
  Information
required by Part III, Item 11, will be included in either Footstar, Inc.’s Proxy
Statement for the 2010 Annual Meeting of Shareholders or an amendment to this
report, one of which will be filed with the SEC within 120 days after the end of
the Company’s fiscal year, and is incorporated herein by reference except that
the information under the caption “Compensation Committee Report” shall be
deemed “furnished” with this report and shall not be deemed “filed” with this
report and not deemed incorporated by reference into any filing under the
Securities Act or Exchange Act except only as may be expressly set forth in any
such filing by specific reference.
  ITEM12.   SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER
MATTERS
  Information
required by Part III, Item 12, that is not provided in this report will be
included in either Footstar, Inc.’s Proxy Statement for the 2010 Annual Meeting
of Shareholders or an amendment to this report, one of which will be filed with
the SEC within 120 days after the end of the Company’s fiscal year, and is
incorporated herein by reference.
  ITEM13.   CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
  Information
required by Part III, Item 13, will be included in either Footstar, Inc.’s Proxy
Statement for the 2010 Annual Meeting of Shareholders or an amendment to this
report, one of which will be filed with the SEC within 120 days after the end of
the Company’s fiscal year, and is incorporated herein by reference.
  ITEM14.   PRINCIPAL ACCOUNTING FEES
AND SERVICES
  Information
required by Part III, Item 14, will be included in either Footstar, Inc.’s Proxy
Statement for the 2010 Annual Meeting of Shareholders or an amendment to this
report, one of which will be filed with the SEC within 120 days after the end of
the Company’s fiscal year, and is incorporated herein by reference.
  22
 Table of Contents
  PARTIV
  ITEM15.   EXHIBITS, FINANCIAL
STATEMENT SCHEDULES
  (a)(1)
Financial Statements
  The
      following financial statements are included within this
      report:
              PageReport
      of Independent Registered Public Accounting Firm
              F-2Consolidated
      Statements of  Operations for the Period January 4, 2009 to May
      5, 2009 and the Year Ended January 3, 2009 (Going Concern
      Basis)
              F-3Consolidated
      Statement of Net Assets as of January 2, 2010 (Liquidation Basis) and
      Consolidated Balance Sheet as of January 3, 2009 (Going Concern
      Basis)
              F-4Consolidated
      Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the
      period January 4, 2009 to May 5, 2009 and the Year Ended January 3, 2009
      (Going Concern Basis)
              F-5Consolidated
      Statement of Changes in Net Assets in Liquidation— For the period May 6,
      2009 through January 2, 2010 (Liquidation Basis)
              F-6Consolidated
      Statements of Cash Flows for the Period January 4, 2009 to May 5, 2009 and
      the Fiscal Year Ended January 3, 2009 (Going Concern
Basis)
              F-7Notes
      to Consolidated Financial Statements
              F-8
 
 (a)(3)
Exhibits
  21.1
              Subsidiaries
      of Footstar, Inc.31.1
              Certification
      of Chief Executive Officer of the Company, pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
              Certification
      of Chief Financial Officer of the Company, pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
              Certification
      of Chief Executive Officer and Chief  Financial Officer of the
      Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of
2002.
  23
 Table of Contents
 
 SIGNATURES
  Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
  FOOTSTAR,
      INC.By
              /s/
      JONATHAN M. COUCHMANJonathan
      M. Couchman
                President,
      Chief Executive Officer
                and Chief Financial Officer
                March
      17, 2010
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons in the capacities and on the date
indicated.
  Signature
              
              Title
              Date/s/
      JONATHAN M. COUCHMAN
              
              President
      & Chief Executive
              March  17,
      2010Jonathan
      M. Couchman
              
              Officer
 
 /s/
      JONATHAN M. COUCHMAN
              
              Chief
      Financial Officer &
              March  17,
      2010Jonathan
      M. Couchman
              
              Principal
      Accounting Officer
 
 /s/
      EUGENE I. DAVIS
              
              Director
              March  17,
      2010Eugene
      I. Davis
 
 /s/
      ADAM W. FINERMAN
              
              Director
              March  17,
      2010Adam
      W. Finerman
   24
 Table of Contents
 
