Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x 

 

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

 

 

 

For the quarterly period ended August 1, 2009

 

 

 

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)

 

Delaware

 

31-1241495

(State or other jurisdiction of

 

(I.R.S. employer

Incorporation or organization)

 

identification number)

 

 

 

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.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

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

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

(Don’t check if smaller reporting company)

 

 

 

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

 

The number of shares outstanding of the registrant’s common stock with a par value of $0.10 per share, as of August 31, 2009 was 27,355,204 shares.

 

 

 



Table of Contents

 

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

 

QUARTERLY REPORT ON FORM 10-Q

 

FOR THE PERIOD ENDED AUGUST 1, 2009

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

 

 

Item 1.

Condensed Consolidated Financial Statements.

 

Condensed Consolidated Balance Sheets

 

Condensed Consolidated Statements of Operations

 

Condensed Consolidated Statements of Cash Flows

 

Notes to Condensed Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Item 4.

Controls and Procedures

 

 

PART II – OTHER INFORMATION

 

 

Item 1.

Legal Proceedings

Item 1A.

Risk Factors

Item 4.

Submission of Matters to a Vote of Security Holders

Item 6.

Exhibits

Signatures

 

 



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 shares issued, authorized and outstanding)

 

 

 

(unaudited)

 

 

 

(unaudited)

 

 

 

August 1,

 

January 31,

 

August 2,

 

 

 

2009

 

2009

 

2008

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 152,198

 

$

 226,206

 

$

 146,704

 

Accounts receivable

 

21,792

 

19,639

 

26,150

 

Inventories

 

262,986

 

211,227

 

219,100

 

Prepaid expenses and other current assets

 

52,236

 

42,674

 

78,167

 

Deferred income taxes

 

47,907

 

19,844

 

22,149

 

Restricted assets in bankruptcy estate of subsidiary

 

 

 

85,265

 

Total current assets

 

537,119

 

519,590

 

577,535

 

Long-term assets:

 

 

 

 

 

 

 

Property and equipment, net

 

310,795

 

318,116

 

333,783

 

Deferred income taxes

 

69,753

 

96,104

 

91,163

 

Other assets

 

5,207

 

5,947

 

6,705

 

Total assets

 

$

 922,874

 

$

 939,757

 

$

 1,009,186

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

LIABILITIES:

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Revolving Loan

 

$

 —

 

$

 —

 

$

 —

 

Short term portion of term loan

 

38,000

 

30,000

 

30,000

 

Accounts payable

 

89,249

 

73,333

 

80,287

 

Income taxes payable

 

3,869

 

3,166

 

5,526

 

Accrued expenses and other current liabilities

 

89,219

 

100,496

 

93,619

 

Liabilities in bankruptcy estate of subsidiary

 

 

 

108,409

 

Total current liabilities

 

220,337

 

206,995

 

317,841

 

Long-term liabilities:

 

 

 

 

 

 

 

Deferred rent liabilities

 

104,043

 

105,565

 

105,016

 

Other tax liabilities

 

9,100

 

17,150

 

24,119

 

Long term portion of term loan

 

 

55,000

 

55,000

 

Other long-term liabilities

 

6,161

 

7,168

 

10,984

 

Total liabilities

 

339,641

 

391,878

 

512,960

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Preferred stock, $1.00 par value, 1,000,000 shares authorized, 0 shares issued and outstanding at August 1, 2009, January 31, 2009, and August 2, 2008

 

 

 

 

Common stock, $0.10 par value, 100,000,000 shares authorized, 29,668,337, 29,465,065 and 29,337,505 issued and outstanding at August 1, 2009, January 31, 2009, and August 2, 2008, respectively

 

2,967

 

2,947

 

2,933

 

Additional paid-in capital

 

214,358

 

205,858

 

202,484

 

Accumulated other comprehensive income (loss)

 

7,283

 

(3,090

)

11,486

 

Retained earnings

 

358,625

 

342,164

 

279,323

 

Total stockholders’ equity

 

583,233

 

547,879

 

496,226

 

Total liabilities and stockholders’ equity

 

$

 922,874

 

$

 939,757

 

$

1,009,186

 

 

See accompanying notes to these condensed consolidated financial statements.

 

1



Table of Contents

 

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

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

August 1,

 

August 2,

 

August 1,

 

August 2,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net sales

 

$

 315,676

 

$

 338,029

 

$

 717,577

 

$

 738,241

 

Cost of sales

 

210,377

 

209,480

 

445,751

 

438,600

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

105,299

 

128,549

 

271,826

 

299,641

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

106,093

 

105,793

 

217,986

 

225,203

 

Asset impairment charge

 

315

 

127

 

1,414

 

127

 

Depreciation and amortization

 

17,564

 

17,709

 

35,088

 

35,361

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

(18,673

)

4,920

 

17,338

 

38,950

 

Interest (expense), net

 

(1,462

)

(398

)

(4,730

)

(891

)

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

(20,135

)

4,522

 

12,608

 

38,059

 

Provision (benefit) for income taxes

 

(12,906

)

1,786

 

(3,904

)

15,903

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

(7,229

)

2,736

 

16,512

 

22,156

 

Income (loss) from discontinued operations, net of income taxes

 

178

 

(2,725

)

(51

)

(2,627

)

Net income (loss)

 

$

 (7,051

)

$

 11

 

$

 16,461

 

$

 19,529

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share amounts (1)

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

 (0.24

)

$

 0.09

 

$

 0.56

 

$

 0.76

 

Income (loss) from discontinued operations, net of income taxes

 

0.01

 

(0.09

)

(0.00

)

(0.09

)

Net income (loss)

 

$

 (0.24

)

$

 0.00

 

$

 0.56

 

$

 0.67

 

Basic weighted average common shares outstanding

 

29,552

 

29,255

 

29,514

 

29,177

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings (loss) per share amounts (1)

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

 (0.24

)

$

 0.09

 

$

 0.56

 

$

 0.75

 

Income (loss) from discontinued operations, net of income taxes

 

0.01

 

(0.09

)

(0.00

)

(0.09

)

Net income (loss)

 

$

 (0.24

)

$

 0.00

 

$

 0.55

 

$

 0.66

 

Diluted weighted average common shares outstanding

 

29,552

 

29,599

 

29,746

 

29,395

 

 


(1) Table may not add due to rounding

 

See accompanying notes to these condensed consolidated financial statements.

 

2



Table of Contents

 

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

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

 

 

 

Twenty-six Weeks Ended

 

 

 

August 1,
2009

 

August 2,
2008

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

 16,461

 

$

 19,529

 

Less (loss) from discontinued operations

 

(51

)

(2,627

)

Income from continuing operations

 

16,512

 

22,156

 

Reconciliation of net income to net cash provided by (used in) operating activities of continuing operations:

 

 

 

 

 

Depreciation and amortization

 

35,088

 

35,361

 

Other amortization

 

2,140

 

232

 

(Gain) loss on disposal of property and equipment

 

493

 

(1,695

)

Asset impairments

 

1,414

 

127

 

Stock-based compensation

 

4,539

 

2,780

 

Deferred taxes

 

(5,879

)

37,186

 

Deferred rent expense and lease incentives

 

(8,361

)

(7,849

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,901

)

6,316

 

Inventories

 

(48,594

)

(23,242

)

Prepaid expenses and other assets

 

(3,851

)

(1,097

)

Accounts payable

 

14,977

 

51,349

 

Accrued expenses and other current liabilities

 

(12,306

)

803

 

Intercompany (discontinued operations)

 

 

(17,995

)

Income taxes payable, net of prepayments

 

(2,396

)

(19,370

)

Deferred rent and other liabilities

 

1,255

 

2,832

 

Total adjustments

 

(23,382

)

65,738

 

Net cash provided by (used in) operating activities of continuing operations

 

(6,870

)

87,894

 

Net cash provided by (used in) operating activities of discontinued operations

 

(51

)

23,228

 

Net cash provided by (used in) operating activities

 

(6,921

)

111,122

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Property and equipment purchases, lease acquisition and software costs

 

(27,085

)

(18,530

)

Cash received for sale of store assets and leases

 

 

2,300

 

Net cash (used in) investing activities of continuing operations

 

(27,085

)

(16,230

)

Net cash (used in) investing activities of discontinued operations

 

 

(23,743

)

Net cash (used in) investing activities

 

(27,085

)

(39,973

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Borrowings under revolving credit facilities

 

86,300

 

649,174

 

Repayments under revolving credit facilities

 

(86,300

)

(718,735

)

Borrowings (payments) on term loan

 

(47,000

)

85,000

 

Purchase of common stock

 

(254

)

 

Exercise of stock options

 

1,840

 

3,695

 

Capital contribution to subsidiary in discontinued operations

 

 

(8,250

)

Deferred financing costs

 

 

(3,839

)

Net cash provided by (used in) financing activities of continuing operations

 

(45,414

)

7,045

 

Net cash (used in) financing activities of discontinued operations

 

 

(11,878

)

Net cash (used in) financing activities

 

(45,414

)

(4,833

)

Effect of exchange rate changes on cash of continuing operations

 

5,412

 

(987

)

Effect of exchange rate changes on cash of discontinued operations

 

 

(251

)

Effect of exchange rate changes on cash

 

5,412

 

(1,238

)

Net increase (decrease) in cash and cash equivalents

 

(74,008

)

65,078

 

Cash and cash equivalents, beginning of period

 

226,206

 

81,626

 

Cash and cash equivalents, end of period

 

$

 152,198

 

$

 146,704

 

 

See accompanying notes to these condensed consolidated financial statements.

 

3



Table of Contents

 

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

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

 

 

 

Twenty-six Weeks Ended

 

 

 

August 1,
2009

 

August 2,
2008

 

OTHER CASH FLOW INFORMATION:

 

 

 

 

 

Net cash paid (refunded) for income taxes

 

$

 7,446

 

$

 (4,012

)

Cash paid for interest

 

3,633

 

1,591

 

(Decrease) in accrued purchases of property and equipment, lease acquisition and software costs

 

(600

)

(10,757

)

 

See accompanying notes to these condensed consolidated financial statements.

 

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Table of Contents

 

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 (“U.S. GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly The Children’s Place Retail Stores, Inc.’s (the “Company”) consolidated financial position as of August 1, 2009, January 31, 2009 and August 2, 2008, the results of its consolidated operations for the thirteen weeks and twenty-six weeks ended August 1, 2009 and August 2, 2008, and its consolidated cash flows for the twenty-six weeks ended August 1, 2009 and August 2, 2008. Due to the seasonal nature of the Company’s business, the results of operations for the thirteen and twenty-six weeks ended August 1, 2009 and August 2, 2008 are not necessarily indicative of operating results for a full fiscal year. The accompanying unaudited condensed consolidated financial statements have the Disney Store business classified as discontinued operations in accordance with U.S. GAAP, reflecting the Company’s exit of the Disney Store business in the first quarter of fiscal 2008 (see Note 2-Discontinued Operations).  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2009.

 

Recently Adopted Accounting Pronouncements

 

On February 1, 2009, the first day of fiscal 2009, the Company adopted FSP 157-2 “Effective Date of FASB Statement No. 157,” which delayed the effective date of Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements,” (“SFAS 157”) for all non-financial assets and non-financial liabilities until the beginning of the first quarter of fiscal 2009.  This adoption did not have any impact on the Company’s condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, the Company adopted SFAS No. 165, “Subsequent Events” (“SFAS 165”).  This statement establishes standards for accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued.  In accordance with SFAS 165, the Company evaluates subsequent events through the date its financial statements are issued.  For the quarter ended August 1, 2009, subsequent events have been evaluated through September 3, 2009.  The adoption of SFAS 165 did not have any impact on the Company’s condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, the Company adopted FSP 157-4 “Determining Whether a Market Is Not Active and a Transaction Is Not Distressed,” which provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157.  FSP 157-4 provides additional authoritative guidance in determining whether a market is active or inactive, and whether a transaction is distressed and is applicable to all assets and liabilities (i.e. financial and non-financial) and requires enhanced disclosures.  The adoption of FSP 157-4 did not have any impact on the Company’s condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, the Company adopted FSP 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which amends SFAS 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments in interim as well as in annual financial statements.  The adoption of the provisions of FSP 107-1 and APB 28-1 did not have any impact on the Company’s condensed consolidated financial statements, but did require additional disclosures, which are provided below- Fair Value Measurement and Financial Instruments.

 

Fair Value Measurement and Financial Instruments

 

Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements,” provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities.

 

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  SFAS No. 157 establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The three levels of the hierarchy are defined as follows:

 

·      Level 1 - inputs to the valuation techniques that are quoted prices in active markets for identical assets or liabilities

 

·      Level 2 - inputs to the valuation techniques that are other than quoted prices but are observable for the assets or liabilities, either directly or indirectly

 

·      Level 3 - inputs to the valuation techniques that are unobservable for the assets or liabilities

 

The Company’s cash and cash equivalents, accounts receivable, accounts payable, credit facilities and certain other short-term financial instruments are all short-term in nature.  As such, their carrying amounts approximate fair value.  The Company’s term loan had a carrying value of $38.0 million as of August 1, 2009, which approximated fair value, based on its payment in full on August 3, 2009.

