UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

(Mark One)

ý           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 29, 2005

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

For the transition period from                            to                           

Commission file number 0-23071

THE CHILDREN’S PLACE RETAIL STORES, INC.

(Exact name of registrant as specified in its charter)

915 Secaucus Road

Secaucus, New Jersey 07094

(Address of principal executive offices) (Zip Code)

(201) 558-2400

(Registrant’s telephone number, including area code)

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.

Indicate by check mark whether the registrant is an accelerated filer.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, par value $0.10 per share, outstanding at December 5, 2005: 27,806,699 shares.

THE CHILDREN’S PLACE RETAIL STORES, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE PERIOD ENDED OCTOBER 29, 2005

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

Item 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THE CHILDREN’S PLACE RETAIL STORES, INC.

AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

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

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THE CHILDREN’S PLACE RETAIL STORES, INC.

AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)

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

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THE CHILDREN’S PLACE RETAIL STORES, INC.

AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

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

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THE CHILDREN’S PLACE RETAIL STORES, INC.

AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) for interim financial information.  Certain information and footnote disclosures required by US 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 29, 2005.  These financial statements should be read in conjunction with the audited financial statements and footnotes for the fiscal year ended January 29, 2005 included in the Company’s Annual Report on Form 10-K for the year ended January 29, 2005 filed with the Securities and Exchange Commission, as amended.  Due to the seasonal nature of the Company’s business, the results of operations for the thirty-nine weeks ended October 29, 2005 and October 30, 2004 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.”  Accordingly, no compensation expense has been recognized for stock-based compensation since the options granted were at prices that equaled or exceeded the estimated fair market value of the related stock at the date of grant.  If compensation expense for the Company’s stock options and employee stock purchases issued during the thirteen weeks and thirty-nine weeks ended October 29, 2005 and the thirteen weeks and thirty-nine weeks ended October 30, 2004 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,” and the disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure,” the Company’s net income would have been adjusted to the pro forma amounts indicated below for the thirteen weeks and thirty-nine weeks ended October 29, 2005 and October 30, 2004, respectively (in thousands, except per share amounts):

Diluted pro forma earnings per common share for the thirteen and thirty-nine weeks ended October 30, 2004 excludes the dilutive effect of stock options, which would have been anti-dilutive as a result of the impact of unamortized stock-based compensation expense determined under fair value based methods.

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The fair value of issued stock options was estimated on the grant date using the Black-Scholes option pricing model, incorporating the following assumptions:

(1) Commencing for options issued in the fourth quarter of fiscal 2004, the Company used the average of the implied volatility from the Company’s market-traded options and the historical volatility of its stock price to compute the volatility factor.

(2) Commencing in fiscal 2005, the expected option term was determined using a Monte Carlo simulation for Black-Scholes based on historical employee exercise behavior.

SFAS No. 123 (Revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) was issued on December 14, 2004 and becomes effective for the Company in the first quarter of fiscal 2006.  SFAS 123(R) requires an entity to recognize compensation cost in an amount equal to the fair value of share-based payments granted to employees.  The Company plans to apply the standard using the modified prospective method, which requires compensation cost to be recorded for new and modified awards.  Additionally, for any unvested portion of previously issued and outstanding awards, compensation cost is required to be recorded based on the previously disclosed SFAS 123 methodology and amounts.  Prior periods are not required to be restated.

On June 23, 2005, at the Annual Meeting of Stockholders of the Company, the stockholders approved the adoption of the 2005 Equity Incentive Plan (the “2005 Plan”).  The 2005 Plan helps to align the interests of its key employees with the Company’s performance through the grant of equity compensation.  To preserve flexibility, the 2005 Plan enables the Compensation Committee of the Board of Directors to grant multiple forms of equity compensation such as stock options, stock appreciation rights, restricted stock awards, deferred stock awards and performance awards.  As a result of the adoption of the 2005 Plan, and the ability under this plan to issue multiple forms of equity compensation, the Company is currently assessing various compensation alternatives for its employees and the associated impact of the adoption of SFAS 123(R) on its future results of operations and financial position.

3.  ACQUISITION OF THE DSNA BUSINESS

On November 22, 2004, effective as of November 21, 2004 (the “Closing Date”), two of the Company’s wholly-owned subsidiaries acquired two Disney operating subsidiaries that were operating a total of 313 Disney Stores (the “DSNA Business”), consisting of all existing Disney Stores in the United States and Canada, other than three flagship stores and certain stores located at Disney theme parks and other Disney properties, along with certain other assets used in the Disney Store business.  Subsequently, the Company’s subsidiaries acquired the flagship stores in Chicago and San Francisco.  All store leases and certain other legal obligations of the acquired entities remain the obligations of the acquired subsidiaries.  Operations of the acquired DSNA Business from November 21, 2004 have been included in the Company’s consolidated financial statements.  The Company’s subsidiaries that operate the Disney Store business are referred to interchangeably and collectively as the “Hoop Operating Entities.”  The Walt Disney Company and/or its subsidiaries are referred to interchangeably as “Disney.”

The Company and one of its subsidiaries entered into a Guaranty and Commitment (the “Guaranty and Commitment”) dated as of November 21, 2004, in favor of the Hoop Operating Entities and Disney.  As required by the Guaranty and Commitment, the Company invested $50 million in the Hoop Operating Entities concurrently with the consummation of the acquisition, and agreed to invest up to an additional $50 million to enable the Hoop Operating Entities to comply with their obligations under the license and conduct of business agreement (the “License Agreement”) (Note 4 – License Agreement with Disney) and otherwise fund the operations of the Hoop Operating Entities.  To date, the Company has not been required to invest any of the additional $50 million in the Hoop Operating Entities.  The Company also agreed to guarantee the payment and performance of the Hoop Operating Entities (for their royalty payment and other obligations to Disney), subject to a maximum guaranty liability of $25 million, plus expenses.

The DSNA Business was acquired for a total acquisition cost of $105.0 million, including transaction costs.  During the third quarter of 2005, the Company finalized the post-closing purchase price true-up and purchase accounting for the acquisition of the DSNA Business.

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Purchase Price Allocation

This acquisition was accounted for under the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations” (“SFAS 141”).  As such, the Company analyzed the fair value of tangible and intangible assets acquired and liabilities assumed, and determined the excess of fair value of net assets acquired over cost.  The Company’s purchase price allocation was as follows (dollars in thousands):

Under the Acquisition Agreement, the preliminary acquisition payment amount was determined using acquired net working capital, as defined, as of the Closing Date, subject to true-up subsequent to the Closing Date.  The Company has finalized the post-closing true-up, which has been included in the purchase price allocation above.

