CHILDRENS PLACE RETAIL STORES INC - 10-Q Quarterly Report

Item 1. CONSOLIDATED FINANCIAL STATEMENTS

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)

	July 31, 2004			January 31, 2004			August 2, 2003
	(Unaudited)						(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	31,333		$	74,772		$	25,194
Accounts receivable		12,974			8,462			15,412
Inventories		136,563			96,128			87,321
Prepaid expenses and other current assets		26,631			20,070			26,042
Total current assets		207,501			199,432			153,969
Property and equipment, net		146,016			146,707			154,617
Other assets		14,337			13,527			9,326
Total assets		$	367,854		$	359,666		$	317,912
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Current liabilities:
Revolving credit facilities		$	0		$	0		$	426
Accounts payable		46,401			35,173			35,488
Income taxes payable		819			9,733			345
Accrued expenses, interest and other current liabilities		41,598			40,251			40,473
Total current liabilities		88,818			85,157			76,732
Long-term liabilities:
Deferred rent liabilities		15,081			14,187			12,859
Other long-term liabilities		3,323			3,317			2,330
Total liabilities		107,222			102,661			91,921
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Common stock, $0.10 par value; 100,000,000 shares authorized; 26,866,251 shares, 26,733,313 shares and 26,627,522 shares issued and outstanding, at July 31, 2004, January 31, 2004 and August 2, 2003, respectively		2,687			2,673			2,663
Additional paid-in capital		103,353			101,288			99,221
Accumulated other comprehensive income		2,680			2,754			604
Retained earnings		151,912			150,290			123,503
Total stockholders’ equity		260,632			257,005			225,991
Total liabilities and stockholders’ equity		$	367,854		$	359,666		$	317,912

The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)

	Thirteen Weeks Ended								Twenty-Six Weeks Ended
	July 31, 2004				August 2, 2003				July 31, 2004			August 2, 2003
Net sales		$	189,165			$	159,082			$	414,945		$	340,092
Cost of sales		130,866				108,612				264,787			219,732
Gross profit		58,299				50,470				150,158			120,360
Selling, general and administrative expenses		64,231				55,988				126,904			107,379
Depreciation and amortization		10,397				9,875				20,702			19,403
Operating (loss) income		(16,329		)		(15,393		)		2,552			(6,422		)
Interest income, net		81				52				107			145
(Loss) income before income taxes		(16,248		)		(15,341		)		2,659			(6,277		)
(Benefit) provision for income taxes		(6,337		)		(5,982		)		1,037			(2,447		)
Net (loss) income		$	(9,911	)		$	(9,359	)		$	1,622		$	(3,830	)
Basic net (loss) income per common share		$	(0.37	)		$	(0.35	)		$	0.06		$	(0.14	)
Basic weighted average common shares outstanding		26,860				26,620				26,837			26,609
Diluted net (loss) income per common share		$	(0.37	)		$	(0.35	)		$	0.06		$	(0.14	)
Diluted weighted average common shares outstanding		26,860				26,620				27,516			26,609

The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

	Tweny-Six Weeks Ended
	July 31, 2004				August 2, 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	1,622			$	(3,830	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		20,702				19,403
Deferred financing fee amortization		29				30
Loss on disposals of property and equipment		367				263
Deferred rent		1,116				1,110
Changes in operating assets and liabilities:
Accounts receivable		(4,514		)		(1,646		)
Inventories		(40,462		)		(11,400		)
Prepaid expenses and other current assets		(6,482		)		(6,414		)
Other assets		(840		)		(53		)
Accounts payable		11,245				4,517
Taxes payable		(8,914		)		147
Accrued expenses, interest and other current liabilities		1,352				4,067
Total adjustments		(26,401		)		10,024
Net cash (used) provided by operating activities		(24,779		)		6,194
CASH FLOWS FROM INVESTING ACTIVITIES:
Property and equipment purchases		(20,453		)		(18,353		)
Net cash used in investing activities		(20,453		)		(18,353		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options and employee stock purchases		2,078				462
Deferred financing costs		0				(175		)
Borrowings under revolving credit facility		59,618				38,940
Repayments under revolving credit facility		(59,618		)		(38,514		)
Net cash provided by financing activities		2,078				713
Effect of exchange rate changes on cash		(285		)		(5		)
Net decrease in cash and cash equivalents		(43,439		)		(11,451		)
Cash and cash equivalents, beginning of period		74,772				36,645
Cash and cash equivalents, end of period		$	31,333			$	25,194
OTHER CASH FLOW INFORMATION:
Cash paid during the period for interest		$	13			$	87
Cash paid during the period for income taxes		14,975				1,104

