SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Commission File Number 1-11681

FOOTSTAR, INC.

(Exact name of registrant as specified in its charter)

Delaware		22-3439443
(State of incorporation)		(IRS Employer Identification No.)

(Address of principal executive offices)

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

(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. o 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 o 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.

Yes þ   No o

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. o

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
		(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 o   No þ

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. (The registrant did not distribute new securities under the plan confirmed by the court; there was no change to the holders of securities as a result of the registrant’s reorganization.)

Yes þ   No o

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 the common stock held by non-affiliates of the registrant as of June 30, 2007, was approximately $81.5 million based on the closing price on June 29, 2007 of $4.20 per share.

Number of shares outstanding of common stock, par value $.01 per share, as of March 1, 2008: 21,126,647.

Portions of Footstar, Inc.’s Proxy Statement for the 2008 Annual Meeting of Shareholders, the information from which is expected to be filed within 120 days after the end of the Company’s fiscal year, are incorporated by reference into Part III.

 

 

FOOTSTAR, INC.
ANNUAL REPORT ON FORM 10-K

PART I			3
Introductory Note			3
Item 1. Business			4
General			4
Competitive Environment			5
Merchandising			5
Marketing			5
Trademarks and Service Marks			6
Employees			6
Executive Officers of the Registrant			6
Available Information			7
Item 1A. Risk Factors			7
Item 1B. Unresolved Staff Comments			11
Item 2. Properties			11
Item 3. Legal Proceedings			12
Item 4. Submission of Matters to a Vote of Security Holders			13
PART II			13
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			13
Item 6. Selected Financial Data			15
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			36
Item 8. Financial Statements and Supplementary Data			36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			37
Item 9A. Controls and Procedures			37
Item 9B. Other Information			39
PART III			39
Item 10. Directors, Executive Officers and Corporate Governance			39
Item 11. Executive Compensation			40
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			41
Item 13. Certain Relationships and Related Transactions, and Director Independence			41
Item 14. Principal Accountant Fees and Services			42
PART IV			43
Item 15. Exhibits and Financial Statement Schedules			43
EX-21.1: SUBSIDIARIES
EX-23.1: CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION

Footstar, the Footstar logo, Just For Feet, Thom McAn, Cobbie Cuddlers, Texas Steer and Cara Mia are, or were as of December 29, 2007, trademarks and/or service marks of Footstar, Inc.’s subsidiaries or affiliates. All other trademarks mentioned in this report are the property of their respective owners.

PART I

INTRODUCTORY NOTE

Footstar, Inc., which may be referred to as “Footstar”, the “Company”, “we”, “us” or “our”, is today filing this Annual Report on Form 10-K for its fiscal year ended December 29, 2007.

On February 7, 2006, Footstar emerged from bankruptcy and have since made payments to creditors totaling $127.5 million, including applicable interest, pursuant to our Plan of Reorganization (the “Plan”). These payments exclude approximately $0.5 million in claims which we expect will be paid upon final resolution. Creditors were or will be paid in full, plus interest where applicable, from existing cash balances.

Pursuant to the guidance provided by the American Institute of Certified Public Accountants in Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP 90-7”), the Company has not adopted fresh-start reporting because there was no change to the holders of existing voting shares and the reorganization value of the Company’s assets was greater than its post petition liabilities and allowed claims.

The Company has operated licensed footwear departments in discount chains since 1961, and is the only major operator of licensed footwear departments in the United States today. As of December 29, 2007, the Company operated licensed footwear departments in 1,388 Kmart Corporation (“Kmart”) stores and in 859 Rite Aid Corporation (“Rite Aid”) stores located on the West Coast. The Company also supplies certain retail stores, including Rite Aid, with family footwear on a wholesale basis.

The business relationship between the Company and Kmart is extremely important to us. The licensed footwear departments in Kmart comprise substantially all of our sales and profits. On August 24, 2005, the Company and Kmart entered into an agreement (the “Kmart Settlement” or “Kmart Agreement”) with respect to the assumption, interpretation and amendment of the Master Agreement, which formerly governed our arrangement with Kmart.

The Kmart Agreement, pursuant to which we operate these footwear departments, is currently scheduled to expire at the end of 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement), at which time Kmart has agreed to purchase the inventory in our Kmart footwear departments (excluding worn, damaged and seasonal inventory, as defined). Because we have not to date identified, and we do not believe we will identify, a course of action to offset this Kmart business, we are currently planning to wind-down our Kmart business and all our other businesses by not later than December 31, 2008. This would likely include a liquidation and wind-up of the Company’s business, including proposing a plan of dissolution to our shareholders.

See Item 7, “Management’s Discussion and Analysis — Factors to Consider”, beginning at page 30, concerning:

	•		Our Board’s continued review and consideration of courses of action to resolve the Company’s future, including a liquidation and dissolution of our business following the termination of our Kmart business;
	•		The terms of the existing Kmart Agreement which unless the parties agree otherwise will govern the rights and obligations of Footstar and Kmart on the termination of the Kmart Agreement at the scheduled December 31, 2008 expiration date; and
	•		Certain other matters in connection with future events, circumstances and uncertainties impacting the Company.

ITEM 1. BUSINESS

GENERAL

The Company sells family footwear through licensed footwear departments and wholesale arrangements.

The Company has operated licensed footwear departments since 1961 and is the only major operator of licensed footwear departments in the United States today.

The following chart represents a summary of stores in which the Company operated licensed footwear departments for fiscal 2007, 2006 and 2005:

		Beginning of Year				Opened				Closed				End of Year
Fiscal 2007
Kmart			1,392				—				(4	)			1,388
Rite Aid			854				16				(11	)			859
Fiscal 2006
Kmart			1,421				—				(29	)			1,392
Rite Aid			859				9				(14	)			854
Fiscal 2005
Kmart			1,482				—				(61	)			1,421
Rite Aid			858				8				(7	)			859

The Company’s licensed footwear operation sells family footwear and lower-priced basic and seasonal footwear in Kmart and Rite Aid stores. Our net sales from Kmart and Rite-Aid for fiscal 2007 were $614.2 million and $15.8 million, respectively. In its licensed footwear departments, the Company generally sells a wide variety of family footwear, including men’s, women’s and children’s dress, casual, athletic and seasonal footwear, work shoes and slippers. As of December 31, 2005, we had been supplying Thom McAn family footwear on a wholesale basis to 1,500 Wal-Mart stores in the United States and 13 stores in Puerto Rico. Beginning in January 2006, Wal-Mart stopped purchasing Thom McAn product for its stores in the United States. Beginning in April 2007, Wal-Mart no longer sourced footwear from us for Wal-Mart stores under Wal-Mart’s proprietary brands, and, beginning August 2007, Wal-Mart no longer purchased Thom McAn footwear for Wal-Mart stores in Puerto Rico. Our total sales to Wal-Mart were approximately $2.0 million in fiscal 2007, approximately $8.9 million in fiscal 2006 and approximately $29.6 million in fiscal 2005.

COMPETITIVE ENVIRONMENT

The family footwear business, where the majority of the Company’s business is generated, is highly competitive.

Competition is concentrated among a limited number of value-priced retailers and discount department stores, including Kmart, Wal-Mart, Payless ShoeSource, Kohl’s, Target and Sears, with a number of traditional off-price and value retailers such as Shoe Carnival, Famous Footwear, DSW and Shoe Show also selling lower-priced footwear.

MERCHANDISING

The Company’s merchandising strategy historically has been to continue to build upon its position in family footwear. The essence of this strategy has been to satisfy the Company’s customers with high in-stock availability of its footwear products and by offering a wide selection of well-known national brands such as Thom McAn and Cobbie Cuddlers (which are Company-owned). We offer a wide range of quality, value-priced footwear. Key strengths have included style development, sourcing, quality control, competitive pricing, planning and inventory management.

In its licensed footwear operations, the Company seeks to attract non-footwear shoppers into the footwear departments from other areas of the stores. Its branded products are also intended to differentiate the Company’s merchandise from that of its competitors. Brands currently available at the Company’s operations include Thom McAn, Cobbie Cuddlers and Texas Steer (which are Company-owned) and Route 66 and Basic Editions.

The Company’s traditional strength has been in quality leather footwear which it currently offers under the Thom McAn brand, as well as seasonal, work, value-priced athletic, women’s casual and children’s shoes. The Company has traditionally built on its strength in these areas by focusing on customer satisfaction. The Company’s “narrow and deep” merchandising strategy and its merchandise planning systems have been designed to ensure that each store is well stocked in product lines that are particularly popular with the Company’s core customers. The Company’s demand-driven merchandise replenishment system has been designed to permit inventory management at the store, style and size levels. In addition, in order to ensure sufficient quantities of footwear in the desired size, style and color for each season, we are required to maintain substantial levels of inventory, especially prior to peak selling seasons when we build up our inventory levels. We must provide consumers with seasonally appropriate merchandise, making our sales highly dependent on seasonal weather conditions.

MARKETING

The Company believes that the typical footwear customer in its licensed footwear departments in Kmart generally resembles the average Kmart softlines shopper, which consists of shoppers from three distinct segments: families with moderate income, mature shoppers with average income and younger/middle-aged Hispanic and African-American families. The Company’s marketing initiatives have been designed to support its overall business strategy of increasing purchases among traditional footwear shoppers, as well as appealing to the growing customer segments that include African Americans and Hispanics.

The Company’s marketing strategy in its Kmart footwear departments has been designed to convey to prospective customers that Kmart carries the right value combination of brands, product selection, quality, comfort and price to make Kmart footwear departments their footwear destination of choice. This message is communicated primarily through weekly advertising in newspaper inserts and in-store presentations. Kmart’s weekly newspaper inserts had a weekly circulation of approximately 43 million as of December 29, 2007.

TRADEMARKS AND SERVICE MARKS

Footstar or its subsidiaries own all rights in the United States to the marks Thom McAn, Cobbie Cuddlers and Cara Mia for use in connection with footwear and/or related products and services. The Company or its subsidiaries have registered or have common law rights in the United States to over 100 trademarks and/or service marks under which we have marketed merchandise or services. Where it has been deemed important, the Company has registered its trademarks and service marks in foreign countries. We protect our trademarks and service marks. We do not believe, however, that any material portion of our business is substantially dependent on any of our trademarks.

In connection with the wind-down of our current business we will consider the sale or other transfer of our trademarks, tradenames and brands, including Thom McAn. We would anticipate that the terms of any such sale or transfer would continue to allow us to utilize our trademarks, tradenames and brands through the scheduled termination of the Kmart Agreement.

EMPLOYEES

As of December 29, 2007, we had 3,948 employees, of which 1,084 were full-time and 2,864 were part-time employees. Approximately 3,617 of the total employees are located in our licensed footwear departments.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following information sets forth the name, age and business experience during the past five years of the current executive officers of the Company:

Jeffrey A. Shepard, age 57, was appointed Chief Executive Officer and President of Footstar on February 6, 2006. He has been a member of the Board of Directors since January 2005. He formerly served as the Executive Vice President of Footstar and President and Chief Executive Officer of Meldisco. Mr. Shepard was an executive officer of Footstar at the time it filed for reorganization under Chapter 11 in March 2004.

William Lenich, age 59, has been Executive Vice President of Footstar since February 7, 2006. Prior to that, he was the Executive Vice President of Meldisco since joining Meldisco in 2002.

Dennis M. Lee, age 58, has been Senior Vice President, Human Resources of Footstar since February 7, 2006. Prior to that, he served as Senior Vice President, Human Resources of Meldisco since joining Meldisco in July 2004. Prior to joining Footstar, he served as an Assistant Professor in Residence for Human Resource Management, College of Continuing Studies and School of Business at the University of Connecticut and was Senior Vice President Human Resources and Logistics for the Venator Group.

Michael J. Lynch, age 41, has been the Chief Financial Officer — Senior Vice President of Footstar since February 7, 2006. Prior to that, he served as Senior Vice President of Finance of Meldisco. Since joining the Company in August 1995, he also served as the Division Vice President — Finance at both Footstar’s former Athletic and Meldisco divisions.

Randall Proffitt, age 62, has been Senior Vice President, Store Operations of Footstar since February 7, 2006 and prior thereto he held such position at Meldisco.