Accrued expenses as of the Closing Date were approximately $0.8 million related to the estimated cost of exiting certain Disney Store facilities, stores and operations.  Through October 29, 2005, the Company had utilized $0.6 million of these accruals, and expects the remaining amounts to be used in the fourth quarter of fiscal 2005.

As the fair value of the acquired assets and liabilities assumed exceeded the acquisition price, in accordance with SFAS 141, the valuation of acquired long-lived assets was reduced.  Accordingly, no basis was assigned to property and equipment or any other long-lived assets, and the remaining excess was recorded as an extraordinary gain.  Of this $1.9 million net extraordinary gain, $0.3 million was recognized in the fourth quarter of fiscal 2004 and $1.7 million was recognized in the third quarter of fiscal 2005.

4.  LICENSE AGREEMENT WITH DISNEY

In connection with the acquisition of the DSNA Business, subsidiaries of the Company and Disney entered into a License Agreement under which the Hoop Operating Entities have the right to use certain Disney intellectual property, subject to Disney approval, in the DSNA Business in exchange for ongoing royalty payments.

Pursuant to the terms of the License Agreement, the Hoop Operating Entities operate retail stores in North America using the “Disney Store” name and contract to manufacture, source, offer and sell merchandise featuring Disney-branded characters, past, present and future.  The initial term of the License Agreement is 15 years and, if certain financial performance and other conditions are satisfied, the License Agreement may be extended at the Company’s option for up to three additional ten-year terms.  The Hoop Operating Entities will make royalty payments to Disney beginning in November 2006 equal to 5% of net sales at physical Disney Store retail locations, subject to an additional royalty holiday with respect to a limited number of stores.  The License Agreement provides for a minimum royalty to be paid in each year, beginning after November 21, 2006.  Beginning in the summer of 2006, the Hoop Operating Entities will also operate the www.disneystore.com Internet store, which will feature a select assortment of merchandise offered in the physical retail locations.  Through October 2006, the Company will pay a 5% royalty on Internet sales.  Thereafter, the Company will pay a 9% royalty on Internet sales, or in some instances, a 10% royalty on Internet sales.

The License Agreement includes provisions regarding the manner in which the Hoop Operating Entities will operate the Disney Store business and requires that approvals be obtained from a Disney affiliate for certain matters, including all uses of the

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intellectual property of Disney and its affiliates and the opening or closing of Disney Stores beyond certain parameters set forth in the License Agreement.  The License Agreement obligates the Hoop Operating Entities to remodel stores as new long-term leases are executed.

The License Agreement limits the ability of the Hoop Operating Entities to make cash dividends or other distributions.  The Hoop Operating Entities’ independent directors must approve payment of any dividends or other distributions, other than payments of:

•      amounts due under the terms of tax sharing and intercompany services agreements;

•      approximately $61.9 million, which represents a portion of the purchase price paid by the Company to Disney (limited to cumulative cash flows since the date of the acquisition);

•      certain other dividend payments, subject to satisfaction of certain additional operating conditions, and limited to 50% of cumulative cash flows up to $90 million, and 90% of cumulative cash flows thereafter (provided that at least $90 million of cash and cash equivalents is maintained at the Hoop Operating Entities).

In the normal course of business, the Hoop Operating Entities have reimbursed the Company for intercompany services but have not paid it any dividends or made other distributions.  The License Agreement also restricts the incurrence of indebtedness in excess of certain permitted amounts.

The License Agreement also entitles Disney to designate a representative to attend meetings of the Board of Directors of the Company as an observer.  Upon the occurrence of certain specified events, including an uncured royalty breach and other repeated material breaches by the Hoop Operating Entities of the terms of License Agreement, certain material breaches by the Company of the terms of the Guaranty and Commitment, and certain changes in ownership or control of the Company or the Hoop Operating Entities, Disney will have the right to terminate the License Agreement, in which event Disney may require the Company to sell the Disney Store business to Disney or one of its affiliates or to a third party at a price to be determined by appraisal or, in the absence of such sale, to wind down the Disney Store business in an orderly manner.

During the thirteen and thirty-nine weeks ended October 29, 2005, the Company accrued $4.9 million and $12.4 million, respectively for royalty expense and had an accrued royalty liability on its balance sheet of $19.5 million as of October 29, 2005.  However, due to the royalty holiday discussed above, there were no royalty amounts due or paid under the License Agreement during the thirteen and thirty-nine weeks ended October 29, 2005.

5.  FINANCIAL RESTATEMENTS

Lease-Related Accounting

Under the requirements of Financial Accounting Standards Board (“FASB”) Technical Bulletin 85-3, “Accounting for Operating Leases with Scheduled Rent Increases,” rent expense is required to be recognized on a straight-line basis over the lease term.  In prior periods, the Company had incorrectly determined that the term of the lease begins on the commencement date of the lease, which generally coincides with the store opening date.  The Company has corrected this policy to commence the lease for accounting purposes when the Company takes physical possession of the property to begin construction.  This correction has the effect of including the construction period in the determination of the period over which rent is calculated.  The Company continues to capitalize occupancy costs incurred prior to the commencement of store pre-opening activities.  These capitalized costs are amortized over the remaining lease term.  The net effect of this correction was to increase depreciation expense with a corresponding decrease to rent expense and to increase the amount of deferred rent liabilities with a corresponding increase in leasehold improvements.  The Company has corrected the prior years’ condensed consolidated financial statements to properly account for these lease-related issues.

In addition, under FASB Technical Bulletin 88-1, “Issues Relating to Accounting for Leases,” lease incentives such as landlord construction allowances received to defray construction costs incurred by the Company should be reflected as a deferred lease incentive, amortized over the lease term and reflected as a reduction to rent expense.  The Company had previously incorrectly classified landlord construction allowances as a reduction to property and equipment instead of as a deferred lease incentive.  In fiscal 2004, the Company corrected its accounting policy to treat landlord construction allowances received as deferred lease incentives.

The primary impact of the restatement was to reclassify, and in some instances increase or decrease, certain expenses on the condensed consolidated statements of income.  In addition, property and equipment and other long term assets were increased, with corresponding increases in deferred rent liabilities.  While the correction of the errors did not change total cash position, changes in classification were made in the condensed consolidated statements of cash flows.  Cash flows provided by operating activities increased with a corresponding increase in cash flows used in investing activities.