 

2.                                      DISCONTINUED OPERATIONS

 

During the first quarter of fiscal 2008, after a thorough review of the Disney Store business, its potential earnings growth, its capital needs and its ability to fund such needs from its own resources, the Company decided to exit the Disney Store business.  The Company’s subsidiaries that operated the Disney Store business are referred to herein interchangeably and collectively as “Hoop.”

 

After assessing the above factors and considering Hoop’s liquidity, Hoop’s Board of Directors determined that the best way to complete an orderly wind-down of Hoop’s affairs was for Hoop to seek relief under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”).  On March 26, 2008, Hoop Holdings, LLC, Hoop Retail Stores, LLC and Hoop Canada Holdings, Inc. each filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the “U.S. Bankruptcy Court”) (Case Nos.  08-10544, 08-10545, and 08-10546, respectively, the “Cases”).  On March 27, 2008, Hoop Canada, Inc. filed for protection pursuant to the Companies’ Creditors Arrangement Act (the “CCAA”) in the Ontario Superior Court of Justice (Commercial List) (“Canadian Bankruptcy Court”) (Court File No.  08-CL-7453, and together with the Cases, the “Filings”).  Each of the foregoing Hoop entities are referred to collectively herein as the “Hoop Entities.”

 

After receiving the approval of the U.S. Bankruptcy Court and the Canadian Bankruptcy Court, on April 30, 2008, Hoop transferred the Disney Store business in the U.S. and Canada and a substantial portion of the Disney Store assets to affiliates of the Walt Disney Company (“Disney”) in an asset sale, pursuant to an asset purchase agreement dated as of April 3, 2008 among the Hoop Entities and Disney (the “Sale Agreement”) and section 363 of the Bankruptcy Code (and a similar provision under the CCAA). Upon closing, affiliates of Disney paid approximately $61.6 million, including certain post-closing adjustments, for the acquired assets of the Disney Store business.  The proceeds received from the asset sale are included in the assets of the Hoop Entities’ for distribution to their creditors pursuant to the plan of reorganization that was approved by the U.S. Bankruptcy Court on December 15, 2008 (the “Plan”).  A similar plan was approved by the Canadian Bankruptcy Court.

 

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According to the terms of the asset sale, Hoop transferred 217 Disney Stores to affiliates of Disney and granted such affiliates the right to operate and wind-down the affairs of the remaining stores.  The lease obligations associated with the stores that were not sold were rejected and resulting damage claims were administered pursuant to the Plan.

 

In April 2008, the Company entered into a settlement and release of claims agreement with Hoop and the official committee of unsecured creditors in the Cases (the “Settlement Agreement”), which was approved by the U.S. Bankruptcy Court on April 29, 2008.  Under the Settlement Agreement, the Company agreed to provide transitional services and to forgive all pre- and post-bankruptcy petition claims against the Hoop Entities.  Such claims included intercompany charges for shared services of approximately $24.9 million, a capital contribution made on March 18, 2008 of approximately $8.3 million, payment of severance and other employee costs for the Company’s employees servicing Hoop of approximately $7.7 million, and $6.8 million of professional fees and other costs the Company has incurred during the Cases, as well as claims that might be asserted against the Company in the Cases.  As of August 1, 2009, the Company has paid approximately $45.5 million related to the Settlement Agreement, and has remaining accruals of $2.1 million, primarily for legal claims and related costs, and severance.

 

On December 15, 2008, the U.S. Bankruptcy Court approved the Plan, pursuant to which the Hoop Entities that were U.S. debtors were dissolved and all assets and liabilities, including their investment in Hoop Canada, Inc., were transferred to a trust (the “Trust”), which is overseen by a trustee appointed by the U.S. Bankruptcy Court under the Plan and a trust oversight committee.

 

Upon effectiveness of the Plan in December 2008, the Company deconsolidated all Hoop Entities.  As a result, all intercompany balances, including investments in subsidiaries, have been eliminated, and the net liabilities in excess of assets transferred resulted in a $25.5 million gain on the relief of indebtedness of discontinued operations in the fourth quarter of fiscal 2008.  The Company continues to incur charges related to the wind-down of the Hoop Entities and such costs are expensed through discontinued operations as incurred.

 

For the twenty-six weeks ended August 1, 2009, loss from discontinued operations, net of taxes, is comprised primarily of professional fees associated with the wind-down of the Hoop Entities.  For the twenty-six weeks ended August 2, 2008, loss from discontinued operations, net of income taxes is comprised of the following items:

 

·                  $10.6 million, pretax, of losses from the operation of the Disney Store business, including $129.2 million of net sales;

 

·                  $16.0 million, pretax, of professional, restructuring and severance expenses associated with the Hoop bankruptcy filings;

 

·                  a pretax gain on the disposal of the Disney Store business of approximately $23.1 million;

 

·                  pretax interest expense of $0.8 million; and

 

·                  the net tax benefit on the above items was approximately $1.6 million.

 

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Table of Contents

 

3.                                      STOCK-BASED COMPENSATION

 

The following tables summarize the Company’s stock-based compensation expense (in thousands):

 

 

 

Thirteen Weeks Ended August 1, 2009

 

 

 

Cost of
Sales

 

Selling,
General &
Administrative

 

Discontinued
Operations

 

Total

 

Stock option expense

 

$

 —

 

$

 94

 

$

 —

 

$

 94

 

Deferred stock expense

 

296

 

817

 

 

1,113

 

Restricted stock expense

 

 

253

 

 

253

 

Performance award expense

 

 

206

 

 

206

 

Total stock-based compensation expense

 

$

 296

 

$

 1,370

 

$

 —

 

$

 1,666

 

 

 

 

Twenty-six Weeks Ended August 1, 2009

 

 

 

Cost of
Sales

 

Selling,
General &
Administrative

 

Discontinued
Operations

 

Total

 

Stock option expense

 

$

 —

 

$

 146

 

$

 —

 

$

 146

 

Deferred stock expense

 

592

 

2,404

 

 

2,996

 

Restricted stock expense

 

 

432

 

 

432

 

Performance award expense

 

 

965

 

 

965

 

Total stock-based compensation expense

 

$

 592

 

$

 3,947

 

$

 —

 

$

 4,539

 

 

 

 

Thirteen Weeks Ended August 2, 2008

 

 

 

Cost of
Sales

 

Selling,
General &
Administrative

 

Discontinued
Operations

 

Total

 

Stock option expense

 

$

 —

 

$

 209

 

$

 108

 

$

 317

 

Deferred stock expense

 

115

 

986

 

 

1,101

 

Restricted stock expense

 

 

155

 

 

155

 

Performance award expense

 

 

290

 

 

290

 

Total stock-based compensation expense

 

$

 115

 

$

 1,640

 

$

 108

 

$

 1,863

 

 

 

 

Twenty-six Weeks Ended August 2, 2008

 

 

 

Cost of
Sales

 

Selling,
General &
Administrative

 

Discontinued
Operations

 

Total

 

Stock option expense

 

$

 —

 

$

 299

 

$

 196

 

$

 495

 

Deferred stock expense

 

247

 

1,507

 

242

 

1,996

 

Restricted stock expense

 

 

266

 

 

266

 

Performance award expense

 

 

461

 

 

461

 

Total stock-based compensation expense

 

$

 247

 

$

 2,533

 

$

 438

 

$

 3,218

 

 

The Company recognized a tax benefit related to stock-based compensation expense of $1.8 million and $1.3 million for the twenty-six weeks ended August 1, 2009 and August 2, 2008, respectively.

 

The 2008 Long Term Incentive Plan (the “LTIP”) provides for the issuance of deferred stock awards and performance awards to key members of management (the “Participants”). The awards are based on salary level and the fair market value of the Company’s common stock on the grant date.  The deferred stock awards vest over three years and have a service requirement only. Key features of the performance awards are as follows:

 

·                  Each performance award has a defined number of shares that a Participant can earn (the “Target Shares”). Based on performance levels, Participants can earn up to 200% of their Target Shares.

 

·                  The awards have a service requirement and performance criteria that must be achieved for the awards to vest.

 

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·                  The performance criteria are based on the Company’s achievement of operating income levels in each of the fiscal years 2008, 2009 and 2010, as well as in the aggregate.

 

·                  Awards may be earned in each of the fiscal years based upon meeting the established performance criteria for that year, however, except in certain circumstances, the Participants must be employed by the Company at the end of the three year performance period or their awards are forfeited.

 

On March 6, 2008, the Compensation Committee approved the performance criteria and thus established a grant date for accounting purposes.

 

During the twenty-six weeks ended August 1, 2009, the Company granted its annual deferred stock awards to its non-employee directors which provide for the issuance of an aggregate of 36,778 shares of common stock and an award to a then newly appointed non-employee director which provides for the issuance of 4,663 shares of common stock.  These awards fully vest on the first anniversary of the date of grant.  The Company also granted employee deferred stock awards of 2,500 shares, which vest equally over three years.

 

In February 2009, in conjunction with the amendment to the interim CEO’s employment agreement, the Company awarded him 55,401 shares of restricted stock, of which 41,551 shares were immediately granted and vest ratably on a monthly basis over three years.  The remaining 13,850 shares were contingent upon the Company’s election to continue his employment as interim CEO beyond August 31, 2009, in accordance with the terms of the employment agreement.  This election was made on July 31, 2009.  These shares will vest 7/36 on September 1, 2009 and the remaining balance will vest 1/36 each month thereafter.

 

During the twenty-six weeks ended August 2, 2008, the Company awarded to key members of management: (a) 42,645 deferred stock awards; and (b) performance awards that provide for 42,645 Target Shares (assuming they are earned at 100%).

 

Deferred and Restricted Stock (“Deferred Awards”)

 

Changes in the Company’s unvested deferred awards for the twenty-six weeks ended August 1, 2009 were as follows:

 

 

 

Number of
Shares

 

Weighted
Average
Grant Date
Fair Value

 

 

 

(in thousands)

 

 

 

Unvested deferred awards beginning of period

 

463

 

$

 32.84

 

Granted

 

99

 

20.63

 

Vested (1)

 

(121

)

32.95

 

Forfeited

 

(19

)

33.01

 

Unvested deferred awards, end of period

 

422

 

$

 29.93

 

 


(1)          The Company withheld approximately 10,196 shares from those that vested to satisfy withholding tax requirements, which were then retired.

 

Total unrecognized equity compensation expense related to unvested deferred awards approximated $10.0 million as of August 1, 2009, which will be recognized over a weighted average period of approximately 1.8 years.

 

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Performance Awards

 

Changes in the Company’s unvested Performance Awards for the twenty-six weeks ended August 1, 2009 were as follows:

 

 

 

Number of
Performance
Shares (1)

 

Weighted
Average
Grant Date

Fair Value

 

 

 

(in thousands)

 

 

 

Unvested performance shares, beginning of period

 

141

 

$

 24.28

 

Granted

 

 

 

 

Vested

 

 

 

 

Forfeited

 

 

 

 

Unvested performance shares, end of period

 

141

 

$

 24.28

 

 


(1)          The number of unvested performance shares is based on the Participants earning their Target Shares at 100%. As of August 1, 2009, the Company estimates that Participants will earn 167% of their Target Shares. The cumulative expense recognized reflects changes in estimates as they occur.

 

Total unrecognized equity compensation expense related to unvested performance awards approximated $2.8 million as of August 1, 2009, which will be recognized over a weighted average period of approximately 1.5 years.

 

Stock Option Plans

 

The Company estimates the fair value of issued stock options using the Black-Scholes option pricing model using certain assumptions for stock price volatility, risk-free interest rates, and the expected life of the options as of each grant date.  In fiscal 2008, the Company ceased issuing stock options in favor of deferred and restricted awards, hence, no stock options were granted during the twenty-six weeks ended August 1, 2009.  During the twenty-six weeks ended August 2, 2008, 30,000 options were granted to two then newly appointed members of the Company’s Board of Directors and the following assumptions were used:

 

 

 

August 2,

 

 

2008

Dividend yield

 

0%

Volatility factor (1)

 

45.6%

Weighted average risk-free interest rate (2)

 

3.2%

Expected life of options (3)

 

5.1 years

Weighted average fair value on grant date

 

$12.81 per share

 


(1)          Expected volatility is based on a 50:50 blend of the historical and implied volatility with a two-year look back on the date of each grant.

(2)          The risk-free interest rate is based on the risk-free rate corresponding to the grant date and expected term.

(3)          The expected life used in the Black-Scholes calculation is based on a Monte Carlo simulation incorporating a forward-looking stock price model and a historical model of employee exercise and post-vest forfeiture behavior.

