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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number 000-21250

The Gymboree Corporation

(415) 278-7000

700 Airport Boulevard, Suite 200, Burlingame, California 94010-1912

          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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o

          As of November 27, 2004, 30,965,401 shares of the registrant’s common stock were outstanding.

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Part I — FINANCIAL INFORMATION

THE GYMBOREE CORPORATION

See notes to condensed consolidated financial statements.

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THE GYMBOREE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

See notes to condensed consolidated financial statements.

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THE GYMBOREE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to condensed consolidated financial statements.

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THE GYMBOREE CORPORATION

      The unaudited interim condensed consolidated financial statements, which include The Gymboree Corporation and its subsidiaries, all of which are wholly owned (“the Company”), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2004.

      The accompanying interim condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to present fairly the results of operations, the financial position and cash flows for the periods presented. All such adjustments are of a normal and recurring nature.

      The results of operations for the thirty-nine weeks ended October 30, 2004 are not necessarily indicative of the operating results that may be expected for the fiscal year ending January 29, 2005 (“fiscal 2004”).

      Effective February 1, 2004, the Company elected to change its accounting method for inventory valuation from the retail method to the lower of cost or market method, determined on a weighted average basis (the “cost method”). The Company believes the cost method is a preferable method for matching the cost of merchandise with the revenues generated. The cumulative effect of this accounting change, which was recorded in the first quarter of fiscal 2004, was income of $1.2 million, or $0.04 per diluted share, net of income taxes. It is not possible to determine the effect of this change on any other previously reported fiscal periods or on fiscal 2004.

      On August 16, 2004, the Board of Directors authorized the Company to proceed with the closure of its United Kingdom and Ireland operations (22 stores and one distribution center), as a result of their continued poor financial performance. As of October 30, 2004, substantially all such operations had ceased, as virtually all of the inventories were sold and the distribution center and 5 of the 22 stores were closed (4 United Kingdom stores and 1 Ireland store). The remaining 17 stores were closed during the first two weeks of November. The results of the United Kingdom and Ireland operations have been presented as discontinued operations in the accompanying financial statements for all periods presented.

      Net sales and net loss from discontinued operations, which were comprised primarily of asset write-offs of $1.7 million, severance of $0.7 million, and lease disposition costs of $1.4 million, were as follows:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The liability for lease disposition costs was as follows:

      The Company estimates that the net loss from discontinued operations (comprised primarily of asset write-offs and lease disposition costs) will approximate $7.6 million, net of income tax benefit, in fiscal 2004 .

      The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Had the Company recorded compensation expense for its stock option plans and purchase plan based on the fair value method consistent with the method of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, net income and net income per share would have been as follows:

      The fair value of option grants and shares issued under stock option plans and the purchase plan are estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Basic net income per share is calculated by dividing net income for the period by the weighted average common shares outstanding for that period. Diluted net income per share includes the effects of dilutive instruments, such as stock options, and uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted average number of shares outstanding. The following summarizes the incremental shares from these potentially dilutive securities, calculated using the treasury stock method.

      Anti-dilutive options to purchase 3,225,671 and 1,995,934 shares of common stock for the 13 weeks ended October 30, 2004 and November 1, 2003, respectively, and 2,919,005 and 1,730,262 shares of common stock for the 39 weeks ended October 30, 2004 and November 1, 2003, respectively, were excluded from the above computations of weighted average shares.

      Comprehensive income, which includes net income, foreign currency translation adjustments and fluctuations in the fair market value of certain derivative financial instruments, is as follows:

      The Company operates two reportable segments, retail stores and Play & Music. Corporate overhead and income taxes are included in the retail stores segment. The following table provides the summary financial data of each reportable segment, excluding discontinued operations (in thousands).

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Net sales from our Canadian operations amounted to $6.5 million and $6.6 million for the 13 weeks ended October 30, 2004 and November 1, 2003, respectively, and $16.8 million and $15.7 million for the 39 weeks ended October 30, 2004 and November 1, 2003, respectively. Long-lived assets held by our Canadian operations amounted to $3.2 million and $2.9 million as of October 30, 2004 and November 1, 2003, respectively.