The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited financial statements contain all material adjustments, consisting of normal recurring accruals, necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods indicated, and have been prepared in a manner consistent with the audited financial statements as of January 31, 2004. These financial statements should be read in conjunction with the audited financial statements and footnotes for the fiscal year ended January 31, 2004 included in the Company’s Annual Report on Form 10-K for the year ended January 31, 2004 filed with the Securities and Exchange Commission. Due to the seasonal nature of the Company’s business, the results of operations for the thirteen weeks ended July 31, 2004 and August 2, 2003 are not necessarily indicative of operating results for a full fiscal year.

2. STOCK BASED COMPENSATION

The Company accounts for its stock option plans and its employee stock purchase plan under the intrinsic value method described in the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Accordingly, no compensation expense has been recognized for stock-based compensation since the options granted were at prices that equaled or exceeded their estimated fair market value at the date of grant. If compensation expense for the Company’s stock options and employee stock purchases issued during the thirteen weeks and twenty-six weeks ended July 31, 2004 and August 2, 2003 had been determined based on the fair value method of accounting, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and the disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure” (“SFAS 148”), the Company’s net income would have been adjusted to the pro forma amounts indicated below for the thirteen weeks and twenty-six weeks ended July 31, 2004 and August 2, 2003, respectively:

	Thirteen Weeks Ended								Twenty-Six Weeks Ended
	July 31, 2004				August 2, 2003				July 31, 2004				August 2, 2003
Net (loss) income—(in thousands)
As reported		$	(9,911	)		$	(9,359	)		$	1,622			$	(3,830	)
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects		1,396				1,019				3,005				2,125
Pro forma		$	(11,307	)		$	(10,378	)		$	(1,383	)		$	(5,955	)
(Loss) earnings per share—
Basic—as reported		$	(0.37	)		$	(0.35	)		$	0.06			$	(0.14	)
Basic—pro forma		$	(0.42	)		$	(0.39	)		$	(0.05	)		$	(0.22	)
Diluted—as reported		$	(0.37	)		$	(0.35	)		$	0.06			$	(0.14	)
Diluted—pro forma		$	(0.42	)		$	(0.39	)		$	(0.05	)		$	(0.22	)

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

3. NET (LOSS) INCOME PER COMMON SHARE

In accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share,” the following table reconciles net (loss) income and share amounts utilized to calculate basic and diluted net (loss) income per common share.

	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 31, 2004			August 2, 2003			July 31, 2004		August 2, 2003
Net (loss) income (in thousands)	$	(9,911	)	$	(9,359	)	$	1,622	$	(3,830	)
Basic shares	26,859,867			26,619,649			26,836,663		26,609,417
Dilutive effect of stock options	0			0			679,576		0
Dilutive shares	26,859,867			26,619,649			27,516,239		26,609,417
Antidilutive options	1,960,396			1,334,659			815,288		1,390,922

The net loss per share presented in the consolidated statements of income for the thirteen weeks ended July 31, 2004 and August 2, 2003, as well as the twenty-six weeks ended August 2, 2003, excludes the dilutive effect of stock options, which would be antidilutive as a result of the net loss.

Antidilutive options consist of the weighted average of stock options for the respective periods ended July 31, 2004 and August 2, 2003 that had an exercise price greater than the average market price during the period. Such options are therefore excluded from the computation of diluted shares.