 

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Changes in the Company’s stock options for the twenty-six weeks ended August 1, 2009 were as follows:

 

 

 

Number of
Options

 

Weighted
Average
Exercise Price

 

Weighted Average
Remaining
Contractual Life

 

Aggregate
Intrinsic Value

 

 

 

(in thousands)

 

 

 

(in years)

 

(in thousands)

 

Options outstanding at January 31, 2009

 

1,187

 

$

 31.73

 

4.6

 

$

 499

 

Granted

 

 

 

 

 

Exercised

 

(93

)

19.89

 

N/A

 

1,200

 

Forfeited

 

(40

)

38.10

 

N/A

 

 

Options outstanding at August 1, 2009

 

1,054

 

$

 32.53

 

4.2

 

$

 5,147

 

Options exercisable at August 1, 2009

 

994

 

$

 32.98

 

3.9

 

$

 4,682

 

 

Changes in the Company’s unvested stock options for the thirteen weeks ended August 1, 2009 were as follows:

 

 

 

Number of
Options

 

Weighted
Average
Grant Date

Fair Value

 

 

 

(in thousands)

 

 

 

Unvested stock options, beginning of period

 

82

 

$

 10.87

 

Granted

 

 

 

Vested

 

(22

)

10.61

 

Forfeited

 

 

 

Unvested stock options, end of period

 

60

 

$

 10.96

 

 

Total unrecognized equity compensation expense related to unvested stock options approximated $0.1 million as of August 1, 2009, which will be recognized over a weighted average period of approximately 1.0 years.

 

4.                                      NET INCOME (LOSS) PER COMMON SHARE

 

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

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

August 1,

 

August 2,

 

August 1,

 

August 2,

 

 

 

2009

 

2008

 

2009

 

2008

 

Income (loss) from continuing operations

 

$

 (7,229

)

$

 2,736

 

$

 16,512

 

$

 22,156

 

Income (loss) from discontinued operations, net of taxes

 

178

 

(2,725

)

(51

)

(2,627

)

Net income (loss)

 

$

 (7,051

)

$

 11

 

$

 16,461

 

$

 19,529

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares

 

29,552

 

29,255

 

29,514

 

29,177

 

Dilutive effect of stock awards

 

 

344

 

232

 

218

 

Diluted weighted average common shares

 

29,552

 

29,599

 

29,746

 

29,395

 

Antidilutive stock awards

 

1,650

 

789

 

1,035

 

1,398

 

 

Antidilutive stock awards (stock options, deferred stock, restricted stock and performance awards) represent those awards that are excluded from the earnings per share calculation as a result of their antidilutive effect in the application of the treasury stock method.

 

The diluted earnings (loss) per share amounts presented in the condensed consolidated statements of operation for the thirteen weeks ended August 1, 2009, excludes the dilutive effect of the Company’s stock awards, which would have been anti-dilutive as a result of the loss from continuing operations.

 

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5.                                      COMPREHENSIVE INCOME (LOSS)

 

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

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

August 1,

 

August 2,

 

August 1,

 

August 2,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net income (loss)

 

$

 (7,051

)

$

 11

 

$

 16,461

 

$

 19,529

 

Foreign currency translation adjustment

 

7,721

 

(631

)

10,373

 

(2,448

)

Comprehensive income (loss)

 

$

 670

 

$

 (620

)

$

 26,834

 

$

 17,081

 

 

6.                                      PROPERTY AND EQUIPMENT

 

Property and equipment consist of the following (in thousands):

 

 

 

Asset

 

August 1,

 

January 31,

 

August 2,

 

 

 

Life

 

2009

 

2009

 

2008

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Land and land improvements

 

 

$

 3,403

 

$

 3,403

 

$

 3,403

 

Building and improvements

 

25 yrs

 

30,451

 

30,451

 

30,450

 

Material handling equipment

 

15 yrs

 

31,243

 

31,243

 

31,243

 

Leasehold improvements

 

Lease life

 

367,636

 

353,636

 

341,040

 

Store fixtures and equipment

 

3-10 yrs

 

253,680

 

244,124

 

242,829

 

Capitalized software

 

5 yrs

 

62,225

 

60,403

 

55,856

 

Construction in progress

 

 

8,482

 

7,073

 

17,450

 

 

 

 

 

757,120

 

730,333

 

722,271

 

Less accumulated depreciation and amortization

 

 

 

(446,325

)

(412,217

)

(388,488

)

Property and equipment, net

 

 

 

$

 310,795

 

$

 318,116

 

$

 333,783

 

 

During the twenty-six weeks ended August 1, 2009, the Company recorded $1.4 million of impairment charges related to three underperforming stores.  During the twenty-six weeks ended August 2, 2008, the Company recorded $0.1 million of impairment charges related to one underperforming store.

 

As of August 1, 2009, January 31, 2009 and August 2, 2008, the Company had $3.5 million, $4.1 million and $6.5 million, respectively, in property and equipment for which payment had not been made.  These amounts are included in accounts payable and accrued expenses and other current liabilities.

 

7.                                      CREDIT FACILITIES

 

On July 31, 2008, the Company and certain of its domestic subsidiaries entered into a five year credit agreement (the “2008 Credit Agreement”) with Wells Fargo Retail Finance, LLC (“Wells Fargo”), Bank of America, N.A., HSBC Business Credit (USA) Inc., and JPMorgan Chase Bank, N.A. as lenders (collectively, the “Lenders”) and Wells Fargo, as Administrative Agent, Collateral Agent and Swing Line Lender.  The 2008 Credit Agreement refinanced a $130 million credit agreement and a $60 million letter of credit agreement which, except under certain limited circumstances, were each scheduled to expire on November 1, 2010 (the “Prior Credit Agreements”).

 

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The 2008 Credit Agreement consists of a $200 million asset based revolving credit facility, with a $175 million sublimit for standby and documentary letters of credit. Revolving credit loans outstanding under the 2008 Credit Agreement bear interest, at the Company’s option, at:

 

(i)                                     the prime rate plus a margin of 0.0% to 0.5% based on the amount of the Company’s average excess availability under the facility; or

(ii)                                  LIBOR for an interest period of one, two, three or six months, as selected by the Company, plus a margin of 2.00% to 2.50% based on the amount of the Company’s average excess availability under the facility.

 

An unused line fee of 0.50% or 0.75%, based on total facility usage, will accrue on the unused portion of the commitments under the facility.  Letter of credit fees range from 1.25% to 1.75% for commercial letters of credit and range from 2.00% to 2.50% for standby letters of credit.  Letter of credit fees are determined based on daily average undrawn stated amount of such outstanding letters of credit. The 2008 Credit Agreement expires on July 31, 2013.  The amount available for loans and letters of credit under the 2008 Credit Agreement is determined by a borrowing base consisting of certain credit card receivables, certain inventory and the fair market value of certain real estate, subject to certain reserves.

 

The outstanding obligations under the 2008 Credit Agreement may be accelerated upon the occurrence of certain events, including, among others, non-payment, breach of covenants, the institution of insolvency proceedings, defaults under other material indebtedness and a change of control, subject, in the case of certain defaults, to the expiration of applicable grace periods.  Should the 2008 Credit Agreement be terminated prior to August 1, 2010 for any reason, whether voluntarily by the Company or by reason of acceleration by the Lenders upon the occurrence of an event of default, the Company would be required to pay an early termination fee in the amount of 0.25% of the revolving credit facility ceiling then in effect.  No early termination fee would be due and payable for termination after July 31, 2010.

 

The 2008 Credit Agreement contains covenants, which include limitations on annual capital expenditures, stock buybacks and the payment of dividends or similar payments.  Credit extended under the 2008 Credit Agreement is secured by a first or second priority security interest in substantially all of the Company’s assets and substantially all of the assets of its domestic subsidiaries.

 

On May 4, 2009, the 2008 Credit Agreement was amended, which included the following changed rates; the LIBOR margin spread is 2.00% to 2.50%, the commercial letter of credit fees range is 1.25% to 1.75%, and the standby letter of credit fees range is 2.00% to 2.50%.

 

On July 29, 2009, the 2008 Credit Agreement was amended to permit the Company to purchase certain of its outstanding shares and to repatriate funds from Hong Kong and Canada.  In connection with this amendment, the Company paid an amendment fee of approximately $1.0 million and increased its unused line fee from 0.25% to 0.50%-0.75% depending on total facility usage.

 

The Company capitalized an aggregate of approximately $2.6 million in deferred financing costs related to the 2008 Credit Agreement, which is being amortized on a straight-line basis over its term.

 

The table below presents the components (in millions) of the Company’s credit facilities:

 

 

 

August 1,
2009

 

January 31,
2009

 

August 2,
2008

 

 

 

 

 

 

 

 

 

Credit facility maximum

 

$

 200.0

 

$

 200.0

 

$

 200.0

 

Borrowing base

 

199.0

 

155.0

 

163.0

 

 

 

 

 

 

 

 

 

Outstanding borrowings

 

$

 

$

 

$

 

Letters of credit outstanding—merchandise

 

35.3

 

32.3

 

34.2

 

Letters of credit outstanding—standby

 

16.1

 

14.6

 

14.6

 

Utilization of credit facility at end of period

 

51.4

 

46.9

 

48.8

 

 

 

 

 

 

 

 

 

Availability

 

147.6

 

108.1

 

114.2

 

 

 

 

 

 

 

 

 

Average loan balance during the period (1)

 

 

20.5

 

 

Highest borrowings during the period (1)

 

0.3

 

80.6

 

 

Average interest rate (1)

 

3.3

%

5.4

%

5.0

%

Interest rate at end of period

 

3.3

%

3.3

%

5.0

%

 


(1)          For the twenty-six weeks ended August 2, 2008, the average loan balance, highest borrowings during the period, and average interest rate includes activity under the Prior Credit Agreement through its termination on July 31, 2008.

 

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Letter of Credit Fees

 

Letter of credit fees approximated $0.2 million in each of the twenty-six week periods ended August 1, 2009 and August 2, 2008. Letter of credit fees are included in cost of sales.

 

8.                                      TERM LOAN

 

On July 31, 2008, concurrently with the execution of the 2008 Credit Agreement, the Company and certain of its domestic subsidiaries and Sankaty Credit Opportunities III, L.P., Sankaty Credit Opportunities IV, L.P., RGIP, LLC, Crystal Capital Fund, L.P., Crystal Capital Onshore Warehouse LLC, 1903 Onshore Funding, LLC, and Bank of America, N.A. (collectively, the “Note Purchasers”), together with Sankaty Advisors, LLC, as Collateral Agent, and Crystal Capital Fund Management, L.P., as Syndication Agent, entered into a note purchase agreement (“Note Purchase Agreement”).

 

Under the Note Purchase Agreement, the Company issued $85 million of non-amortizing secured notes (the “Notes”) which are due and payable on July 31, 2013.  Amounts outstanding under the Note Purchase Agreement bear interest at the greater of (i) LIBOR, for an interest period of one, two, three or six months, as selected by the Company, and (ii) 3.00%, plus, in each case, a margin of between 8.50% and 9.75% depending on the Company’s leverage ratio.  As of August 1, 2009, the interest rate applicable to the outstanding principal amount of the Notes was 11.5%.

 

A majority of the proceeds from the Note Purchase Agreement were used to repay in full the Company’s outstanding obligations under the Prior Credit Agreements, and the remaining proceeds were used for working capital needs.

 

The Company capitalized approximately $2.2 million in deferred financing costs related to the Note Purchase Agreement, which was being amortized on a straight-line basis over its term except that in the event of prepayments, the portion of the deferred financing costs related to prepayments is accelerated.  In conjunction with the $47 million of prepayments made on April 13, 2009 (see below), the Company expensed an additional $0.9 million of deferred financing costs.  In anticipation of the prepayment on August 3, 2009 (see below), the Company expensed the remaining $1.0 million of deferred financing costs as of August 1, 2009.

 

Based on the Company’s cash flow for fiscal 2008, it was required to make a mandatory prepayment of $31.3 million and had the option to make an additional prepayment, free of prepayment premium, of up to $15.7 million.  On April 13, 2009, after electing to make the full optional prepayment, the Company paid a total of $47 million.

 

On August 3, 2009, the Company prepaid the remaining principal amount of $38.0 million (the “Prepayment”) under the Note Purchase Agreement.  In accordance with the terms of the Note Purchase Agreement, the Company was required to pay a prepayment premium of 1.5%, or approximately $0.6 million.  In connection with the Prepayment, the Note Purchase Agreement and the Company’s obligations under the Note Purchase Agreement were terminated.  The Prepayment was approved by the Board of Directors on July 29, 2009, and accordingly, the Company recorded the $0.6 million prepayment premium in its results of operations for the quarter ended August 1, 2009.  Due to the Prepayment, the total principal amount outstanding of $38.0 million is classified as current in the accompanying condensed consolidated balance sheet at August 1, 2009.