      In late 2003, the Company entered into co-branded credit card agreements (the “Agreements”) with a third-party bank (the “Bank”) and Visa U.S.A. Inc. for the issuance of a Visa credit card bearing the Gymboree brand and administration of an associated incentive program for cardholders. The program, which was launched in April 2004, offers incentives to cardholders, including a 5% discount on in-store purchases using the Gymboree Visa card and annual rewards in the form of a Gymboree gift card equal to 1% of total non-Gymboree purchases. The Bank is the sole owner of the accounts issued under the program and will absorb all losses associated with non-payment by the cardholder and any fraudulent usage of the accounts by third parties. The Company is responsible for redeeming the incentives, including the issuance of any gift cards. The Bank pays fees to the Company based on the number of credit card accounts opened and card usage and makes certain guaranteed minimum annual payments. Visa U.S.A. Inc. also pays fees to the Company based on card usage. Cardholder incentives are funded from the fees paid by the Bank to the Company. The Company recognizes revenues related to these Agreements as follows:

	•	New account fees will be recognized as other revenues on a straight-line basis over the estimated life of the credit card relationship, currently estimated to be 3 years.
	•	Credit card usage fees will be recognized as other revenues as actual usage occurs.
	•	Minimum guaranteed annual payments which exceed amounts earned based on the number of accounts opened and card usage, will be recognized as other revenues on a straight-line basis over the estimated life of the credit card relationship, currently estimated to be 3 years.
	•	Annual rewards earned will be recorded as gift card liabilities and recognized as retail revenues when the gift cards are redeemed.

      As of October 30, 2004 and as of January 31, 2004, the Company has received $6.0 million in advance payments under these Agreements. During the 13 weeks and 39 weeks ended October 30, 2004, the Company recognized approximately $195,000 and $280,000 in new account and credit card usage fees, respectively, which are included in Play & Music and Other net sales in the respective condensed consolidated statements of income. As of October 30, 2004, $4.5 million in advance payments and $0.1 million in gift card liabilities are included in accrued liabilities and deferred revenue of $1.1 million is included in other long-term liabilities, in the condensed consolidated balance sheet.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In March 2004, the Company signed a lease agreement (the “Lease”) for a new corporate office building in San Francisco, California. The Lease, which expires on April 14, 2018, requires base rent payments of approximately $4.7 million annually, subject to market value adjustments after 11 years. The Lease requires the Company to provide a $2.4 million standby letter of credit, which the Company may elect to reduce on each anniversary of the Lease commencement. As part of the Lease, the Company’s new landlord assumed the Company’s lease obligations for its Burlingame, California headquarters through the 2006 expiration of such lease. On November 15, 2004, the Company moved into its new corporate headquarters in San Francisco and ceased use of the Burlingame headquarters. As a result, the Company will record a non-cash charge, before income tax, of approximately $4.0 to $4.5 million in the fourth quarter of fiscal 2004. At the same time, the same amount will be recorded as a deferred lease incentive from the new landlord, which will be amortized over the life of the Lease as a reduction of rent expense. The Company remains the guarantor on lease agreements for the Burlingame, California offices through the 2006 expiration date.

      Income from continuing operations in the current quarter included an income tax benefit of $3.4 million or $0.11 per diluted share due to the reversal of a tax reserve, which was largely attributable to the favorable resolution of a Canadian income tax audit.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To The Board of Directors and Stockholders of The Gymboree Corporation:

      We have reviewed the accompanying condensed consolidated balance sheets of The Gymboree Corporation and subsidiaries (the “Company”) as of October 30, 2004 and November 1, 2003, and the related condensed consolidated statements of income for the three-month and nine-month periods then ended, and cash flows for the nine-month periods then ended. These condensed consolidated financial statements are the responsibility of the Company’s management.

      We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

      Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

      As discussed in Note 2 to the condensed consolidated financial statements, effective February 1, 2004, the Company changed its accounting method for inventory valuation from the retail method to the lower of cost or market method, determined on a weighted average basis.