As a result of these restatements for the thirteen weeks and thirty-nine weeks ended October 30, 2004, cost of sales was reduced by $2.5 million and $7.3 million, respectively.  Conversely, depreciation expense increased by $2.5 million and $7.3 million

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in the thirteen and thirty-nine weeks ended October 30, 2004, respectively, with no impact on reported net income.  While the correction of the errors did not change the Company’s total cash position, landlord construction allowances were reclassified in the condensed consolidated statements of cash flows from cash flows used in investing activities to cash flows provided by operating activities.  For the thirty-nine weeks ended October 30, 2004, cash flows used by operating activities increased by approximately $10.2 million with offsetting increases in cash flows used in investing activities.  Cash flows used in investing activities was also impacted by the restatement of investments as summarized in the sub-heading, “Investments” in the following paragraph.

Investments

Under the requirements of SFAS No. 95, “Statement of Cash Flows,” as amended, cash equivalents are short-term, highly liquid investments that are readily convertible to cash and have original maturities of less than three months.  Historically, the Company recorded auction rate securities as cash equivalents.  However, these securities do not meet the definition of cash equivalents due to their longer ultimate contractual maturities and pricing reset feature.  Accordingly, the Company’s management determined to restate prior period information to correct the classification of its auction rate securities from cash equivalents to investments.  These securities were held by the Company at the beginning of the second quarter of 2004, but were sold during the second quarter of 2004.  There is no impact on any income statement items, including earnings per share; total current assets or current liabilities; total assets or liabilities; stockholders’ equity; debt covenants or liquidity; or cash flow from operating activities or cash flows from financing activities as a result of this restatement.  Cash flows used in investing activities decreased $22.3 million during the thirty-nine weeks ended October 30, 2004 as a result of the net sale of auction rate securities during the period.

Impacts to Previously Filed Condensed Consolidated Financial Statements

The following tables summarize the impact of the lease-related accounting and investment restatements on previously filed quarterly condensed consolidated statements of income, balance sheet and cash flow data.  The investment restatement did not impact the condensed consolidated statements of income and the balance sheet data listed below (in thousands, except per share amounts):

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6.  NET INCOME PER COMMON SHARE

In accordance with SFAS No. 128, “Earnings Per Share,” the following table reconciles net income and share amounts utilized to calculate basic and diluted net income per common share (amounts in thousands):

Anti-dilutive options consist of the weighted average of stock options for the thirteen and thirty-nine weeks ended October 29, 2005 and the thirteen and thirty-nine weeks ended October 30, 2004 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.

7.  COMPREHENSIVE INCOME

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

8.  CREDIT FACILITIES

Amended Loan Agreement

As of October 30, 2004, the Company amended and restated its credit facility (“the Amended Loan Agreement”) with Wells Fargo, as syndicate agent, and certain other lenders, partly in connection with its acquisition of the Disney Store retail chain.  The Amended Loan Agreement provides for borrowings up to $130 million (including a sub-limit for letters of credit of $100 million).  The term of the facility ends on November 1, 2007 with successive one-year renewal options.  The amount that could be borrowed under the credit facility depends on the Company’s level of inventory and accounts receivable.

The Amended Loan Agreement is secured by a first priority security interest in substantially all the assets of the Company and its subsidiaries, other than assets in Canada and assets owned by the Company’s subsidiaries that were formed in connection with the acquisition of the DSNA Business.  Amounts outstanding under the Amended Loan Agreement 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%.  The unused line fee under the Amended Loan Agreement is 0.38%.

On July 29, 2005, the Company entered into an amendment of its Amended Loan Agreement to provide a temporary overadvance facility under which the Company had the right to borrow up to $20 million through October 31, 2005 (the “Overadvance Facility”).  The Overadvance Facility expired unused on October 31, 2005.

The Company had $55.3 million in borrowings under its Amended Loan Agreement as of October 29, 2005 and had letters of credit outstanding of $40.8 million.  The average balance during the thirty-nine weeks ended October 29, 2005 was approximately $18.2 million and the average interest rate was 6.19%.  Availability under the Amended Loan Agreement as of October 29, 2005 was $33.9 million, excluding the $20 million available under the Overadvance Facility.  During the thirty-nine weeks ended October 29, 2005, maximum borrowings under the Amended Loan Agreement were $55.3 million.  The interest rate charged under the Amended Loan Agreement was 6.75% as of October 29, 2005.

The Amended Loan Agreement also contains covenants, which include limitations on the Company’s annual capital

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expenditures, the maintenance of certain levels of collateral, and a prohibition on the payment of dividends.  Noncompliance with these covenants can result in additional fees, could affect the Company’s ability to borrow, or could require the Company to repay the outstanding balance.  As of October 29, 2005, the Company was in compliance with all of its covenants under the Amended Loan Agreement.

Hoop Loan Agreement

In connection with the acquisition of the DSNA Business, the United States Hoop Operating Entity entered into a Loan and Security Agreement (the “Hoop Loan Agreement”) dated as of November 21, 2004 with certain financial institutions and Wells Fargo, as administrative agent, establishing a senior secured credit facility for the DSNA Business.  The Hoop Loan Agreement provides for borrowings up to $100 million (including a sub-limit for letters of credit of $90 million), subject to the amount of eligible inventory and accounts receivable for the domestic Hoop Operating Entity from time to time.  The term of the facility extends until November 21, 2007.  Amounts outstanding under the Hoop Loan Agreement bear interest at a floating rate equal to the prime rate plus a pre-determined margin or, at the Hoop Operating Entities’ option, the LIBOR rate plus a pre-determined margin.  The prime rate margin is 0.25% and the LIBOR margin is 2.0% or 2.25%, depending on the United States Hoop Operating Entity’s level of excess availability from time to time.  The unused line fee is 0.30%.

The Hoop Loan Agreement contains various covenants, including limitations on indebtedness, maintenance of certain levels of excess collateral and restrictions on the payment of intercompany dividends and indebtedness.  Credit extended under the Hoop Loan Agreement is secured by a first priority security interest in substantially all the assets of the Hoop Operating Entities as well as a pledge of a portion of the equity interests in the Canada Hoop Operating Entity.  Borrowings and letters of credit under the Hoop Loan Agreement are used by the Hoop Operating Entities for working capital purposes for the Disney Store business.

There were no borrowings under the Hoop Loan Agreement as of October 29, 2005.  During the thirty-nine weeks ended October 29, 2005, there were no borrowings under the Hoop Loan Agreement other than letters of credit that cleared after business hours.  The average loan balance during the thirty-nine weeks ended October 29, 2005 was approximately $411,000 and the average interest rate was 6.53%.  The maximum outstanding letters of credit were $60.4 million during the thirty-nine weeks ended October 29, 2005.  Letters of credit outstanding as of October 29, 2005 were $43.1 million and availability as of October 29, 2005 was $18.8 million.  The interest rate charged under the Hoop Loan Agreement was 7.00% as of October 29, 2005.