 

9.                                      LEGAL AND REGULATORY MATTERS

 

On August 5, 2009, certain current and former members of the board of directors and senior executives of The Children’s Place Retail Stores, Inc. (the “Company”) were served with a stockholder derivative action filed in the Superior Court of New Jersey, Hudson County, Chancery Division.  The Company has been named as a nominal defendant.  The Complaint alleges, among other things, that certain of the Company’s current and former officers and directors breached their fiduciary duties to the Company and its stockholders and engaged in corporate waste in connection with the Disney Store transaction and resignation of the Company’s former Chief Executive Officer.  The complaint seeks money damages, the costs and disbursements of the lawsuit, as well as equitable relief.  While the Company believes there are valid defenses to the claims and it will defend itself vigorously, no assurance can be given as to the outcome of this litigation.  The Company does not believe that the costs and expenses of this litigation will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

On September 21, 2007, a stockholder class action was filed in the United States District Court, Southern District of New York against the Company and certain of its current and former senior executives.  The complaint alleges, among other

 

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things, that certain of the Company’s current and former officers made statements to the investing public which misrepresented material facts about the business and operations of the Company, or omitted to state material facts required in order for the statements made by them not to be misleading, causing the price of the Company’s stock to be artificially inflated in violation of provisions of the Exchange Act, as amended.  It alleges that subsequent disclosures establish the misleading nature of these earlier disclosures.  The complaint seeks monetary damages plus interest as well as costs and disbursements of the lawsuit.  On October 10, 2007, a third stockholder class action was filed in the United States District Court, Southern District of New York, against the Company and certain of its current and former senior executives.  This complaint alleges, among other things, that certain of the Company’s current and former officers made statements to the investing public which misrepresented material facts about the business and operations of the Company, or omitted to state material facts required in order for the statements made by them not to be misleading, thereby causing the price of the Company’s stock to be artificially inflated in violation of provisions of the Exchange Act, as amended.  According to this complaint, subsequent disclosures establish the misleading nature of these earlier disclosures.  This complaint seeks, among other relief, compensatory damages plus interest, and costs and expenses of the lawsuit, including counsel and expert fees.  These two actions have been consolidated and the plaintiff filed a consolidated amended class action complaint on February 28, 2008.  The Company’s motion to dismiss was denied by the court on July 18, 2008.  On June 26, 2009, the company and all other parties entered into a Stipulation of Settlement to settle the action in the amount of $12 million, which settlement was preliminarily approved by the Court on July 17, 2009.  The final settlement hearing is scheduled for October 16, 2009.  The cost of the settlement is covered by the Company’s insurance.

 

On or about July 12, 2006, Joy Fong, a former Disney Store manager in the San Francisco district, filed a lawsuit against the Company and its subsidiary Hoop Retail Stores, LLC in the Superior Court of California, County of Los Angeles.  The lawsuit alleges violations of the California Labor Code and California Business and Professions Code and sought class action certification on behalf of Ms. Fong and other individuals similarly situated.  The Company filed its answer on August 11, 2006 denying any and all liability, and on January 14, 2007, Ms. Fong filed an amended complaint, adding Disney as a defendant.  Effective as of March 26, 2008, the prosecution of this lawsuit against Hoop was stayed under the automatic stay provisions of the U.S. Bankruptcy Code by reason of Hoop’s petition for relief filed that same day.  The case is currently proceeding against the other defendants and, on December 18, 2008, the Court granted the plaintiff’s motion for class certification on the misclassification claim. The Company has reached a tentative settlement in the amount of $0.6 million and the parties are negotiating the terms of the settlement agreement.  The cost of this settlement was accrued as part of the Company’s accounting for discontinued operations.

 

The Company is also involved in various legal proceedings arising in the normal course of business.  In the opinion of management, any ultimate liability arising out of these proceedings will not have a material effect on the Company’s financial condition.

 

Except as described above, during the quarter ended August 1, 2009, neither the Company nor any of its subsidiaries became a party to, nor did any of their property become the subject of, any material legal proceedings, and there were no material developments to any legal proceedings previously reported in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2009 and on Form 10-Q for the quarter ended May 2, 2009.

 

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 the financial statement and income tax bases of assets and liabilities. Deferred tax assets and liabilities are comprised largely of book tax differences relating to depreciation, rent expense, inventory and various accruals and reserves.

 

During the first quarter of fiscal 2009, the Company recorded a $4.5 million benefit related to a favorable settlement of an IRS income tax audit.  During the second quarter of fiscal 2009, the Company recorded a $4.8 million tax benefit related to excess foreign tax credits generated by a one time dividend from its Canada subsidiaries.  As a result, the Company’s effective tax rate from continuing operations for the thirteen weeks and twenty-six weeks ended August 1, 2009 was 64.1% and (31.0)%, respectively, compared to 39.5% and 41.8% during the thirteen weeks and twenty-six weeks ended August 2, 2008, respectively.  The higher effective tax rate in the thirteen weeks ended August 1, 2009, which results from a pre-tax loss and the excess foreign tax credits noted above, yields a higher tax benefit.  The repatriation of cash from Canada did not impact the Company’s ability to remain permanently reinvested in the earnings of the Canadian subsidiaries.

 

During the thirteen weeks and twenty-six weeks ended August 1, 2009, the Company recognized approximately $0.2 million and $0.3 million, respectively, of additional interest expense related to its unrecognized tax benefits. During the

 

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thirteen weeks and twenty-six weeks ended August 2, 2008, the Company recognized approximately $0.3 million and $0.6 million, respectively of additional interest expense related to its unrecognized tax benefits. The Company recognizes accrued interest and penalties related to unrecognized income tax liabilities in income tax expense.

 

The Company is subject to taxation in the U.S. and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal income tax audits for years through fiscal 2006.  With limited exception, the Company is no longer subject to state, local or non-U.S. income tax audits by taxing authorities for years through fiscal 2003.  The Company does not expect any material changes to unrecognized tax benefits in the next 12 months.

 

11.                               INTEREST (EXPENSE) INCOME, NET

 

The following table presents the components of the Company’s interest (expense) income, net (in thousands):

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

August 1,

 

August 2,

 

August 1,

 

August 2,

 

 

 

2009

 

2008

 

2009

 

2008

 

Interest income

 

$

169

 

$

517

 

$

503

 

$

1,254

 

Tax-exempt interest income

 

5

 

11

 

11

 

21

 

Total interest income

 

174

 

528

 

514

 

1,275

 

 

 

 

 

 

 

 

 

 

 

Less:

 

 

 

 

 

 

 

 

 

Interest expense – term loan

 

1,687

 

82

 

3,858

 

82

 

Interest expense – credit facilities

 

82

 

197

 

139

 

1,113

 

Unused line fee

 

94

 

62

 

191

 

92

 

Amortization of deferred financing fees (1)

 

1,103

 

115

 

2,140

 

126

 

Other interest and fees (2)

 

(1,330

)

470

 

(1,084

)

753

 

Interest (expense), net

 

$

(1,462

)

$

(398

)

$

(4,730

)

$

(891

)

 


(1)          The thirteen and twenty-six weeks ended August 1, 2009 include approximately $1.0 million and $1.9 million, respectively, of accelerated deferred financing costs associated with prepayments made on the Company’s term loan.

 

(2)          The thirteen and twenty-six weeks ended August 1, 2009 include a credit of approximately $1.5 million of interest accrual reversals related to the favorable settlement of an IRS employment tax audit related to stock options.

 

12.                               SEGMENT INFORMATION

 

After the disposal of its Disney Business during fiscal 2008, the Company continued its reassessment of its internal reporting structure.  Net sales of Canadian operations have grown approximately 56% over the last three fiscal years, and with the disposal of the Disney business, its percentage of consolidated net sales has grown from approximately 9% to approximately 12%.  In addition, the fluctuations in the Canadian dollar exchange rate in recent years have had a significant impact on the Company’s Canadian operating results.  Beginning in fiscal 2009, the Company’s chief operating decision maker (“CODM”) required, and the Company began reporting, discrete financial information for its Canadian operations.

 

Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”), establishes standards for reporting information about a company’s operating segments.  In accordance with SFAS 131, the Company reports segment data based on management responsibility: The Children’s Place U.S. and The Children’s Place Canada.  Included in The Children’s Place U.S. segment is its U.S. based stores, including Puerto Rico, and its e-commerce store, www.childrensplace.com.  The Company measures its segment profitability based on operating income, defined by the Company as earnings before interest and taxes.  Net sales and direct costs are recorded by each segment.  Certain centrally managed inventory procurement functions such as production and design are allocated to each segment based upon usage.  Corporate overhead, including executive management, finance, real estate, human resources, legal, and information technology services are allocated to the segments based primarily on net sales.  The Company periodically reviews these allocations and adjusts them based upon changes in business circumstances.  Net sales from external customers are derived from merchandise sales and the Company has no major customers that account for more than 10% of its net sales.

 

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The following tables provide segment level financial information for the thirteen and twenty-six weeks ended August 1, 2009 and August 2, 2008 (dollars in thousands):

 

 

 

Thirteen Weeks Ended August 1, 2009

 

 

 

The Children’s
Place U.S.

 

The Children’s
Place Canada

 

Total
Company

 

Net Sales

 

$

275,947

 

$

39,729

 

$

315,676

 

Operating income (loss)

 

(22,007

)

3,334

 

(18,673

)

Operating income (loss) as a percent of net sales

 

-8.0

%

8.4

%

-5.9

%

 

 

 

 

 

 

 

 

Capital expenditures

 

15,021

 

 

15,021

 

 

 

 

Thirteen Weeks Ended August 2, 2008

 

 

 

The Children’s
Place U.S.

 

The Children’s
Place Canada

 

Total
Company

 

Net Sales

 

$

293,309

 

$

44,720

 

$

338,029

 

Operating income

 

495

 

4,425

 

4,920

 

Operating income as a percent of net sales

 

0.2

%

9.9

%

1.5

%

 

 

 

 

 

 

 

 

Capital expenditures

 

9,451

 

 

9,451

 

 

 

 

Twenty-six Weeks Ended August 1, 2009

 

 

 

The Children’s
Place U.S.

 

The Children’s
Place Canada

 

Total
Company

 

Net Sales

 

$

639,018

 

$

78,559

 

$

717,577

 

Operating income

 

8,780

 

8,558

 

17,338

 

Operating income as a percent of net sales

 

1.4

%

10.9

%

2.4

%

 

 

 

 

 

 

 

 

Capital expenditures

 

25,938

 

1,147

 

27,085

 

 

 

 

Twenty-six Weeks Ended August 2, 2008

 

 

 

The Children’s
Place U.S.

 

The Children’s
Place Canada

 

Total
Company

 

Net Sales

 

$

647,578

 

$

90,663

 

$

738,241

 

Operating income

 

25,688

 

13,262

 

38,950

 

Operating income as a percent of net sales

 

4.0

%

14.6

%

5.3

%

 

 

 

 

 

 

 

 

Capital expenditures

 

18,499

 

31

 

18,530

 

 

Total assets by segment are as follows (dollars in thousands):

 

 

 

The Children’s
Place U.S.

 

The Children’s
Place Canada

 

Restricted assets in
bankruptcy estate of
subsidiary

 

Total
Company

 

August 1, 2009

 

$

836,989

 

$

85,885

 

$

 

$

922,874

 

January 31, 2009

 

845,701

 

94,056

 

 

939,757

 

August 2, 2008

 

826,965

 

96,956

 

85,265

 

1,009,186

 

 

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13.                               NEW ACCOUNTING PRONOUNCEMENTS

 

On February 1, 2009, the first day of fiscal 2009, the Company adopted FSP 157-2 “Effective Date of FASB Statement No. 157,” which delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities until the beginning of the first quarter of fiscal 2009.  This adoption did not have any impact on the Company’s condensed consolidated financial statements.

 

In May 2009, FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”).  This statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  In particular, this statement sets forth: (a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (b) the circumstances under which an entity should recognize events or transaction occurring after the balance sheet date in its financial statements; and (c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date.  Effective May 3, 2009, the Company adopted SFAS 165.  This adoption did not have any impact on the Company’s condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, the Company adopted FSP 157-4 “Determining Whether a Market Is Not Active and a Transaction Is Not Distressed,” which provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157.  FSP 157-4 provides additional authoritative guidance in determining whether a market is active or inactive, and whether a transaction is distressed and is applicable to all assets and liabilities (i.e. financial and non-financial) and requires enhanced disclosures.  The adoption of FSP 157-4 did not have any impact on the Company’s condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, the Company adopted FSP 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which amends SFAS 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments in interim as well as in annual financial statements.  The adoption of the provisions of FSP 107-1 and APB 28-1 did not have any impact on the Company’s condensed consolidated financial statements.

 

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”).  This standard is effective for financial statements issued for reporting periods that end after September 15, 2009 and will serve as the sole source for authoritative U.S. GAAP.  The codification will reorganize all accounting standards in U.S. GAAP, aside from those issued by the SEC.  SFAS 168 also replaces SFAS No. 162 to establish a new hierarchy of GAAP sources for non-governmental entities under the FASB Accounting Standards Codification.  The Company is evaluating the impact of the adoption of these standards on its consolidated financial statements.

 

14.                               RELATED PARTY TRANSACTIONS

 

Merchandise for Re-Sale

 

Stanley Silverstein, who was a member of the Board of Directors until August 3, 2009 and the father-in-law of Ezra Dabah, who was also a member of the Board of Directors until August 3, 2009, is an owner of Nina Footwear Corporation.  During the first quarter of fiscal 2008, the Company purchased approximately $0.4 million of footwear from Nina Footwear Corporation. No purchases have been made since.