Maureen Richards, age 51, has been the Senior Vice President, General Counsel and Corporate Secretary of Footstar since March 2001 and was an executive officer of Footstar at the time it filed for reorganization under Chapter 11 in March 2004 and prior to March 2001, was Vice President, General Counsel and Corporate Secretary of Footstar.

Craig M. Haines, age 35, has been Vice President and Controller, and Principal Accounting Officer of Footstar since March 31, 2006 and prior thereto he was the Company’s Vice President and Controller since he joined the Company in June 2005. From November 2002 through May 2005, Mr. Haines served as Executive Vice President, Finance and Administration for National Vision Administrators, LLC.

AVAILABLE INFORMATION

We make available free of charge through our web site, www.footstar.com, all materials that we file electronically with 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. During the period covered by this Form 10-K, we made all such materials available through our web site as soon as reasonably practicable after filing such materials with the SEC.

You may also read and copy any materials filed by us with the SEC 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.

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 Maureen Richards, Senior Vice President, General Counsel and Corporate Secretary, at the Company’s principal executive office set forth above.

ITEM 1A. RISK FACTORS

The matters discussed in this Annual Report on Form 10-K include forward-looking statements that involve significant risks and uncertainties. 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, “Management’s Discussion and Analysis — Factors to Consider”, beginning at page 30, each of which is a risk factor and is incorporated into this Item 1A by reference and “Recent Events”, beginning on page 18, 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.

Anticipated wind-down of our current footwear business by not later than the end of 2008

Our operation of the footwear departments in Kmart stores accounts for substantially all of our net sales and net profits. Our agreement with Kmart provides for the termination of this business by no later than December 31, 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement) at which time Kmart is obligated to purchase our inventory, as defined in that agreement. There can be no assurance that we will not have issues and disputes with Kmart in winding up our business with Kmart.

If we do not operate these footwear departments through the end of 2008 or receive timely payments from Kmart for our inventory after the Kmart Agreement terminates, it could have a material adverse effect on our operations and financial condition. In addition, because the Company has not to date identified, and we do not believe we will identify, a course of action to offset this business, we are currently planning to wind-down our Kmart business and all our other businesses by not later than December 31, 2008. This would likely include a liquidation and wind-up of the Company's business, including proposing a plan of dissolution to our shareholders. Such liquidation could cause the Company to incur significant costs. See Item 7, “Management’s Discussion and Analysis — Factors to Consider”, beginning at page 30, concerning our Board’s review of courses of action to resolve the Company’s future, including a liquidation and dissolution following the termination of our Kmart business.

Our April 30, 2007 declaration and payment of a special cash distribution may impact our future cash requirements and liquidity needs.

On March 27, 2007, we announced the declaration of a $5.00 per common share cash distribution, paid on April 30, 2007. The Board considered, among other factors, our cash position, our expected future operating results, our future cash needs and cash position, our liquidity needs and available capital resources, and our strategic options.

This special cash distribution reduced cash available for future operations, and for future cash needs and liquidity, by a total of $104.8 million. The Company may be required to periodically borrow under its Credit Facility to support normal operating needs. This Credit Facility expires the earlier of on November 30, 2008 or thirty days prior to the termination of the Kmart Agreement. If our future operating results or cash needs or obligations differ in any material respect from our expectations, or other changes occur in our business or operations, which we have not anticipated, our cash needs could be greater than our cash generated from operations and funds available under our Credit Facility, which would have a material adverse impact on our financial condition. There can be no assurance that we will have sufficient available cash and available cash resources (including funds available under our Credit Facility and credit available from our vendors) to satisfy all of our future cash needs.

We may be unable to retain talented personnel.

Our success is dependent upon our ability to retain qualified individuals. We have instituted several

retention programs designed to retain key executives and employees and may seek to implement additional programs to retain key executives and employees if and when necessary. However, if we are unable to retain key executives and employees, including senior management, and qualified accounting and finance, marketing, and merchandising personnel, or put in place additional retention programs, it could adversely affect our businesses. This risk potentially is more acute given the anticipated wind-down of our current business.

We rely on key vendors and third parties to manufacture, warehouse and distribute our products.

Product sourcing in the family footwear business is driven by relationships with foreign manufacturers. Because of the anticipated expiration of the Kmart Agreement by no later than the end of 2008, beginning in the first quarter of 2008 we provided our vendors with more current payment terms. If the terms under which these vendors deal with us, including payment terms, change adversely, there could be a material adverse impact on our operations and financial condition. Also, if these foreign manufacturers are unable to secure sufficient supplies of raw materials or maintain adequate manufacturing capacity, they may be unable to provide us with timely delivery of products of acceptable quality. In addition, if manufacturing costs increase, our cost of acquiring merchandise could increase. Although we pay for finished goods in U.S. dollars, it is possible that higher costs could be passed on to us through higher product costs. If we cannot recover these cost increases with increased pricing to our customers, it could have a material adverse effect on our operations and financial condition. These risks become potentially more acute given the anticipated wind-down of our current business.

The Company manages against possible product cost increases by shifting manufacturing production to lower cost regions of China. It is possible that the Company could experience lower product quality and/or late shipments from these new factories which could unfavorably impact the Company’s financial results.

We also depend on third parties to receive, warehouse, transport and deliver our products. If these third parties are unable to perform for any reason, or if they increase the price of their services, there could be a material adverse effect on our operations and financial performance.

We may be unable to adjust to constantly changing fashion trends.

Our level of current sales depends, in large part, upon our ability to gauge the evolving fashion tastes of our customers and potential customers and to provide merchandise that satisfies those fashion tastes in a timely manner. The retailing industry fluctuates according to changing fashion tastes and seasons, and merchandise usually must be ordered well in advance of the season, frequently before consumer fashion tastes are evidenced by consumer purchases. In addition, in order to ensure sufficient quantities of footwear in the desired size, style and color for each season, we are required to maintain substantial levels of inventory, especially prior to peak selling seasons when we build up our inventory levels.

As a result, if we fail to properly gauge the fashion tastes of consumers or to respond to changes in fashion tastes in a timely manner, this failure could adversely affect retail and consumer acceptance of our merchandise and leave us with substantial unsold inventory. If that occurs, we may be forced to rely on markdowns or promotional sales to dispose of excess, slow-moving inventory, which may harm our business and financial results.

We must provide consumers with seasonally appropriate merchandise, making our sales highly dependent on seasonal weather conditions.

If the weather conditions for a particular period vary significantly from those typical for that period, such as an unusually cold spring or an unusually warm winter, consumer demand for seasonally appropriate merchandise that we have available in our footwear departments will be lower, and our net sales and margins will be adversely affected. Lower sales may leave us with excess inventory of our basic products and seasonally appropriate products, forcing us to sell both types of our products at significantly discounted prices and, thereby, adversely affecting our net sales and margins.

Declines in our sales will have a magnified impact on profitability because of our fixed costs.

A significant portion of our operating expenses are fixed costs that are not dependent on our sales performance, as opposed to variable costs, which vary proportionately with sales performance. These fixed costs include, among other things, the costs associated with operating as a public company and a substantial portion of our labor expenses. If our sales decline we may not be able to reduce our operating expenses proportionately. If our sales fall below certain minimums set forth in our agreement with Kmart, our right to operate in Kmart stores, which accounts for substantially all of our business, could potentially be terminated prior to the scheduled termination of the Kmart Agreement.

We operate in the highly competitive footwear retailing industry.

The family footwear industry, where our business is concentrated, is highly competitive. Competition is concentrated among a limited number of retailers and discount department stores, including Payless ShoeSource, Kmart, Wal-Mart, Kohl’s, Sears and Target, with a number of traditional mid-tier and value-priced retailers such as Shoe Carnival, Famous Footwear and Rack Room also selling lower-priced footwear. The events that caused us to seek bankruptcy put us at a disadvantage with respect to our competitors. In addition, our agreement with Kmart which provides that we will no longer operate the footwear departments in Kmart stores beyond December 31, 2008 at the latest, puts us at a disadvantage with respect to our competitors, many of which are growing rapidly and have substantial financial and marketing resources which are unavailable to us. If we are unable to overcome these disadvantages and our sales fall below certain minimums set forth in our agreement with Kmart, our right to operate in Kmart stores, which accounts for substantially all of our business, could potentially be terminated prior to the scheduled termination of the Kmart Agreement.

There are risks associated with our importation of products.

Approximately 97% of the Company’s products are directly imported by us and manufactured in China. Substantially all of this imported merchandise is subject to customs duties and tariffs imposed by the United States. Penalties may be imposed for violations of labor and wage standards by foreign contractors.

In addition, China and other countries in which our merchandise is manufactured may, from time to time, impose additional new quotas, tariffs, duties, taxes or other restrictions on its merchandise or adversely change existing quotas, tariffs, duties, taxes or other restrictions. Any such changes could

adversely affect our ability to import our products and, therefore, our results of operations.

Any deterioration in the trade relationship between the United States and China or any other disruption in our ability to import products from China could adversely affect our business, financial condition or results of operations.

Other risks inherent in sourcing products from foreign countries include economic and political instability, social unrest and the threat of terrorism, each of which risks could adversely affect our business, financial condition or results of operations. In addition, we incur costs as a result of security programs designed to prevent acts of terrorism such as those imposed by government regulations and our participation in the Customs-Trade Partnership Against Terrorism implemented by the United States Bureau of Customs and Border Protection. Significant increases in such costs could adversely affect our business, financial condition or results of operations.

Our ability to successfully import merchandise into the United States from foreign sources is also dependent on stable labor conditions in the major ports of the United States. Any instability or deterioration of the domestic labor environment in these ports could result in increased costs, delays or disruption in merchandise deliveries that could cause loss of revenue, damage to customer relationships and have a material adverse effect on our business operations and financial condition.

The footwear retailing industry is heavily influenced by general economic cycles.

Footwear retailing is a cyclical industry that is heavily dependent upon the overall level of consumer spending. Purchases of footwear, apparel and related goods tend to be highly correlated with the cycles of the levels of disposable income of our customers. As a result, any substantial deterioration in general economic conditions could have a material adverse effect on our operations and financial condition.

See “Forward-Looking Statements” in Item 7 for additional risk factors to consider.

ITEM 1 B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

As of December 29, 2007, we operated licensed footwear departments in 2,247 stores. The licensed footwear departments are located in 49 states, Guam, Puerto Rico and the U.S. Virgin Islands. Of the licensed departments operated as of December 29, 2007, 1,388 were located in Kmart discount stores and 859 were in Rite Aid drugstores on the West Coast.

Kmart and Rite Aid provide us with store space to sell footwear in exchange for certain payments. The footwear departments we operate in Kmart stores range from 1,200 to 4,400 square feet.

Our corporate headquarters is located in 129,000 square feet of owned office space in Mahwah, New Jersey.

In connection with the wind-down of our current business, we are actively pursuing the sale of our corporate headquarters. We currently anticipate that the terms of any such sale will allow us to continue to utilize our corporate headquarters for our required needs through December 2008. If we are successful in the sale of our corporate headquarters, we anticipate that after December 2008 we will have limited operating space and the Company currently would intend to lease operating space, if necessary, suitable at a minimum for our wind-down activities.

We also lease approximately 20,000 square feet of space in Mahwah, New Jersey for use by our footwear testing lab and for storage. Our corporate tax department is located in 3,500 square feet of leased office space in Worcester, Massachusetts. We also lease approximately 7,800 square feet in Hong Kong. The leases for these properties expire approximately at the end of 2008 and no renewals, other than for a short time as we wind-down the current businesses, are currently anticipated.

ITEM 3. LEGAL PROCEEDINGS

In addition to the matters described below, we are involved in other ordinary routine legal proceedings, lawsuits and claims incidental to the conduct of our business. Estimates of the probable costs for resolution of these claims are accrued to the extent that they can be reasonably estimated. These estimates are based on an analysis of potential outcomes, assuming a combination of litigation and settlement strategies. These estimates also take into account any claim relating to events that occurred prior to our bankruptcy filing, which were required to be reported in a proof of claim filed with the Bankruptcy Court. However, legal proceedings are subject to significant uncertainties, the outcomes of which are difficult to predict, and assumptions and strategies may change. Consequently, we are unable to ascertain the ultimate financial impact of any legal proceedings.