Toronto Dominion Credit Facility

The Company previously had an $8.2 million credit facility with Toronto Dominion Bank (the “Toronto Dominion Credit Facility”) to support its Canadian subsidiary, which operates “The Children’s Place” stores in Canada.  The Toronto Dominion Credit Facility has expired and the Company does not plan to replace the facility.

Letter of Credit Fees

Letter of credit fees approximated $0.7 million in the thirty-nine weeks ended October 29, 2005 and were included in cost of goods sold.

9.  LITIGATION

The Company reserves for litigation settlements when it can determine the probability of outcome and can estimate costs.  Estimates are adjusted as facts and circumstances require.  The Company is involved in various legal proceedings arising in the normal course of its business.  In the opinion of management, any liability arising out of such proceedings will not have a material adverse effect on the Company’s financial position or results of operations.

10.  INCOME TAXES

The Company computes income taxes using the liability method.  This method 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 thirty-nine weeks ended October 29, 2005 was 35.4% and 33.8%, respectively, which reflects increased efficiencies from a tax point of view that were identified in the course of the Company’s global operations review.

During the thirty-nine weeks ended October 29, 2005, the Company has recorded a tax benefit for stock option exercises in

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its additional paid-in-capital of $3.7 million.

As of October 29, 2005, the Company has not made a U.S. tax provision on approximately $51 million of unremitted earnings of its international subsidiaries.  These earnings are currently expected to be reinvested overseas, except as discussed below, to fund expansion in Asia and other foreign markets.  Accordingly, the Company has not provided any provision for income tax expenses in excess of foreign jurisdiction income tax requirements relative to such unremitted earnings in the accompanying financial statements. 

On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law.  The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividend-received deduction for certain dividends from controlled foreign corporations.  As of October 29, 2005, the Company had not made a final determination regarding the Act, and accordingly, the financial statements do not reflect any provision for taxes on unremitted foreign earnings. 

11.  SEGMENT INFORMATION

Prior to the acquisition of the DSNA Business, the Company operated under one operating segment.  Since November 21, 2004, the Company has segmented its operations based on management team responsibility: The Children’s Place stores and the Disney Stores.  Direct administrative expenses are recorded by each segment.  Non-allocable expenses are considered shared services and principally include executive management, finance, real estate, human resources, legal and information technology services.  Shared service assets principally represent capitalized software and computer equipment.

The following tables provide segment level financial information for the thirteen weeks and thirty-nine weeks ended October 29, 2005 (dollars in millions):

12.  RECENT ACCOUNTING PRONOUNCEMENTS

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3.”  SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle.  Previously, most voluntary changes in accounting principles required recognition through a cumulative adjustment within net income of the period of the change.  The new standard requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change.  SFAS No. 154 does not change the transition provisions of any existing pronouncements.  The Company does not believe that the adoption of SFAS No. 154 will have a significant impact on the Company’s financial position or results of operations.

In October 2005, the FASB issued FASB Staff Position (“FSP”) FAS No. 13-1, “Accounting for Rental Costs Incurred during a Construction Period” (“FSP FAS No. 13-1”).  The FASB has concluded that rental costs incurred during and after a construction period are for the right to control the use of a leased asset and must be recognized as rental expense.  Such costs were previously capitalizable as construction costs if the company had a policy to do so, which the Company does.  In the first quarter of fiscal 2006, in accordance with FSP FAS No. 13-1, the Company will expense occupancy costs incurred during the construction

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period.  Construction-period occupancy costs incurred during or prior to fiscal 2005 were capitalized and will continue to be depreciated over the life of the lease.  Based upon current expectations of new lease commitments for fiscal 2006, the Company estimates that the implementation of FSP FAS No. 13-1 will require the recognition of approximately $7 million in rent expense during the construction period.

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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 29, 2005, as amended.  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 condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the annual audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 29, 2005, as amended, filed with the Securities and Exchange.

Financial Restatements

Lease-Related Accounting

Under the requirements of Financial Accounting Standards Board (“FASB”) Technical Bulletin 85-3, “Accounting for Operating Leases with Scheduled Rent Increases,” rent expense is required to be recognized on a straight-line basis over the lease term.  In prior periods, we had incorrectly determined that the term of the lease begins on the commencement date of the lease, which generally coincides with the store opening date.  We have corrected this policy to commence the lease for accounting purposes when we take physical possession of the property to begin construction.  This correction has the effect of including the construction period in the determination of the period over which rent is calculated.  We continue to capitalize occupancy costs incurred prior to the commencement of store pre-opening activities.  These capitalized costs are amortized over the remaining lease term.  The net effect of this correction was to increase depreciation expense with a corresponding decrease to rent expense and to increase the amount of deferred rent liabilities with a corresponding increase in leasehold improvements.  We have corrected the prior years’ condensed consolidated financial statements to properly account for these lease-related issues.

In addition, under FASB Technical Bulletin 88-1, “Issues Relating to Accounting for Leases,” lease incentives such as landlord construction allowances received to defray construction costs should be reflected as a deferred lease incentive, amortized over the lease term and reflected as a reduction to rent expense.  We had previously incorrectly classified landlord construction allowances as a reduction to property and equipment instead of as a deferred lease incentive.  In fiscal 2004, we corrected our accounting policy to treat landlord construction allowances received as deferred lease incentives.

The primary impact of the restatement was to reclassify, and in some instances increase or decrease, certain expenses on the condensed consolidated statements of income.  In addition, property and equipment and other long-term assets were increased, with corresponding increases in deferred rent liabilities.  While the correction of the errors did not change total cash position, changes in classification were made in the condensed consolidated statements of cash flows.  Cash flows provided by operating activities increased with a corresponding increase in cash flows used in investing activities.

As a result of these restatements, for the thirteen and thirty-nine weeks ended October 30, 2004, cost of sales were reduced by $2.5 million and $7.3 million, respectively.  Conversely, depreciation expense increased by $2.5 million and $7.3 million in the thirteen and thirty-nine weeks ended October 30, 2004, respectively, with no impact on reported net income.  While the correction of the errors did not change our total cash position, landlord construction allowances were reclassified in the condensed consolidated statements of cash flows from cash flows used in investing activities to cash flows used in operating activities.  For the thirty-nine weeks ended July 31, 2004, cash flows provided by operating activities increased by approximately $10.2 million with offsetting increases in cash flows used in investing activities.  Cash flows used in investing activities was also impacted by the restatement of investments as summarized in the sub-heading, “Investments” in the following paragraph.