4. COMPREHENSIVE (LOSS) INCOME

The following table presents the Company’s comprehensive (loss) income (in thousands):

	Thirteen Weeks Ended								Twenty-Six Weeks Ended
	July 31, 2004				August 2, 2003				July 31, 2004				August 2, 2003
Net (loss) income		$	(9,911	)		$	(9,359	)		$	1,622			$	(3,830	)
Translation adjustments		865				37				(74		)		351
Comprehensive (loss) income		$	(9,046	)		$	(9,322	)		$	1,548			$	(3,479	)

5. DERIVATIVE INSTRUMENTS

SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS No. 133”), as amended and interpreted, requires that each derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability and measured at its fair value. The statement also requires that changes in the derivative’s fair value be recognized currently in earnings in either income (loss) from continuing operations or accumulated other comprehensive income (loss), depending on whether the derivative qualifies for hedge accounting treatment.

Commencing in the thirteen weeks ended July 31, 2004, the Company began using foreign currency forward contracts for the specific purpose of reducing the exposure to variability in forecasted cash flows associated primarily with inventory purchases for the Company’s Canadian operations. These instruments

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5. DERIVATIVE INSTRUMENTS (Continued)

are not designated as hedges and, in accordance with SFAS No. 133, the changes in fair value are included in current period earnings.

At July 31, 2004, the Company had forward contracts maturing through January 2005 for its Canadian operations to buy $8.5 million U.S. dollars for $11.3 million Canadian dollars. The Company’s Canadian operations uses Canadian dollars as its functional currency, but purchases most of its merchandise in U.S. dollars. The Company has recorded an unrealized fair market value gain of approximately eight thousand dollars in its earnings for the period ending July 31, 2004, which represents the fair market value of the forward contracts at July 31, 2004.

6. CREDIT FACILITIES

Wells Fargo Credit Facility

The Company has a credit facility (the “Wells Fargo Credit Facility”) with Wells Fargo Retail Finance, LLC (“Wells Fargo”). The Wells Fargo Credit Facility provides for up to $85 million in borrowings which includes a sublimit of up to $80 million in letters of credit. Wells Fargo acts as our agent bank for a syndicated group of lenders on this facility. This credit facility also contains provisions to increase borrowings up to $120 million (including a sublimit for letters of credit of $100 million), subject to sufficient collateralization and the syndication of the incremental line of borrowing. The amount that can be borrowed under the credit facility depends on the Company’s levels of inventory and accounts receivable. The Wells Fargo Credit Facility expires in April 2006 and provides for one year renewal options.

The Company had no outstanding borrowings under this credit facility as of July 31, 2004 and had letters of credit outstanding of $55.8 million. During the twenty-six weeks ended July 31, 2004, the Company’s borrowings under this credit facility represented overnight borrowings for letters of credit that cleared after business hours. The average balance during the twenty-six weeks ended July 31, 2004 was approximately $507,000 and the average interest rate was 4.04%. The maximum outstanding letters of credit under the Wells Fargo Credit Facility was $60.0 million during the twenty-six weeks ended July 31, 2004. Availability as of July 31, 2004 was $29.2 million.

The Wells Fargo Credit Facility also contains covenants, which include limitations on the Company’s annual capital expenditures, the maintenance of certain levels of excess collateral, and a prohibition on the payment of dividends. Credit extended under the Wells Fargo Credit Facility is secured by a first priority security interest in all of the Company’s assets, except for assets in Canada. As of July 31, 2004, the Company was in compliance with all of its covenants under the Wells Fargo Credit Facility.

Noncompliance with these covenants could result in additional fees, could affect the Company’s ability to borrow, or require the Company to repay the outstanding balance. Amounts outstanding under the Wells Fargo Credit Facility bear interest at a floating rate equal to the prime rate or, at the Company’s option, a LIBOR rate plus a pre-determined spread. The LIBOR spread is 1.50% to 3.00% depending on the Company’s level of availability from time to time.