      We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of The Gymboree Corporation as of January 31, 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated April 14, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of January 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

	/s/ DELOITTE & TOUCHE LLP

San Francisco, California

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Forward-Looking Statements

      You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The discussion in this report contains forward-looking statements that involve risks and uncertainties, including statements regarding planned capital expenditures, planned store openings, expansions and renovations, systems infrastructure development, future cash generated from operations, future cash needs and the wind down of our United Kingdom and Ireland operations. Inaccurate assumptions and known and unknown risks and uncertainties can affect the accuracy of forward-looking statements, and our actual results could differ materially from results that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, customer reactions to new merchandise, concepts and marketing activity, gross margin achievement, our ability to manage inventory levels appropriately, general economic conditions, success in meeting delivery targets, competitive market conditions, trade restrictions, unexpected complications with the wind down of our United Kingdom and Ireland operations, instability in countries where our merchandise is manufactured and the other factors described in this document. When used in this document, the words “believes,” “expects,” “estimates,” “anticipates” and similar expressions are intended to identify certain of these forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this document should be read as being applicable to all related forward-looking statements wherever they appear in this document. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on information available as of the date of this report. We do not intend to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made in this report, in our Annual Report on Form 10-K for fiscal year 2003 and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

General

      The Gymboree Corporation is a specialty retailer operating stores selling high quality apparel and accessories for women and children under the GYMBOREE®, JANIE AND JACK®, and JANEVILLE^TM brands, as well as play programs for children under the GYMBOREE PLAY & MUSIC^TM brand. As of October 30, 2004, the Company conducted its business through four divisions: Gymboree, Janie and Jack, Janeville and Gymboree Play & Music. As of October 30, 2004, we had 643 stores, including 615 stores in the United States (including all 51 Janie and Jack shops and all 12 Janeville stores) and 28 stores in Canada. The Company also operates two on-line stores at www.gymboree.com and www.janieandjack.com.

      Our plan for the remainder of fiscal 2004 is to continue to grow our domestic store base for Gymboree, Janie and Jack and Janeville, bringing the total number of store openings for fiscal 2004 to approximately 24, 23 and 14 new stores, respectively.

      On August 16, 2004, the Board of Directors authorized the Company to proceed with the closure of its United Kingdom and Ireland operations (22 stores and one distribution center), as a result of their continued poor financial performance. As of October 30, 2004, substantially all such operations had ceased, as virtually all of the inventories were sold and the distribution center and 5 of the 22 stores were closed (4 United Kingdom stores and 1 Ireland store). The remaining 17 stores were closed during the first two weeks of November. The results of the United Kingdom and Ireland operations have been presented as discontinued operations in the accompanying financial statements for all periods presented.

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Results of Operations

      Net retail sales in the thirteen weeks ended October 30, 2004 increased to $152.6 million from $140.9 million in the same period last year, an increase of $11.7 million or 8.3%. Comparable store sales increased 2% or $3.5 million over the same period last year. This increase was primarily due to an increase in the average transaction value. Strong product performance in our baby boy, kid girl, and baby girl departments was slightly offset by weakness in our accessories and kid boy departments. Non-comparable store sales increased $9.5 million due to net store and square footage growth of 55 stores and 130,000 square feet, respectively. The increase was also due to a $304,000 increase in shipping income related to our web business. These increases were offset by a decrease of $505,000 in sales to off-price retailers as a result of our seasonal clearance strategy whereby markdown merchandise is primarily sold at our retail stores, as well as an increase of $1.0 million in sales returns and Gymbucks promotional discounts. The number of stores open at the end of the quarter was 643 compared to 588 at the end of the same period last year (excluding stores in the United Kingdom and Ireland).

      Play & Music and Other net sales in the third quarter of fiscal 2004 increased to $3.0 million from $2.9 million in the same period last year, an increase of $0.1 million or 3.4%. The increase was primarily due to revenues associated with our Gymboree Visa Card program, partially offset by lower sales from our Play & Music business due to the sale and closure of 8 corporate owned sites as part of our ongoing restructuring of that division.