 EXHIBIT
INDEX
  EXHIBIT
                  NUMBER
              DESCRIPTION2.1
              Joint
      Plan of Reorganization and related Disclosure Statement as filed with the
      United States Bankruptcy Court for the Southern District of New York (Case
      No. 04-22350(ASH)) on November 12, 2004 (incorporated by reference to
      Exhibit 2.1 and Exhibit 2.2 to Footstar, Inc.’s Current Report on Form 8-K
      filed on November 15, 2004 and to Exhibit 2.1 to Footstar, Inc.’s Current
      Report on Form 8-K filed on November 23, 2004).2.2
              First
      Amended Joint Plan of Reorganization under Chapter 11 of the Bankruptcy
      Code as filed with the Bankruptcy Court for the Southern District of New
      York (Case No. 04-22350 (ASH)) on November 30, 2005 and related Disclosure
      Statement (incorporated by reference to Exhibits 2.1 and 2.2 to Footstar,
      Inc.’s Current Report on Form 8-K filed on December 2, 2005 and to Exhibit
      2.1 to Footstar, Inc.’s Current Report on Form 8-K filed on February 2,
      2006).2.3
              Plan
      of Complete Liquidation of Footstar, Inc. (incorporated by reference to
      Exhibit 2.1 of Footstar, Inc.’s Form 8-K filed on May 09,
      2008).2.4
              Amended
      Plan of Complete Dissolution and Liquidation of Footstar, Inc.
      (incorporated by reference to Annex A of Footstar, Inc.’s definitive
      Proxy Statement filed on April 6, 2009).3.1
              Second
      Amended and Restated Certificate of Incorporation of Footstar, Inc. and
      Certificate of Amendment of Second Amended and Restated Certificate of
      Incorporation of Footstar, Inc. (incorporated by reference to Exhibits 3.1
      and 3.2 to Footstar, Inc.’s Current Report on Form 8-K filed on February
      7, 2006).3.2
              Amended
      and Restated Bylaws of Footstar, Inc. (incorporated by reference to
      Exhibit 3.1 to Footstar Inc.’s Form 8-K filed on July 29,
      2009).4.1
              Rights
      Agreement, dated as of March 8, 1999, between Footstar, Inc. and Chase
      Mellon Shareholder Services, L.L.C. (now Mellon Investor Services LLC), as
      Rights Agent, which includes, as Exhibit A, the Certificate of
      Designation, Preferences and Rights of Series A Junior Participating
      Preferred Stock of Footstar, Inc., as Exhibit B, the Form of Right
      Certificate, and as Exhibit C, the Summary of Rights to Purchase Preferred
      Shares (incorporated by reference to Exhibit 1 to Footstar, Inc.’s Form
      8-A filed on March 9, 1999).4.2
              Amendment
      No. 1 to the Rights Agreement dated as of May 31, 2002, between Footstar,
      Inc. and Mellon Investor Services LLC (formerly chase Mellon Shareholder
      services L.L.C.), as rights agent, which includes as Exhibit C, the
      modified and amended Summary of Rights to Purchase Preferred Shares
      (incorporated by reference to Exhibit 2 to Footstar, Inc.’s Form 8-A/A
      filed on June 4, 2002).4.3
              Amendment
      No. 2 to the Rights Agreement, dated as of February 4, 2009, between
      Footstar, Inc. and Mellon Investor Services LLC (formerly chase Mellon
      Shareholder services L.L.C.), as rights agent (incorporated by reference
      to Exhibit 4.1 to Footstar’s Current Report on Form 8-K filed on February
      4, 2009).  25
 Table of Contents
  EXHIBIT
                      NUMBER
                  DESCRIPTION
 10.1
              Amended
      and Restated Master Agreement dated as of August 24, 2005 by and between
      Kmart Corporation, Sears Holding Corporation as guarantor of payments to
      be made by Kmart Corporation and Footstar, Inc. (incorporated by reference
      to Exhibit 10.1 to Footstar, Inc.’s Current Report on Form 8-K filed on
      August 26, 2005).10.2
              1996
      Incentive Compensation Plan of Footstar, Inc. (incorporated by reference
      to Exhibit 10.3 to Footstar, Inc.’s Amendment No. 5 to Form 10/A filed on
      September 13, 1996).*10.3
              Form
      of Restricted Stock Agreement with Executive Officers (incorporated by
      reference to Exhibit 10.2(a) to Footstar, Inc.’s Amendment No. 1 to Annual
      Report on Form 10-K/A filed on March 16, 2006).*10.4
              Footstar,
      Inc. 2006 Non-Employee Director Stock Plan (incorporated by reference to
      Exhibit 10.1 to Footstar, Inc.’s Current Report on Form 8-K filed on
      February 7, 2006).*10.5
              First
      Amendment, dated June 17, 2008, to Footstar, Inc. 2006 Non-Employee
      Director Stock Plan (incorporated by reference to Exhibit 10.4 to
      Footstar’s Quarterly Report on Form 10-Q filed on August 6,
      2008).*10.6
              Form
      of Restricted Stock Agreement with Non-Employee Directors (incorporated by
      reference to Exhibit 10.3(b) to Footstar, Inc.’s Amendment No. 1 to
      Annual Report on Form 10-K/A filed on March 16, 2006).*10.8
              Employment
      Agreement with Michael J. Lynch dated as of December 16, 2005
      (incorporated by reference to Exhibit 10.3 of Footstar, Inc.’s Current
      Report on Form 8-K filed on December 22, 2005).*10.9
              Employment
      Agreement with Maureen Richards dated as of December 16, 2005
      (incorporated by reference to Exhibit 10.5 of Footstar, Inc.’s Current
      Report on Form 8-K filed on December 22, 2005).*10.10
              Footstar,
      Inc. Senior Executive Base Salary Review (incorporated by reference to
      Item 1.01 of Footstar, Inc.’s Current Report on Form 8-K filed on March
      24, 2006).*10.11
              Employment
      Agreement, by and between Craig Haines and Footstar, Inc., dated as of
      December 30, 2005 (incorporated by reference to Footstar, Inc.’s Current
      Report on Form 8-K filed on March 24, 2006).*10.12
              Employment
      Agreement, by and between Jonathan M. Couchman and Footstar, Inc., dated
      as of December 9, 2008 (incorporated by reference to Footstar Inc.’s
      Current Report on Form 8-K filed on December 9, 2008).*  26
 Table of Contents
  EXHIBIT
                      NUMBER
                  DESCRIPTION
 10.13
              Footstar,
      Inc. Deferred Compensation Plan (incorporated by reference to Exhibit 10.8
      to Footstar, Inc.’s Annual Report on Form 10-K filed on March 28, 1997,
      Reg. No. 001-11681).*10.14
              Supplemental
      Retirement Plan for Footstar, Inc., as Amended and Restated effective on
      June 19, 2002 (incorporated by reference to Exhibit 10.9(a) to Footstar,
      Inc.’s Quarterly Report on Form 10-Q filed on August 13, 2002, Reg. No.
      001-11681).*10.15
              2000
      Equity Incentive Plan (incorporated by reference to Exhibit 10.11 to
      Footstar, Inc.’s Annual Report on Form 10-K filed on March 31, 2000, Reg.
      No. 001-11681).*10.16
              Intellectual
      Property Purchase Agreement, dated as of April 3, 2008, by and among
      Footstar Corporation, Sears Brands LLC and Sears Holdings Corporation
      (incorporated by reference to Exhibit 10.1 of Footstar, Inc.’s Current
      Report on Form 8-K filed on April 04, 2008).10.17
              Master
      Agreement Amendment, dated as of April 3, 2008, by and among Footstar,
      Inc., Kmart Corporation, certain affiliates of Kmart Corporation and Sears
      Holdings Corporation (incorporated by reference to Exhibit 10.2 of
      Footstar, Inc.’s Current Report on Form 8-K filed on April 04,
      2008).10.18
              First
      Amendment to Amended and Restated Exit Credit Agreement dated May 9, 2008
      by and among Footstar, Inc., and Footstar Corporation as Borrowers, the
      Lenders from time to time party thereto, Bank of America, N.A., as
      Administrative Agent for itself and the Lenders, as swingline lender, as
      issuing bank and as collateral agent (incorporated by reference to Exhibit
      10.1 of Footstar, Inc.’s Current Report on Form 8-K filed on May 9,
      2008).10.19
              Second
      Amendment, dated March 31, 2009, to Footstar, Inc. 2009 Non-Employee
      Director Stock Plan (incorporated by reference to Exhibit 10.1 of
      Footstar, Inc.’s Current Report on Form 8-K filed on April 6,
      2009).*21.1
              Subsidiaries
      of Footstar, Inc.31.1
              Certification
      of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              Certification
      of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
              Certification
      of Chief Executive Officer and Chief Financial Officer of the Company,
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.
 *
              Management
      contract or compensatory plan.
 
 27
 Table of Contents
 
 
 INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
  INDEX
              PageReport
      of Independent Registered Public Accounting Firm
              F-2Consolidated
      Statements of  Operations for the Period January 4, 2009 to May
      5, 2009 and the Year Ended January 3, 2009 (Going Concern
      Basis)
              F-3Consolidated
      Statement of Net Assets as of January 2, 2010 (Liquidation Basis) and
      Consolidated Balance Sheet as of January 3, 2009 (Going Concern
      Basis)
              F-4Consolidated
      Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the
      period January 4, 2009 to May 5, 2009 and the Year Ended January 3, 2009
      (Going Concern Basis)
              F-5Consolidated
      Statement of Changes in Net Assets in Liquidation— For the period May 6,
      2009 through January 2, 2010 (Liquidation Basis)
              F-6Consolidated
      Statements of Cash Flows for the Period January 4, 2009 to May 5, 2009 and
      the Fiscal Year Ended January 3, 2009 (Going Concern Basis)
              F-7Notes
      to Consolidated Financial Statements
              F-8
  F-1
 Table of Contents
 
 Report
of Independent Registered Public Accounting Firm
  To the
Board of Directors and Shareholders of Footstar, Inc.:
 
 We have
audited the accompanying consolidated statement of net assets in liquidation
(liquidation basis) of Footstar, Inc. (“the Company”) as of January 2, 2010, and
the related consolidated statement of changes in net assets in liquidation
(liquidation basis) for the period May 6, 2009 to January 2, 2010. We also have
audited the consolidated balance sheet of the Company as of January 3, 2009 and
the related consolidated statements of operations, shareholders’ equity and
comprehensive income (loss), and cash flows for the period January 4, 2009
through May 5, 2009 and the year ended January 3. 2009. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 As
Discussed in Note 1 to the accompanying consolidated financial statements, the
Company’s Kmart Agreement expired by its terms on December 31, 2008 and all
operations with respect to the Kmart business, which represented substantially
all of the Company’s net sales and income ceased.
 
 As
described in Notes 1 and 2 to the consolidated financial statements, the
shareholders of Footstar, Inc. approved a plan of liquidation on May 5, 2009. As
a result, the Company changed its basis of accounting effective May 6, 2009 from
the going-concern basis to a liquidation basis.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated net assets in liquidation
(liquidation basis) as of January 2, 2010 of the Company, the consolidated
changes in net assets in liquidation for the period May 6, 2009 to January 2,
2010, the consolidated financial position at January 3, 2009 and the
consolidated results of their operations and their cash flows for the period
from January 4, 2009 to May 5, 2009 and the year ended January 3, 2009, in
conformity with accounting principles generally accepted in the United States of
America.
 