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Investments

Under the requirements of Statement of Financial Accounting Standard (“SFAS”) No. 95, “Statement of Cash Flows,” as amended, cash equivalents are short-term, highly liquid investments that are readily convertible to cash and have original maturities of less than three months.  Historically, we recorded auction rate securities as cash equivalents.  However, these securities do not meet the definition of cash equivalents due to their longer ultimate contractual maturities and pricing reset feature.  Accordingly, we determined to restate prior period information to correct the classification of our auction rate securities from cash equivalents to investments.  These securities were held at the beginning of the second quarter of 2004, but were sold during the second quarter of 2004.  There is no impact on any income statement items, including earnings per share; total current assets or current liabilities; total assets or liabilities; stockholders’ equity; debt covenants or liquidity; or cash flow from operating activities or cash flow from financing activities as a result of this restatement.  Cash flows used in investing activities decreased $22.3 million during the thirty-nine weeks ended October 30, 2004 as a result of the net sale of auction rate securities during the period.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“US GAAP”) 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 received by the customer if the product was purchased via the Internet, net of coupon redemptions and anticipated sales returns.  Actual sales return rates historically have been within our expectations and the allowance established.  However, in the event that the actual rate of sales returns by customers increases significantly, our operational results could be adversely affected.  Our net sales include the 7% commission we receive from a Disney subsidiary on the sale of Walt Disney World® Resort and Disneyland® Resort tickets.

Our policy with respect to gift cards is to record revenue as the gift cards are redeemed for merchandise.  For The Children’s Place, prior to their redemption, unredeemed gift cards are recorded as a liability, included within accrued expenses and other current liabilities.  For the Disney Store, we act as agent on behalf of Disney for gift cards sold to customers.  Therefore, we do not record a customer gift card liability for the Disney Store business.  However, we recognize a trade payable to Disney for the net purchase of Disney gift cards.

We offer a private label credit card to our Children’s Place customers that provides a discount on future purchases, once a minimum annual purchase threshold has been exceeded.  We estimate the future discounts to be provided based on prior year history, the number of customers who have earned or are likely to earn the discount and current year sales trends on the private label credit card.  We defer a proportionate amount of revenue from customers based on an estimated value of future discounts.  We recognize such deferred revenue as future discounts are taken on sales above the annual minimum.  This is done by utilizing estimates based upon sales trends and the number of customers who have earned the discount privilege.  All deferred revenue is recognized by the end of the fiscal year, as our private label customers must earn the discount privilege on an annual basis, and such privilege expires prior to our fiscal year end.  As of October 29, 2005, approximately $802,000 in revenue has been deferred and will be recognized over the remainder of fiscal 2005.

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 by merchandise department 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.  The Company estimates its rate of shrink based on historical results of physical inventories.  To the extent that our markdown estimates or shrinkage reserves are not adequate, additional markdowns or reserves may have to be recorded, which could reduce our gross profit and operating results.  Our success is largely dependent upon our ability to gauge the fashion taste of our customers, including the popularity and relevancy of the Disney characters, 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.

Accounting for Acquisitions – The acquisition of the DSNA Business was accounted for under the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS 141”).  As such, we analyzed the fair value of identified tangible and intangible assets acquired and liabilities assumed, and determined the excess of fair value of net assets acquired over cost.

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Accounting for Royalties – In exchange for the right to use certain Disney intellectual property, we are required to make royalty payments to Disney pursuant to a License and Conduct of Business Agreement (the “License Agreement”).  Minimum royalty commitments are recorded on a straight-line basis over the life of the initial 15 year term of the License Agreement.  During each period, amounts due in excess of the minimum royalty commitment are recorded as an expense if we expect to surpass the minimum royalty commitment on an annual basis, even if the contingency threshold has not been surpassed in that particular period.

We were granted a royalty holiday for all stores for two years.  In addition, depending on the specific store location, certain stores have an extension of the royalty holiday for up to eight years.  The actual value of the royalty holiday is not determinable until the completion of the royalty holiday period, and may differ materially from our current estimate.  Changes in the estimates for the royalty holiday are adjusted on a periodic basis.  The amortization of the estimated value of the royalty holiday is recognized on a straight-line basis as a reduction of royalty expense over the term of the License Agreement.  Royalty expense, and the associated amortization of the royalty holiday, is recorded in selling, general and administrative expenses.

The royalty percentage does not increase over the term of the License Agreement, except for royalties on Internet sales.  Through October 2006, the Internet sales royalty is 5%.  Thereafter, the Company will pay a 9% royalty on Internet sales, and in certain instances, a 10% royalty on Internet sales.  We expect the effective net royalty expense to range from 4.3% to 5.0% of net sales of the Disney Store business.

Rent Expense and Deferred Rent – Rent expense and rent incentives, including landlord construction allowances, are recognized on a straight-line basis over the lease term, beginning on the date of physical possession.  The Company records rent expense and rent incentives as a component of cost of sales.  The unamortized portion of deferred rent is included in deferred rent liabilities.  Rent incurred during construction, prior to commencement of store pre-opening activities, is capitalized and then amortized starting over the remaining lease term.  Unamortized pre-opening rent is included in leasehold improvements.  In the first quarter of fiscal 2006, we will adopt the policy of expensing occupancy costs incurred during the construction period in accordance with FASB Staff Position (“FSP”) FAS No. 13-1, “Accounting for Rental Costs Incurred during a Construction Period” (“FSP FAS No. 13-1”).  Based upon current expectations of new lease commitments for fiscal 2006, the Company estimates that the implementation of FSP FAS No. 13-1 will require the recognition of approximately $7 million in rent expense during the construction period.

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 reserve for litigation settlements when we can determine the probability of outcome and can estimate costs.  Estimates are adjusted as facts and circumstances require.  We are involved in various legal proceedings arising in the normal course of our business.  In our opinion, any liability arising out of such proceedings will not have a material adverse effect on our business.

Stock Options – We record no compensation expense in 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.  Effective in fiscal 2006, we will be required to recognize compensation cost in an amount equal to the fair value of the stock-based compensation granted to employees.  We are currently assessing various compensation alternatives for our employees and the associated impact of the adoption of SFAS 123(R) on our future results of operations and financial position.