THE CHILDREN’S PLACE RETAIL STORES, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

6. CREDIT FACILITIES (Continued)

Toronto Dominion Credit Facility

The Company has a $7.5 million credit facility with Toronto Dominion Bank (the “Toronto Dominion Credit Facility”) to support its Canadian subsidiary. As of July 31, 2004, the Toronto Dominion Credit Facility was secured by a standby letter of credit issued under the Wells Fargo Credit Facility to permit up to $1.8 million in borrowings. As of July 31, 2004, there were no borrowings and no letters of credit outstanding under the Toronto Dominion Credit Facility. During the twenty-six weeks ended July 31, 2004, the Company did not borrow under the Toronto Dominion Credit Facility. The Toronto Dominion Bank can demand repayment and cancel the availability of the Toronto Dominion Credit Facility at any time.

7. INSURANCE PROCEEDS

During the twenty-six weeks ended August 2, 2003, the Company received approximately $1.5 million in a partial settlement of its business interruption claim for its World Trade Center store. These proceeds reduced selling, general and administrative expenses on the Company’s consolidated statement of income.

8. LITIGATION

The Company is involved in various legal proceedings arising in the normal course of its business. In the opinion of management, any ultimate liability arising out of such proceedings will not have a material adverse effect on the Company’s financial position or results of operations.

9. INCOME TAXES

The Company computes income taxes using the liability method. This standard requires recognition of deferred tax assets and liabilities, measured by enacted rates, attributable to temporary differences between financial statement and income tax basis of assets and liabilities. Temporary differences result primarily from accelerated depreciation and amortization for tax purposes and various accruals and reserves being deductible for future tax periods. The income tax provision recorded for the thirteen and twenty-six weeks ended July 31, 2004 reflects our estimated expected annual effective tax rate.

10. SUBSEQUENT EVENT

On August 4, 2004, we entered into a non-binding letter of intent with The Walt Disney Company to negotiate the possible acquisition and operation of The Disney Store retail chain in the United States and Canada under a long-term license arrangement. There is no certainty at this stage that our discussions will lead to any definitive agreement or transaction.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of federal securities laws, which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, the discussions of the Company’s operating and growth strategy. Investors are cautioned that all forward-looking statements involve risks and uncertainties including, without limitation, those set forth under the caption “Risk Factors” in the Business section of the Company’s Annual Report on Form 10-K for the year ended January 31, 2004. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could prove to be inaccurate, and therefore, there can be no assurance that the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. The Company undertakes no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

The following discussion should be read in conjunction with the Company’s unaudited financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the annual audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 31, 2004, filed with the Securities and Exchange Commission.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reported period. Actual results could differ from our estimates. The accounting policies that we believe are the most critical to aid in fully understanding and evaluating reported financial results include the following:

Revenue Recognition—Sales are recognized upon purchase by customers at our retail stores or when shipped from our distribution center if the product was purchased via the Internet, net of anticipated returns. Actual merchandise return rates have historically been within our expectations and the allowance established. However, in the event that the actual rate of sales returns by customers increased significantly, our operational results could be adversely affected.

Our policy with respect to gift cards is to record revenue as the gift cards are redeemed for merchandise. Prior to their redemption, unredeemed gift cards are recorded as a liability.

Once an annual minimum customer purchase threshold is satisfied on our private label credit card, we offer a discount on future purchases for the remainder of the fiscal year. Revenue is deferred for the future discount earned by our private label credit card customers that have satisfied or are expected to satisfy minimum purchase thresholds.

Inventory Valuation—Merchandise inventories are stated at the lower of average cost or market, using the retail inventory method. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are calculated by applying a cost-to-retail ratio to the retail value of inventories. At any one time, inventories include items that have been marked down to our best estimate of their fair market value. We base our decision to mark down merchandise upon its current rate of sale, the season, age and sell-through of the item. To the extent that our estimates differ from actual results, additional markdowns may have to be recorded, which could reduce our gross margins and operating results. Our success is largely dependent upon our ability to gauge the fashion taste of our customers and

provide a well-balanced merchandise assortment that satisfies customer demand. Any inability to provide the proper quantity of appropriate merchandise in a timely manner could increase future markdown rates.

Impairment of Assets—We continually evaluate each store’s performance and measure the carrying value of each location’s fixed assets, principally leasehold improvements and fixtures, versus its projected cash flows. An impairment loss is recorded if the projected future cash flows are insufficient to recapture the net book value of their assets. To the extent our estimates of future cash flows are incorrect, additional impairment charges may be recorded in future periods.