 
 /s/
Amper, Politziner and Mattia, LLP
 Edison,
New Jersey
 March 17,
2010
  F-2
 Table of Contents
  Consolidated
Statements of Operations - For the period of January 4, 2009 through May 5, 2009
 and
the Year Ended January 3, 2009 (Going Concern Basis)
 (amounts
in millions, except per share amounts)
  For
      the period January 4, 2009 to May 5, 2009
              
              
              For
      the year ended January 3, 2009RevenueNet
      sales
              
              $
              --
              
              
              $
              580.0Liquidation
      of Inventory
              
              
              2.5
              
              
              
              54.2Total
      Sales
              
              
              2.5
              
              
              
              634.2Costs:Cost
      of revenue
              
              
              --
              
              
              
              396.7Cost
      of revenue – liquidation of inventory
              
              
              --
              
              
              
              59.1Total
      Cost
              
              
              --
              
              
              
              455.8Total
      Gross Profit
              
              
              2.5
              
              
              
              178.4Store
      operating, selling, general and administrative expenses
              
              
              6.5
              
              
              
              146.8Depreciation
      and amortization
              
              
              --
              
              
              
              4.5Loss
      on impairment of long-lived assets
              
              
              --
              
              
              
              10.8Gain
      on cancellation of retiree benefit plan
              
              
              --
              
              
              
              (22.3
              )Gain
      on sale of intangible assets
              
              
              --
              
              
              
              (10.5
              )Gain
      on expiration of Kmart Agreement
              
              
              --
              
              
              
              (5.0
              )Other
      income
              
              
              (0.3
              )
              
              
              --Interest
      expense
              
              
              --
              
              
              
              1.1Interest
      income
              
              
              --
              
              
              
              (0.7
              )Income
      (loss) before income taxes and discontinued operations
              
              
              (3.7
              )
              
              
              53.7Provision
      for income taxes
              
              
              --
              
              
              
              (1.3
              )Income
      (loss) from continuing operations
              
              
              (3.7
              )
              
              
              52.4Income
      discontinued operations, net of tax
              
              
              --
              
              
              
              1.3Net
      income (loss)
              
              $
              (3.7
              )
              
              $
              53.7Average
      common shares outstandingBasic
              
              
              21.3
              
              
              
              20.9Diluted
              
              
              21.3
              
              
              
              21.1Income
      (loss) per share:Basic:Income
      (loss) from continuing operations
              
              $
              (0.17
              )
              
              $
              2.51Income
      from discontinued operations
              
              
              --
              
              
              
              0.06Net
      income (loss)
              
              $
              (0.17
              )
              
              $
              2.57Diluted:Income
      (loss) from continuing operations
              
              $
              (0.17
              )
              
              $
              2.48Income
      from discontinued operations
              
              
              --
              
              
              
              0.06Net
      income (loss)
              
              $
              (0.17
              )
              
              $
              2.54
 
 See
accompanying notes to consolidated financial statements.
  F-3
 Table of Contents
  Consolidated
Statement of Net Assets as of January 2, 2010 (Liquidation Basis) and
Consolidated
 Balance
Sheet as of January 3, 2009 (Going Concern Basis)
 ($
in millions)
  January
      2, 2010
                
                
                January
      3, 2009Current
      assets:Cash
      and cash equivalents
                
                $
                9.8
                
                
                $
                56.6Receivables
      and other
                
                
                -
                
                
                
                56.8Prepaid
      expenses
                
                
                5.1
                
                
                
                8.3Real
      Estate
                
                
                6.2
                
                
                
                6.2Total
      current assets
                
                
                21.1
                
                
                
                127.9Other
      assets
                
                
                0.2
                
                
                
                1.0Total
      assets
                
                $
                21.3
                
                
                $
                128.9Current
      liabilities:Accounts
      Payable and Accrued Expenses
                
                
                5.3
                
                
                
                21.4Income
      Tax Payable
                
                
                -
                
                
                
                1.3Liabilities
      of discontinued operations
                
                
                -
                
                
                
                0.5Total
      current liabilities
                
                
                5.3
                
                
                
                23.2Other
      long term liabilities
                
                
                6.0
                
                
                
                1.2Total
      liabilities
                
                $
                11.3
                
                
                $
                24.4Shareholders’
      equity:Common
      stock $.01 par value: 100,000,000 shares authorized;
                  32,236,400
      shares issued
                
                
                
                
                
                
                0.3Additional
      paid-in capital
                
                
                
                
                
                
                330.1Treasury
      stock: 10,711,569 shares, at cost
                
                
                
                
                
                
                (310.6
                )Retained
      earnings
                
                
                
                
                
                
                84.1Accumulated
      other comprehensive income
                
                
                
                
                
                
                0.6Total
      shareholders’ equity
                
                
                
                
                
                
                104.5Total
      liabilities and shareholders’ equity
                
                
                
                
                
                $
                128.9Net
      Assets in Liquidation
                
                $
                10.0
  See
accompanying notes to consolidated financial statements.
  F-4
 Table of Contents
  Consolidated
Statements of Shareholders' Equity and Comprehensive Income
 (Going
Concern Basis)
 ($
in millions, except share amounts)
  Common Stock
                  Shares Amount
                
                
                Treasury Stock
                  Shares Amount
                
                
                Add’l
                  Paid-in
                  Capital
                
                
                Retained
      Earnings
                
                
                Accum.
                  Other Compre-
                  hensive
                  Income
                
                
                TotalBalance
      as of December 29, 2007
                
                
                31,836,762
                
                
                $
                0.3
                
                
                
                10,711,569
                
                
                $
                (310.6
                )
                
                $
                328.9
                
                
                $
                51.7
                
                
                $
                8.8
                
                
                $
                79.1Comprehensive
      income:Net
      income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                53.7
                
                
                
                
                
                
                
                53.7Defined
      benefit plans, net of tax (see notes 20 and 21):Amortization
      of prior service credit
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                (0.6
                )
                
                
                (0.6
                )Cancellation
      of post retirement benefit plan
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                (7.7
                )
                
                
                (7.7
                )Amortization
      of gain
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (0.4
                )
                
                
                (0.4
                )Net
      gain
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                0.5
                
                
                
                0.5Total
      comprehensive income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                45.5Special
      cash distribution
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                (21.3
                )
                
                
                --
                
                
                
                (21.3
                )Common
      stock incentive plans
                
                
                399,638
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                1.2
                
                
                
                --
                
                
                
                --
                
                
                
                1.2Balance
      as of January 3, 2009
                
                
                32,236,400
                
                
                $
                0.3
                
                
                
                10,711,569
                
                
                $
                (310.6
                )
                
                $
                330.1
                
                
                $
                84.1
                
                
                $
                0.6
                
                
                $
                104.5Comprehensive
      income:Net
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (3.7
                )
                
                
                
                
                
                
                (3.7
                )Total
      Comprehensive loss
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                (3.7
                )Special
      cash distribution
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                (21.6
                )
                
                
                --
                
                
                
                (21.6
                )Common
      stock incentive plans
                
                
                50,573
                
                
                
                --
                
                
                
                --
                
                
                
                --
                
                
                
                0.8
                
                
                
                --
                
                
                
                --
                
                
                
                0.8Balance
      as of May 5, 2009
                
                
                32,286,973
                
                
                $
                0.3
                
                
                
                10,711,569
                
                
                $
                (310.6
                )
                
                $
                330.9
                
                
                $
                58.8
                
                
                $
                0.6
                
                
                $
                80.0
 See accompanying notes to consolidated
financial statements.
  F-5
 Table of Contents
 
  Consolidated
Statement of Changes in Net Assets in Liquidation
 For
the period May 6, 2009 through
January 2, 2010 (Liquidation Basis)
 ($
in millions)
  For
      the period
                  May
      6, 2009 to January 2, 2010Shareholders'
      Equity at May 5, 2009
              