      Gross profit for the third quarter of fiscal 2004 increased to $62.8 million from $60.4 million in the same period last year. As a percentage of net sales, gross profit decreased 1.6 percentage points to 40.4% in the third quarter of fiscal 2004 from 42.0% in the same period last year. The decrease in our gross profit margin was primarily due to increased product costs resulting from further investments in product quality, novelty items, and fashion embellishments. Due to cautious consumer sentiment and a highly promotional competitive environment, average retail sales per unit sold did not increase enough to offset these higher costs, which resulted in lower product margins. In addition, buying costs and store occupancy costs increased as a percentage of sales due in part to the deleveraging impact of our new concepts, Janie and Jack and Janeville. Gross profit in fiscal 2004 was calculated using the cost method compared to the retail method in fiscal 2003. The impact of this change cannot be determined.

      Selling, general and administrative (“SG&A”) expenses, which principally consist of non-occupancy store expenses, corporate overhead and distribution expenses, increased to $54.3 million in the third quarter of fiscal 2004 from $46.7 million in the same period last year. As a percentage of net sales, SG&A expenses increased 2.4 percentage points to 34.9% in the third quarter of fiscal 2004 from 32.5% in the same period last year. The increase in SG&A was largely attributable to higher store expenses related to increases in our store base. In addition, SG&A for the quarter was impacted by marketing expenses related to the Gymboree re-branding campaign, consulting expenses related to the implementation of our new merchandising system, and professional fees related to Sarbanes-Oxley compliance.

      Other income increased to $69,000 in the third quarter of fiscal 2004 from $19,000 in the same period last year primarily due to foreign exchange gains. These gains resulted from foreign currency fluctuations on inter-company transactions between our United States operations and foreign subsidiaries. The amount of foreign exchange gains or losses is dependent on both monthly currency fluctuations and balances held in those

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      During the third quarter of fiscal 2004, we recorded an income tax benefit of $0.3 million due to the reversal of a $3.4 million tax reserve, which was largely attributable to the favorable resolution of a Canadian income tax audit. Without the effect of this tax benefit, our effective tax rate for the quarter would have been 36.0%. Our effective tax rate for the third quarter of fiscal 2003 was 38.0%.

      The loss reported for the discontinued United Kingdom and Ireland operations includes operating results, as well as charges related to asset write-offs, severance, and lease disposition costs in the third quarter of fiscal 2004.

      Net retail sales for the thirty-nine weeks ended October 30, 2004 increased to $410.5 million from $373.6 million in the same period last year, an increase of $36.9 million or 9.9%. Comparable store sales increased 4% or $16.5 million over the same 39-week period last year. This increase was primarily due to an increase in the number of transactions, as well as an increase in average transaction value, driven by higher average retail sales per unit sold. Non-comparable store sales increased $23.2 million due to net store and square footage growth of 55 stores and 130,000 square feet, respectively. The increase was also due to a $673,000 increase in shipping income related to our web business. These increases were offset by a decrease of $2.6 million in sales to off-price retailers as a result of our seasonal clearance strategy whereby markdown merchandise is primarily sold at our retail stores, as well as an increase of $1.0 million in sales returns and Gymbucks promotional discounts.

      Play & Music and Other net sales for the thirty-nine weeks ended October 30, 2004 decreased to $8.2 million from $9.0 million in the same period last year, a decrease of $0.8 million or 8.9%. The decrease was primarily due to lower Play & Music sales resulting from the sale and closure of a total of 15 corporate owned sites as part of our ongoing restructuring of the Play & Music business.

      Gross profit for the thirty-nine weeks ended October 30, 2004 increased to $168.3 million from $156.8 million in the same period last year, an increase of $11.5 million. As a percentage of net sales, gross profit decreased 0.8 percentage points to 40.2% in the thirty-nine weeks ended October 30, 2004 from 41.0% in the same period last year. Although product margins were pressured by higher product costs and a promotional competitive environment in the third quarter of fiscal 2004, product margins for the thirty-nine weeks ended October 30, 2004 were higher than the prior year due largely to the impact of markdown optimization, whereby markdowns are targeted to maximize SKU level sales and margins. This effect was offset by increased buying costs related to our new concepts, Janie and Jack and Janeville, as well as higher occupancy costs as a percentage of net sales. Gross profit in fiscal 2004 was calculated using the cost method compared to the retail method in fiscal 2003. The impact of this change cannot be determined.