Litigation—We are involved in various legal proceedings arising in the normal course of our business. In our opinion, any ultimate liability arising out of such proceedings will not have a material adverse effect on our business.

Stock Options—We record no compensation expense on our financial statements for stock-based compensation, since we grant stock options at prices that equal or exceed the fair market value of the related shares at the date of the grant. If, in the future, we elect or are required to adopt fair value accounting for our stock-based compensation, the related compensation charge will adversely impact net income. In addition, increases to our stock price would result in more diluted shares outstanding and reduce our diluted net income per common share.

Results of Operations

The following table sets forth, for the periods indicated, selected income statement data expressed as a percentage of net sales:

	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		69.2			68.3			63.8			64.6
Gross profit		30.8			31.7			36.2			35.4
Selling, general and administrative expenses		34.0			35.2			30.6			31.6
Depreciation and amortization		5.5			6.2			5.0			5.7
Operating (loss) income		(8.7	)		(9.7	)		0.6			(1.9	)
Interest income, net		0.1			0.1			—			0.1
(Loss) income before income taxes		(8.6	)		(9.6	)		0.6			(1.8	)
(Benefit) provision for income taxes		(3.4	)		(3.7	)		0.2			(0.7	)
Net (loss) income		(5.2	)%		(5.9	)%		0.4	%		(1.1	)%
Number of stores, end of period		715			679			715			679

Thirteen Weeks Ended July 31, 2004 (the “Second Quarter 2004”) Compared to Thirteen Weeks Ended August 2, 2003 (the “Second Quarter 2003”)

Net sales increased by $30.1 million, or 19%, to $189.2 million during the Second Quarter 2004 from $159.1 million during the Second Quarter 2003. During the Second Quarter 2004, we opened 16 new stores, including our first store in Puerto Rico, and closed one store. Our comparable store sales increased 10% and contributed $15.4 million of our net sales increase in the Second Quarter 2004. Comparable store sales increased 3% during the Second Quarter 2003. During the Second Quarter 2004, our comparable store sales increase was primarily the result of increases in the number of comparable store sales transactions, partially offset by a decrease in our average dollar transaction size. Net sales for the 16 new

stores, as well as other stores that did not qualify as comparable stores, increased our net sales by $14.7 million.

Gross profit increased by $7.8 million to $58.3 million during the Second Quarter 2004 from $50.5 million during the Second Quarter 2003. As a percentage of net sales, gross profit decreased to 30.8% during the Second Quarter 2004 from 31.7% during the Second Quarter 2003. The decrease in gross profit, as a percentage of net sales, was principally due to a lower initial markup, partially offset by the leveraging of occupancy costs over a larger sales base and lower markdowns. Our initial markup was lower due to our continuing investment in the quality of our garments and the receipt of a larger proportion of basic merchandise, which carries a lower initial markup. During the Second Quarter 2004, we continued our strategic acceleration of merchandise receipts, which we believe provides us with greater flexibility, enhances product flows to our stores and improves floorset execution of new season merchandise.

Selling, general and administrative expenses increased $8.2 million to $64.2 million during the Second Quarter 2004 from $56.0 million during the Second Quarter 2003. Selling, general and administrative expenses decreased to 34.0% of net sales during the Second Quarter 2004 from 35.2% of net sales during the Second Quarter 2003. Selling, general and administrative expenses decreased, as a percentage of net sales, due primarily to the leveraging of store payroll and store operating expenses, as well as lower pre-opening and store remodeling costs. We recorded lower pre-opening and remodeling costs as a result of opening 16 new stores and remodeling one store during the Second Quarter 2004, as compared to 19 new stores opened and 8 stores remodeled during the Second Quarter 2003. These decreases, as a percentage of net sales, were partially offset by increased corporate payroll and medical expenses. Marketing expenses, as a percentage of net sales, were comparable to the Second Quarter 2003.

Depreciation and amortization amounted to $10.4 million, or 5.5% of net sales, during the Second Quarter 2004, as compared to $9.9 million, or 6.2% of net sales, during the Second Quarter 2003. The increase in depreciation and amortization primarily was a result of increases to our store base. Depreciation and amortization decreased, as a percentage of net sales, as a result of the leveraging over a larger sales base.