LITIGATION MATTERS

On or about March 3, 2005, a first amended complaint was filed against us in the U.S. District Court for the District of Oregon, captioned Adidas America, Inc. and Adidas —Salomon AG v. Kmart Corporation and Footstar, Inc. The first amended complaint and subsequent amendments, seek injunctive relief and unspecified monetary damages for alleged trademark infringement, trademark dilution, unfair competition, deceptive trade practices and breach of contract arising out of our use of four stripes as a design element on footwear which Adidas claims infringes on its registered three stripe trademark. While it is not possible to predict the outcome of the litigation, we believe that we have meritorious defenses which we have asserted in the pleadings filed in the Oregon proceedings and in our bankruptcy proceedings. At each balance sheet date, or more frequently as conditions warrant, the Company reviews the status of this claim, as well as its potential insurance coverage for such claim with due consideration given to potentially applicable deductibles and reservations of rights under its insurance policies. While the ultimate outcome of any litigation cannot be

predicted, management believes that adequate provision has been made with respect to such claim and does not believe that an amount of loss in excess of recorded amounts is reasonably possible. Based on the information presently available and the availability of insurance, the Company does not expect that the outcome of such claim will have a material adverse effect on the Company’s financial condition, results of operations or liquidity. There can be no assurance, however, that future events will not require the Company to increase the amount it has accrued for this matter. It is currently anticipated that a trial in this matter will take place in July 2008.

We are involved in various other claims and legal actions arising in the ordinary course of business. We do not believe that any of them will have a material adverse effect on our financial position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

After the delisting of our common stock from the NYSE on December 30, 2003, our common stock was traded on the over-the-counter bulletin board (“OTCBB”) under the symbol “FTSTQ.PK.” Effective March 13, 2006 our symbol changed to FTAR.OB. Our common stock 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 February 29, 2008, the closing bid quotation of our common stock was $4.25 and there were 1,535 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				LOW
2006
First Quarter		$	4.75			$	3.35
Second Quarter		$	5.95			$	4.25
Third Quarter		$	5.45			$	4.15
Fourth Quarter		$	6.60			$	4.75
2007
First Quarter		$	8.50			$	6.10
Second Quarter		$	9.12			$	4.10
Third Quarter		$	4.72			$	4.00
Fourth Quarter		$	4.92			$	4.20

On March 27, 2007, the Company announced that its Board of Directors declared a special cash distribution to shareholders in the amount of $5.00 per common share. The Company recorded this distribution effective the date the declaration was made by the Board of Directors.

The Company has no plans to pay regular cash distribution(s) or dividends. However, the Company’s Board of Directors has considered, and could determine in the future, in its discretion, to approve and declare further distribution(s) or dividend(s) to shareholders. There can be no assurance that any such distribution(s) or dividend(s) will be approved or, if paid, in what amount or amounts or the timing thereof.

Please refer to “Introductory Note” and Item 1A, Risk Factors, above, in connection with the anticipated wind-down of the Company’s businesses in connection with the Kmart Agreement.

Stock Performance Graph

The graph set forth below shows the cumulative total return to stockholders over the five-year fiscal period ended December 29,2007, assuming an investment of $100 on December 27, 2002 in each of Footstar’s common stock, the NASDAQ Composite Index and the S&P Footwear Index. The graph assumes all dividends have been reinvested. The stock price performance included in the graph is not necessarily indicative of future stock price performance.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Footstar, Inc., The NASDAQ Composite Index
And The S&P Footwear Index

The Performance Graph in this Item 5 is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR HISTORICAL FINANCIAL SUMMARY

(dollars in millions except per share data)		2007				2006				2005				2004				2003
Statement of Operations Data
Net sales		$	637.0			$	666.7			$	715.4			$	800.2			$	962.4
Cost of sales			427.4				452.1				490.4				535.8				650.3
Gross profit			209.6				214.6				225.0				264.4				312.1
Store operating, selling, general and administrative expenses			148.6				160.6				183.1				236.1				250.7
Depreciation and amortization			8.1				8.8				7.7				21.7				19.0
Restructuring, asset impairment and other charges, net			—				—				—				—				2.5
Loss on Kmart Settlement (1)			—				—				—				6.3				—
Other income			(0.6	)			—				—				(9.2	)			(5.4	)
Interest expense			1.2				1.6				4.6				11.0				23.4
Interest income			(2.6	)			(3.8	)			—				—				(1.1	)
Income (loss) before reorganization items, income taxes, minority interests and discontinued operations			54.9				47.4				29.6				(1.5	)			23.0
Reorganization items (2)			—				—				(14.6	)			(37.1	)			—
Income (loss) before income taxes, minority interests and discontinued operations			54.9				47.4				15.0				(38.6	)			23.0
(Provision) benefit for income taxes (3)			(2.1	)			(1.4	)			(4.2	)			2.9				(10.0	)
Income (loss) before minority interests and discontinued operations			52.8				46.0				10.8				(35.7	)			13.0
Minority interests in net loss (income)			—				—				—				11.0				(17.3	)
Income (loss) from continuing operations			52.8				46.0				10.8				(24.7	)			(4.3	)
(Loss) income from discontinued operations, net of tax (4)			(0.8	)			(0.8	)			4.7				(66.7	)			(50.1	)
Gain from disposal of discontinued operations, net of tax			—				0.1				8.9				21.4				—
Net income (loss)		$	52.0			$	45.3			$	24.4			$	(70.0	)		$	(54.4	)
Basic income (loss) per share from continuing operations		$	2.56			$	2.23			$	0.53			$	(1.20	)		$	(0.21	)
Diluted income (loss) per share from continuing operations		$	2.52			$	2.21			$	0.53			$	(1.20	)		$	(0.21	)

ITEM 6. SELECTED FINANCIAL DATA, cont.

FIVE-YEAR HISTORICAL FINANCIAL SUMMARY

(dollars in millions)		2007				2006				2005				2004				2003
Balance Sheet Data
Current assets:
Cash and cash equivalents		$	53.8			$	101.3			$	196.1			$	189.6			$	1.1
Inventories			86.7				92.0				89.2				98.9				179.7
Other			15.8				18.5				30.3				50.5				39.7
Assets related to discontinued operations			—				—				0.1				6.2				284.5
Total current assets			156.3				211.8				315.7				345.2				505.0
Property and equipment, net			20.7				25.2				28.9				35.4				147.2
Other assets			4.6				8.3				12.1				13.5				12.5
Total assets		$	181.6			$	245.3			$	356.7			$	394.1			$	664.7
Notes payable		$	—			$	—			$	—			$	—			$	198.0
Amount due under Kmart Settlement (1)			5.1				—				—				45.0				—
Other current liabilities			69.9				78.5				107.8				98.0				133.2
Liabilities related to discontinued operations			0.9				2.3				7.4				3.5				110.5
Liabilities subject to compromise			0.5				1.2				125.5				152.3				—
Total current liabilities			76.4				82.0				240.7				298.8				441.7
Other long term liabilities			26.1				26.6				35.0				38.5				58.9
Amount due under Kmart Settlement (1)			—				5.2				5.5				5.5				—
Minority interests in subsidiaries (1)			—				—				—				—				42.2
Total liabilities			102.5				113.8				281.2				342.8				542.8
Shareholders’ equity			79.1				131.5				75.5				51.3				121.9
Total liabilities and shareholders equity		$	181.6			$	245.3			$	356.7			$	394.1			$	664.7

		2007				2006				2005				2004				2003
Athletic Segment		$	—			$	(0.9	)		$	5.1			$	(38.9	)		$	(39.9	)
Meldisco Businesses			—				0.1				(0.4	)			(27.8	)			(10.2	)
Closed Manufacturing Facility		$	(0.8	)			—				—				—				—
Total		$	(0.8	)		$	(0.8	)		$	4.7			$	(66.7	)		$	(50.1	)

See Note 3 “Discontinued Operations” of Notes to Consolidated Financial Statements.

ITEM 7. 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 of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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 Company’s ability to manage the anticipated wind-down of its current businesses in connection with the termination of our Kmart business by the end of 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement);
	•		whether the Company continues to operate the footwear departments in Kmart stores through December 2008;
	•		the impact of the payment of the $5.00 per share special distribution on April 30, 2007 on our future cash requirements and liquidity needs, both for our operating plans and any contingencies and obligations;
	•		the Company’s ability to obtain and maintain adequate terms and service with vendors and service providers and to ensure timely delivery of goods through December 2008;
	•		the effect of making more current certain vendor payable terms effective February 2008;
	•		the ability to maintain contracts that are critical to the Company’s operations;
	•		the Company’s ability to successfully implement and maintain internal control and procedures that ensure timely, effective and accurate financial reporting;
	•		the Company’s ability to reduce overhead costs commensurate with any decline in sales and in connection with the winding down of our business;
	•		any adverse developments in existing commercial disputes or legal proceedings;
	•		the Company’s ability to manage and plan for the disposal of, closing or conversion of Kmart stores;
	•		intense competition in the markets in which the Company competes; and
	•		retention of employees.

The Company’s operation of the footwear departments in Kmart stores accounts for substantially all of the Company’s net sales and net profits. The Kmart Agreement, pursuant to which we operate these footwear departments, is scheduled to expire at the end of 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement) at which time Kmart has agreed to purchase the inventory in our Kmart footwear departments (excluding inventory that is damaged, unsaleable and seasonal inventory, as defined in the agreement), at book value, as defined in the agreement.

Because the Company has not to date identified, and we do not believe we will identify, a course of action to offset this Kmart business, we are currently planning to wind-down our Kmart business and all our other businesses by not later than December 31, 2008. This would likely include a liquidation and wind-up of the Company’s business, including proposing a plan of dissolution to our shareholders.

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 performance. Actual results, performance, events, plans and expectations may differ from our current projections, estimates and expectations and the differences may be material, individually or in the aggregate, to our business, 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 our future required SEC filings, or as may otherwise be legally required.

RECENT EVENTS

Our Board has continued to review and consider courses of action to resolve the Company’s future in the best interest of all shareholders, including liquidation and dissolution following the termination of our Kmart business.

We have been marketing our corporate headquarters in Mahwah, New Jersey for possible sale and we will consider the sale or other transfer of our trademarks, tradenames and brands, including Thom McAn. See Item 2 — “Properties” and Item 1 — “Business — Trademarks and Service Marks” above.

OVERVIEW

The following points highlight the Company’s operations, cash flows and financial position for the year ended December 29, 2007:

•

As of December 29, 2007, we operated in 1,388 Kmart stores compared with 1,392 stores on December 30, 2006 and we operated in 859 Rite Aid stores on December 29, 2007 in the western region of the United States, compared with 854 stores on December 30, 2006;

•

Operating profit increased by $7.7 million to $52.9 million in fiscal 2007 as compared to $45.2 million in fiscal 2006, primarily due to an increase in the gross margin rate and a reduction in selling, general and administrative expenses offset by a decrease in sales.

•

The Company provided $60.4 million in cash (from operating activities of its continuing operations) during fiscal 2007, as compared to cash provided by operating activities (from continuing operations) of $5.4 million during fiscal 2006.

•

As of December 29, 2007, the Company had $53.8 million of cash and cash equivalents with no loans outstanding under the Credit Facility. Outstanding standby letters of credit as of December 29, 2007 were $8.1 million. The Company had $60.4 million available for additional borrowings under the Credit Facility as of December 29, 2007.

•

On April 30, 2007, the Company paid a special cash distribution of $5.00 per common share totaling $104.8 million.

KMART AGREEMENT

Our business relationship between the Company and Kmart is extremely important to us. The licensed footwear departments in Kmart provide substantially all of our net sales and net profits and operated pursuant to the terms of the Kmart Agreement entered into on August 24, 2005.

The Kmart Agreement, which governs the structure of our existing relationship with Kmart, extinguished Kmart’s 49% equity interests in the Shoemart Corporations and fixed the cure amount with respect to our assumption of the Master Agreement at $45 million.

We are required to pay Kmart 14.625% of the gross sales of the footwear departments along with a miscellaneous expense fee of $23,500 per open store per year. The Kmart Agreement is scheduled to expire at the end of 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement) at which time Kmart is obligated to purchase our inventory (but not our brands) related to the Kmart footwear departments at book value, as defined in the agreement.