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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 October 29, 2005 (the “Third Quarter 2005”) Compared to Thirteen Weeks Ended October 30, 2004 (the “Third Quarter 2004”)

Net sales increased by $160.6 million, or 57%, to $441.1 million during the Third Quarter 2005 from $280.5 million during the Third Quarter 2004.  Net sales include $320.0 million in net sales from The Children’s Place business, a 14% increase over the $280.5 million in net sales reported in the Third Quarter 2004, and $121.1 million in net sales from the Disney Store business.  Comparable store sales increased 6% and contributed $16.2 million of our net sales increase in the Third Quarter 2005.  Our comparable store sales increase was the result of a 6% increase in our average dollar transaction size.  Comparable store sales increased 18% during the Third Quarter 2004.  Net sales from our new stores and other non-comparable stores contributed $144.4 million to our sales increase during the Third Quarter 2005.

During the Third Quarter 2005, we opened 19 The Children’s Place stores and 13 Disney Stores.  In addition, we closed one The Children’s Place store during the Third Quarter 2005.

Since we did not operate the Disney Store business for the majority of fiscal 2004, those stores will not be included in the comparable store sales base until February 2006, when we expect approximately 240 Disney Stores to be added for the first quarter of fiscal 2006.  We currently define comparable store sales as net sales from stores that have been open for more than 14 months and have not been substantially remodeled during that time.

During the Third Quarter 2005, our Southwest and West regions in our The Children’s Place business reported the strongest comparable store sales increases, while our Northeast, Metro New York and Mid-Atlantic regions reported low single-digit comparable store sales increases.  By department, our accessories and girls departments performed strongest, followed by the boys department.  Our newborn reported a low single digit comparable store sales decline. 

Our annual profitability is highly dependent on our sales and gross margin performance during the holiday season in the fourth quarter.  During the four weeks ended November 26, 2005, net sales increased by $47.4 million, or 40%, to $166.0 million from the $118.6 million during the four weeks ended November 27, 2004.  Net sales included $114.4 million in net sales from The Children’s Place business, a 20% increase over the $95.4 million in net sales reported in the four weeks ended November 27, 2004, and $51.6 million in net sales from the Disney Store business.  During the four weeks ended November 27, 2004, net sales included $23.2 million in net sales from the Disney Store business, which we acquired effective November 21, 2004.  Our comparable store sales

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increased 12% in the four weeks ended November 26, 2005 as compared to a 9% comparable store sales increase for the four weeks ended November 27, 2004.

During the Third Quarter 2005, Hurricanes Katrina, Rita and Wilma adversely impacted store operations in approximately 55 stores with temporary store closings.  Hurricane Katrina caused six stores to be closed for an extended period due to storm damage, of which three stores were re-opened at the end of the Third Quarter 2005.  The remaining three stores are not expected to re-open until fiscal 2006.  No charge was recorded during the Third Quarter 2005 for our hurricane losses due to the nature of our property and casualty loss insurance coverage.

Consolidated gross profit increased by $68.7 million to $185.2 million during the Third Quarter 2005 from $116.5 million during the Third Quarter 2004.  As a percentage of net sales, consolidated gross profit increased 0.5% to 42.0% during the Third Quarter 2005 from 41.5% during the Third Quarter 2004.  This increase in consolidated gross profit, as a percentage of net sales, resulted from a higher merchandise margin of 2.0%, partially offset by higher distribution and occupancy costs of 1.5%.  At The Children’s Place stores, our gross margin was higher than the Third Quarter 2004 due to lower markdowns, a higher initial markup and the leveraging of occupancy costs over a higher sales base, partially offset by higher distribution costs.  During the Third Quarter 2005, distribution costs were higher as a result of start-up costs associated with our new distribution center as well as higher fuel costs.  While our Disney Store business has a lower gross margin structure than The Children’s Place, those results benefited from lower markdowns and the implementation of our low-cost sourcing strategies.

Selling, general and administrative expenses increased $54.5 million to $128.5 million during the Third Quarter 2005 from $74.0 million during the Third Quarter 2004.  Selling, general and administrative expenses increased 2.8% to 29.2% of net sales during the Third Quarter 2005 from 26.4% of net sales during the Third Quarter 2004.  This increase, as a percentage of net sales, was due primarily to Disney Store expenses that we did not have last year, such as royalty expense and remodel costs, and higher marketing, store repair, maintenance and utility costs, partially offset by lower employee benefit expenses.  During the Third Quarter 2005, Disney Store royalty expense represented approximately 1.1% of net sales.  Although this expense was recorded under US GAAP, no royalty payment was made due to the royalty holiday under the License Agreement.  Marketing costs in the Third Quarter 2005 were approximately 1.9% higher than the Third Quarter 2004, as a percentage of net sales, due primarily to the introduction of a national television advertising campaign and increased print advertising for The Children’s Place stores.  Store repair, maintenance and utility costs were approximately 0.7% of net sales higher during the Third Quarter 2005 due to our continued focus on the customer brand experience and increased utility rates.  Our employee benefit costs were approximately 100 basis points lower during the Third Quarter 2005 than the Third Quarter 2004.

Depreciation and amortization amounted to $13.8 million, or 3.1% of net sales, during the Third Quarter 2005, as compared to $13.0 million, or 4.6% of net sales, during the Third Quarter 2004.  Depreciation and amortization decreased, as a percentage of net sales, as the result of the leveraging of the expense over a larger sales base and minimal depreciation and amortization for the Disney Store.

Our income tax provision was $15.1 million and $11.8 million during the Third Quarter 2005 and the Third Quarter 2004, respectively.  Our effective tax rate was 35.4% during the Third Quarter 2005 which reflects increased efficiencies from a tax point of view that were identified in the course of our global operations review.  During the Third Quarter 2004, our effective tax rate was 40.1%. We anticipate that our effective tax rate for fiscal 2005 will approximate 38%, which implies a 39% effective tax rate for the fourth quarter of fiscal 2005.

During the Third Quarter 2005, we recorded a $1.7 million extraordinary gain, net of taxes.  This extraordinary gain represents the finalization of purchase accounting for the DSNA business, including the post-closing true-up of acquired net working capital.

Due to the factors discussed above, net income was $29.3 million and $17.7 million during the Third Quarter 2005 and the Third Quarter 2004, respectively.

Thirty-Nine Weeks Ended October 29, 2005 compared to Thirty-Nine Weeks Ended October 30, 2004

Net sales increased $433.6 million, or 62% to $1,129.0 million during the thirty-nine weeks ended October 29, 2005 from $695.4 million during the thirty-nine weeks ended October 30, 2004.  Net sales include $815.9 million in net sales from The Children’s Place business, which represented a 17% increase over the $695.4 million in net sales reported in the thirty-nine weeks ended October 30, 2004, and $313.1 million in net sales from the Disney Store business.  Comparable store sales increased 8% and contributed $51.7 million of our net sales increase in the thirty-nine weeks ended October 29, 2005.  Our comparable store sales increase was primarily the result of a 6% increase in our average dollar transaction size and a 2% increase in the number of comparable store sales transactions.  Comparable store sales increased 15% during the thirty-nine weeks ended October 30, 2004.  Net

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sales from our new stores and other non-comparable stores increased by $381.9 million.