Our benefits from income taxes were $6.3 million and $6.0 million during the Second Quarter 2004 and the Second Quarter 2003, respectively. Our effective tax rate was 39.0% during both periods.

Our net loss in the Second Quarter 2004 was $9.9 million as compared to a net loss of $9.4 million during the Second Quarter 2003, due to the factors discussed above.

Twenty-Six Weeks Ended July 31, 2004 Compared to Twenty-Six Weeks Ended August 2, 2003

Net sales increased $74.8 million, or 22%, to $414.9 million during the twenty-six weeks ended July 31, 2004 from $340.1 million during the twenty-six weeks ended August 2, 2003. During the twenty-six weeks ended July 31, 2004, we opened 26 stores and closed two stores. Comparable store sales increased 13% during the twenty-six weeks ended July 31, 2004, which increased our net sales by $42.0 million. Comparable store sales declined 6% during the twenty-six weeks ended August 2, 2003. During the twenty-six weeks ended July 31, 2004, our comparable store sales increase primarily was the result of an increase in the number of comparable store transactions. Net sales for the 26 stores opened during the twenty-six weeks ended July 31, 2004, as well as other stores that did not qualify as comparable stores, contributed $32.8 million of the net sales increase.

Gross profit increased by $29.8 million during the twenty-six weeks ended July 31, 2004 to $150.2 million from $120.4 million during the twenty-six weeks ended August 2, 2003. As a percentage of net sales, gross profit increased to 36.2% during the twenty-six weeks ended July 31, 2004 from 35.4% during the twenty-six weeks ended August 2, 2003. The increase in gross profit, as a percentage of net sales, was principally due to lower markdowns and the leveraging of occupancy costs over a larger sales base, partially

offset by a lower initial markup. Our markdowns were lower due to continued positive customer response to our merchandise, combined with improved techniques to allocate merchandise to our stores. Our initial markup was lower due to our continuing investment in garment quality and a larger portion of our inventory invested in basic merchandise, which carries a lower initial markup.

Selling, general and administrative expenses increased $19.5 million to $126.9 million during the twenty-six weeks ended July 31, 2004 from $107.4 million during the twenty-six weeks ended August 2, 2003. Selling, general and administrative expenses were 30.6% of net sales during the twenty-six weeks ended July 31, 2004 as compared with 31.6% of net sales during the twenty-six weeks ended August 2, 2003. As a percentage of net sales, selling, general and administrative expenses decreased due to lower store payroll and store operating expenses, as well as lower pre-opening and store remodeling costs. During the twenty-six weeks ended July 31, 2004, we opened 26 new stores, as compared to 38 new stores during the twenty-six weeks ended August 2, 2003. During the twenty-six weeks ended July 31, 2004, we remodeled four stores as compared to 11 stores during the twenty-six weeks ended August 2, 2003. These decreases, as a percentage of net sales, were partially offset by increased marketing costs to promote brand awareness, as well as increased corporate payroll and medical expenses. In addition, during the twenty-six weeks ended August 2, 2003, we received approximately $1.5 million, or 0.4% of net sales, in insurance proceeds from a partial settlement of our business interruption claim from our World Trade Center store.

Depreciation and amortization amounted to $20.7 million, or 5.0% of net sales, during the twenty-six weeks ended July 31, 2004, as compared to $19.4 million, or 5.7% of net sales, during the twenty-six weeks ended August 2, 2003. The increase in depreciation and amortization primarily was a result of a larger store base. As a percentage of net sales, depreciation and amortization decreased as a result of leveraging over a larger sales base.

Our provision for income taxes for the twenty-six weeks ended July 31, 2004 was $1.0 million. During the twenty-six weeks ended August 2, 2003, we recorded a tax benefit of $2.4 million, due to our net loss. Our effective tax rate was 39.0% during both twenty-six week periods.

Due to the factors discussed above, we recorded net income of $1.6 million during the twenty-six weeks ended July 31, 2004 as compared to a net loss of $3.8 million during the twenty-six weeks ended August 2, 2003.