We and Kmart each have the right to terminate the Kmart Agreement early if the gross sales of the footwear departments are less than $529.6 million during the remaining term of the Kmart Agreement, provided that this gross sales minimum will be reduced by $0.4 million for each additional store that is closed or converted during 2008 (subject to limitation as described below). The Company also has the unilateral right to terminate the Kmart Agreement if either (i) the number of Kmart stores is less than 900 or (ii) the gross sales of the footwear departments in any four consecutive quarters are less than $450.0 million. In the event of any such termination, Kmart is obligated to purchase all of the inventory (including inventory that is on order but excluding inventory that is damaged, unsaleable, and seasonal inventory, as defined in the agreement) at book value, as defined in the agreement.

Pursuant to the Kmart Agreement, Kmart must pay us the stipulated loss value (as set forth below) if it terminates our licenses to operate footwear departments in up to 456 Kmart stores during the remaining term of the Kmart Agreement by disposing of, closing or converting those stores. As of December 29, 2007, Kmart could dispose of, close or convert 456 stores during 2008 without paying us a stipulated loss value. For each store that is disposed of, closed or converted, Kmart must purchase all of our in-store inventory (excluding inventory that is damaged, unsaleable and seasonal inventory, as defined) at book value, as defined in the agreement. In addition, to the extent Kmart exceeds the 456 store aggregate limit, Kmart must pay us a non-refundable stipulated loss value per store equal to $20,000. If the entire Kmart Agreement is terminated in accordance with its terms, Kmart is not obligated to make any stipulated loss value payments for such stores.

The Kmart Agreement sets forth the parties’ obligations with respect to staffing and advertising. Specifically, we must spend at least 10% of gross sales in the footwear departments on staffing costs, as defined in the agreement, for the stores and we must schedule the staffing in each store at a minimum of 40 hours per week. In addition, Kmart is required to allocate at least 52 weekend newspaper advertising insert pages per year to our products.

Kmart has a claim against us in the amount of $11,000 for each store that was an existing store, as defined in the agreement, on August 25, 2005, which is disposed of, closed or converted to another

retail format in accordance with the 550 store limitation described above, such claim generally payable by us to Kmart at the time of store closing, disposal or conversion. However, upon the expiration of the Kmart Agreement or upon early termination of that agreement other than as a result of our breach, all such claims not yet due and payable will be waived for any remaining stores. If the Kmart Agreement is terminated as a result of our breach, such claims for remaining stores will not be waived and will become immediately due and payable.

See Item 7, “Management’s Discussion and Analysis — Factors to Consider — Termination of Kmart Agreement”, beginning at page 31, for additional information concerning the rights and obligations of the Company and Kmart at the termination of the Kmart Agreement at its scheduled December 31, 2008 expiration date.

BUSINESS RELATIONSHIP WITH WAL-MART STORES

Until December 31, 2005, we were supplying Thom McAn family footwear to 1,500 Wal-Mart stores in the United States and 13 stores in Puerto Rico. Beginning in January 2006, Wal-Mart stopped purchasing Thom McAn product for its stores in the United States. Beginning in April 2007, Wal-Mart no longer sourced footwear from us for Wal-Mart stores under Wal-Mart’s proprietary brands, and, beginning August 2007, Wal-Mart no longer purchased Thom McAn footwear for Wal-Mart stores in Puerto Rico. Our total sales to Wal-Mart were approximately $2.0 million in fiscal 2007, approximately $8.9 million in fiscal 2006 and approximately $29.6 million in fiscal 2005.

PRODUCT SOURCING

Product sourcing in the family footwear business is driven by relationships with foreign manufacturers. Approximately 97% of our products are imported by us and manufactured in China where the cost of labor has increased. A portion of our footwear product is comprised of petrochemical products where prices have fluctuated dramatically over the past year. Furthermore, higher product prices could result from China’s July 2005 currency revaluation which allows the value of the Yuan to link to a trade-weighted basket of currencies rather than being pegged to the U.S. dollar at a fixed rate. Although we pay for finished goods in U.S. dollars, it is possible that these costs could be passed on to us through higher product costs. As a result of these issues, the Company has shifted certain manufacturing production to lower cost regions of China. It is possible that the Company could experience lower product quality and/or late shipments in these new factories which could unfavorably impact the Company’s financial results.

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.

FISCAL 2007 VERSUS FISCAL 2006

(in millions)		2007				2006				% of Sales — 2007				% of Sales — 2006
Net Sales		$	637.0			$	666.7				100.0				100.0
Gross Profit			209.6				214.6				32.9				32.2
SG&A Expenses			148.6				160.6				23.3				24.0
Depreciation/Amortization			8.1				8.8				1.3				1.3
Operating Profit		$	52.9			$	45.2				8.3				6.8

NET SALES

Net sales decreased $29.7 million, or 4.5%, to $637.0 million in 2007 compared with $666.7 million in 2006. Sales within the footwear departments in Kmart stores (“Shoemart”) were approximately $614.2 million in 2007 and $636.6 million in 2006 for a 3.5% decrease during 2007. The Shoemart sales decrease was the result of a decrease in comparable store sales of 3.1% and average store counts that were 0.6% lower than last year. There were 1,388 Kmart stores open at the end of fiscal 2007 versus 1,392 at the end of fiscal 2006. The balance of the sales decline was due to a 4.6% comparable store sales decline at Rite Aid and lower wholesale shipments to Wal-Mart.

GROSS PROFIT

Gross profit decreased $5.0 million or 2.3% to $209.6 million in 2007 compared with $214.6 million in 2006. The gross margin decline is due to the lower sales volumes in 2007, offset by the gross margin rate improvement to 32.9% in 2007 from 32.2% in 2006. The improvement in gross margin rate is predominantly due to the decrease in the fixed minimum revenue commitment with our third party logistics provider, FMI. (See Note 22 of our Notes to Consolidated Financial Statements for additional information regarding our relationship with FMI.)

SG&A EXPENSES

SG&A expenses decreased $12.0 million, or 7.5%, to $148.6 million in 2007 compared with $160.6 million in 2006. The overall SG&A rate as a percentage of sales decreased to 23.3% in 2007 versus 24.0% in 2006. The decrease in SG&A expenses was due to lower compensation and benefit costs ($7.6 million) and administrative costs ($4.4 million).

DEPRECIATION/AMORTIZATION

Depreciation and amortization decreased $0.7 million to $8.1 million in 2007 compared with $8.8 million in 2006.

OPERATING PROFIT

Operating profit increased $7.7 million to $52.9 million in 2007 compared with $45.2 million in 2006 primarily due to the increase in the gross margin rate, which partially offset the effect of reduced sales, and decrease in expenses noted above.

FISCAL 2006 VERSUS FISCAL 2005

										% of Sales —				% of Sales —
(in millions)		2006				2005				2006				2005
Net Sales		$	666.7			$	715.4				100.0				100.0
Gross Profit			214.6				225.0				32.2				31.5
SG&A Expenses			160.6				183.1				24.0				25.6
Depreciation/Amortization			8.8				7.7				1.3				1.1
Operating Profit		$	45.2			$	34.2				6.8				4.8

NET SALES

Net sales decreased $48.7 million, or 6.8%, to $666.7 million in 2006 compared with $715.4 million in 2005. Sales within the footwear departments in Kmart stores (“Shoemart”) were approximately $636.6 million in 2006 and $667.8 million in 2005 for a 4.7% decrease during 2006. The Shoemart sales decrease was the result of a decrease in comparable store sales of 1.9% and average store counts that were 3.8% lower than last year. There were 1,392 Kmart stores open at the end of fiscal 2006 versus 1,421 at the end of fiscal 2005. Rite Aid sales were essentially flat during fiscal 2006. The balance of the sales decrease in 2006 versus 2005 was the result of no longer selling Thom McAn product within Wal-Mart domestic stores effective at the beginning of 2006.

GROSS PROFIT

Gross profit decreased $10.4 million or 4.6% to $214.6 million in 2006 compared with $225.0 million in 2005. The gross margin decline was due to the lower sales volumes in 2006; however, the gross margin rate improved to 32.2% in 2006 from 31.5% in 2005. The improvement in gross margin rate was predominantly due to higher average selling prices realized in the Shoemart business.

SG&A EXPENSES

SG&A expenses decreased $22.5 million, or 12.3%, to $160.6 million in 2006 compared with $183.1 million in 2005. The overall SG&A rate as a percentage of sales decreased to 24.1% in 2006 versus 25.6% in 2005. SG&A expenses decreased due to a reduction in sales and the number of open Shoemart stores (accounting for approximately $7.0 million) and a reduction in corporate overhead resulting from our emergence from bankruptcy (accounting for approximately $15.3 million).

DEPRECIATION/AMORTIZATION

Depreciation and amortization increased $1.1 million to $8.8 million in 2006 compared with $7.7 million in 2005 due to higher trademark amortization expense recorded in 2006.

OPERATING PROFIT

Operating profit increased $11.0 million to $45.2 million in 2006 compared with $34.2 million in 2005 primarily due to the increase in the gross margin rate, which partially offset the effect of reduced sales, and decrease in expenses noted above.

REORGANIZATION ITEMS

Reorganization items, which consisted of income and expenses that were related to our bankruptcy, were comprised of the following for 2006 and 2005 (in millions):

		2006				2005
Store and distribution center closing and related asset impairment costs		$	—			$	0.1
Professional fees			1.5				18.5
Trustee fees			0.1				3.1

		2006				2005
Gain on disposition of bankruptcy claims			(0.9	)			(1.5	)
Interest income			(0.7	)			(5.6	)
Total		$	—			$	14.6

Reorganization items decreased $14.6 million to $0 million in 2006 compared with $14.6 million in 2005 primarily because we emerged from bankruptcy on February 7, 2006. The disposition of bankruptcy claims resulted in a decrease of $0.6 million in income from continuing operations in 2006 compared to 2005. Professional fees were reduced from $18.5 million to $1.5 million as the Company was only in bankruptcy for one month in 2006 versus the entire year in 2005.

SOP 90-7 requires that interest income earned on cash accumulated during bankruptcy proceedings be included as a reorganization item. During fiscal 2006 and 2005, interest income of $0.7 million and $5.6 million, respectively, was earned on cash that would otherwise have been used to pay such pre-petition liabilities.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity used in funding short-term operations are our current balances in cash and cash equivalents, operating cash flows and borrowings available under our revolving credit facility (the “Credit Facility”) which expires the earlier of November 30, 2008, or 30 days prior to the termination of the Kmart Agreement. The Credit Facility is structured to support general corporate borrowing requirements.

Subsequent to our emergence from Chapter 11 on February 7, 2006 through December 29, 2007, we made payments to creditors totaling $127.5 million, including interest where applicable. These payments exclude claims for approximately $0.5 million which we currently expect will be paid, with interest where applicable, upon final resolution.

Net cash provided by operating activities of continuing operations in 2007 was $60.4 million, primarily consisting of income from continuing operations of $52.8 million, depreciation and amortization of $8.1 million and decreases in inventory, prepaids and other assets of $9.1 million offset by a decrease of accounts payable and accrued expenses of $8.9 million and miscellaneous items of $0.7 million. Net cash provided by operating activities of continuing operations in 2006 was $5.4 million, primarily related to income from continuing operations of $46.0 million, depreciation and amortization of $8.8 million, and a decrease in prepaid expenses, deferred charges and other assets of $14.0 million (primarily related to the collection of income tax refunds) and miscellaneous items totaling $5.1 million offset by payments of pre-petition claims and interest of $30.2 million, an increase in inventory of $2.9 million and a reduction of accounts payable and accrued expenses of $25.9 million, primarily related to the payment of bankruptcy and emergence related expenses.

In light of the anticipated termination of the Kmart Agreement by the end of December 2008, we began providing more current payment terms (shifting from 60 days to 30 days) to various suppliers in the first quarter of fiscal 2008, which we do not expect to impair or have an adverse material impact on our liquidity or results of operations.

Cash used in investing activities was $0.3 million and cash used in financing activities was $105.9 million in 2007 compared to using $1.9 million in cash in investing activities and using $1.0 million

in cash in financing activities in 2006. During 2007, the Company paid a special cash distribution to shareholders totaling $104.8 million.

Cash used in operating activities of discontinued operations was $1.7 million in 2007 compared with cash used in operating activities of discontinued operations of $97.3 million in 2006. Cash used in operating activities of discontinued operations for 2007 and 2006 consisted primarily of payments of pre-petition claims and interest.