              $
              80.0Liquidation
      basis adjustments:Adjust
      assets and liabilities to fair value
              
              
              (1.2
              )Accrued
      cost of liquidation
              
              
              (10.0
              )Net
      Assets in Liquidation May 5, 2009
              
              
              68.8Cash
      distribution to shareholders
              
              
              (59.4
              )Change
      in liquidation accrualsAccrued
      Cost of liquidation May 6, 2009 to January 2, 2010
              
              
              (0.1
              )Cost
      incurred May 6, 2009 to January 2, 2010
              
              
              (1.3
              )Decrease
      in State Income Tax
              
              
              0.4Federal
      Income Tax receivable
              
              
              1.1Other
      cash proceeds received
              
              
              0.5Net
      Assets in Liquidation January 2, 2010
              
              $
              10.0
 
 See
accompanying notes to consolidated financial statements.
  F-6
 Table of Contents
  Consolidated
Statements of Cash Flows for the period
 January
4, 2009 to May 5, 2009 and the Year Ended January 3, 2009
 (Going
Concern Basis)
  ($ in
millions)
  For
      the period January 4, 2009 to May 5, 2009
              
              
              For
      the year ended
                January
      3, 2009Cash
      flows from operating activities:Net
      income (loss)
              
              $
              (3.7
              )
              
              $
              53.7Adjustments
      to reconcile net income (loss) to net cash provided
                by
      operating activities:Income
      from discontinued operations, net of tax
              
              
              --
              
              
              
              (1.3
              )Depreciation
      and amortization
              
              
              --
              
              
              
              4.5Gain
      on retiree medical plan cancellation
              
              
              --
              
              
              
              (22.3
              )Gain
      on sale of intellectual property
              
              
              
              
              
              
              (10.5
              )Loss
      in impairment of long-lived assets
              
              
              
              
              
              
              10.8Stock
      incentive plans
              
              
              0.8
              
              
              
              1.2Changes
      in operating assets and liabilities:(Increase)
      decrease in accounts receivable, net
              
              
              56.9
              
              
              
              (45.5
              )Decrease
      (increase) in inventories
              
              
              --
              
              
              
              86.7(Increase)
      decrease in prepaid expenses and other assets
              
              
              1.4
              
              
              
              (3.5
              )Decrease
      in accounts payable, accrued expenses and amount
                due
      under Kmart Settlement
              
              
              (10.3
              )
              
              
              (54.1
              )Decrease
      in income taxes payable and other long-term liabilities
              
              
              (1.2
              )
              
              
              (8.3
              )Net
      cash  provided by operating activities
              
              
              43.9
              
              
              
              11.4Cash
      flows provided by (used in) investing activities:Proceeds
      from sale of intellectual property
              
              
              --
              
              
              
              13.0Net
      cash used in investing activities
              
              
              --
              
              
              
              13.0Cash
      flows used in financing activities:Special
      cash distribution paid
              
              
              (21.6
              )
              
              
              (21.3
              )Payments
      on mortgage note
              
              
              (0.7
              )
              
              
              (1.2
              )Net
      cash used in financing activities
              
              
              (22.3
              )
              
              
              (22.5
              )Cash
      flows from discontinued operations:Net
      cash provided by (used in) operating activities of discontinued
      activities
              
              
              --
              
              
              
              0.9Net
      increase (decrease) in cash – discontinued operations
              
              
              --
              
              
              
              0.9Net
      increase (decrease) in cash and cash equivalents
              
              
              21.6
              
              
              
              2.8Cash
      and cash equivalents, beginning of period
              
              
              56.6
              
              
              
              53.8Cash
      and cash equivalents, end of period
              
              $
              78.2
              
              
              $
              56.6
 
 See
accompanying notes to consolidated financial statements.
  F-7
 Table of Contents
  1.           Nature
of Company
  Background
  Footstar,
Inc. (“Footstar”, the “Company”, “we”, “us”, or “our”) is a holding company that
operated its businesses through its subsidiaries which principally operated as a
retailer selling family footwear through licensed footwear departments in Kmart
Corporation (“Kmart”) stores. These operations comprised substantially all of
our sales and profits.
 
 Commencing
March 2, 2004, Footstar and most of its subsidiaries filed voluntary petitions
for reorganization under Chapter 11 of Title 11 of the United States Code in the
United States Bankruptcy Court.
 
 On
February 7, 2006, we successfully emerged from bankruptcy and paid substantially
all our creditors in full with interest.
  Dissolution
and Liquidation of the Company’s Business.
  As part
of its emergence from bankruptcy in February 2006, substantially all of the
Company’s business operations consisted of running licensed footwear departments
in Kmart stores pursuant to an Amended and Restated Master Agreement among
Kmart, Sears Holding Corporation (“Sears”) and the Company (as amended, the
“Kmart Agreement”) . The Kmart Agreement expired by its terms at the end of 2008
and during the first quarter of 2009, the Company received approximately $55.3
million from Kmart related to the liquidation sale of inventory.
  In May
2008 the Board of Directors determined that it is in the best interests of the
Company and its shareholders to liquidate and ultimately dissolve after the
expiration of the Kmart Agreement in December 2008 (and other miscellaneous
contracts through the end of such term) and to sell and/or dispose of any of the
Company’s other remaining assets, including its owned property in Mahwah, New
Jersey, which contains its corporate headquarters building, improvements and 21
acres of underlying land (“collectively, the “Mahwah Real Estate”). In May 2008,
the Board of Directors approved the Plan of Complete Liquidation of Footstar,
Inc. (the “Original Plan”), which provided for the complete liquidation and
ultimate dissolution of the Company after expiration of the Kmart Agreement on
December 31, 2008.
  The Board
amended the Original Plan on March 5, 2009.  The Amended Plan of
Complete Dissolution and Liquidation of Footstar, Inc. (the “Plan of
Dissolution”)  reflects technical and legal changes to the Original
Plan consistent with Delaware corporate law and is intended to modify, supersede
and replace the Original Plan in order to more efficiently facilitate the
liquidation and dissolution of the Company in the best interests of
shareholders.  The Plan of Dissolution provides for the complete,
voluntary liquidation of the Company by providing for the sale of its remaining
assets and the wind-down of the Company’s business as described in the Plan of
Dissolution and for distributions of available cash to shareholders as
determined by the Board of Directors (the “Dissolution”).
  In
connection with the anticipated liquidation, wind-down and ultimate dissolution
of the Company, the Company will, when and as determined by the Board of
Directors in its absolute discretion, pay, or make adequate provision for
payment of, all known and uncontroverted liabilities of the Company (including
indemnification obligations and expenses associated with the liquidation and
dissolution of the Company and the satisfaction in full of the obligations of
the Company) and will set aside from its cash-on-hand such additional amount as
the Board of Directors in its absolute discretion determines to be appropriate
from time to time in connection with other, unascertained or contingent,
liabilities of the Company.
  F-8
 Table of Contents
  From 2007
through January 2, 2010, the Company’s Board of Directors declared and paid cash
distributions to shareholders in the amount of $9.75 per common share or $207.1
million.
  On
February 24, 2010, the Company announced that its Board of Directors declared a
special cash distribution to shareholders in the amount of $.10 per common
share. The Company recorded the distribution effective the date the declaration
was made by the Board of Directors. The special cash distribution totaling $2.2
million was paid on March 12, 2010 to the holders of record at the close of
business on March 8, 2010.
  On
February 24, 2010, the Company announced it anticipates it will not make any
further distributions until the monetization of the Mahwah Real
Estate.
  The
aggregate amount of any remaining liquidation distribution to our shareholders
is expected to be in the range of $.38 to $.46 per common share (before giving
effect of the $.10 per share liquidating distribution paid on March 12,
2010).  However, uncertainties as to the ultimate amount of our
liabilities make it impossible to predict with certainty the actual aggregate
net amounts that will ultimately be available for distribution to shareholders
or the timing of any such distributions.  Such amount and timing will
depend on a number of factors, several of which cannot be determined at this
time, including:
  1)
              the
      ultimate amount of our known, unknown and contingent debts and
      liabilities;
  2)
              the
      fees and expenses incurred by us in the liquidation of our assets;
      and
  3)
              the
      ultimate proceeds from the sale of the Mahwah Real
  Estate.
  As a
result, the amount of cash remaining following completion of our liquidation
could vary significantly from our current estimates.
  2.           Basis
of Presentation
  Basis
of Presentation
  The
consolidated financial statements for the period January 4, 2009 through May 5,
2009 and for the fiscal year 2008 were prepared on the going concern basis of
accounting, which contemplates realization of assets and satisfaction of
liabilities in the normal course of business.  As a result of the
shareholders’ approval of the Plan of Dissolution, the Company adopted the
liquidation basis of accounting effective May 6, 2009.  This basis of
accounting is considered appropriate when, among other things, liquidation of a
company is probable and the net realizable values of assets are reasonably
determinable.  Under this basis of accounting, assets are valued at
their net realizable values and liabilities are stated at their estimated
settlement amounts.
  The
conversion from the going concern to liquidation basis of accounting required
management to make significant estimates and judgments.  In order to
record assets at estimated net realizable value and liabilities at estimated
settlement amounts under the liquidation basis of accounting, the Company
recorded the following adjustments to record its assets and liabilities at fair
value as of May 6, 2009, the date of adoption of the liquidation basis of
accounting:
  ($
      in millions)Adjust
      assets and liabilities to fair value:Write
      down of Other Assets
              