      SG&A expenses increased to $152.0 million in the thirty-nine weeks ended October 30, 2004 from $133.2 million in the same period last year. As a percentage of net sales, SG&A expenses increased 1.5 percentage points to 36.3% in the thirty-nine weeks ended October 30, 2004 from 34.8% in the same period last year. The increase in SG&A was attributable to both higher store costs resulting from increases in our store base, and higher corporate expenses largely related to increased marketing, compensation, and benefits

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      Other income increased to $451,000 in the thirty-nine weeks ended October 30, 2004 from $354,000 in the same period last year primarily due to interest income, partially offset by foreign exchange losses. Interest income increased by $273,000 due to higher cash and cash equivalent balances compared to the same period last year. Foreign exchange losses resulted from foreign currency fluctuations on inter-company transactions between our United States operations and foreign subsidiaries. The amount of foreign exchange gains or losses is dependent on both monthly currency fluctuations and balances held in those associated currencies.

      During the thirty-nine weeks ended October 30, 2004, our effective tax rate for continuing operations was reduced from 36.5% to 15.9% due to the reversal of a $3.4 million tax reserve, which was largely attributable to the favorable resolution of a Canadian income tax audit. Without the effect of this one-time tax benefit, our effective tax rate for the 39 weeks ended October 30, 2004 would have been 36.2%. Our effective tax rate for the 39 weeks ended November 1, 2003 was 38.0%.

      The loss reported for the discontinued United Kingdom and Ireland operations includes operating results, as well as charges related to asset write-offs, severance, and lease disposition costs.

Seasonality

      Our business is impacted by the general seasonal trends characteristic of the apparel and retail industries. Sales from retail operations have historically been highest during the fourth fiscal quarter, somewhat lower during the first and third fiscal quarters and lowest during the second fiscal quarter. Consequently, the results for any fiscal quarter are not necessarily indicative of results for the full year.

Financial Condition

      Net cash provided by operating activities for the thirty-nine weeks ended October 30, 2004 was $29.8 million compared to $17.6 million in the same period last year. This increase was primarily due to changes in working capital items and cash provided by discontinued operations.

      Net cash used in investing activities for the thirty-nine weeks ended October 30, 2004 was $57.9 million and consisted primarily of capital expenditures for the opening of 50 new stores, relocation and/or expansion of 16 existing stores, expenditures related to store openings and relocations currently in progress, and information technology improvements. The Company estimates that capital expenditures will be approximately $50 to $55 million during fiscal 2004, net of allowances of approximately $16.0 million, and will primarily be used to relocate 16 Gymboree stores, re-brand 200 existing Gymboree stores, open 24 new Gymboree stores, 23 new Janie and Jack shops and 14 new Janeville stores (approximately $30 million for all stores), build-out our new corporate headquarters (approximately $9 million), continue our systems infrastructure replacement (approximately $9 million), and further invest in our web and distribution infrastructure (approximately $4 million).

      Net cash provided by financing activities for the thirty-nine weeks ended October 30, 2004 totaled $3.4 million compared to $3.5 million in the same period last year. This decrease was due to a decrease in proceeds from stock option exercises.

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      Because of the seasonal nature of our business, our cash needs vary throughout the year. In the third quarter, our cash and cash equivalents and working capital typically decrease. Cash and cash equivalents were $64.6 million at October 30, 2004, a decrease of $24.9 million from January 31, 2004. Working capital as of October 30, 2004 was $96.7 million compared to $115.3 million as of January 31, 2004.