During the thirty-nine weeks ended October 29, 2005, we opened 39 The Children’s Place stores and 15 Disney Stores.  In addition, we closed four stores (three The Children’s Place and one Disney Store).

Consolidated gross profit increased by $154.4 million to $425.8 million during the thirty-nine weeks ended October 29, 2005 from $271.4 million during the thirty-nine-six weeks ended October 30, 2004.  As a percentage of net sales, gross profit decreased 1.3% to 37.7% during the thirty-nine weeks ended October 29, 2005 from 39.0% during the thirty-nine weeks ended October 30, 2004.  This decrease in gross profit, as a percentage of net sales, was comprised of higher distribution costs of 0.8% of net sales, a lower merchandise margin of 0.4% of net sales, and a charge related to the fair value write-up of Disney Store inventory of 0.1% of net sales.  The $1.2 million charge represented the remaining sell-through of inventory acquired from the acquisition of the Disney Store.  The decrease in gross margin was primarily attributable to the Disney Store, which has a lower gross margin structure than The Children’s Place business.  For The Children’s Place, our gross margin was higher in the thirty-nine weeks ended October 29, 2005 than the prior year comparable period due to the leveraging of occupancy costs over a higher sales base and a higher initial markup and lower markdowns.

Selling, general and administrative expenses increased $155.7 million to $356.6 million during the thirty-nine weeks ended October 29, 2005 from $200.9 million during the thirty-nine weeks ended October 30, 2004.  As a percentage of net sales, selling, general and administrative expenses increased 2.7% to 31.6% of net sales during the thirty-nine weeks ended October 29, 2005 from 28.9% of net sales during the thirty-nine weeks ended October 30, 2004.  This increase, as a percentage of net sales, was due primarily to Disney Store expenses that we did not have last year, such as royalty expenses, transitional services and remodel expenses and higher store repair, maintenance and utility costs.  During the thirty-nine weeks ended October 29, 2005, we have remodeled 24 Disney stores and plan to complete 32 Disney Store remodels by the end of fiscal 2005.  During the thirty-nine weeks ended October 29, 2005, Disney Store royalty, transition and remodel costs represented approximately 1.7% of net sales.  Although royalty expense was recorded under generally accepted accounting principles, no royalty payment was made due to the royalty holiday under the License Agreement.  During the thirty-nine weeks ended October 29, 2005, repair, maintenance and utility expenses were approximately 0.7% higher as a percentage of net sales due to our continued focus on the store environment and increased utility costs.

Depreciation and amortization amounted to $40.0 million or 3.5% of net sales, during the thirty-nine weeks ended October 29, 2005 as compared to $38.5 million, or 5.5% of net sales, during the thirty-nine weeks ended October 30, 2004.  Depreciation and amortization expense decreased, as a percentage of net sales, as the result of leveraging of the expense over a larger sales base and minimal depreciation for the Disney Store.

Our income tax provision was $10.0 million during the thirty-nine weeks ended October 29, 2005 as compared with $12.9 million during the thirty-nine weeks ended October 30, 2004.  Our effective tax rate was 33.8% during the thirty-nine weeks ended October 29, 2005 which reflects increased efficiencies from a tax point of view that were identified in the course of our global operations review.  Our tax provision was 40.0% during the thirty-nine weeks ended October 30, 2004.

During the thirty-nine weeks ended October 29, 2005, we recorded a $1.7 million extraordinary gain, net of taxes.  This extraordinary gain represents the finalization of purchase accounting for the DSNA business, including the post-closing true-up of acquired net working capital.

Due to the factors discussed above, we recorded a net income of $21.2 million and $19.3 million during the thirty-nine weeks ended October 29, 2005 and during the thirty-nine weeks ended October 30, 2004, respectively.

Liquidity and Capital Resources

Debt Service/Liquidity

Our working capital needs follow a seasonal pattern, peaking during the third and fourth quarters when inventory is purchased for the back-to-school and holiday selling seasons.  In general, our primary uses of cash are financing new store openings and providing for working capital, which principally represents the purchase of inventory.  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 October 29, 2005, we had no long-term debt obligations.  We manage liquidity for The Children’s Place and Disney Stores separately, including cash receipts, disbursements and credit facilities.

We entered into a Guaranty and Commitment (the “Guaranty and Commitment”) dated as of November 21, 2004, in favor of

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the Hoop Operating Entities and Disney.  As required by the Guaranty and Commitment, we invested $50 million in the Hoop Operating Entities concurrently with the consummation of the acquisition, and agreed to invest up to an additional $50 million to enable the Hoop Operating Entities to comply with their obligations under the License Agreement and otherwise fund the operations of the Hoop Operating Entities.  To date, we have not been required to invest any of this additional $50 million in the Hoop Operating Entities in order to comply with the terms of the License Agreement.  We also agreed to guarantee the payment and performance of the Hoop Operating Entities (for their royalty payment and other obligations to Disney), subject to a maximum guaranty liability of $25 million, plus expenses.

In connection with the acquisition of the DSNA Business, some of our subsidiaries and Disney’s subsidiaries entered into a License Agreement under which the Hoop Operating Entities have the right to use certain Disney intellectual property in the DSNA Business in exchange for ongoing royalty payments.  The License Agreement limits the ability of the Hoop Operating Entities to make cash dividends or other distributions.  The Hoop Operating Entities’ independent directors must approve payment of any dividends or other distributions, other than payments of:

•       amounts due under the terms of the tax sharing and intercompany services agreements,

•       approximately $61.9 million which represents a portion of the purchase price paid by the Company to Disney (limited to cumulative cash flows since the date of the acquisition), and

•       certain other dividend payments, subject to satisfaction of certain additional operating conditions and limited to 50% of cumulative cash flows up to $90 million, and 90% of cumulative cash flows thereafter (provided that at least $90 million of cash and cash equivalents is maintained at the Hoop Operating Entities).

In the normal course of business, the Hoop Operating Entities have reimbursed intercompany services but have not paid any dividends or made other distributions.  We are currently evaluating the Hoop Operating Entities’ ability to reimburse the Company for all or a portion of the $61.9 million described above. We do not expect the Hoop Operating Entities to pay other dividends to the Company during the next 12 months.  The Hoop Operating Entities cash on hand and cash generated from operations will be utilized to finance store remodels and provide working capital.  The License Agreement also restricts the incurrence of indebtedness in excess of certain permitted amounts.