              $
              1.2Total
              
              $
              1.2
  
 F-9
 Table of Contents
 
 Accrued
Cost of Liquidation
  Under the
liquidation basis of accounting, the Company has accrued for the estimated known
costs to be incurred in liquidation, as follows:
  ($
      in millions)Compensation
      and Benefits Costs
              
              $
              3.3Professional
      Fees, Board of Director Fees, and Insurance Costs
              
              
              2.8General
      Administrative and Other Costs
              
              
              1.5Headquarter
      Building Costs
              
              
              2.4Total
      Estimated Expenses
              
              $
              10.0
 
 In order
to record assets at estimated net realizable value and liabilities at estimated
settlement amounts under the liquidation basis of accounting, the Company
recorded a $10.0 million liquidating expense accrual on its balance sheet as of
May 5, 2009, the date of adoption of the liquidation basis of
accounting.  The Company converted to liquidation accounting effective
May 6, 2009.
  The
Company will continue to incur certain operating costs and receive income on its
investments throughout the liquidation period.  On a regular basis, we
will evaluate our assumptions, judgments and estimates that can have a
significant impact on our reported net assets in liquidation based on the most
recent information available to us, and when necessary make changes
accordingly.  Actual costs and income may differ from our estimates,
which might reduce net assets available in liquidation to be distributed to
shareholders.  Subsequent to the adoption of the liquidation basis of
accounting, during the period May 6, 2009 to January 2, 2010, the Company
recorded a net increase in liquidating expense accrual of $0.1 million and
received cash proceeds from the sale of certain assets of $0.5
million.
  The
company does not expect to make any further distributions until such time as it
has monetized its Mahwah Real Estate, following which, the Company expects to
make further distributions to its shareholders of its remaining cash, less any
amount applied to or reserved for actual or contingent liabilities (which may be
deposited in a liquidating trust).  The amounts reserved will be based
on a determination by the board of directors, derived from consultation with
management and outside experts, if the board of directors determines that it is
advisable to retain such experts, and a review of, among other things, our
estimated contingent liabilities and our estimated ongoing expenses, including,
but not limited to, payroll, legal expenses, regulatory filings and other
miscellaneous expenses.  Each shareholder will receive its pro rata
share of each distribution based on the number of shares held on the record date
for such distribution. If at the end of the statutory three-year dissolution
period on May 5, 2012, the Company has unsettled liabilities
(i.e.  Office Lease Guarantee, etc) as more fully discussed in Note 9,
it may determine to transfer its remaining assets and liabilities to a
liquidating trust.
  Cash
and Cash Equivalents
  Cash and
cash equivalents consist of highly liquid instruments with maturities of three
months or less from the date acquired and stated at cost that approximates their
fair market value. At times the Company has cash and cash equivalents balances
in excess of the FDIC and SIPC insured limits.
  F-10
 Table of Contents
  Comprehensive
Income (Loss)
  The
components of comprehensive income (loss) consisted of the following (in
millions):
  For
      the period
                  January
      4, 2009 to
                  May
      5, 2009
              
              
              For
      the year ended January 3, 2009Comprehensive
      Income (Loss):Net
      Income (loss)
              
              $
              (3.7
              )
              
              $
              53.7Defined
      postretirement benefit plan, net of tax:
              
              
              -
              
              
              
              (7.7
              )Amortization
      of prior service credit
              
              
              -
              
              
              
              (0.6
              )Amortization
      of actuarial gain
              
              
              -
              
              
              
              (0.4
              )Net
      Gain
              
              
              -
              
              
              
              0.5Comprehensive
      Income (Loss)
              
              $
              (3.7
              )
              
              $
              45.5
 
 Insurance
Liabilities
  We were
primarily self-insured for health care costs for fiscal 2007 and
prior.  We were self-insured for workers’ compensation insurance for
fiscal 2004 and prior.  Our health care and workers’ compensation
insurance (fiscal 2004 and prior) had a deductible of $250,000, property
insurance with deductibles ranging between $25,000 to $100,000 and general
liability insurance with no deductible.  For self-insured claims,
provisions are made for our actuarially determined estimates of discounted
future claim costs for such risks. Commencing in 2005, the Company is no longer
self-insured for workers’ compensation insurance and we maintained workers’
compensation insurance with no deductible. Commencing January 1, 2008, the
Company entered into premium based health care programs and therefore is no
longer self-insured for health care costs.
  Earnings
(Loss) Per Share
  Basic
earnings (loss) per share (“EPS”) is computed by dividing net (loss) income
available for common shareholders by the weighted average number of common
shares outstanding for the period.  Diluted EPS is computed by
dividing net (loss) income available to common shareholders by the weighted
average shares outstanding, after giving effect to the potential dilution that
could occur if outstanding options or other contract or obligations to issue
common stock were exercised or converted.
  The
following table reflects average shares outstanding used to compute basic and
diluted (loss) earnings per share (in millions):
  For
      the period January 4, 2009 to May 5, 2009
              
              
              For
      the year ended January 3, 2009Average
      shares outstanding
              
              
              21.3
              
              
              
              20.9Average
      contingently issuable  shares (1)
              
              
              -
              
              
              
              -Average
      shares outstanding – basic
              
              
              21.3
              
              
              
              20.9Average
      shares outstanding – diluted
              
              
              21.3
              
              
              