Factors that could affect our short and long term liquidity include, among other things, maintaining the support of our key vendors and lenders, retaining key personnel, the payment of further dividends or distributions, the impact of subsequent financial results and the timing of the wind-down of our current businesses, many of which are beyond our control. Because the Company to date has not identified, and we do not believe we will identify, a course of action to replace its current business, we are currently planning to wind-down our Kmart business and all our other businesses by not later than December 31, 2008. This would likely include a liquidation and wind-up of the Company’s business, including proposing a plan of dissolution to our shareholders. Although we cannot reasonably assess the impact of all of these or other uncertainties, we believe that our cash balances, cash generated from operations and borrowings available under our Credit Facility will be sufficient to fund our currently expected operating expenses, current business plan and expected capital expenditures and working capital needs during the next twelve to eighteen months. See “Factors to Consider” below concerning matters in connection with future events, circumstances and uncertainties impacting the Company.

The Company currently does not expect to begin paying regular cash distribution(s) or dividends. However, the Company’s Board of Directors has considered, and could determine in the future, in its discretion, to approve and declare further distribution(s) or dividend(s) to shareholders. There can be no assurance that any such distribution(s) or dividend(s) will be paid or, if to be approved, in what amount or amounts or the timing thereof.

CREDIT FACILITY

We currently maintain a $100 million senior-secured revolving Credit Facility (containing a sub-limit for issuance of letters of credit). The amount we may borrow under the Credit Facility is determined by a borrowing base formula, based upon eligible inventory and accounts receivable, and other terms of the facility. Revolving loans under the Credit Facility bear interest, at our option, either at the prime rate plus a variable margin of 0.0% to 0.5% or the London Interbank Offered Rate (“LIBOR”) plus a variable margin of 1.75% to 2.50%. The variable margin is based upon quarterly excess availability levels specified in the Credit Facility. A quarterly fee of 0.3% per annum is payable to the lenders on the unused balance. The Credit Facility has a maturity date of the earlier of November 30, 2008 or thirty days prior to the termination of the Kmart Agreement.

The Credit Facility is secured by substantially all of the assets of the Company and contains various affirmative and negative covenants, representations, warranties and events of default to which we are subject, including certain financial covenants and restrictions such as limitations on additional indebtedness, other liens, dividends, distributions, stock repurchases and capital expenditures. The Company is required to maintain a minimum excess availability level equal to at least 10% of the borrowing base. In addition, if minimum excess availability falls below 20% of the calculated borrowing base, we will be subject to a fixed charge coverage covenant. The Company is currently in compliance with all of its covenants under the Credit Facility.

The Credit Facility also includes representations and warranties, that, on an ongoing basis, there are no material adverse events affecting our business, operations, property, assets, or condition and that the Kmart Agreement is in full force and effect and not in default. A failure by us to satisfy any of the covenants, representations or warranties would result in default or other adverse impact under the Credit Facility.

As of December 29, 2007, the Company had no loans outstanding under the Credit Facility, standby letters of credit totaling $8.1 million and $60.4 million available for additional borrowings under the Credit Facility.

CONTRACTUAL OBLIGATIONS

The following is a summary of our significant contractual obligations, excluding interest, as of December 29, 2007 (in millions):

		Payments Due By Period
						Less than												After
		Total				1 Year				1-3 Years				4-5 Years				5 Years
Mortgage payable		$	3.2			$	1.2			$	2.0			$	—			$	—
Operating leases			1.5				1.2				0.3				—				—
Purchase obligations			135.8				135.8				—				—				—
Compensation obligations			12.7				5.7				7.0				—				—
Third party service provider			7.4				7.4				—				—				—
Postretirement benefit obligations			14.7				0.9				2.0				2.2				9.6
Workers’ compensation obligations			2.4				0.7				1.5				0.2				—
Environment remediation			1.6				—				—				—				1.6
Total		$	179.3			$	152.9			$	12.8			$	2.4			$	11.2

The above table does not include the Kmart license fees, as defined in the Kmart Agreement, as such fees are based on sales. The Kmart Agreement also requires the payment of a miscellaneous expense fee equal to $23,500 per open store per year, which also is not included in the table above.

Also not included in the above table is the claim Kmart has against us for $11,000 for each existing store as of August 25, 2005, which is generally payable by us to Kmart at the time a store is disposed of, closed or converted to another retail format in accordance with the store limitation as described in the Kmart Agreement.

The above table also does not include any unrecognized tax positions as of December 29, 2007 as the Company has no unrecognized tax benefits.

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.

The preparation of these consolidated financial statements requires us to make estimates and

judgments that affect the reported amounts of assets, liabilities, expenses and related disclosure of contingent liabilities. On an ongoing basis, we evaluate these estimates, including those related to the valuation of inventory, deferred tax assets and the impairment of long-lived assets. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the bases for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. Our management has discussed with the Audit Committee of the Board of Directors the development, selection and disclosure of our critical accounting estimates and the application of these estimates. We considered the following to be our critical accounting estimates in the preparation of the Consolidated Financial Statements included in this report.

Valuation and Aging of Inventory and Shrink Reserve

Merchandise inventory is a significant portion of our consolidated balance sheets, representing approximately 47.7% of total assets at December 29, 2007.

Inventories are valued using the lower of cost or market value, determined by the reverse mark-up or retail inventory method (“RIM”). Under the RIM, the valuation of inventories at cost and the resulting gross margins are calculated by applying a calculated cost-to-retail ratio to the retail value of inventories. RIM is an averaging method that is widely used in the retail industry due to its practicality. Also, it is recognized that the use of RIM will result in valuing inventories at the lower of cost or market if markdowns are currently taken as a reduction of the retail value of inventories.

The methodologies we utilize in our application of RIM are consistent for all periods presented. Such methodologies include the development of cost-to-retail ratios, the development of shrinkage reserves and the accounting for price changes. RIM calculations require management to make estimates, such as merchandise mark-on, mark-ups, markdowns and shrinkage, which can significantly impact the ending inventory valuation at cost as well as resulting gross margins. These significant estimates, coupled with the fact that the RIM is an averaging process, may not, in all circumstances, reflect actual historical experience, and could result in significant differences to amounts recorded. Future events, such as store closings and liquidations (including the anticipated wind-down of our business), could result in an increase in the level of estimated markdowns which could result in lower inventory values and increases to cost of sales in future periods. In addition, failure to take markdowns currently can result in an overstatement of inventory value under the lower of cost or market principle.

As a supplement to the inventory values established under the RIM, we establish reserves for additional markdowns associated with shrink and aged product. The shrink expense reserve represents a reserve for the unidentified loss of inventory. Management uses historical percentages to accrue shrink expense. Physical inventory counts are performed at each store and distribution center throughout the year. At the completion of the inventory count, actual shrink expense is quantified and compared to the shrink reserve. Any difference between actual shrink expense and the reserve is recorded as a reduction or addition to inventory on the consolidated balance sheet and as a reduction or addition to cost of sales in the consolidated statements of operations.

The aged inventory reserve represents an estimate of the markdown required to liquidate aged inventory, which is generally defined as inventory that is aged 12 months or more. In addition, the Company estimates the portion of current inventory that will be on hand and considered aged or

seasonal on the currently scheduled expiration date, which is December 31, 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement), and reserves for that amount as Kmart will not be obligated to purchase aged inventory upon expiration of our contract. Management calculates a reserve for aged inventory by comparing the cost of the inventory to the estimated realizable value of the inventory. In order to accomplish this, we analyze the quantity and quality of all inventory in seasonal aging brackets (i.e., aged one season, two seasons, etc.). The expected markdowns necessary to liquidate each aging bracket are thus analyzed to determine if the related cost exceeds the net realizable value and a reserve, if necessary, is established.

Impairment of Long-Lived Assets

We evaluate the recoverability of our long-lived assets in accordance with Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets to be Disposed Of, which generally requires us to assess these assets for recoverability whenever events or changes in circumstances indicate that the carrying amounts of long-lived tangible assets and intangible assets that are amortized may not be recoverable.

We consider historical performance and future estimated results in our evaluation of potential impairment and then compare the carrying amount of the asset to the estimated future undiscounted cash flows expected to result from the use of the asset. The ability to accurately predict future cash flows may impact the determination of fair value. Management’s assessments of cash flows represent its best estimate as of the time of the impairment review and are based upon expected future results of operations. Management believes that its estimates of applicable cash flows in the current period are reasonable; however, if different cash flows had been estimated in the current period, the long-lived asset balances could have been materially impacted. Furthermore, estimates may change from period to period as new information is generated and as trends are identified, and this could materially impact results in future periods.

Factors that management must estimate when performing impairment tests include, among other items, possible liquidation of our business, sales volume, the related cost of product, markdowns, shrink and estimated flow through or operating profit percentages. Actual results may differ materially from these estimates and, as a result, the fair values may be adjusted in the future.

During fiscal 2005 the useful lives of all long-lived assets except for land and building and improvement were revised so that long-lived assets will be fully depreciated as of December 2008 to coincide with the currently scheduled expiration of the Kmart Agreement, which is December 31, 2008 (subject to any earlier termination by mutual agreement of Kmart and the Company or, in certain particular circumstances provided for in the Kmart Agreement, unilaterally by a party pursuant to the existing early termination or default terms of the Kmart Agreement).

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 is no longer self-insured for medical costs (the Company was self-insured for workers’ compensation insurance in fiscal 2004 and prior).

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 $3.3 million at the end of fiscal year 2007 and $4.2 million at the end of fiscal year 2006. 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 (although use against taxable income after 2008 will not be possible if the Company has no operating income or if the Company liquidates and dissolves).

As of December 29, 2007 we have recorded a net deferred tax asset of $67.4 million and a related valuation allowance of $67.4 million. In connection with the preparation of our fiscal years 2007, 2006 and 2005 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 anticipated liquidation of our business no later than the end of 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.

In June, 2006 the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes (“FIN 48”). The Company adopted the provisions of FIN 48 effective December 31, 2006. The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. 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 FIN 48, 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 and also as of December 29, 2007, the Company did not have any unrecognized tax benefits.

Retiree Medical Benefits

The costs and obligations of our retiree medical plans (for current retirees and a “closed” group of active associates who meet certain eligibility requirements) are calculated by third party actuarial assessments using many assumptions to estimate the benefit that the employee earns while working, the amount of which cannot be completely determined until the benefit payments cease.

The most significant assumptions, as presented in Note 20 “Post Retirement Benefits” of Notes to the Consolidated Financial Statements, include discount rate and future trends in health care costs. The selection of assumptions is based on historical trends and known economic and market conditions at the time of valuation. Future health care costs may differ substantially from these assumptions. These differences may significantly impact future retiree medical expenses.

During 2006, the Company adopted the recognition and related disclosure provisions of FASB Statement Number 158, “Employees’ Accounting for Defined Benefit Pension and other Postretirement Plans” (“Statement No. 158”). Statement No. 158 requires companies to recognize the funded status of their defined benefit post retirement plans in their balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The Company had unrecognized actuarial gains related to the retiree medical plans. Upon adoption of FASB Statement No. 158 the unrecognized gains in the amount of $9.6 million were recognized as accumulated other comprehensive income and a reduction of the retiree obligation.

During 2007, the Company adopted the measurement date and related disclosure provisions of FASB Statement Number 158. Statement Number 158 requires companies to measure plan assets and benefit obligations as of the balance sheet date. See Note 21 “Supplemental Executive Retirement Plan” of Notes to the Consolidated Financial Statements.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles followed in the United States (“GAAP”), and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. In November, 2007 the FASB agreed to defer for one year the effective date of Statement No. 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position, results of operations and cash flows.

In February 2006, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Liabilities Including an Amendment of FASB Statement No. 115,” which allows companies to elect to measure many financial instruments and certain other items at fair value. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 159 on our consolidated financial position, results of operations and cash flows.

FACTORS TO CONSIDER

Continuing review of strategic course of action

To date, we have not identified a course of action under which we would continue to operate following the termination of our Kmart Agreement, which accounts for substantially all of our net sales and net profits. Absent a strategic course of action under which we would continue to operate, we are currently planning to wind-down our Kmart business and all our other businesses by not later than December 31, 2008. This would likely include a liquidation and wind-up of the Company’s business, including proposing a plan of dissolution to our shareholders.