 

15.                               SUBSEQUENT EVENTS

 

On July 29, 2009, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with Ezra Dabah, Renee Dabah and certain related trusts (collectively, the “Sellers”) pursuant to which the Company agreed to purchase from the Sellers an aggregate of approximately 2.45 million shares of common stock of the Company at a price of $28.88 per share, which represented a discount of 5% to the average of the closing prices of the Company’s common stock of the three days ended July 28, 2009 (the “Sale”).  The Company incurred approximately $3.3 million of fees associated with the Sale.  Pursuant to the Securities Purchase Agreement, the Company has also agreed to file a Registration Statement on Form S-3 ASR (or other appropriate form for which the Company is eligible) to effect the registration, offer and sale of the remaining approximately 2.5 million shares held by the Sellers, after giving effect to the Sale, in a firm commitment underwritten offering (the “Offering”) in the event the Sellers elect to sell such additional shares.  The Company has agreed to pay all expenses incident to the Offering except for (i) underwriting discounts, commissions or fees attributable to the Offering or any counsel, accountants or other persons retained by the Sellers and (ii) any taxes incident to the sale and delivery of the securities in connection with the Offering, each of which will be the sole responsibility of the Sellers.  The Company anticipates its cost for the Offering to total approximately $0.7 million.  In connection with the Company’s

 

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agreement to purchase the shares and facilitate the Offering, Ezra Dabah and Stanley Silverstein have tendered their resignations from the board of directors of the Company (the “Board”), effective as of the closing of the Sale.  For a period of 12 months from the date of the Securities Purchase Agreement, the Sellers have agreed to customary standstill provisions.  On August 3, 2009, the Sale was completed with the Company making total payments to the Sellers of approximately $70.8 million.  Immediately after the Sale, the acquired shares of common stock were retired.

 

On August 3, 2009, as more fully discussed in Note 8, the Company prepaid the remaining principal amount of $38.0 million under the Note Purchase Agreement, thereby terminating the Note Purchase Agreement and all of the Company’s obligations thereunder.

 

Effective as of August 4, 2009, the employment of Richard Flaks, the Company’s Senior Vice President, Planning, Allocation and Information Technology was terminated.  The Company is currently negotiating the terms of his severance, and as of August 1, 2009, a related pre-tax charge of approximately $0.5 million was recorded.

 

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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 31, 2009.  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, 2009.

 

Terms that are commonly used in our management’s discussion and analysis of financial condition and results of operations are defined as follows:

 

·                  Second Quarter 2009 – The thirteen weeks ended August 1, 2009.

·                  Second Quarter 2008 – The thirteen weeks ended August 2, 2008.

·                  Comparable Store Sales – Net sales, in constant currency, from stores that have been open at least 14 full months and that have not been substantially remodeled during that time.

·                  Comparable Retail Sales – Comparable Store Sales plus comparable sales from our e-commerce store.

·                  Gross Margin – Gross profit expressed as a percentage of net sales.

 

Our Business

 

We are a leading specialty retailer of children’s apparel and accessories.  We design, contract to manufacture and sell high-quality, value-priced merchandise under our proprietary “The Children’s Place” brand name.  Our objective is to deliver high-quality merchandise at value prices.  As of August 1, 2009, we owned and operated 849 stores in the United States, 88 stores in Canada and an e-commerce store at www.childrensplace.com.

 

Recent Developments

 

During the four weeks ended August 29, 2009, our Comparable Retail Sales decreased 8% compared to a 1% increase in Comparable Retail Sales during the four weeks ended August 30, 2008.

 

On August 27, 2009, we amended our lease for our corporate headquarters, which provides for additional space of approximately 17,500 square feet at an annual rate of approximately $0.5 million.  The additional space will be used primarily for our information technology needs, including our data center.

 

Effective as of August 4, 2009, the employment of Richard Flaks, our Senior Vice President, Planning, Allocation and Information Technology was terminated.  We are currently negotiating the terms of his severance, and as of August 1, 2009, a related pre-tax charge of approximately $0.5 million was recorded.

 

On August 3, 2009, as more fully discussed below (under Term Loan), we prepaid the remaining principal amount of $38.0 million under the Note Purchase Agreement, thereby terminating the Note Purchase Agreement and all of our obligations thereunder.

 

On July 29, 2009, we entered into a securities purchase agreement (the “Securities Purchase Agreement”) with Ezra Dabah, Renee Dabah and certain related trusts (collectively, the “Sellers”) pursuant to which we agreed to purchase from the Sellers an aggregate of approximately 2.45 million shares of our common stock at a price of $28.88 per share, which represented a discount of 5% to the average of the closing prices of our common stock of the three days ending July 28, 2009

 

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(the “Sale”).  We incurred approximately $3.3 million of fees associated with the Sale.  Pursuant to the Securities Purchase Agreement, we have also agreed to file a Registration Statement on Form S-3 ASR (or other appropriate form for which the Company is eligible) to effect the registration, offer and sale of the remaining approximately 2.5 million shares held by the Sellers, after giving effect to the Sale, in a firm commitment underwritten offering (the “Offering”) in the event the Sellers elect to sell such additional shares.  We have agreed to pay all expenses incident to the Offering except for (i) underwriting discounts, commissions or fees attributable to the Offering or any counsel, accountants or other persons retained by the Sellers and (ii) any taxes incident to the sale and delivery of the securities in connection with the Offering, each of which will be the sole responsibility of the Sellers.  We anticipate our cost for the Offering to total approximately $0.7 million.  In connection with our agreement to purchase the shares and facilitate the Offering, Ezra Dabah and Stanley Silverstein have tendered their resignations from our board of directors (the “Board”), effective as of the closing of the Sale.  For a period of 12 months from the date of the Securities Purchase Agreement, the Sellers have agreed to customary standstill provisions.  On August 3, 2009, the Sale was completed with us making total payments to the Sellers of approximately $70.8 million.  Immediately after the Sale, the acquired shares of common stock were retired.

 

The Disney Store Business

 

After a thorough review of the Disney Store business, its potential earnings growth, its capital needs and its ability to fund such needs from its own resources, the Company announced on March 20, 2008 that it had decided to exit the Disney Store business.  Our subsidiaries that operated the Disney Store business are referred to herein interchangeably and collectively as “Hoop”.

 

After assessing the above factors and considering Hoop’s liquidity, Hoop’s Board of Directors determined that the best way to complete an orderly wind-down of Hoop’s affairs was for Hoop to seek relief under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”).  On March 26, 2008, Hoop Holdings, LLC, Hoop Retail Stores, LLC and Hoop Canada Holdings, Inc. each filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the “U.S. Bankruptcy Court”) (Case Nos.  08-10544, 08-10545, and 08-10546, respectively, the “Cases”).  On March 27, 2008, Hoop Canada, Inc. filed for protection pursuant to the Companies’ Creditors Arrangement Act (the “CCAA”) in the Ontario Superior Court of Justice (Commercial List) (“Canadian Bankruptcy Court”) (Court File No.  08-CL-7453, and together with the Cases, the “Filings”).  Each of the foregoing Hoop entities are referred to collectively herein as the “Hoop Entities.”

 

After receiving the approval of the U.S. Bankruptcy Court and the Canadian Bankruptcy Court, on April 30, 2008, Hoop transferred the Disney Store business in the U.S. and Canada and a substantial portion of the Disney Store assets to affiliates of Disney in an asset sale, pursuant to an asset purchase agreement dated as of April 3, 2008 among the Hoop Entities and affiliates of Disney (the “Sale Agreement”) and section 363 of the Bankruptcy Code (and a similar provision under the CCAA). Upon closing, affiliates of Disney paid approximately $61.6 million, including certain post-closing adjustments, for the acquired assets of the Disney Store business.  The proceeds received from the asset sale are included in the assets of the Hoop Entities’ for distribution to their creditors pursuant to the plan of reorganization that was approved by the U.S. Bankruptcy Court on December 15, 2008 (the “Plan”).  A similar plan was approved by the Canadian Bankruptcy Court.

 

According to the terms of the asset sale, Hoop transferred 217 Disney Stores to affiliates of Disney and granted such affiliates the right to operate and wind-down the affairs of the remaining stores.  The lease obligations associated with the stores that were not sold were rejected and resulting damage claims were administered pursuant to the Plan.

 

In April 2008, the Company entered into a settlement and release of claims agreement with Hoop and the official committee of unsecured creditors in the Cases (the “Settlement Agreement”), which was approved by the U.S. Bankruptcy Court on April 29, 2008.  Under the Settlement Agreement, the Company agreed to provide transitional services and to forgive all pre- and post-bankruptcy petition claims against the Hoop Entities.  Such claims included intercompany charges for shared services of approximately $24.9 million, a capital contribution made on March 18, 2008 of approximately $8.3 million, payment of severance and other employee costs for the Company’s employees servicing Hoop of approximately $7.7 million, and $6.8 million of professional fees and other costs the Company has incurred during the Cases, as well as claims that might be asserted against the Company in the Cases.  As of August 1, 2009, the Company has paid approximately $45.5 million related to the Settlement Agreement, and has remaining accruals of $2.1 million, primarily for legal claims and related costs, and severance.

 

On December 15, 2008, the U.S. Bankruptcy Court approved the Plan, pursuant to which the Hoop Entities that were U.S. debtors were dissolved and all assets and liabilities, including their investment in Hoop Canada, Inc., were

 

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transferred to a trust (the “Trust”), which is overseen by a trustee appointed by the U.S. Bankruptcy Court under the Plan and a trust oversight committee.

 

Upon effectiveness of the Plan in December 2008, the Company deconsolidated all Hoop Entities.  As a result, all intercompany balances, including investments in subsidiaries, were eliminated, and the net liabilities in excess of assets transferred were written off, which resulted in a $25.5 million gain on the relief of indebtedness of the Hoop Entities in the fourth quarter of fiscal 2008.  The Company continues to incur charges related to the wind-down of the Disney Store business and such costs are expensed through discontinued operations as incurred.

 

In accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), the Disney Store business has been segregated from continuing operations and included in “Income (loss) from discontinued operations, net of income taxes” in the consolidated statements of operations.

 

Segment Reporting

 

After the disposal of its Disney Business during fiscal 2008, senior management continued its reassessment of our internal reporting structure.  Net sales of Canadian operations have grown approximately 56% over the last three fiscal years, and with the disposal of the Disney business, its percentage of consolidated net sales has grown from approximately 9% to approximately 12%.  In addition, the fluctuations in the Canadian dollar exchange rate in recent years have had a significant impact on our Canadian operating results.  Beginning in fiscal 2009, our chief operating decision maker (“CODM”) required, and we began reporting, discrete financial information for our Canadian operations.

 

Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”), establishes standards for reporting information about a company’s operating segments.  In accordance with SFAS 131, we report segment data based on management responsibility: The Children’s Place U.S. and The Children’s Place Canada.  Included in The Children’s Place U.S. segment is its U.S. based stores, including Puerto Rico, and its e-commerce store, www.childrensplace.com.  We measure our segment profitability based on operating income, defined as earnings before interest and taxes.  Net sales and direct costs are recorded by each segment.  Certain centrally managed inventory procurement functions such as production and design are allocated to each segment based upon usage.  Corporate overhead, including executive management, finance, real estate, human resources, legal, and information technology services are allocated to the segments based primarily on net sales.  We periodically review these allocations and adjust them based upon changes in business circumstances.  Net sales from external customers are derived from merchandise sales and we have no major customers that account for more than 10% of its net sales.

 

Operating Highlights

 

Net sales decreased by $20.6 million, or 3%, to $717.6 million during the twenty-six weeks ended August 1, 2009 from $738.2 million during the twenty-six weeks ended August 2, 2008.  Our Comparable Retail Sales decreased 3% during the twenty-six weeks ended August 1, 2009 compared to an 8% increase during the twenty-six weeks ended August 2, 2008.  During the twenty-six weeks ended August 1, 2009, we opened 21 The Children’s Place stores and closed one.  During the twenty-six weeks ended August 2, 2008, we opened three The Children’s Place stores and closed five.

 

During the twenty-six weeks ended August 1, 2009, we reported income from continuing operations of $16.5 million, or $0.56 per diluted share, compared to $22.2 million, or $0.75 per diluted share, in the twenty-six weeks ended August 2, 2008.  During the twenty-six weeks ended August 1, 2009, the following factors significantly impacted our business:

 

·                  The downturn in the U.S. and Canadian economic environments;

 

·                  Reductions in selling, general and administrative expenses; and

 

·                  The decrease in value of the Canadian Dollar versus the U.S. Dollar.

 

Additionally, income from continuing operations in the twenty-six weeks ended August 1, 2009 included:

 

·                  Approximately $2.2 million of professional fees related to our proxy contest;

 

·                  Approximately $2.4 million of interest and deferred financing expenses related to our planned repayment of the remaining $38 million on our term loan;

 

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·                  A $4.5 million tax benefit related to the settlement of an IRS income tax audit and $4.8 million of foreign tax credits related to the repatriation of foreign cash;

 

·                  A $4.6 million gain from the favorable settlement of an IRS employment tax audit related to stock options of which approximately $1.5 million was a reversal of accrued interest; and

 

·                  Restructuring costs of approximately $2.8 million related to our strategic initiatives, primarily the moving of our e-commerce fulfillment center from Secaucus, New Jersey to our distribution center in Fort Payne, Alabama.