              21.1
 
 (1)
              The
      computation of diluted EPS does not assume conversion, exercise or
      issuance of shares that would have an anti-dilutive effect on
      EPS.  During the period of January 4, 2009 – May 5, 2009 we had
      a net loss; as a result, any assumed conversions would result in reducing
      the loss per share and, therefore, are not included in the
      calculation.  Shares which were not included in the calculation
      of diluted EPS because to do so would have been anti-dilutive, totaled
      260,125 shares for the period of January 4, 2009 – May 5, 2009 and 327,725
      shares at January 3, 2009.
  F-11
 Table of Contents
  Fair
Value of Financial Instruments
  Cash and
cash equivalents, accounts receivable, accounts payable and accrued expenses are
reflected in the consolidated statement of net assets and balance sheet at
carrying value, which approximates fair value due to the short-term nature of
these instruments and the variability of the respective interest rates where
applicable.  The carrying value of the mortgage, which approximated
fair value due to its short-term nature, was $.7 million and $2.0 million as of
January 2, 2010 and January 3, 2009, respectively.
  Reclassification
of Prior Year Balances
  Certain
prior year balances have been reclassified to conform to the current period
financial statement presentation. This reclassification has no impact on
Reported Earnings, New Worth, or Cash Flows for prior fiscal
periods.
  3.           Reduction
in Workforce
  The
Company currently has five employees, which includes one officer, to assist in
the liquidation process.  Cash payments to terminated employees
totaling approximately $5.5 million were paid during the period of January 4,
2009 to May 5, 2009.  As of January 2, 2010, the Company has an
accrual of approximately $39,000 relating to severance and benefit costs
included in accrued expenses.  In order to continue to retain key
employees as it liquidates its businesses, the Company may commit to additional
cash charges when and if such plans are approved by the Board of
Directors.
  The
following is a reconciliation of the beginning and ending severance and benefit
costs accrual as of January 2, 2010 (in millions):
  January
      2, 2010Balance
      at January 3, 2009
              
              $
              6.76Costs
      charged to expense
              
              
              1.25Cash
      payments
              
              
              (7.97
              )Ending
      balance of termination benefits accrual
              
              $
              0.04
 
 4.           Discontinued
Operations
  In April
2008, the Company entered into an agreement with CVS Pharmacy, Inc. (“CVS”), its
former parent entity, pursuant to which CVS agreed to assume any and all of
Footstar’s obligations with respect to the environmental
remediation.  The assumption by CVS eliminated the previously recorded
obligation of $1.6 million for cash consideration of $0.9 million, resulting in
a gain of $0.7 million, net of tax, included in income from discontinued
operations.
  In
addition, in February 2008, the Company received $0.6 million, net of tax, due
to a settlement of a class action lawsuit relating to the Company’s Athletic
segment, which was discontinued in 2004.
  5.           Impact
of Recently Issued Accounting Standards
  In June
2009, the Financial Accounting Standards Board (“FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168 – “The FASB
Accounting Standards ASC Topic and the Hierarchy of Generally Accepted
Accounting Principles a replacement of FASB Statement No.
162”.  (“SFAS NO. 168”).  SFAS No. 168 made the FASB
Accounting Standards Codification (the “ASC”) the single source of U.S.
Generally Accepted Accounting Policies (“U.S. GAAP”) used by nongovernmental
entities in the preparation of financial statements, except for rules and
interpretive releases of the SEC under authority of federal securities laws
which are sources of authoritative accounting guidance for SEC
registrants.  The ASC is meant to simplify user access to all
authoritative accounting guidance by reorganizing U.S. GAAP pronouncements into
roughly 90 accounting topics within a consistent structure: its purpose in not
to create new accounting and reporting guidance.  The ASC superseded
all existing non-SEC accounting and reporting standards and was effective for
the Company beginning July 1, 2009.  Following SFAS No. 168, the Board
will not issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issues Task Force Abstracts; instead, it will issue Accounting
Standards Updates.  The FASB will not consider Accounting Standards
Updates (“ASU”) as authoritative in their own right; these updates will serve
only to update the ASC topic, provide background information about the guidance,
and provide the bases for conclusions on the change(s) in the ASC.  In
the description of ASC and ASU that follows, references relate to ASC or ASU
topics and their descriptive titles, as appropriate.
  F-12
 Table of Contents
  Effective
January 1, 2008, the Company adopted FASB ASC Topic 820, “Fair Value Measurement
and Disclosure,” which defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles and expands disclosure
about fair value measurements.  The Company uses the following methods
for determining fair value in accordance with FASB ASC Topic 820.  For
assets and liabilities that are measured using quoted prices in active markets
for the identical asset or liability, the total fair value is the published
market price per unit multiplied by the number of units held without
consideration of transaction costs (Level 1).  Assets and liabilities
that are measured using significant other observable inputs are valued by
reference to similar assets or liabilities, such as quoted prices for similar
assets or liabilities, quoted prices in markets that are not active, or other
inputs that are observable or can be corroborated by observable market data
(Level 2).  For all remaining assets and liabilities for which there
are no significant observable inputs, fair value is derived using an assessment
of various discount rates, default risk, credit quality and the overall capital
market liquidity (Level 3).
  The
following table summarizes the basis used to measure certain financial assets
and liabilities at fair value on a recurring basis in the consolidated balance
sheet:
  Fair
Value Measurements at January 2, 2010 Using
  (In
      millions)
                  
                  Description
                
                Balance
      at
                    January
      2, 2010
                
                
                Quoted
      Prices
                  in
      Active
                  Markets
      for
                  Identical
      Items
                  (Level
      1)
                
                
                Significant
                  Other
                  Observable
                  Inputs
                  (Level
      2)
                
                
                Significant
                    Unobservable
                    Inputs
      (Level 3)Cash
      in bank
                
                $
                0.5
                
                
                $
                0.5
                
                
                $
                -
                
                
                $
                -Money
      Market Funds
                
                
                9.3
                
                
                
                9.3
                
                
                
                -
                
                
                
                -Mahwah
      Real Estate
                
                
                6.2
                
                
                
                -
                
                
                
                -
                
                
                
                6.2
 
 Money
Market Funds – money market funds are valued using quoted market
prices.  Accordingly, money market funds are categorized in Level 1 of
the fair value hierarchy.
  See Note
7 for discussion on Mahwah Real Estate Valuation.
  F-13
 Table of Contents
  6.           Accounts
Receivable
  Accounts
receivable consisted of the following (in millions):
  2009
              
              
              2008Due
      from Kmart
              
              $
              --
              
              
              $
              54.3Other
      – primarily trade
              
              
              --
              
              
              
              2.6--
              
              
              
              56.9Less:   Allowance
      for doubtful accounts
              
              
              --
              
              
              
              (0.1
              )Total
              
              $
              --
              
              
              $
              56.8
 
 7.           Mahwah
Real Estate
  In
connection with the expiration of the Kmart Agreement, the Company has been
marketing its Mahwah Real Estate which was classified as assets held for sale at
January 3, 2009.  As of January 2, 2010, the Company estimates that
the fair value of the real estate, less estimated closing costs, is
approximately $6.2 million. This estimate is based on unobservable inputs
including real estate broker estimate and property assessment. There was no
change in this value from January 3, 2009 to January 2, 2010.
  8.           Prepaid
Expenses and Other Current Assets
  Prepaid
expenses and other current assets consisted of the following (in
millions):
  2009
              
              
              2008Income
      tax refund receivable and other prepaid taxes
              
              $
              1.3
              
              
              $
              0.6Cash
      collaterized letters of credit
              
              
              3.8
              
              
              
              7.1Other
              
              
              --
              
              
              
              0.6Total
              
              $
              5.1
              
              
              $
              8.3
 
 9.           Accrued
Expenses
  Accrued
expenses consisted of the following (in millions):
  2009
              
              
              2008Taxes
      other than federal income taxes
              
              $
              --
              
              
              $
              0.3Salaries
      and bonus
              
              
              --
              
              
              
              8.8Employee
      benefit costs
              
              
              --
              
              
              
              6.9Mortgage
              
              
              0.7
              
              
              
              2.0Liquidation
      Accrual - Short-Term
              
              
              3.5
              
              
              
              --Workers
      Compensation - Short-Term
              
              
              0.3
              
              
              
              --Other
      – individually not in excess of 5%
              
              
              0.8
              
              
              