In connection with the termination of our Kmart Agreement, our Board has continued to review our strategic courses of action to resolve the Company’s future in the best interest of all shareholders.

Because we have not to date identified, and we do not believe that we will identify, a course of action under which we would continue to operate a business following termination of the Kmart Agreement, we are currently planning to wind-down our Kmart business and all our other businesses by not later than December 31, 2008. This would likely include a liquidation and wind-up of the Company’s business, including proposing a plan of dissolution to our shareholders.

In connection with the likely wind-down of our current business, we continue to evaluate all assets that would be available for sale, including our corporate headquarters and our trademarks and brands. See Item 2 — “Properties” and Item 1 — “Business — Trademarks and Service Marks” above. We cannot assure you that we will be successful in the sale of our corporate headquarters or any other saleable assets on the terms or at the time we may expect or plan for.

In connection with a plan of liquidation and dissolution, there can be no assurance as to the amount, if any, of cash or other property that could be distributed to our shareholders or the timing of any such future distribution.

Our Board has no fixed timetable for when a decision concerning a proposed plan of liquidation and dissolution would be made, or when any distribution to our shareholders may occur due to the many contingencies and uncertainties inherent in winding up and liquidating a business.

A proposed plan of liquidation and dissolution would be subject to approval and adoption by the Company’s shareholders.

Under a plan of liquidation and dissolution the Company’s assets would be sold or otherwise disposed of, known liabilities would be paid or provided for, reserves would be established for contingent liabilities and any remaining assets would ultimately be distributed to shareholders.

If a plan of liquidation and dissolution were to be approved and adopted by our Board and our shareholders, it is expected that the Company would have limited or no new revenue generation sources or activities and that it would not engage in further business activities following the adoption of a liquidation plan except for winding up the business of the Company, selling or disposing of any of its remaining saleable assets and satisfying and providing for its liabilities and claims. The amount and timing of any distributions to shareholders would be determined by our Board (or the trustee of a liquidating trust if our assets and liabilities are transferred to a liquidating trust pursuant to a plan of liquidation and dissolution), in its sole discretion, and would depend, in part, on our ability to settle or otherwise resolve and provide for all of our remaining liabilities and contingencies and convert any remaining assets into cash.

If we pursue liquidation and dissolution, uncertainties as to the amount of our liabilities and the disposition value, if any, of our remaining assets make it impractical to predict the net value which might ultimately be distributable to our shareholders. No assurance can be given that available cash and any amounts received on any sale of assets will be adequate to provide for our obligations, liabilities, expenses and claims and to make cash distributions to shareholders. We also cannot

assure you that any distribution in liquidation would equal the price or prices at which our common stock has recently traded or may trade in the future.

Termination of Kmart Agreement

There can be no assurance that issues will not arise in connection with any of the obligations, adjustments and payments to occur on the termination of our Kmart Agreement.

Upon the termination of the Kmart Agreement at its scheduled December 31, 2008 expiration date, each of Footstar and Kmart has significant obligations to be satisfied to the other party. These include:

	•		Final adjustments of all fees and amounts owed by Footstar to Kmart, and all receipts and amounts owed by Kmart to Footstar, must be computed and finally settled through the expiration date.
	•		During the term of the agreement, Footstar pays license fees to Kmart equal to 14.625% of gross sales of covered products of all licensed footwear departments. These license fees are payable through the termination date.
	•		Kmart provides weekly sales amounts to Footstar (called “weekly sales remittances”) under the agreement covering licensed footwear sales department receipts, less license fees, miscellaneous expense deductions, sales and gross receipts taxes, employee compensation and costs, and other amounts owed by Footstar to Kmart. Kmart has a right to offset any amounts owed by Footstar from weekly sales remittances.
	•		On and as of the December 31, 2008 termination date, under the agreement Kmart is required to purchase from Footstar the inventory in all remaining licensed footwear departments (including inventory that is on order pursuant to Kmart’s written request but excluding inventory that is damaged or unsaleable and excluding seasonal inventory) for an amount equal to the “book value” of such inventory plus $1,500,000. Footstar must deliver the inventory to be purchased by Kmart free and clear of all liens, security interests and encumbrances. The inventory is currently subject to liens and security interests under Footstar’s Credit Facility, and Footstar may need to obtain the release of such liens and security interests upon purchase of the inventory by Kmart. Footstar is required to vacate all licensed footwear departments within seven days after the termination date.
	•		Under the agreement, “book value” means, with respect to any inventory owned by Footstar in a licensed footwear department, the book value of such inventory calculated in accordance with generally accepted accounting principles (GAAP) applied on a consistent basis, but excluding (i) distribution and delivery costs incurred by Footstar after receipt of such merchandise from suppliers at a Footstar distribution center, and (ii) any intercompany royalty or other intercompany charges between and among Footstar and its affiliates (other than charges that reflect an out-of-pocket cost incurred by Footstar or an affiliate and that do not result in a book value with respect to the applicable inventory greater than the book value of such inventory that would have existed had Footstar and its affiliates been consolidated into a single entity).

	•		“Seasonal inventory” under the agreement means inventory that is more than four months post-season. Kmart has no obligation to purchase inventory that was purchased for a selling season that was completed at least four calendar months prior to the buy-out date set forth in the agreement. For inventory purchased for a former selling season, Footstar has four months after the end of such season to sell such inventory. If the buy-out date occurs during that four month period Kmart has an obligation to purchase such inventory. If the buy-out date occurs after that four month period such inventory will be “seasonal inventory” and Kmart will not have an obligation to purchase it.
	•		Footstar is required to provide to Kmart all necessary documentation to support the determination of book value for the six-month period prior to the termination date, which reflects all permanent markdowns of the inventory. Footstar is not to have (i) at any time prior to the termination date, purchased or transferred any goods into inventory outside of the ordinary course in contemplation of the termination date, (ii) purchased inventory for or otherwise stocked in any licensed footwear department at a level disproportionately greater than the average level of such licensed footwear department at the same time of year for the prior three years, unless gross sales at such licensed footwear department during the prior six months support such increased stocking, or (iii) prior to the termination date, marked up any inventory. The inventory mix at each licensed footwear department as of the termination date must be reasonably comparable to the average mix at such licensed footwear department during the same time period for the prior three years and shall reflect ordinary course practice; and all inventory markdowns shall have been taken in the ordinary course and the documentation provided to Kmart is to reflect all permanent markdowns.
	•		No later than seven days following the termination date, Footstar must remove from the remaining licensed footwear department all fixtures, furnishings, equipment and other property belonging to Footstar and surrender possession of all footwear departments premises in the same condition as received, ordinary wear and tear excepted.
	•		With respect to any purchase of inventory by Kmart under the agreement, Kmart and Footstar each have the right to require an actual third party physical count and determination of the quantity and quality (i.e., damaged, unsaleable or seasonal inventory) of such inventory for purchase.
	•		Under the agreement, Footstar is required to spend, in the aggregate and on an annual basis during the term of the agreement, a minimum of 10% of gross sales from the licensed footwear departments on salaries, payroll taxes, moving and travel expenses, worker’s compensation, incentives and other employee costs (“staffing costs”).
	•		Under the agreement, Footstar is also obligated to pay a claim amount to Kmart equal to $11,000 per licensed footwear department for the 1,430 licensed footwear departments existing at the inception of the agreement (totaling $15,730,000). This claim obligation is waived upon certain conditions provided in the agreement, including the termination and expiration of the agreement at the scheduled termination date of December 31, 2008.
	•		Footstar is required to keep accurate books and records necessary for computation of (i) the book value of any inventory purchased by Footstar for sale in the licensed footwear

departments and for any inventory to be purchased by Kmart upon termination of the agreement, and (ii) the total amount expended by Footstar on staffing costs. These books and records are to be available for inspection by Kmart or its designated agent upon reasonable notice during the term of the agreement and for six months following the termination of the agreement.

•

Pursuant to the terms of the agreement, Footstar is obligated to indemnify Kmart with respect to, among other things, any failure by Footstar to pay when due taxes owed to any taxing authority or to file all necessary tax reports and documents. Kmart withholds from weekly sales remittances certain sales taxes and gross receipts taxes paid on Footstar’s behalf directly to the taxing authorities. Kmart also advances payroll costs for footwear department employees of Footstar, subject to reimbursement by Footstar, which may be set off against weekly sales remittances. Footstar’s and Kmart’s indemnification obligations under the agreement continue and survive following the termination date.

The above summary does not purport to be complete and is subject in its entirety to the terms of the Kmart Agreement (Exhibit 10.1 referenced in this Form 10-K) and to any modifications and adjustments as may be agreed to by the parties.

In connection with and as part of Footstar’s reorganization proceeding under the Bankruptcy Code, Kmart and Footstar had various significant disputes in connection with amounts owed and payable between the parties under the terms of the prior Kmart Agreement. In light of the significant adjustments and amounts payable in connection with the termination of the Kmart Agreement, including determinations as to purchase price to be paid by Kmart for inventory, there is no assurance that the parties will in all instances be able to resolve all remaining obligations to be satisfied and all amounts payable between them upon and in connection with the termination of this business.

Certain issues in winding-down our business

As our Kmart business winds down during 2008, we may encounter problems and other issues which may adversely impact our Kmart Agreement and our other business operations and our financial results.

We have been operating our business with Kmart for over forty years. The Kmart business currently accounts for substantially all of our net sales and net profits and is expected to terminate by no later than December 31, 2008. We could potentially encounter numerous problems and issues in winding down and terminating this business and all of our other operations, many of which may be beyond our control.

	•		We could potentially have issues with our suppliers and other vendors which may be concerned with the pending termination of our business, and we could potentially encounter problems with merchandise production, shipments or quality;
	•		We may encounter difficulty retaining or replacing our store personnel or administrative or management personnel;

•

In connection with scaling back and winding down our business in anticipation of the termination of the Kmart Agreement, we may likely incur cash and non-cash special charges in connection with exit activities, severance charges, and potential other charges or matters.

Our Rite-Aid business is currently expected to end at or about the end of 2008.

We currently anticipate that our business with Rite-Aid will not continue in any material respect following the end of 2008.

As we scale back our business operations we anticipate reducing our workforce.

As we wind-down our current business in connection with the termination of the Kmart business, we anticipate reducing our workforce at such times and to the level necessary to fulfill our Kmart Agreement and other obligations.

We do not currently expect to generate any material revenues or operating income as an independent company following the termination of our current business.

Following the termination of our Kmart Agreement, which we expect to occur by no later than December 31, 2008, we currently do not expect to own or manage any material revenue-producing assets and we will not generate any meaningful revenues. We will endeavor to operate the Company on a scaled back basis. However, we will continue to incur significant costs to maintain our ongoing administrative operations and continued corporate existence as well as costs to wind-down our business, without corresponding revenues.

If we are deemed to be an investment company after we wind-down our current businesses, we could be required to institute burdensome compliance requirements and our activities could be restricted, which could make it difficult to implement any future business opportunities.

In the period following termination of our Kmart business, in order not to be regulated as an investment company under the Investment Company Act of 1940, the Company must ensure that it is engaged primarily in a business other than investing, reinvesting or trading of securities and that

its activities do not include investing, reinvesting, owning, holding or trading investment securities, unless the Company can qualify for an exclusion.

We would seek to manage our activities in such a manner so as to avoid being subject to the Investment Company Act of 1940.

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 would lose the benefit of these net operating loss carryforwards in a plan of liquidation and dissolution as well as 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. However, under our certificate of incorporation, these restrictions will expire no later than December 31, 2008. We can provide no assurances that an ownership change will not occur either before or after this expiration date, 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.

Our executive officers may have interests that are different from the interests of other shareholders.

As our Board determines the best course to resolve our future in the interest of all shareholders, including a plan to liquidate and dissolve, our executive officers may have interests that are different from or in addition to those of our other shareholders. Each of our executive officers is subject to an employment agreement with the Company, the original term of which ends on December 31, 2008. Although the employment agreements may be automatically renewed for successive one-year terms, either the executive or the Company may elect to terminate employment at the expiration of the then current term of employment. Each of our executive officers would be entitled to significant severance compensation and other benefits upon any termination or constructive termination of employment without cause (including a termination in connection with any election by the Company not to renew the term of the employment agreement at the expiration of its original term or any renewal term or in connection with an acquisition or transfer of the business of the Company or certain other transfers of assets or stock or other transactions).