 

We have subsidiaries in Canada, Hong Kong and Shanghai whose operating results are based in foreign currencies and are thus subject to the fluctuations of the corresponding translation rates into U.S. dollars.  The following table summarizes the average translation rates impacting our operating results, and the resulting effect of related rate changes on net sales, gross profit and income from continuing operations, for each fiscal period presented in our condensed consolidated statements of operations:

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

August 1,

 

August 2,

 

August 1,

 

August 2,

 

 

 

2009

 

2008

 

2009

 

2008

 

Average Translation Rates (1)

 

 

 

 

 

 

 

 

 

Canadian Dollar

 

0.8777

 

0.9915

 

0.8421

 

0.9936

 

Hong Kong Dollar

 

0.1290

 

0.1282

 

0.1290

 

0.1283

 

China Yuan Renminbi

 

0.1464

 

0.1447

 

0.1464

 

0.1429

 

 

 

 

 

 

 

 

 

 

 

Effect on Operating Results (in millions)

 

 

 

 

 

 

 

 

 

Net sales (2)

 

$

(5.1

)

$

2.6

 

$

(14.2

)

$

8.6

 

Gross profit

 

(1.7

)

1.0

 

(6.2

)

4.4

 

Income (loss) from continuing operations before income taxes

 

(0.9

)

0.7

 

(2.8

)

2.4

 

 


(1)          The average translation rates are the average of the monthly translation rates used during each period to translate the respective income statements.  The rates represent the U.S. dollar equivalent of each foreign currency.

 

(2)          Net sales are affected only by the Canadian Dollar translation rates.

 

In addition to the translation impact noted above, the gross margin of our Canadian subsidiary is also impacted by its purchases of inventory, which is priced in U.S. Dollars.  The effects of these purchases on our gross profit were decreases of approximately $1.8 million and $3.8 million for the thirteen and twenty-six weeks ended August 1, 2009 compared to increases of approximately $1.4 million and $3.9 million for the thirteen and twenty-six weeks ended August 2, 2008.

 

CRITICAL ACCOUNTING POLICIES

 

The preparation of consolidated financial statements in conformity with U.S. 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 our reported financial results include the following:

 

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, for each merchandise department, to the retail value of inventories.  An initial mark-up is applied to inventory at cost to establish a cost-to-retail ratio.  Permanent markdowns, when taken, reduce both the retail and cost components of inventory on hand so as to maintain the already established cost-to-retail relationship.  At any one time, inventories include items that have been marked down to our best estimate of the lower of their cost or fair market value and an estimate of our inventory shrinkage.

 

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We base our decision to mark down merchandise upon its current rate of sale, the season, and the age and sell-through of the item.  We estimate sell-through rates based upon historical and forecasted information.  Markdown reserves are assessed and adjusted each quarter based on current sales trends and their resulting impact on forecasts.  Our success is largely dependent upon our ability to gauge the fashion taste of our customers, and to provide a well-balanced merchandise assortment that satisfies customer demand.  Throughout the year, we review our inventory in order to identify slow moving items and generally use markdowns to clear them.  Any inability to provide the proper quantity of appropriate merchandise in a timely manner, or to correctly estimate the sell-through rate, could have a material impact on our consolidated financial statements.  Our historical estimates have not differed materially from actual results; however, a 10% difference in our markdown reserve as of August 1, 2009 would have impacted net income by approximately $0.9 million.  Our markdown reserve balance at August 1, 2009 was $15.1 million.

 

Additionally, we adjust our inventory based upon an annual physical inventory, which is taken during the last quarter of the fiscal year.  Based on the results of our historical physical inventories, an estimated shrink rate is used for each successive quarter until the next annual physical inventory, or sooner if facts or circumstances should indicate differently.  A 100 basis point difference in our shrinkage rate at retail could impact each quarter’s net income by approximately $1.0 million.

 

Equity Compensation—Effective January 29, 2006, we adopted the provisions of SFAS No. 123(R) using the modified prospective transition method. The provisions of SFAS 123(R) apply to new stock options and stock options outstanding but not yet vested, as of the effective date.  Prior to January 29, 2006, we accounted for stock option grants under the recognition and measurement provisions of APB 25 and related interpretations.

 

Stock Options

 

During Fiscal 2008, we ceased issuing stock options in favor of deferred stock awards.  The fair value of all outstanding stock options was estimated using the Black-Scholes option pricing model based on a Monte Carlo simulation, which requires extensive use of accounting judgment and financial estimates, including estimates of how long employees will hold their vested stock options before exercise, the estimated volatility of our common stock over the expected term, and the number of options that will be forfeited prior to the completion of vesting requirements.  All exercise prices were based on the average of the high and low of the selling price of our common stock on the grant date.  Application of other assumptions could have resulted in significantly different estimates of fair value of stock-based compensation and consequently, the related expense recognized in our financial statements.  Additionally, we estimate a forfeiture rate for those awards not expected to vest.  While actual forfeitures could vary significantly from those estimated, a 10% difference would not have a material impact on our net income.  Total unamortized stock compensation at August 1, 2009 was $0.1 million.

 

Restricted Stock, Deferred Stock and Performance Awards

 

We grant restricted shares and deferred stock awards to our employees and non-employee directors and performance awards to certain key members of management.  The fair value of these awards is based on the average of the high and low selling price of our common stock on the grant date.  Compensation expense is recognized ratably over the related service period reduced for estimated forfeitures of those awards not expected to vest due to employee turnover.  While actual forfeitures could vary significantly from those estimated, a 10% change in our forfeiture rate would impact our net income by approximately $0.3 million.  In addition, the number of performance shares earned is dependant upon our operating results over a specified time period.  The expense for performance shares is based on an estimate of the number of shares we think will vest based on our earnings-to-date plus our estimate of future earnings for the remaining performance period.  To the extent that actual operating results differ from our estimates, future performance share compensation expense could be significantly different.  A 50% decrease in our projected future earnings could decrease our equity compensation, pre-tax, by approximately $1.8 million, and a 50% increase in our projected future earnings could increase our equity compensation, pre-tax, by approximately $0.5 million.

 

Insurance and Self-Insurance Liabilities—Based on our assessment of risk and cost efficiency, we self-insure as well as purchase insurance policies to provide for workers’ compensation, general liability, and property losses, as well as directors’ and officers’ liability, vehicle liability and employee medical benefits.  We estimate risks and record a liability based upon historical claim experience, insurance deductibles, severity factors and other actuarial assumptions.  These estimates include inherent uncertainties due to the variability of the factors involved, including type of injury or claim, required services by the providers, healing time, age of claimant, case management costs, location of the claimant, and governmental regulations.  While we believe that our risk assessments are appropriate, these uncertainties or a deviation in future claims trends from recent historical patterns could result in our recording additional or reduced expenses, which could have a significant impact on our results of operations.  Our historical estimates have not differed materially from actual

 

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results; however, a 10% difference in our insurance reserves as of August 1, 2009 would have impacted net income by approximately $0.8 million.

 

Impairment of Long-Lived Assets—We periodically review our long-lived assets when events indicate that their carrying value may not be recoverable.  Such events include a historical trend or projected trend of cash flow losses or a future expectation that we will sell or dispose of an asset significantly before the end of its previously estimated useful life.  In reviewing for impairment, we group our long-lived assets at the lowest possible level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities.  In that regard, we group our assets into two categories; corporate-related and store-related.  Corporate-related assets consist of those associated with our corporate offices, distribution centers and our information technology systems.  Store-related assets consist of leasehold improvements, furniture and fixtures, certain computer equipment and lease related assets associated with individual stores.

 

For store-related assets, we review all stores that have been open for at least two years, or sooner if circumstances should dictate, on at least an annual basis.  For each of these stores, we project future cash flows over the remaining life of the lease and compare the total undiscounted cash flows to the net book value of the related long-lived assets.  If the undiscounted cash flows are less than the related net book value of the long-lived assets, they are written down to their fair market value.  We primarily determine fair market value to be the discounted future cash flows associated with those assets.  In evaluating future cash flows, we consider external and internal factors.  External factors comprise the local environment in which the store resides, including mall traffic, competition, and their effect on sales trends.  Internal factors include our ability to gauge the fashion taste of our customers, control variable costs such as cost of sales and payroll, and in certain cases, our ability to renegotiate lease costs.  Historically, less than 2% of our stores required impairment charges in any one year.  If external factors should change unfavorably, if actual sales should differ from our projections, or if our ability to control costs is insufficient to sustain the necessary cash flows, future impairment charges could be material.  At August 1, 2009, the average net book value per store was $0.2 million.

 

Income Taxes—We utilize the liability method of accounting for income taxes as set forth in SFAS No. 109, Accounting for Income Taxes.  Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and income tax bases of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse.  A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.  In determining the need for a valuation allowance, we consider projected future taxable income and the availability of tax planning strategies.  If, in the future we determine that we would not be able to realize our recorded deferred tax assets, an increase in the valuation allowance would decrease earnings in the period in which such determination is made.

 

We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date.  For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information.  For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements.

 

Newly Issued Accounting Pronouncements

 

On February 1, 2009, the first day of fiscal 2009, we adopted FSP 157-2 “Effective Date of FASB Statement No. 157,” which delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities until the beginning of the first quarter of fiscal 2009.  Neither adoption had any impact on our condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, we adopted FSP 157-4 “Determining Whether a Market Is Not Active and a Transaction Is Not Distressed,” which provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157.  FSP 157-4 provides additional authoritative guidance in determining whether a market is active or inactive, and whether a transaction is distressed and is applicable to all assets and liabilities (i.e. financial and non-financial) and requires enhanced disclosures.  The adoption of FSP 157-4 did not have any impact on our condensed consolidated financial statements.

 

In the second quarter of fiscal 2009, we adopted FSP 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which amends SFAS 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments in interim as well as in annual financial statements.  The adoption of the provisions of FSP 107-1 and APB 28-1 did not have any impact on our condensed consolidated financial statements.

 

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In May 2009, FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”).  This statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  In particular, this statement sets forth: a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; b) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date.  Effective May 3, 2009, the Company adopted SFAS 165.  This adoption did not have any impact on our condensed consolidated financial statements.

 

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”).  This standard is effective for financial statements issued for reporting periods that end after September 15, 2009 and will serve as the sole source for authoritative U.S. GAAP.  The codification will reorganize all accounting standards in U.S. GAAP, aside from those issued by the SEC.  SFAS 168 also replaces SFAS No. 162 to establish a new hierarchy of GAAP sources for non-governmental entities under the FASB Accounting Standards Codification.  We are evaluating the impact of the adoption of these standards on our condensed consolidated financial statements.

 

RESULTS OF OPERATIONS

 

The following table sets forth, for the periods indicated, selected income statement data expressed as a percentage of net sales. We primarily evaluate the results of our operations as a percentage of net sales rather than in terms of absolute dollar increases or decreases by analyzing the year over year change in our business expressed as a percentage of net sales (i.e. “basis points”). For example, our selling, general and administrative expenses increased approximately 230 basis points to 33.6% of net sales during the thirteen weeks ended August 1, 2009 from 31.3% during the thirteen weeks ended August 2, 2008.  Accordingly, to the extent that our sales have increased at a faster rate than our costs (i.e. “leveraging”), the more efficiently we have utilized the investments we have made in our business.  Conversely, if our sales decrease or if our costs grow at a faster pace than our sales (i.e. “de-leveraging”), we have less efficiently utilized the investments we have made in our business.

 

 

 

Thirteen Weeks Ended

 

Twenty-six Weeks Ended

 

 

 

August 1,

 

August 2,

 

August 1,

 

August 2,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales

 

66.6

 

62.0

 

62.1

 

59.4

 

Gross profit

 

33.4

 

38.0

 

37.9

 

40.6

 

Selling, general and administrative expenses

 

33.6

 

31.3

 

30.4

 

30.5

 

Asset impairment charge

 

0.1

 

 

0.2

 

 

Depreciation and amortization

 

5.6

 

5.2

 

4.9

 

4.8

 

Operating income (loss)

 

(5.9

)

1.5

 

2.4

 

5.3

 

Interest (expense), net

 

(0.5

)

(0.1

)

(0.7

)

(0.1

)

Income (loss) from continuing operations before income taxes

 

(6.4

)

1.3

 

1.8

 

5.2

 

Provision (benefit) for income taxes

 

(4.1

)

0.5

 

(0.5

)

2.2

 

Income (loss) from continuing operations

 

(2.3

)

0.8

 

2.3

 

3.0

 

Income (loss) from discontinued operations, net of taxes

 

0.1

 

(0.8

)

 

(0.4

)

Net income (loss)

 

(2.2

)%

%

2.3

%

2.6

%

Number of stores, end of period

 

937

 

902

 

937

 

902

 

 

Table may not add due to rounding.

 

The Second Quarter 2009 Compared to the Second Quarter 2008

 

Net sales decreased by $22.3 million, or 7%, to $315.7 million during the Second Quarter 2009 from $338.0 million during the Second Quarter 2008.  Our Second Quarter 2009 sales decrease resulted from a consolidated Comparable Retail Sales decrease of 9%, which accounted for $27.3 million of our sales decrease, a $5.1 million decrease due to unfavorable changes in the Canadian exchange rates and a $0.3 million impact of closed stores, partially offset by a $10.4 million increase in sales from new stores and other stores that did not qualify as comparable stores.  During the Second Quarter 2008, our Comparable Retail Sales increased 10%.  During the Second Quarter 2009, we opened 15 The Children’s Place stores.  During the Second Quarter 2008, we closed four The Children’s Place stores.