              3.4Total
              
              $
              5.3
              
              
              $
              21.4
 
 10.           Credit
Facility
  In the
past, we have entered into standby letters of credit to secure certain
obligations, including insurance programs and duties related to the import of
our merchandise.  As of January 2, 2010, we had standby letters of
credit which were cash collateralized at 103% of face value, plus a reserve for
future fees (the “L/C Cash Collateral”) totaling $3.8 million, with Bank of
America as issuing bank.  In connection therewith, Bank of America has
been granted a first priority security interest and lien upon the L/C Cash
Collateral.  Amounts will be refunded to the Company as the letters of
credit are reduced, terminated or expired.  Amounts are included in
prepaid expenses (see Note 8). As of February 8, 2010, the Company’s letters of
credit obligation decreased by $1.0 million resulting in the release by Bank of
America of $1.1 million in cash collateral.
  F-14
 Table of Contents
  11.           Other
Long-Term Liabilities
  Other
long-term liabilities consisted of the following (in millions):
  2009
              
              
              2008Workers
      compensation - LT
              
              $
              1.0
              
              
              $
              1.2Liquidation
      accrual - LT
              
              
              5.0
              
              
              
              --Total
              
              $
              6.0
              
              
              $
              1.2
 
 12.           Income
Taxes
  The
provision for income taxes was comprised of the following (in
millions):
  For
      the period January 4, 2009 to May 5, 2009
              
              
              For
      the year ended January 3. 2009Federal
              
              $
              --
              
              
              $
              --State
              
              
              --
              
              
              
              1.3Total
              
              $
              --
              
              
              $
              1.3
 
  
 The 2008
income tax provision relates to the estimated income tax obligation of our
stores located in Puerto Rico, Guam and the Virgin Islands, which do not have
net operating losses available to offset income.  The Company did not
have any operations in these locations during the period ended January 2,
2010.
  Income
tax expense differs from the “expected” income tax expense computed by applying
the U.S. federal income tax of 35% to income before income taxes as follows (in
millions):
  For
      the period January 4, 2009 to May 5, 2009
              
              
              For
      the year ended January 3. 2009Computed
      “expected” income tax  expense (benefit)
              
              $
              (1.3
              )
              
              $
              18.8Increases
      (decreases) in income taxes resulting from:State
      income taxes, net of federal tax benefit
              
              
              --
              
              
              
              1.1Other
              
              
              --
              
              
              
              (1.3
              )Valuation
      allowance
              
              
              1.3
              
              
              
              (17.3
              )Net
      income tax expense
              
              $
              --
              
              
              $
              1.3
 
 Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.
  Significant
components of our deferred tax asset and liabilities for the 2009 and 2008
fiscal years were as follows (in millions):
  2009
              
              
              2008Deferred
      tax assets:Employee
      benefits
              
              $
              0.5
              
              
              $
              2.5NOL
      carryforward
              
              
              46.1
              
              
              
              41.3Tax
      credit carryforward
              
              
              --
              
              
              
              1.1Property
      and equipment
              
              
              4.6
              
              
              
              5.1Other
              
              
              --
              
              
              
              0.1Total
      gross deferred tax assets
              
              
              51.2
              
              
              
              50.1Less
      valuation allowance
              
              
              (51.2
              )
              
              
              (50.1
              )Total
      deferred tax assets
              
              $
              --
              
              
              $
              --
 
 F-15
 Table of Contents
  As of
January 2, 2010, we have net operating loss carry forwards for federal income
tax purposes of approximately $119.8 million that, if not utilized, will begin
expiring for federal purposes in 2025 and state net operating losses that have
already begun expiring.  Utilization of the net operating loss carry
forwards may be subject to an annual limitation in the event of a change in
ownership in future years as defined by Section 382 of the Internal Revenue Code
and similar state provisions.
 
  In
assessing the realizability of deferred taxes, we consider whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized based on projections of our future taxable earnings.  The
ultimate realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which those temporary differences
become deductible.
  As of
January 2, 2010 we have recorded net deferred tax assets of $51.2 million and a
related valuation allowance of $51.2 million.  In connection with the
preparation of our fiscal years 2009 and 2008 consolidated financial statements,
we reviewed the valuation of our deferred tax assets based on objective positive
evidence along with negative evidence, such as operational uncertainties, no
taxable income in carryback period, and the liquidation of our Kmart business on
December 31, 2008.  For accounting purposes, we cannot rely on
anticipated long-term future profits to utilize our deferred tax
assets.  As a result, we could not conclude that it is more likely
than not that certain deferred tax assets will be realized and have recorded a
non-cash valuation allowance on our net deferred tax asset.
  During
fiscal years 2009 and 2008 the Company recorded an increase (decrease) of the
valuation allowance of $1.1 million and ($17.3) million
respectively.
  As of
January 2, 2010, all of the Company’s deferred tax assets continue to be subject
to a full valuation allowance, including the net operating losses available to
offset future taxable income.
  On
November 5, 2009, the Worker, Homeownership, and Business Assistance Act of 2009
was enacted and allowed businesses with net operating losses for 2008 or 2009 to
carry back those losses for up to five years. The Company expects to realize
income tax refund in the approximate amount of $1.1 million and has record the
related receivable.
  13.           Share-Based
Compensation Plans
  Our
effective stock incentive plans include the shareholder-approved 1996 Incentive
Compensation Plan (the “1996 Plan”) and the non-shareholder-approved 2000 Equity
Incentive Plan (the “2000 Plan”), which is to be used exclusively for
non-executive officers of the Company.  Under the 1996 Plan, a maximum
of 3,100,000 shares may be issued in connection with stock options, restricted
stock, deferred stock and other stock-based awards, of which 1,621,873 are
available for issuance.  Under the 2000 Plan, a maximum of 2,000,000
shares may be issued in connection with stock options, restricted stock,
deferred stock and other stock-based awards, of which 1,752,442 are available
for issuance. The number of shares of common stock available under such plans is
subject to adjustment for recapitalization, merger, and other similar
events.
 
 On May 5,
2009, the Company de-registered all of the securities registered under the 1996
Incentive Compensation Plan and the 2000 Equity Incentive Plan that remained
unsold as of this date. The Company has no plans to make any additional grants
under any of these plans.
  F-16
 Table of Contents
 
 The
following table provides information relating to the potential dilutive effect
and shares available for grant under each of our stock compensation
plans.
 
 Plan
      Category
              
              Number
      of Shares to be Issued upon Exercise of Outstanding
      Options/Awards
              
              
              Weighted
      Average Exercise Price of Outstanding Options
              
              
              Number
      of Shares
                Issued,
                Inception
      to Date as of 1/2/2010
              
              
              Number
      of Shares Remaining Available for Future Issuance, as of
      1/2/2010
              
              
              Number
      of Shares Remaining Available for Future Issuance, as of
      1/3/20091996
      Incentive Compensation Plan
              
              
              546,394
              
              
              $
              15
              
              
              
              931,733
              
              
              
              1,621,873
              
              
              
              1,621,8732000
      EquityIncentive
      Plan
              
              
              101,215
              
              
              $
              32
              
              
              
              146,343
              
              
              
              1,752,442
              
              
              
              1,752,442Total
              
              
              647,609
              
              
              $
              15
              
              
              
              1,078,076
              
              
              
              3,374,315
              
              
              
              3,374,315
  The table
below provides information relating to deferred restricted stock units and
performance-based stock awards:
 
 Deferred
      Restricted Stock Units and Shares and Performance-Based Stock
      AwardsDeferred
                Shares
      and Units
              
              
              Weighted
      Average Grant Date Fair ValueNon-vested,January
      3, 2009
              
              
              189,383
              
              
              $
              4Granted
              
              
              --
              
              
              
              --Canceled
              
              
              --
              
              
              
              --Vested
              
              
              (189,383
              )
              
              $
              4Non-vested,
      January 2, 2010
              
              
              --
              
              
              
              --
 
 As of
January 2, 2010 there was $0 million of unrecognized compensation costs related
to restricted stock and performance-based awards. The total fair value of shares
vested during 2009 and 2008 was $0.2 million, $1.4 million,
respectively.
 