Liquidity and Capital Resources

Debt Service/Liquidity

Our primary uses of cash are financing new store openings and providing for working capital, which principally represents the purchase of inventory. Our working capital needs follow a seasonal pattern, peaking during the second and third quarters when inventory is purchased for the back-to-school and holiday seasons. We have been able to meet our cash needs principally by using cash on hand, cash flows from operations and seasonal borrowings under our credit facilities. As of July 31, 2004, we had no long-term debt obligations or short-term borrowings.

We have a credit facility with Wells Fargo Retail Finance, LLC. The Wells Fargo Credit Facility currently provides for borrowings up to $85 million (including a sublimit for letters of credit of $80 million). The Wells Fargo Credit Facility also contains provisions to allow us to increase borrowings up to $120 million (including a sublimit for letters of credit of $100 million), subject to sufficient collateralization and the syndication of the incremental line of borrowing. The amount that may be borrowed under the Wells Fargo Credit Facility depends on our levels of inventory and accounts receivable. Amounts outstanding under the facility bear interest at a floating rate equal to the prime rate or, at our option, a LIBOR rate plus a pre-determined spread. The LIBOR spread is 1.50% to 3.00%, depending on our level of availability from time to time. The Wells Fargo Credit Facility contains covenants, which include,

limitations on our annual capital expenditures, maintenance of certain levels of excess collateral and a prohibition on the payment of dividends. Credit extended under the Wells Fargo Credit Facility is secured by a first priority security interest in all our assets, except for our assets in Canada. We were in compliance with all of the covenants under the Wells Fargo Credit Facility as of July 31, 2004. Noncompliance with these covenants could result in additional fees, could affect our ability to borrow or could require us to repay the outstanding balance.

As of July 31 2004, we had no borrowings under our Wells Fargo Credit Facility and had outstanding letters of credit of $55.8 million. Availability under the Wells Fargo Credit Facility was $29.2 million. The maximum outstanding letters of credit under our working capital facility during the twenty-six weeks ended July 31, 2004 were $60.0 million.

To support our Canadian operations, we have a $7.5 million credit facility with Toronto Dominion Bank, which, as of July 31, 2004, was collateralized by a standby letter of credit obtained under the Wells Fargo Credit Facility to permit up to $1.8 million in borrowings. As of July 31, 2004, we had no borrowings under our Canadian credit facility and had no outstanding letters of credit. During the twenty-six weeks ended July 31, 2004, we did not utilize our Canadian credit facility.

Cash Flows/Capital Expenditures

During the twenty-six weeks ended July 31, 2004, operating activities used $24.8 million in cash flow as compared to $6.2 million provided by operating activities during the twenty-six weeks ended August 2, 2003. During the twenty-six weeks ended July 31, 2004, operating activities used more cash primarily as a result of increased inventory levels and higher tax payments, partially offset by higher earnings and increases in accounts payable. During the twenty-six weeks ended July 31, 2004, we strategically accelerated the receipt of our merchandise and correspondingly increased our inventory levels. We believe this strategy provides us with greater flexibility in reacting to sales trends, enables us to better manage product flows to our stores and improves our floorset execution of new season merchandise.

Cash flows used in investing activities were $20.4 million and $18.4 million in the twenty-six weeks ended July 31, 2004 and the twenty-six weeks ended August 2, 2003, respectively. During the twenty-six weeks ended July 31, 2004 and the twenty-six weeks ended August 2, 2003, we opened 26 stores and 38 stores and remodeled four stores and 11 stores, respectively. The increase in cash flows used in investing activities reflects increased expenditures for information systems initiatives and our new Canadian distribution center, partially offset by lower new store expenditures reflecting fewer store openings and remodels during the twenty-six weeks ended July 31, 2004. Capital expenditures also include ongoing store, office and distribution center equipment needs. We anticipate that total capital expenditures for our business during fiscal 2004 will be approximately $45 million.