It is likely that at some point our executives may be terminated without cause or constructively terminated without cause due to the termination of the Kmart business. The employment of these officers would ultimately terminate as a part of any potential liquidation and dissolution.

ITEM 7A.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

DERIVATIVES

As of December 29, 2007, we were not materially exposed to changes in the underlying values of our assets or liabilities nor were we materially exposed to changes in the value of expected foreign currency cash flows. We historically have not entered into derivative instruments for any purpose other than to manage our interest rate exposure. That is, we do not hold derivative financial investments for trading or speculative purposes.

INTEREST RATES

Revolving loans under our Credit Facility bear interest at rates that are tied to the LIBOR and the prime rate and therefore our condensed consolidated financial statements could be exposed to changes in interest rates. Although we did incur short term borrowings under the Credit Facility as a result of our special cash distribution in the second quarter of fiscal 2007, which was repaid prior to June 30, 2007, the Company has not considered this exposure to be material. We assess interest rate cash flow risk by identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows. To the extent that we may borrow pursuant to our Credit Facility in the future, we may be exposed to market risk related to interest rate fluctuations. Additionally, we have not entered into financial instruments for hedging purposes.

FOREIGN EXCHANGE

A significant percentage of the Company’s products are sourced or manufactured offshore, with China accounting for approximately 97% of all sources. Our offshore product sourcing and purchasing activities are currently, and have been historically, denominated in U.S. dollars, and, therefore, we do not currently have material exposure to cash flows denominated in foreign currencies nor have net foreign exchange gains or losses been material to operating results in the reporting periods presented in this report.

Historically, China’s national currency, the Yuan, was pegged to the U.S. dollar at a fixed rate. However, in July 2005, the Chinese government revalued the Yuan allowing its value to now link to a trade-weighted basket of currencies. If the exchange rate of the Chinese Yuan were to continue increasing versus the U.S. dollar, the Company may experience higher product costs with regards to inventory purchased from China.

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The reports of independent registered public accounting firm, the consolidated financial statements

of the Company, the notes to consolidated financial statements, and the supplementary financial information called for by this Item 8 are listed below. Specific financial statements and supplementary data can be found beginning on the page listed in the following index:

INDEX

		Page
Report of Independent Registered Public Accounting Firm			F-2
Consolidated Statements of Operations for the Fiscal Years Ended December 29, 2007, December 30, 2006 and December 31, 2005			F-3
Consolidated Balance Sheets as of December 29, 2007 and December 30, 2006			F-4
Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Fiscal Years Ended December 29, 2007, December 30, 2006 and December 31, 2005			F-5
Consolidated Statements of Cash Flows for the Fiscal Years Ended December 29, 2007, December 30, 2006 and December 31, 2005			F-6
Notes to Consolidated Financial Statements			F-7
Selected Quarterly Data (See Note 27 to the Consolidated Financial Statements)			F-32
Schedule II — Valuation and Qualifying Accounts for the Fiscal Years ended December 29, 2007, December 30, 2006 and December 31, 2005			45

ITEM 9.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A.		CONTROLS AND PROCEDURES

(a) Disclosure Controls and Procedures

The Company has established controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. The Company’s management, with the participation of our Chief Executive Officer and President and Chief Financial Officer — Senior Vice President, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report (the “Evaluation Date”). There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based on such evaluation, the Chief Executive Officer and President and Chief Financial Officer — Senior Vice President concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective at a reasonable assurance level.

(b) Management’s Annual Report on Internal Control Over Financial Reporting

Management of the Company 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.

Management, with the participation of the Company’s Chief Executive Officer and President- (Principal Executive Officer) and Chief Financial Officer — Senior Vice President (Principal Financial Officer), assessed the effectiveness of the Company’s internal control over financial reporting as of December 29, 2007. 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 and President and our Chief Financial Officer — Senior Vice President (Principal Financial Officer)) has concluded that, as of December 29, 2007, our internal control over financial reporting was effective at a reasonable assurance level.

The Company’s internal control over financial reporting as of December 29, 2007 has been audited by Amper Politziner & Mattia, PC, the independent registered public accounting firm which audited the financial statements in this Annual Report, as stated in their report which appears herein.

(c) Changes in Internal Control Over Financial Reporting

No changes in the Company’s internal control over financial reporting have occurred during the quarter ended December 29, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

(d) Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Footstar, Inc.

We have audited Footstar, Inc. and its subsidiaries’ (the “Company”) internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit 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 effective internal control over financial reporting was

maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control-Internal Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company and our report dated March 4, 2008 expressed an unqualified opinion.

/s/ Amper, Politziner & Mattia P.C.
March 4, 2008
Edison, New Jersey

ITEM 9B.		OTHER INFORMATION

Not applicable.

PART III

ITEM 10.		DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Only those sections of the Proxy Statement that specifically address the items set forth herein are incorporated by reference.

BOARD OF DIRECTORS

The information required by this item with respect to our directors is incorporated herein by reference from the information under the caption “Election of Directors” which will be contained in the Company’s Proxy Statement in connection with the Company’s 2008 Annual Meeting of Stockholders (the “Proxy Statement”).

EXECUTIVE OFFICERS OF THE REGISTRANT

Certain information required by this item concerning executive officers is set forth in Item 1 of this Report under the caption “Executive Officers of the Registrant.”

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

The information required by this item with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 will be contained under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement and is incorporated herein by reference.

CODE OF ETHICS

The information required by this item with respect to the Company’s code of ethics will be contained under the heading “Code of Business Conduct and Ethics” in the Proxy Statement and is incorporated herein by reference.

AUDIT COMMITTEE

The information regarding the Company’s audit committee and designated audit committee financial expert is set forth under the caption “Audit Committee” in the Proxy Statement and such information is incorporated by reference herein.

STOCKHOLDER RECOMMENDATIONS FOR DIRECTOR NOMINEES

The Company has adopted, as part of its Shareholder Communication Process, a procedure by which its stockholders may recommend director nominees. The information concerning this process is set forth under “Nominating and Governance Committee” in the Proxy Statement and such information is incorporated by reference herein.

ITEM 11.		EXECUTIVE COMPENSATION

The information relating to executive and director compensation is set forth under the captions “Executive Compensation,” “Director Compensation,” and “Compensation Committee Interlocks and Insider Participation” in the Proxy Statement and such information is incorporated by reference herein; 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 of 1933 or Securities Exchange Act of 1934 except only as many be expressly set forth in any such filing by specific reference.

ITEM 12.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information relating to security ownership of management and certain beneficial owners is set forth under the caption “Beneficial Ownership of Common Stock” in the Proxy Statement and such information is incorporated by reference herein.

EQUITY COMPENSATION PLAN INFORMATION

		(a)				(b)				(c)
										Number of securities
										remaining available for
		Number of securities to				Weighted-average exercise				future issuance under
		be issued upon exercise				price of outstanding				equity compensation plans
		of outstanding options,				options,				(excluding securities
Plan category		warrants and rights				warrants and rights				reflected in column (a))
Equity compensation plans approved by security holders (1)			931,830			$	13				1,579,413	(3)
Equity compensation plans not approved by security holders (2)			242,075			$	26				1,649,169	(4)
Total			1,173,905			$	15				3,228,582

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 18 to the Consolidated Financial Statements.

ITEM 13.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information regarding certain relationships and related party transactions is set forth under the caption “Transactions with Related Persons” in the Proxy Statement and such information is incorporated by reference herein.

The information regarding director independence is set forth under the captions “Board Independence and Composition,” “Audit Committee,” “Compensation Committee,” and “Nominating and Governance Committee” in the Proxy Statement and such information is incorporated by reference herein.

ITEM 14.		PRINCIPAL ACCOUNTING FEES AND SERVICES

The information regarding the accounting fees and services provided by the Company’s independent registered public accounting firm (“independent accountant”) and the Company’s pre-approval policies and procedures for audit and non-audit services provided by the independent accountant are set forth under the caption “Ratification of Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement and such information is incorporated by reference herein.

PART IV

ITEM 15.		EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements

The following financial statements are included within this report:		Page
Report of Independent Registered Public Accounting Firm			F-2
Consolidated Statements of Operations for the Fiscal Years ended December 29, 2007, December 30, 2006 and December 31, 2005			F-3
Consolidated Balance Sheets as of December 29, 2007 and December 30, 2006			F-4
Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Fiscal Years ended December 29, 2007, December 30, 2006 and December 31, 2005			F-5
Consolidated Statements of Cash Flows for the Fiscal Years ended December 29, 2007, December 30, 2006 and December 31, 2005			F-6
Notes to Consolidated Financial Statements			F-7
Selected Quarterly Data (see Note 27 to the Consolidated Financial Statements)			F-32

(a)(2) Schedule

The following schedule is included in Part IV of this report:		Page
Schedule II — Valuation and Qualifying Accounts for the Fiscal Years ended December 29, 2007, December 30, 2006 and December 31, 2005			45

Schedules not included above have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or related notes.

(a)(3) Exhibits

The exhibits to this report are listed in the Exhibit Index included elsewhere herein.

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.

Pursuant to the requirements of the Securities 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   Jonathan M. Couchman		Chairman of the Board		March 12, 2008
/s/ JEFFREY A. SHEPARD   Jeffrey A. Shepard		Chief Executive Officer and President		March 12, 2008
/s/ MICHAEL J. LYNCH   Michael J. Lynch		Chief Financial Officer- Senior Vice President		March 12, 2008
/s/ CRAIG M. HAINES   Craig M. Haines		Vice President-Controller and  Principal Accounting Officer		March 12, 2008
/s/ EUGENE I. DAVIS   Eugene I. Davis		Director		March 12, 2008
/s/ ADAM W. FINERMAN   Adam W. Finerman		Director		March 12, 2008
/s/ MICHAEL A. O’HARA   Michael O’Hara		Director		March 12, 2008
/s/ ALAN I. WEINSTEIN   Alan I. Weinstein		Director		March 12, 2008
/s/ ALAN KELLY   Alan Kelly		Director		March 12, 2008
/s/ GERALD F. KELLY, JR.   Gerald F. Kelly, Jr.		Director		March 12, 2008
/s/ STEVEN D. SCHEIWE   Steven D. Scheiwe		Director		March 12, 2008

FOOTSTAR, INC. AND SUBSIDIARY COMPANIES
Valuation and Qualifying Accounts for the Fiscal Years ended
December 29, 2007, December 30, 2006 and December 31, 2005
(in millions)

Schedule II

						Additions
		Balance at				Charged to								Balance at
		Beginning				Costs and								End of
Description		of Fiscal Year				Expenses				Deductions(1)(2)				Fiscal Year
Fiscal Year Ended December 29, 2007
Allowance for Doubtful Accounts		$	0.1			$	—			$	(0.1	)		$	—
Aged Inventory Reserve		$	0.1			$	1.0			$	(0.2	)		$	0.9
Allowance for Sales Returns		$	0.9			$	0.3			$	(0.3	)		$	0.9
Fiscal Year Ended December 30, 2006
Allowance for Doubtful Accounts		$	1.0			$	0.2			$	(1.1	)		$	0.1
Aged Inventory Reserve		$	0.1			$	0.5			$	(0.5	)		$	0.1
Allowance for Sales Returns		$	0.8			$	0.2			$	(0.1	)		$	0.9
Fiscal Year Ended December 31, 2005
Allowance for Doubtful Accounts		$	0.4			$	1.0			$	(0.4	)		$	1.0
Aged Inventory Reserve		$	0.1			$	0.3			$	(0.3	)		$	0.1
Allowance for Sales Returns		$	1.2			$	0.5			$	(0.9	)		$	0.8

This Schedule II reflects continuing operations only.