 Stock
Options
  The
Company records stock based compensation in accordance with FASB ASC Topic 718
“Compensation – Stock Compensation,” which requires all companies to measure and
recognize compensation expense at fair value for all stock-based payments to
employees and directors.  The Company uses the Black-Scholes
option-pricing model to estimate fair value of grants of employee and director
stock options.
  The
Company calculates expected volatility for a share-based grant based on historic
daily stock price observations of our common stock during the period immediately
preceding the grant that is equal in length to the expected term of the
grant.  FASB ASC Topic 718 also requires that estimated forfeitures be
included as a part of the estimate of expense as of the grant
date.  The Company has used historical data to estimate expected
employee behaviors related to option term, exercises and
forfeitures.  With respect to both grants of options and awards of
restricted stock, the risk free rate of interest is based on the U.S. Treasury
rates appropriate for the expected term of the grant or award.  Stock
option expense relating to stock options was $0 for the period of January 4,
2009 – May 5, 2009.  A summary of option activity as of January 2,
2010 and changes during the twelve months ended is presented below.
  F-17
 Table of Contents
  Shares
              
              
              Weighted
      Average
                  Exercise
      PriceBalance
      : January 3, 2009
              
              
              323,725
              
              
              $
              30.58Granted
              
              
              -
              
              
              
              -Exercised
              
              
              -
              
              
              
              -Forfeited
              
              
              (132,485
              )
              
              $
              29.57Balance
      : January 2, 2010
              
              
              191,240
              
              
              $
              31.28Options
      Exercisable: January 2, 2010
              
              
              191,240
              
              
              $
              31.28
 
 For 2009
and 2008 there was a charge for stock option-based compensation expense. As of
January 2, 2010 and January 3, 2009 there was $0 total unrecognized compensation
costs related to stock options.
  2006
Non-Employee Director Stock Plan
  On our
emergence from bankruptcy on February 7, 2006, the 2006 Non-Employee Director
Stock Plan (the “2006 Plan”) became effective.  Pursuant to its terms,
no further grants are permitted to be made under the 2006 Plan.
  The 2006
Director Stock Plan provided for an automatic initial grant of 10,000 shares of
restricted common stock to each eligible director.  Beginning with the
2007 annual meeting of the Company, the Company made additional, annual grants
to each eligible director of 10,000 shares of restricted common stock, or such
other amount determined by the Board of Directors of the Company (the “Board”),
subject to the provisions of the 2006 Director Stock Plan. In connection with
the annual grant in 2007, the Board determined that for equitable reasons 20,965
shares of restricted stock should be granted to each eligible director instead
of the 10,000 shares that would otherwise have been automatically granted under
the terms of the plan. All prior grants were fully vested in 2009 upon the
adoption of the Plan of Dissolution.
  In
addition to the grants eligible directors received under the 2006 Plan, each
non-employee director of the Company shall receive $50,000 annually, which shall
be paid quarterly in cash in equal installments, unless any such director elects
to receive common stock in lieu of cash.
  F-18
 Table of Contents
  The
following table provides information relating to the status of, and changes in,
stock units granted under the 2006 Plan:
  Director
      Stock Plan UnitsStock
      Units
              Weighted
      Average Grant Date Fair ValueNon-vested,
      January 3, 2009
              174,964
              $5Granted
              55,000
              $3Cancelled
              (38,965)Shares
      Vested
              (190,999)
              $3Non-vested,  January
      2, 2010
              --
              $--
  The total
fair value of shares vested during 2009 and 2008 was $0.5 million and $0.6
million, respectively.
 
 14.           Commitments
and Contingencies
  Kmart
Relationship
  The Kmart
Agreement expired at December 31, 2008.
  Litigation
Matters
  The
Company is involved in various and routine litigation matters, which arise
through the normal course of business.  Management believes that the
resolution of these matters will not have a material adverse effect on the final
liquidation of the Company.  While it firmly maintains that all
pending claims are meritless, the Company will continue to expend costs as it
vigorously defends against these claims.
  In
connection with the Company’s discontinued operations in 1995, the Company
entered into a sublease formerly occupied by its Thom McAn stores. The lease
expires effective February 1, 2014. The obligation under the sublease is $3.1
million, although the Company believes that there has been a novation of its
obligations under such lease and may in the future bring litigation to have a
court finally determine such issue. If we are unable to resolve this matter
prior to the conclusion of our statutory dissolution period on May 6, 2012, we
may be required to fund a Liquidating Trust with $1.5 million until such time as
the matter is concluded.
  15.           Shareholder
Rights Plan
  On March
9, 1999, the Company’s Board of Directors approved the adoption of a Shareholder
Rights Agreement, dated as of March 8, 1999, as amended as of May 31, 2002 and
February 4, 2009 (as amended, the “Rights Agreement”), which expires March 8,
2012. Under the Rights Agreement, Preferred Stock Purchase “Rights” have been
distributed as a dividend to shareholders at the rate of one Right for each
share of common stock outstanding. Initially, the Rights are not exercisable.
Upon a “trigger event,” each Right entitles its holder (other than the holder
who caused the trigger event) to purchase at an “Exercise Price” of $100 the
equivalent of that number of shares of common stock of the Company worth twice
the Exercise Price.
  The
Rights are exercisable only if a person or group that is not currently a 4.75
percent shareholder acquires beneficial ownership of 4.75 percent or more of the
Company’s common stock. In addition, stock repurchases by the Company do not
constitute a trigger event under any circumstances. Shareholders who owned more
than 4.75 percent of the stock as of February 4, 2009 or increase their
ownership percentage as a result of the Company’s share repurchases are
“grandfathered” under this plan as long as they do not purchase additional
shares.
  F-19
 Table of Contents
  The
Company is entitled, but not required, to redeem the Rights at a price of $0.01
per Right at any time prior to the earlier of the trigger or expiration of the
Rights.
  16.           Supplemental
Cash Flow Information
  Cash
payments for income taxes and interest from continuing operations for the fiscal
years ended January 2, 2010 and January 3, 2009 were as follows (in
millions):
  2009
              
              2008Income
      taxes (received) paid
              
              $0.5
              
              $(1.2)Interest
      received
              
              --
              
              $0.8Interest
      paid
              
              --
              
              $1.2
 
 17.           Subsequent
Events
  On March
15, 2010, the Company issued shares of common stock having an aggregate grant
date fair value of $50,000, or 217,391 shares, to each of Adam Finerman and
Eugene Davis, the Company’s non-employee directors, in lieu of cash compensation
for their service as directors in 2010 to which they would otherwise be
entitled. The Company believes that compensating the non-employee directors in
the form of common stock in lieu of cash better aligns the interests of the
Company and the non-employee directors.
 
 On March
15, 2010, the Company issued shares of common stock having an aggregate grant
date fair value of $500,000, or 2,173,913 shares, to Jonathan M. Couchman, the
Company’s President, Chief Executive Officer and Chief Financial Officer, in
lieu of cash compensation for base salary for Mr. Couchman’s services as
President, Chief Executive Officer and Chief Financial Officer for the twelve
months commencing March 1, 2010. The Company believes that compensating Mr.
Couchman in the form of common stock in lieu of cash better aligns his interests
with those of the Company.
 
 On March
15, 2010, Mr. Couchman was also awarded a stock option to purchase up to
2,500,000 shares of the Company’s common stock at an exercise price of $0.40 per
share (after giving effect to the liquidating cash dividend of $0.10 paid on
March 12, 2010). On the date of the grant, the closing stock price of the
Company’s stock price was $0.23. The stock option was fully vested at the time
of the grant. The stock option expires upon the earlier of the tenth anniversary
of the grant date and the payment of the final liquidation distribution to the
Company’s shareholders. The Company believes that granting a stock option with
an exercise price substantially above both the estimated liquidation value per
share and market price per share at the time of the grant will further incentive
Mr. Couchman to work to maximize distributions to shareholders.
  F-20