 

On a segment basis, The Children’s Place U.S. net sales decreased $17.4 million, or 5.9%, to $275.9 million in the Second Quarter 2009 compared to $293.3 million in the Second Quarter 2008.  This decrease resulted primarily from a Comparable Store Sales decline of 11%, or $28.3 million, partially offset by an increase in net sales of $6.6 million from new

 

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stores and other stores that did not qualify as comparable stores and an increase in our e-commerce sales of $4.3 million. Our decrease in Comparable Store Sales was primarily the result of a decrease in customer traffic in both mall and non-mall locations, which we believe contributed to an 8% decline in transactions.  In addition, we experienced a 3% decline in the average transaction size.  Comparable Store Sales were down in all regions and departments.  E-commerce sales, as a percentage of net sales, increased to 7% in the Second Quarter 2009 from 5% in the Second Quarter 2008, reflecting the increase in e-commerce sales and the decline in net sales at our physical stores.  The Children’s Place Canada net sales decreased $5.0 million, or 11.2%, to $39.7 million in the Second Quarter 2009 compared to $44.7 million in the Second Quarter 2008.  This decrease resulted from a decline in Comparable Store Sales of 8%, or $3.0 million, and a $5.1 million decrease attributable to unfavorable changes in the average Canadian exchange rates for the Second Quarter 2009 compared to the Second Quarter 2008, partially offset by $3.1 million of increased net sales from new stores and other stores that did not qualify as comparable stores.  The decrease in Comparable Store Sales was primarily attributable to a 6% decline in the number of transactions and a 2% decrease in the average transaction size.  Comparable Store Sales were down in all departments except for accessories.

 

Gross profit decreased by $23.2 million to $105.3 million during the Second Quarter 2009 from $128.5 million during the Second Quarter 2008.  Consolidated Gross Margin decreased approximately 460 basis points to 33.4% during the Second Quarter 2009 from 38.0% during the Second Quarter 2008.  The decrease in consolidated Gross Margin resulted primarily from the de-leveraging of distribution, occupancy, production and design and other costs of approximately 240 basis points, higher markdowns and shrink provisions of approximately 160 basis points and a lower initial markup of approximately 60 basis points, which is due in part to the unfavorable changes in the Canadian exchange rates noted above.  Gross Margin at The Children’s Place U.S. decreased approximately 440 basis points from 36.5% in the Second Quarter 2008 to 32.1% in the Second Quarter 2009.  This decrease resulted primarily from higher mark downs, the de-leveraging of certain fixed costs, and a lower initial mark-up.  Gross Margin at The Children’s Place Canada decreased approximately 560 basis points from 47.8% in the Second Quarter 2008 to 42.2% in the Second Quarter 2009.  This decrease resulted primarily from a lower initial mark-up, which was unfavorably affected by the impact of foreign exchange rates, and higher mark downs.

 

Selling, general and administrative expenses increased $0.3 million to $106.1 million during the Second Quarter 2009 from $105.8 million during the Second Quarter 2008. As a percentage of net sales, selling, general and administrative expenses increased approximately 230 basis points to 33.6% during the Second Quarter 2009 from 31.3% during the Second Quarter 2008.  Our increase in selling, general and administrative expenses was impacted by the following items, which we consider to be unusual:

 

Second Quarter 2009

 

·                  a gain from the favorable settlement of an IRS employment tax audit related to stock options of approximately $3.1 million or 100 basis points;

·                  professional fees incurred during the Second Quarter 2009 of approximately $2.2 million, or 70 basis points, related to a proxy contest; and

·                  restructuring costs of approximately $0.3 million or 10 basis points, related to our strategic initiative of moving our e-commerce fulfillment center from Secaucus, New Jersey to our distribution center in Fort Payne, Alabama.

 

Second Quarter 2008

 

·                  transition service income, net of variable expenses, of approximately $5.5 million, or 160 basis points, related to services provided to the acquirer of the Disney Store business;

·                  a gain on the sale of a store lease of approximately $2.3 million, or 70 basis points; and

·                  professional fees of approximately $1.7 million, or 50 basis points, related to a stock option investigation.

 

Excluding the effect of the above items, our selling, general and administrative expenses decreased during the Second Quarter 2009 by approximately $5.2 million; however, as a percentage of net sales, these expenses de-leveraged 70 basis points to 33.8% during the Second Quarter 2009 from 33.1% during the Second Quarter 2008.  The de-leverage is primarily attributable to the lower net sales; however, we were able to decrease certain selling, general and administrative expenses, primarily through cost control initiatives, in the Second Quarter 2009 as follows:

 

·                  store expenses, excluding payroll, decreased approximately $1.7 million, or 20 basis points.  Store payroll decreased approximately $0.5 million, but de-leveraged approximately 90 basis points.  These decreases were achieved despite having 35 more stores and is attributable to savings achieved in payroll, supplies, repairs and maintenance, and insurance costs;

 

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·                  administrative expenses, excluding payroll and marketing, decreased approximately $1.2 million, or 10 basis points, resulting primarily from savings achieved in information technology and consulting fees;

·                  administrative payroll decreased approximately $0.7 million, but de-leveraged approximately 10 basis points, resulting from reduced headcount;

·                  bonus expense decreased $1.3 million, or 30 basis points, resulting from less favorable operating results in the Second Quarter 2009 compared to the Second Quarter 2008;

·                  equity compensation decreased $0.4 million, or 10 basis points, resulting from forfeitures in excess of those estimated, and certain awards made during the Second Quarter 2008 that were immediately expensed in accordance with U.S. GAAP; and

·                  transactional gains from foreign exchange rate fluctuations were $0.4 million in the Second Quarter 2009 compared to transactional losses of $0.3 million from foreign exchange rate fluctuations in the Second Quarter 2008.  While foreign exchange rates moved unfavorably year over year, within the respective quarters, the rates moved more favorably in the Second Quarter 2009 compared to the Second Quarter 2008.

 

The above decreases were partially offset by the following:

 

·                  store opening and remodel costs increased $0.7 million, or 30 basis points, as we opened more stores during the Second Quarter 2009 than during the Second Quarter 2008; and

·                  marketing expenses increased approximately $0.6 million, or 40 basis points, primarily in support of the growing e-commerce business.

 

Depreciation and amortization was $17.6 million, or 5.6% of net sales, during the Second Quarter 2009, compared to $17.7 million, or 5.2% of net sales, during the Second Quarter 2008.

 

Interest expense, net was $1.5 million, or 0.5% of net sales, during the Second Quarter 2009, compared to $0.4 million, or 0.1% of net sales, during the Second Quarter 2008.  The increase was due primarily to interest expense related to our term loan, which was not acquired until the end of the Second Quarter 2008.  Also included in our net interest expense in the Second Quarter 2009 was a $1.5 million credit related to the reversal of accrued interest resulting from a favorable settlement of an IRS employment tax audit related to stock options and $1.5 million of interest expense related to the prepayment of the remaining balance on our term loan, which was made on August 3, 2009.

 

Provision (benefit) for income taxes was a benefit of $12.9 million during the Second Quarter 2009 compared to a provision of $1.8 million during the Second Quarter 2008.  Our effective tax rate was 64.1% and 39.5% during the Second Quarter 2009 and the Second Quarter 2008, respectively.  The increase in our effective tax rate in the Second Quarter 2009 reflected a $4.8 million one time benefit related to the repatriation of foreign cash during the Second Quarter 2009.

 

Income (loss) from discontinued operations, net of taxes was income of $0.2 million in the Second Quarter 2009 compared to a loss of $2.7 million in the Second Quarter 2008.  The income during the Second Quarter 2009 resulted from the settlement of certain claims on more favorable terms than originally estimated, partially offset by current quarter professional fees related to the wind-down of the Hoop Entities.  The loss in the Second Quarter 2008 reflected restructuring charges, primarily comprised of professional fees incurred by the Hoop estate and adjustments to accrued expenses, partially offset by interest income received on the proceeds from the Private Sale.

 

Net income (loss) was a loss of $7.1 million during the Second Quarter 2009 compared to break even net income during the Second Quarter 2008, due to the factors discussed above.

 

Twenty-Six Weeks Ended August 1, 2009 Compared to Twenty-Six Weeks Ended August 2, 2008

 

Net sales decreased by $20.6 million, or 3%, to $717.6 million during the twenty-six weeks ended August 1, 2009 from $738.2 million during the twenty-six weeks ended August 2, 2008.  This decrease resulted from a consolidated Comparable Retail Sales decrease of 3%, which accounted for $23.5 million, a $14.3 million decrease due to unfavorable changes in the Canadian exchange rates and a $0.3 million impact of closed stores; partially offset by a $17.5 million increase in sales from new stores and other stores that did not qualify as comparable stores.  During the twenty-six weeks ended August 2, 2008, our Comparable Retail Sales increased 8%.  During the twenty-six weeks ended August 1, 2009, we opened 21 The Children’s Place stores and closed one.  During the twenty-six weeks ended August 2, 2008, we opened three The Children’s Place stores and closed five The Children’s Place stores.

 

On a segment basis, The Children’s Place U.S. net sales decreased $8.5 million, or 1.3%, to $639.0 million for the twenty-six weeks ended August 1, 2009 compared to $647.6 million for the twenty-six weeks ended August 2, 2008.  This

 

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decrease resulted primarily from a Comparable Store Sales decline of 5%, or $31.3 million, mostly offset by an increase in our e-commerce sales of $12.6 million and an increase in net sales from new stores and other stores that did not qualify as comparable stores of $10.2 million. Our decrease in Comparable Store Sales was primarily the result of a decrease in customer traffic in both mall and non-mall locations, which we believe contributed to a 5% decline in transactions.  In addition, we experienced a 1% decline in the average transaction size.  E-commerce sales, as a percentage of net sales, increased to 7% for the twenty-six weeks ended August 1, 2009 from 5% for the twenty-six weeks ended August 2, 2008 reflecting the increase in e-commerce sales and a decline in net sales at our physical stores.  The Children’s Place Canada net sales decreased $12.1 million, or 13.4%, to $78.6 million for the twenty-six weeks ended August 1, 2009 compared to $90.6 million for the twenty-six weeks ended August 2, 2008.  This decrease resulted from a decline in Comparable Store Sales of 5%, or $4.0 million and a $14.3 million decrease attributable to unfavorable changes in the average Canadian exchange rates for the twenty-six weeks ended August 1, 2009 compared to the twenty-six weeks ended August 2, 2008, partially offset by $6.2 million of increased net sales from new stores and other stores that did not qualify as comparable stores.  The decrease in Comparable Store Sales was primarily attributable to a 2% decline in the number of transactions and a 3% decrease in the average transaction size.

 

Gross profit decreased by $27.8 million to $271.8 million during the twenty-six weeks ended August 1, 2009 from $299.6 million during the twenty-six weeks ended August 2, 2008.  Consolidated Gross Margin decreased approximately 270 basis points to 37.9% during the twenty-six weeks ended August 1, 2009 from 40.6% during the twenty-six weeks ended August 2, 2008.  The decrease in consolidated Gross Margin resulted primarily from the de-leveraging of distribution, occupancy, production and design and other costs of approximately 130 basis points, a lower initial markup of approximately 90 basis points, and higher markdowns and shrink provisions of approximately 60 basis points.  The lower initial markup was due in part to the unfavorable changes in the Canadian exchange rates noted above.  Gross margin at The Children’s Place U.S. decreased approximately 200 basis points from 39.2% in the twenty-six weeks ended August 2, 2008 to 37.2% in the twenty-six weeks ended August 1, 2009.  This decrease resulted primarily from the de-leveraging of certain fixed costs and a lower initial mark-up.  Gross margin at The Children’s Place Canada decreased approximately 650 basis points from 50.4% in the twenty-six weeks ended August 2, 2008 to 43.9% in the twenty-six weeks ended August 1, 2009.  This decrease resulted primarily from a lower initial mark-up, which was unfavorably affected by the impact of foreign exchange rates, higher markdowns, and the de-leveraging of certain fixed costs.

 

Selling, general and administrative expenses decreased $7.2 million to $218.0 million during the twenty-six weeks ended August 1, 2009 from $225.2 million during the twenty-six weeks ended August 2, 2008. As a percentage of net sales, selling, general and administrative expenses decreased approximately 10 basis points to 30.4% for the twenty-six weeks ended August 1, 2009 from 30.5% for the twenty-six weeks ended August 2, 2008.  Our decrease in selling, general and administrative expenses was impacted by the following items, which we consider to be unusual:

 

The Twenty-Six Weeks Ended August 1, 2009

 

·                  a gain from the favorable settlement of an IRS employment tax audit related to stock options of approximately $3.1 million or 40 basis points;

·                  professional fees incurred during the Second Quarter 2009 of approximately $2.2 million or 30 basis points, related to a proxy contest; and

·                  restructuring costs of approximately $2.8 million or 40 basis points, related to our strategic initiatives, primarily the moving of our e-commerce fulfillment center from Secaucus, New Jersey to our distribution center in Fort Payne, Alabama.