      The Company has an unsecured revolving credit facility for borrowings of up to $70 million (increased from $60 million in August 2004). This credit facility has a three-year term expiring in August 2006, and may be used for working capital and capital expenditure needs, as well as the issuance of documentary and standby letters of credit. This credit facility requires the Company to meet financial covenants on a quarterly basis and limits annual capital expenditures. During the quarter ended October 30, 2004, the Company’s capital expenditures exceeded the annual limit for fiscal 2004 due to the amount of capital expenditures for the Company’s new offices and the Company announced plans to close its European operations. The bank subsequently provided the Company with a waiver and amendment to the credit facility to increase the capital expenditures limit for fiscal 2004 and to allow for the closure and winddown of the United Kingdom and Ireland operations. As of October 30, 2004, $48.5 million of documentary and standby letters of credit were outstanding under this facility. The increase in documentary and standby letters of credit outstanding is primarily due to the increased merchandise requirements related to our new concepts, Janie and Jack and Janeville.

      In late 2003, the Company entered into co-branded credit card agreements (the “Agreements”) with a third-party bank (the “Bank”) and Visa U.S.A. Inc. for the issuance of a Visa credit card bearing the Gymboree brand and administration of an associated incentive program for cardholders. The program, which was launched in April 2004, offers incentives to cardholders, including a 5% discount on in-store purchases using the Gymboree Visa card and annual rewards in the form of a Gymboree gift card equal to 1% of total non-Gymboree purchases. The Bank is the sole owner of the accounts issued under the program and will absorb all losses associated with non-payment by the cardholder and any fraudulent usage of the accounts by third parties. The Company is responsible for redeeming the incentives, including the issuance of any gift cards. The Bank pays fees to the Company based on the number of credit card accounts opened and card usage and makes certain guaranteed minimum annual payments. Visa U.S.A. Inc. also pays fees to the Company based on card usage. Cardholder incentives are funded from the fees paid by the Bank to the Company. The Company recognizes revenues related to these Agreements as follows:

	•	New account fees will be recognized as other revenues on a straight-line basis over the estimated life of the credit card relationship, currently estimated to be 3 years.
	•	Credit card usage fees will be recognized as other revenues as actual usage occurs.
	•	Minimum guaranteed annual payments which exceed amounts earned based on the number of accounts opened and card usage, will be recognized as other revenues on a straight-line basis over the estimated life of the credit card relationship, currently estimated to be 3 years.
	•	Annual rewards earned will be recorded as gift card liabilities and recognized as retail revenues when the gift cards are redeemed.

      As of October 30, 2004 and as of January 31, 2004, the Company has received $6.0 million in advance payments under these Agreements. During the 13 weeks and 39 weeks ended October 30, 2004, the Company recognized approximately $195,000 and $280,000 in new account and credit card usage fees, respectively, which are included in Play & Music and Other net sales in the respective condensed consolidated statements of income. As of October 30, 2004, $4.5 million in advance payments and $0.1 million in gift card liabilities are included in accrued liabilities and deferred revenue of $1.1 million is included in other long-term liabilities, in the condensed consolidated balance sheet.

      In March 2004, the Company signed a lease agreement (the “Lease”) for a new corporate office building in San Francisco, California. The Lease, which expires on April 14, 2018, requires base rent payments of approximately $4.7 million annually, subject to market value adjustments after 11 years. The Lease requires the Company to provide a $2.4 million standby letter of credit, which the Company may elect to reduce on each anniversary of the Lease commencement. As part of the Lease, the Company’s new landlord assumed

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      There have been no material changes to the Company’s contractual obligations since its Annual Report on Form 10-K for the year ended January 31, 2004, except for the lease obligations related to the Company’s new corporate offices described above.

      The Company is liable on lease agreements for 3 Play & Music sites sold to franchisees. However, the Company does not believe that payment by the Company of its maximum potential amount of future payments under the Play & Music lease agreements would have a material current or future effect on its liquidity or capital resources.

      The Company enters into forward foreign exchange contracts to hedge certain inter-company loans and inventory purchases. The term of the forward exchange contracts is generally less than one year. The purpose of our foreign currency hedging activities is to protect us from the risk that the eventual dollar net cash inflow resulting from the repayment of certain inter-company loans from our foreign subsidiaries and dollar margins resulting from inventory purchases will be adversely affected by changes in exchange rates.

      The tables below summarize by major currency the notional amounts and fair values of our forward foreign exchange contracts in U.S. dollars as of October 30, 2004 and November 1, 2003.