EXHIBIT INDEX

Exhibit
Number		DESCRIPTION
2.1		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 Form 8-K filed on November 15, 2004 and to Exhibit 2.1 to Footstar, Inc.’s 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).
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 3.3 to Footstar Inc.’s Current Report on Form 8-K filed on February 7, 2006).
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) and Amendment No. 1 to the Rights Agreement dated as of May 31, 2002, 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).
10.1		Amended and Restated Master Agreement (the “Kmart 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 Form 10/A Information Statement filed on September 13, 1996).*
10.2(a)		Form of Restricted Stock Agreement with Executive Officers (incorporated by

Exhibit
Number		DESCRIPTION
		reference to Exhibit 10.2(a) to Footstar, Inc.’s Form 10-K/A filed on March 16, 2006).*
10.3(a)		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).*
10.3(b)		Form of Restricted Stock Agreement with Non-Employee Directors (incorporated by reference to Exhibit 10.3(b) to Footstar, Inc.’s Form 10-K/A filed on March 16, 2006).*
10.3(c)		1996 Non-Employee Director Stock Plan of Footstar, Inc. (incorporated by reference to Exhibit 10.4 to Footstar, Inc.’s Form 10/A Information Statement filed on September 13, 1996).*
10.4(a)		Employment Agreement with Jeffrey Shepard dated as of October 28, 2005 (incorporated by reference to Exhibit 10.1 of Footstar Inc.’s Current Report on Form 8-K filed on November 3, 2005).*
10.4(b)		Confidentiality and Non-Competition Agreement with Jeffrey Shepard (incorporated by reference to Exhibit 10.5(h) of Footstar, Inc.’s 2003 Annual Report on Form 10-K filed on April 8, 2005).*
10.4(c)		Employment Agreement with William Lenich dated as of December 16, 2005 (incorporated by reference to Exhibit 10.1 of Footstar, Inc.’s Current Report on Form 8-K filed on December 22, 2005).*
10.4(d)		Employment Agreement with Dennis M. Lee dated as of December 16, 2005 (incorporated by reference to Exhibit 10.2 of Footstar, Inc.’s Current Report on Form 8-K filed on December 22, 2005).*
10.4(e)		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).*
10.4(f)		Employment Agreement with Randall Proffitt dated as of December 16, 2005 (incorporated by reference to Exhibit 10.4 of Footstar, Inc.’s Current Report on Form 8-K filed on December 22, 2005).*
10.4(g)		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).*
10.4(h)		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).*

Exhibit
Number		DESCRIPTION
10.4(i)		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).*
10.4(j)		Compensatory arrangement between Mr. George A. Sywassink and Footstar, Inc., in connection with Mr. Sywassink’s resignation effective March 26, 2007 (incorporated by reference to Item 5.02 of Footstar, Inc.’s Current Report on Form 8-K filed on March 29, 2007).*
10.5		Footstar, Inc. Deferred Compensation Plan (incorporated by reference to Exhibit 10.8 to Footstar, Inc.’s 1996 Annual Report on Form 10-K filed on March 28, 1997, Reg. No. 001-11681).*
10.6(a)		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).*
10.7(a)		2000 Equity Incentive Plan (incorporated by reference to Exhibit 10.11 to Footstar, Inc.’s 1999 Annual Report on Form 10-K filed on March 31, 2000, Reg. No. 001-11681). *
10.7(b)		Performance Criteria under the Company’s Annual Incentive Plan (incorporated by reference to Footstar, Inc.’s Current Report on From 8-K filed on March 8, 2006).*
10.8		Amended and Restated Exit Credit Agreement dated as of February 7, 2006 among Footstar, Inc., as Lead Borrower for Footstar, Inc., and Footstar Corporation, the Lenders party thereto; Bank of America, N.A., as Administrative Agent, Swingline Lender and Collateral Agent; and General Electric Capital Corporation as Syndication Agent (incorporated by reference to Exhibit 10.1 of Footstar, Inc.’s Current Report on Form 8-K filed on February 13, 2006).
10.9		Third Amendment dated as of June 25, 2007 to the Receiving, Warehousing and Physical Distribution Services Agreement dated as of July 8, 2004, as amended by First Amendment to Warehousing and Physical Distribution Services Agreement dated as of July 19, 2004 and a letter agreement dated January 7, 2005 by and between Footstar Corporation and FMI International LLC. (incorporated by reference to Exhibit 10.2 to Footstar, Inc.’s Quarterly Report on Form 10-Q filed on August 09, 2007).
10.10		Receiving, Warehousing and Physical Distribution Services Agreement dated as of July 8, 2004 by and between Footstar Corporation and FMI International LLC, as amended by First Amendment to Warehousing and Physical Distribution Services Agreement dated as of July 19, 2004 (incorporated by reference to Exhibits 99.2 and 99.3 to Footstar, Inc.’s Current Report on Form 8-K filed on August 5, 2004).
21.1		Subsidiaries of Footstar, Inc.

Exhibit
Number		DESCRIPTION
23.1		Consent of Independent Registered Public Accounting Firm.
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 — Senior Vice President (Principal Financial Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32		Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

INDEX		Page
Report of Independent Registered Public Accounting Firm			F-2
Consolidated Statements of Operations for the Fiscal Years Ended December 29, 2007, December 30, 2006 and December 31, 2005			F-3
Consolidated Balance Sheets as of December 29, 2007 and December 30, 2006			F-4
Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Fiscal Years Ended December 29, 2007, December 30, 2006 and December 31, 2005			F-5
Consolidated Statements of Cash Flows for the Fiscal Years Ended December 29, 2007, December 30, 2006 and December 31, 2005			F-6
Notes to Consolidated Financial Statements			F-7
Schedule II — Valuation and Qualifying Accounts for the Fiscal Years ended December 29, 2007, December 30, 2006 and December 31, 2005			45 (Part IV, Item 15(a)(2))

FOOTSTAR, INC. and SUBSIDIARY COMPANIES

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Footstar, Inc.:

We have audited the consolidated balance sheets of Footstar, Inc. and its subsidiaries (the “Company”) as of December 29, 2007 and December 30, 2006, and the related consolidated statements of operations, stockholders’ equity and comprehensive income and cash flows for each of the three years in the period ended December 29, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 29, 2007 and December 30, 2006 and the results of its operations and its cash flows for each of the three years in the period ended December 29, 2007, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the accompanying consolidated financial statements, the Company’s Kmart Agreement is scheduled to expire by its terms on December 31, 2008 and all operations with respect to the Kmart business, which represents substantially all the Company’s net sales and income, will cease.

As discussed in Note 16 to the consolidated financial statements, in 2007, the Company adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109”.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board of the United States of America, the effectiveness of the internal control over financial reporting of Footstar, Inc. and Subsidiaries as of December 29, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 4, 2008 expressed an unqualified opinion.

We have also audited the consolidated financial statement schedule listed in the index at Item 15(a), Schedule II for each of the three years in the period ended December 29, 2007. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects information set forth therein.

Amper, Politziner and Mattia, P.C.
Edison, New Jersey
March 4, 2008

FOOTSTAR, INC. and SUBSIDIARY COMPANIES

Consolidated Statements of Operations
(in millions, except per share amounts)

		For the Fiscal Years Ended
		December 29, 2007				December 30, 2006				December 31, 2005
Net sales		$	637.0			$	666.7			$	715.4
Cost of sales			427.4				452.1				490.4
Gross profit			209.6				214.6				225.0
Store operating, selling, general and administrative expenses			148.6				160.6				183.1
Depreciation and amortization			8.1				8.8				7.7
Other income			(0.6	)			—				—
Interest expense			1.2				1.6				4.6
Interest income			(2.6	)			(3.8	)			—
Income before reorganization items, income taxes and discontinued operations			54.9				47.4				29.6
Reorganization items			—				—				(14.6	)
Income before income taxes and discontinued operations			54.9				47.4				15.0
Provision for income taxes			(2.1	)			(1.4	)			(4.2	)
Income before discontinued operations			52.8				46.0				10.8
Income from continuing operations			52.8				46.0				10.8
(Loss) income from discontinued operations, net of tax			(0.8	)			(0.8	)			4.7
Gain from disposal of discontinued operations, net of tax			—				0.1				8.9
Net income		$	52.0			$	45.3			$	24.4
Average common shares outstanding
Basic			20.7				20.6				20.5
Diluted			21.0				20.8				20.5
Income (loss) per share:
Basic:
Income from continuing operations		$	2.56			$	2.23			$	0.53
(Loss) income from discontinued operations			(0.04	)			(0.03	)			0.66
Net income		$	2.52			$	2.20			$	1.19
Diluted:
Income from continuing operations		$	2.52			$	2.21			$	0.53
(Loss) income from discontinued operations			(0.04	)			(0.03	)			0.66
Net income		$	2.48			$	2.18			$	1.19

See accompanying notes to consolidated financial statements.

FOOTSTAR, INC. and SUBSIDIARY COMPANIES

Consolidated Balance Sheets
(in millions, except share amounts)

		December 29, 2007				December 30, 2006
Assets
Current assets:
Cash and cash equivalents		$	53.8			$	101.3
Accounts receivable, net			11.4				10.6
Inventories			86.7				92.0
Prepaid expenses and other current assets			4.4				7.9
Total current assets			156.3				211.8
Property and equipment, net			20.7				25.2
Intangible assets, net			3.3				6.7
Deferred charges and other noncurrent assets			1.3				1.6
Total assets		$	181.6			$	245.3
Liabilities and Shareholders’ Equity
Current liabilities:
Liabilities not subject to compromise
Accounts payable		$	48.0			$	50.0
Accrued expenses			20.7				27.6
Amount due under Kmart Settlement			5.1				—
Income taxes payable			1.2				0.9
Liabilities related to discontinued operations			0.9				2.3
Liabilities subject to compromise			0.5				1.2
Total current liabilities			76.4				82.0
Other long-term liabilities			26.1				26.6
Amount due under Kmart Settlement			—				5.2
Total liabilities			102.5				113.8
Shareholders’ equity:
Common stock $.01 par value: 100,000,000 shares Authorized 31,836,762 and 31,634,242 shares issued			0.3				0.3
Additional paid-in capital			328.9				343.7
Treasury stock: 10,711,569 shares, at cost			(310.6	)			(310.6	)
Retained earnings			51.7				88.6
Accumulated other comprehensive income			8.8				9.5
Total shareholders’ equity			79.1				131.5
Total liabilities and shareholders’ equity		$	181.6			$	245.3

See accompanying notes to consolidated financial statements.

FOOTSTAR, INC. and SUBSIDIARY COMPANIES

Consolidated Statements of Shareholders’ Equity and Comprehensive Income
(in millions, except share amounts)

																														Accum.
																														Other
																		Add’l				Unearned								Compre-
		Common Stock								Treasury Stock								Paid-in				Compen-				Retained				hensive
		Shares				Amount				Shares				Amount				Capital				sation				Earnings				Income(Loss)				Total
Balance as of January 1, 2005			31,018,065			$	0.3				10,711,569			$	(310.6	)		$	343.1.			$	(0.4	)		$	18.9			$	—			$	51.3
Comprehensive income:
Net income			—				—				—				—				—				—				24.4				—				24.4
Total comprehensive income																																			24.4
Common stock incentive plans			66,582				—				—				—				(0.5	)			0.3				—				—				(0.2	)
Balance as of December 31, 2005			31,084,647			$	0.3				10,711,569			$	(310.6	)		$	342.6			$	(0.1	)		$	43.3			$	—			$	75.5
Comprehensive income:
Net income			—				—				—				—				—				—				45.3				—				45.3
Total comprehensive income																																			45.3
Adjustment to initially apply FASB Statement No. 158, net of tax			—				—				—				—				—				—				—				9.5				9.5
Common stock incentive plans			549,595				—				—				—				1.1				0.1				—				—				1.2
Balance as of December 31, 2006			31,634,242			$	0.3				10,711,569			$	(310.6	)		$	343.7			$	—			$	88.6			$	9.5			$	131.5
Comprehensive income:
Net income																											52.0								52.0
Defined benefit plans, net of tax (see notes 20 and 21):
Amortization of prior service credit			—				—				—				—				—				—				—				(1.4	)			(1.4	)
Net gain																															0.7				0.7
Total comprehensive income																																			51.3
Effect of changing the SERP measurement date pursuant to FASB Statement No. 158:
Service and interest cost for December 1- December 29, 2007, net of tax			—				—				—				—				—				—				(0.1	)			—				(0.1	)
Special cash distribution			—				—				—				—				(16.0	)			—				(88.8	)			—				(104.8	)
Common stock incentive plans			202,520				—				—				—				1.2				—				—				—				1.2
Balance as of December 29, 2007			31,836,762			$	0.3				10,711,569			$	(310.6	)		$	328.9			$	—			$	51.7			$	8.8			$	79.1