In July 2004, we entered into an 11 year lease, with two five-year renewal option periods, for an approximately 525,000 square foot distribution center in South Brunswick Township, New Jersey to support our continued growth. Annual rent under this lease is approximately $2.3 million. We plan to utilize this facility beginning in the second quarter of fiscal 2005. We expect to make a total cash outlay of approximately $15 million to install an automated warehouse management system and to renovate this distribution center to meet our needs. In fiscal 2004, we expect to make a cash outlay of approximately $3 million (which is included in our fiscal 2004 capital plans), with the remainder during fiscal 2005.

Cash flows provided by financing activities were $2.1 million and $0.7 million during the twenty-six weeks ended July 31, 2004 and twenty-six weeks ended August 2, 2003, respectively. During the twenty-six weeks ended July 31, 2004, cash flows provided by financing activities reflected funds received from the exercise of employee stock options and employee stock purchases. During the twenty-six weeks ended August 2, 2003, cash flow provided by financing activities reflected funds received from borrowings under

the Toronto Dominion Credit Facility and the exercise of employee stock options and employee stock purchases, partially offset by cash used for deferred financing fees.

During the twenty-six weeks ended July 31, 2004, we opened 26 stores and closed two stores. During fiscal 2004, we plan to open approximately 60 stores and plan to remodel approximately 8 stores. We believe that cash on hand, cash generated from operations and funds available under our credit facilities will be sufficient to fund our capital and other cash flow requirements for at least the next 12 months for our existing business. Our ability to meet our capital requirements will depend on our ability to generate cash from operations. In addition, we will consider additional sources of financing to fund our long-term growth.

Item 3. Quantitative and Qualitative Disclosures about Market Risks.

In the normal course of business, our financial position and results of operations are routinely subject to market risk associated with interest rate movements on borrowings and investments and currency rate movements on non-U.S. dollar denominated assets, liabilities and income. We utilize cash from operations and short-term borrowings to fund our working capital and investment needs.

Cash balances are normally invested in short-term financial instruments. Because of the short-term nature of these investments, changes in interest rates would not materially affect the fair value of these financial instruments.

Our $85 million Wells Fargo Credit Facility provides a source of financing for our working capital requirements. Borrowings under this facility bear interest at a floating rate equal to the prime rate or, at the Company’s option, a LIBOR rate plus a pre-determined spread. As of July 31, 2004, we had no borrowings outstanding under this credit facility.

Assets and liabilities outside the United States are primarily located in Canada. Our investment in foreign subsidiaries with a functional currency other than the U.S. dollar, are generally considered long-term. We have purchased forward contracts to reduce the exposure to variability in currency fluctuations in our Canadian operations, which are not designated as hedges for accounting purposes.

Item 4. Controls and Procedures.

(a) Disclosure controls and procedures. As of the end of the Company’s most recently completed fiscal quarter covered by this report, the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded, as of the end of the period covered by this report, that the Company’s disclosure controls and procedures are effective in ensuring that information required by the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b) Changes in internal controls over financial reporting. There have been no changes in the Company’s internal controls over financial reporting that occurred during the Company’s most recently completed fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Delaware	31-1241495
(State or other jurisdiction of incorporation or organization)	(I. R. S. Employer Identification Number)

Exhibit No.		Description of Document
10.2		Lease Agreement between the Company and Turnpike Crossing I, LLC, dated as of July 14, 2004.
31		Section 302 Certifications
32		Section 906 Certifications

	The Children’s Place Retail Stores, Inc.
Date: September 7, 2004	By:	/s/ Ezra Dabah
		Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
Date: September 7, 2004	By:	/s/ Seth L. Udasin
		Vice President and Chief Financial Officer (Principal Financial Officer)

		Page
Part I—Financial Information
Item 1.	Consolidated Financial Statements:
	Consolidated Balance Sheets	1
	Consolidated Statements of Income	2
	Consolidated Statements of Cash Flows	3
	Notes to Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8
Item 3.	Quantitative and Qualitative Disclosures about Market Risks	13
Item 4.	Controls and Procedures	13
Part II—Other Information
Item 1.	Legal Proceedings	14
Item 4.	Submission of Matters to a Vote of Security Holders	14
Item 6.	Exhibits and Reports on Form 8-K	14
Signatures		15