As of October 30, 2004, we amended and restated our credit facility (the “Amended Loan Agreement”) with Wells Fargo Retail Finance, LLC (“Wells Fargo”), partly in connection with our acquisition of the DSNA Business.  The Amended Loan Agreement provides for borrowings up to $130 million (including a sub-limit for letters of credit of $100 million).  The term of the facility ends on November 1, 2007 with successive one-year renewal options.  The amount that could be borrowed under the Amended Loan Agreement depends on our level of inventory and accounts receivable.

The Amended Loan Agreement is secured by a first priority security interest in substantially all of our assets, other than assets in Canada and assets owned by our subsidiaries that were formed in connection with the acquisition of the DSNA Business.  Amounts outstanding under the Amended Loan Agreement 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%.  The unused line fee under the Amended Loan Agreement is 0.38%.

On July 29, 2005, we entered into an amendment of our Amended Loan Agreement to provide a temporary overadvance facility under which we had the right to borrow up to $20 million through October 31, 2005 (the “Overadvance Facility”).  The Overadvance Facility expired unused on October 31, 2005.

As of October 29, 2005, we had $55.3 million in borrowings under our Amended Loan Agreement and had outstanding letters of credit of $40.8 million.  Availability as of October 29, 2005 under the Amended Loan Agreement was $33.9 million, excluding the $20 million available under the Overadvance Facility.  The maximum borrowings during the thirty-nine weeks ended October 29, 2005 were $55.3 million.  We were in compliance with all of the covenants under the Amended Loan Agreement as of October 29, 2005.  Noncompliance with these covenants could result in additional fees, could affect our ability to borrow or could require us to repay the outstanding balance.

In connection with our acquisition of the DSNA Business, the Hoop Operating Entities entered into a Loan and Security Agreement (the “Hoop Loan Agreement”) with certain financial institutions and Wells Fargo, as administrative agent, establishing a senior secured credit facility for the DSNA Business.  The Hoop Loan Agreement provides for borrowings of up to $100 million (including a sub-limit for letters of credit of $90 million), subject to the amount of eligible inventory and accounts receivable of the domestic Hoop Operating Entity.  The term of the facility extends until November 21, 2007.  Amounts outstanding under the Hoop Loan Agreement bear interest at a floating rate equal to the prime rate plus a pre-determined margin or, at Hoop Operating Entities’ option, the LIBOR rate plus a pre-determined margin.  The prime rate margin is 0.25% and the LIBOR margin is 2.0% or 2.25%, depending on the domestic Hoop Operating Entity’s level of excess availability.  The unused line fee is 0.30%.

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The Hoop Loan Agreement contains various covenants, including limitations on indebtedness, maintenance of certain levels of excess collateral and restrictions on the payment of dividends and payment of any indebtedness.  Credit extended under the Hoop Loan Agreement is secured by a first priority security interest in substantially all the assets of Hoop Operating Entities as well as a pledge of a portion of the equity interests in the Canada Hoop Operating Entity.  Borrowings and letters of credit under the Hoop Loan Agreement are used by the Hoop Operating Entities for working capital purposes for the Disney Store business.

As of October 29, 2005, we had no borrowings under the Hoop Loan Agreement and had outstanding letters of credit of $43.1 million.  Availability under the Hoop Loan Agreement was $18.8 million as of October 29, 2005.  During the thirty-nine weeks ended October 29, 2005, there were no borrowings under the Hoop Loan Agreement other than letters of credit that cleared after business hours.  The average loan balance under the Hoop Loan Agreement during the thirty-nine weeks ended October 29, 2005 was approximately $411,000 and the average interest rate was 6.53%.  The maximum outstanding letters of credit outstanding during the thirty-nine weeks ended October 29, 2005 were $60.4 million.

During fiscal 2005, we expect to have no borrowings under the Hoop Loan Agreement and seasonal borrowings under the Amended Loan Agreement.  We expect to use both credit facilities to support letters of credit throughout fiscal 2005.

We previously had an $8.2 million credit facility with Toronto Dominion Bank to support our Canadian subsidiary, which operates “The Children’s Place” stores in Canada.  This credit facility expired and we do not plan to replace the facility.

During the thirty-nine weeks ended October 29, 2005, letter of credit fees approximated $0.7 million and were included in cost of goods sold.

Cash Flows/Capital Expenditures

During the thirty-nine weeks ended October 29, 2005, operating activities used $19.5 million in cash flow as compared to $14.3 million provided by operating activities during the thirty-nine weeks ended October 30, 2004.  Cash flow used by operating activities increased during the thirty-nine weeks ended October 29, 2005 due primarily to a higher seasonal buildup of inventory to support our businesses and higher income tax payments, partially offset by deferred royalty expense, which was non-cash due to the royalty holiday.

Cash flows used in investing activities were $54.1 million and $25.0 million in the thirty-nine weeks ended October 29, 2005 and the thirty-nine weeks ended October 30, 2004, respectively.  Cash flows used in investing activities during the thirty-nine weeks ended October 30, 2004 included the net sale of $22.3 million of short-term investments.  During the thirty-nine weeks ended October 29, 2005, capital expenditures were $55.4 million as compared with $47.2 million during the thirty-nine weeks ended October 30, 2004.  The increase in capital expenditures in the thirty-nine weeks ended October 29, 2005 primarily reflects capital expenditure investments made for our new distribution center in South Brunswick, New Jersey and upgrades in our other distribution centers to support the Disney Store acquisition, as well as our new office facility in Pasadena, California.  During the thirty-nine weeks ended October 29, 2005 and the thirty-nine weeks ended October 30, 2004, we opened 54 stores and 45 stores and remodeled 28 stores and six stores, respectively.  Our capital expenditures also include ongoing store, office, information technology and equipment needs.  We anticipate that total capital expenditures for The Children’s Place and Disney Store businesses during fiscal 2005 will be approximately $75 million.  We also anticipate receiving approximately $10 to $13 million in lease incentives during fiscal 2005.

Cash flows provided by financing activities were $29.9 million during the thirty-nine weeks ended October 29, 2005 reflecting net borrowings under our credit facilities and funds received from the exercise of employee stock options and employee stock purchases.  During the thirty-nine weeks ended October 30, 2004, cash flows provided by financing activities were $2.7 million reflecting funds received from the exercise of employee stock options and employee stock purchases.

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As of December 1, 2005, we operated 800 The Children’s Place Stores and 323 Disney Stores.  During the remainder of fiscal 2005, we expect to open two The Children’s Place stores and close five Disney Stores.  The following table summarizes our store openings, closings and remodels through December 1, 2005.