 

The Twenty-Six Weeks Ended August 2, 2008

 

·                  transition service income, net of variable expenses, of approximately $5.5 million or 70 basis points related to services provided to the acquirer of the Disney Store business;

·                  a gain on the sale of a store lease of approximately $2.3 million, or 30 basis points; and

·                  professional fees of approximately $2.5 million, or 30 basis points, related to a stock option investigation.

·                  restructuring costs of approximately $1.3 million or 20 basis points, related to our strategic initiatives review.

 

Excluding the effect of the above items, our selling, general and administrative expenses decreased approximately $13.1 million during the twenty-six weeks ended August 1, 2009 compared to the twenty-six weeks ended August 2, 2008, and as a percentage of net sales, selling, general and administrative expenses decreased approximately 90 basis points to 30.1% during the twenty-six weeks ended August 1, 2009 from 31.0% of net sales during the twenty-six weeks ended August 2, 2008.  This decrease resulted primarily from the following:

 

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·                  administrative expenses, excluding payroll, decreased $5.9 million, or 70 basis points.  While savings were achieved in most areas, the most significant savings were in consulting fees, marketing costs and other outside services;

·                  store expenses, excluding payroll, decreased approximately $5.2 million, or 60 basis points.  The decrease in dollars was achieved despite having 35 more stores and is attributable primarily to cost control initiatives achieved in supplies, repairs and maintenance; and

·                  administrative payroll decreased approximately $3.5 million, or 40 basis points, resulting from reduced headcount.

 

The above decreases were partially offset by the following:

 

·                  equity compensation increased $1.4 million, or 20 basis points, resulting from an increase in the number of deferred awards unvested and an increase, during the first quarter of fiscal 2009, in the estimated number of performance shares that are expected to vest under our long term incentive plan;

·                  higher pre-opening costs of approximately $1.4 million, or 20 basis points, which were attributable to our opening 18 more stores in the twenty-six weeks ended August 1, 2009 compared to the twenty-six weeks ended August 2, 2008; and

·                  store payroll was flat in dollars despite having 35 more stores, but de-leveraged 40 basis points.

 

Depreciation and amortization was $35.1 million, or 4.9% of net sales, during the twenty-six weeks ended August 1, 2009, compared to $35.4 million, or 4.8% of net sales, during the twenty-six weeks ended August 2, 2008.

 

Interest expense, net was $4.7 million, or 0.7% of net sales, during the twenty-six weeks ended August 1, 2009, and $0.9 million, or 0.1% of net sales, during the twenty-six weeks ended August 2, 2008.  The increase was due primarily to interest expense related to our term loan, which was not acquired until the end of the Second Quarter 2008.  Also included in our net interest expense in the twenty-six weeks ended August 1, 2009 is a $1.5 million credit related to the reversal of accrued interest resulting from a favorable settlement of an IRS employment tax audit related to stock options and $1.5 million of interest expense related to the prepayment of the remaining balance on our term loan, which was made on August 3, 2009.

 

Provision (benefit) for income taxes was a benefit of $3.9 million for the twenty-six weeks ended August 1, 2009 and a provision of $15.9 million for the twenty-six weeks ended August 2, 2008.  Our effective tax rate was (31.0%) and 41.8% for the twenty-six weeks ended August 1, 2009 and the twenty-six weeks ended August 2, 2008, respectively.  The negative effective tax rate for the twenty-six weeks ended August 1, 2009 is the result of a $4.5 million favorable settlement of an IRS income tax audit and a $4.8 million one time benefit related to the repatriation of foreign cash during the Second Quarter 2009.

 

Income (loss) from discontinued operations, net of taxes was income of $0.1 million in the twenty-six weeks ended August 1, 2009 compared to a loss of $2.6 million in the twenty-six weeks ended August 2, 2008.  The loss in the twenty-six weeks ended August 1, 2009 consisted of professional fees related to the wind down of the Hoop Entities and adjustments of accruals.  The loss in the twenty-six weeks ended August 2, 2008 included approximately $16.0 million in professional, restructuring and severance expenses associated with the Hoop bankruptcy filings, approximately $23.1 million of a gain on the disposal of the Disney Store business, approximately $10.6 million of operating losses as we operated the Disney Store business through April 30, 2008, and interest expense, net of approximately $0.8 million, and a $1.6 million net tax benefit related to the above items.

 

Net income in the twenty-six weeks ended August 1, 2009 and August 2, 2008 was $16.5 million and $19.5 million, respectively, due to the factors discussed above.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Debt Service/Liquidity

 

Our working capital needs typically follow a seasonal pattern, peaking during the third quarter when inventory is purchased for the back-to-school and holiday selling seasons.  Our primary uses of cash are the financing of new store openings, providing working capital, principally used for inventory purchases, and the servicing of our term loan.

 

As of August 1, 2009, we had $152.2 million in cash and cash equivalents, no borrowings outstanding under our credit facility and $38 million in remaining borrowings under a five year $85 million term loan, which we entered into at the end of the second quarter of fiscal 2008.  Our credit facility provides for borrowings up to the lesser of $200 million or our

 

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borrowing base, as defined by the credit facility agreement (see “Credit Facilities” below).  At August 1, 2009, our borrowing base was approximately $199.0 million.

 

As previously discussed, on July 29, 2009, we entered into the Securities Purchase Agreement, pursuant to which, among other things, we agreed to purchase approximately 2.45 million shares of our common stock at a price of $28.88 per share.  On August 3, 2009, this purchase was completed by making total payments of approximately $70.8 million.  Pursuant to the Securities Purchase Agreement, we expect to incur total fees of approximately $4.0 million.  On August 3, 2009, as more fully discussed below (under Term Loan), we prepaid the remaining principal amount of $38.0 million under the Note Purchase Agreement.  All of these payments were made from our cash balances.

 

During the remainder of fiscal 2009, we anticipate spending approximately $15 to $20 million on the build out of a new office facility, in addition to our new store and remodeling expenditures.  We expect to be able to meet our capital expenditure and working capital requirements with remaining cash, cash generated from operations, and availability on our credit facility.

 

Credit Facilities

 

On July 31, 2008, we and certain of our domestic subsidiaries entered into a five year credit agreement (the “2008 Credit Agreement”) with Wells Fargo Retail Finance, LLC (“Wells Fargo”), Bank of America, N.A., HSBC Business Credit (USA) Inc., and JPMorgan Chase Bank, N.A. as lenders (collectively, the “Lenders”) and Wells Fargo, as Administrative Agent, Collateral Agent and Swing Line Lender.  The 2008 Credit Agreement refinanced a $130 million credit agreement and a $60 million letter of credit agreement which, except under certain limited circumstances, were each scheduled to expire on November 1, 2010 (the “Prior Credit Agreements”).

 

The 2008 Credit Agreement consists of a $200 million asset based revolving credit facility, with a $175 million sublimit for standby and documentary letters of credit. Revolving credit loans outstanding under the 2008 Credit Agreement bear interest, at our option, at:

 

(i)                                     the prime rate plus a margin of 0.0% to 0.5% based on the amount of the our average excess availability under the facility; or

(ii)                                LIBOR for an interest period of one, two, three or six months, as selected by us, plus a margin of 2.00% to 2.50% based on the amount of our average excess availability under the facility.

 

An unused line fee of 0.50% or 0.75% based on total facility usage will accrue on the unused portion of the commitments under the facility.  Letter of credit fees range from 1.25% to 1.75% for commercial letters of credit and range from 2.00% to 2.50% for standby letters of credit.  Letter of credit fees are determined based on daily average undrawn stated amount of such outstanding letters of credit. The 2008 Credit Agreement expires on July 31, 2013.   The amount available for loans and letters of credit under the 2008 Credit Agreement is determined by a borrowing base consisting of certain credit card receivables, certain inventory and the fair market value of certain real estate, subject to certain reserves.

 

The outstanding obligations under the 2008 Credit Agreement may be accelerated upon the occurrence of certain events, including, among others, non-payment, breach of covenants, the institution of insolvency proceedings, defaults under other material indebtedness and a change of control, subject, in the case of certain defaults, to the expiration of applicable grace periods.  Should the 2008 Credit Agreement be terminated prior to August 1, 2010 for any reason, whether voluntarily by us or by reason of acceleration by the Lenders upon the occurrence of an event of default, we would be required to pay an early termination fee in the amount of 0.25% of the revolving credit facility ceiling then in effect.  No early termination fee would be due and payable for termination after July 31, 2010.

 

The 2008 Credit Agreement contains covenants, which include limitations on annual capital expenditures, stock buybacks and the payment of dividends or similar payments.  Credit extended under the 2008 Credit Agreement is secured by a first or second priority security interest in substantially all of our assets and substantially all of the assets of our domestic subsidiaries.

 

On May 4, 2009, the 2008 Credit Agreement was amended, which included the following changed rates; the LIBOR margin spread is 2.00% to 2.50%, the commercial letter of credit fees range is 1.25% to 1.75%, and the standby letter of credit fees range is 2.00% to 2.50%.

 

On July 29, 2009, the 2008 Credit Agreement was amended to permit us to purchase certain of our outstanding shares and to repatriate funds from Hong Kong and Canada.  In connection with this amendment, we paid an amendment fee of approximately $1.0 million and increased our unused line fee from 0.25% to 0.50%-0.75% depending on total facility usage.

 

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We capitalized an aggregate of approximately $2.6 million in deferred financing costs related to the 2008 Credit Agreement, which is being amortized on a straight-line basis over its term.

 

Term Loan

 

On July 31, 2008, concurrently with the execution of the 2008 Credit Agreement, we and certain of our domestic subsidiaries and Sankaty Credit Opportunities III, L.P., Sankaty Credit Opportunities IV, L.P., RGIP, LLC, Crystal Capital Fund, L.P., Crystal Capital Onshore Warehouse LLC, 1903 Onshore Funding, LLC, and Bank of America, N.A. (collectively, the “Note Purchasers”), together with Sankaty Advisors, LLC, as Collateral Agent, and Crystal Capital Fund Management, L.P., as Syndication Agent, entered into a note purchase agreement (“Note Purchase Agreement”).

 

Under the Note Purchase Agreement, we issued $85 million of non-amortizing secured notes (the “Notes”) which are due and payable on July 31, 2013.  Amounts outstanding under the Note Purchase Agreement bear interest at the greater of (i) LIBOR, for an interest period of one, two, three or six months, as selected by the Company, and (ii) 3.00%, plus, in each case, a margin of between 8.50% and 9.75% depending on our leverage ratio.  As of August 1, 2009, the interest rate applicable to the outstanding principal amount of the Notes was 11.5%.

 

A majority of the proceeds from the Note Purchase Agreement were used to repay in full our outstanding obligations under the Prior Credit Agreements, and the remaining proceeds were used for working capital needs.

 

We capitalized approximately $2.2 million in deferred financing costs related to the Note Purchase Agreement, which was being amortized on a straight-line basis over its term except that in the event of prepayments, the portion of the deferred financing costs related to prepayments is accelerated.  In conjunction with the $47 million of prepayments made on April 13, 2009 (see below), we expensed an additional $0.9 million of deferred financing costs.  In anticipation of the prepayment on August 3, 2009 (see below), we expensed the remaining $1.0 million of deferred financing costs as of August 1, 2009.

 

Based on our cash flow for fiscal 2008, we were required to make a mandatory prepayment of $31.3 million and we had the option to make an additional prepayment, free of prepayment premium, of up to $15.7 million.  On April 13, 2009, after electing to make the full optional prepayment, we paid a total of $47 million.

 

On August 3, 2009, we prepaid the remaining principal amount of $38.0 million (the “Prepayment”) under the Note Purchase Agreement.  In accordance with the terms of the Note Purchase Agreement, we were required to pay a prepayment premium of 1.5%, or approximately $0.6 million.  In connection with the Prepayment, the Note Purchase Agreement and our obligations under the Note Purchase Agreement were terminated.  The Prepayment was approved by the Board of Directors on July 29, 2009, and accordingly, we recorded the $0.6 million prepayment premium in our results of operations for the quarter ended August 1, 2009.  Due to the Prepayment, the total principal amount outstanding of $38.0 million is classified as current in the accompanying condensed consolidated balance sheet at August 1, 2009.

 

Cash Flows/Capital Expenditures

 

During the twenty-six weeks ended August 1, 2009, cash flows used in operating activities were $6.9 million compared to cash provided by operating activities of $111.1 million in the twenty-six weeks ended August 2, 2008.

 

Cash used in operating activities of continuing operations were $6.9 million in the twenty-six weeks ended August 1, 2009 compared to cash provided by operating activities of continuing operations of $87.9 million in the twenty-six weeks ended August 2, 2008.  The net decrease in cash from operating activities of continuing operations resulted primarily from:

 

·                  the timing of payments on accounts payables, primarily in-transit inventory, resulted in $36.4 million less of cash inflow;

·                  increased inventory purchases of approximately $25.4 million;

·                  income from continuing operations before taxes, exclusive of non-cash charges, decreased by approximately $19.1 million, resulting primarily from lower sales and gross profit;

·                  the timing of payments on accrued expenses and other current liabilities, primarily payroll and occupancy costs, resulted in $12.3 million of less cash flow; and

·                  net taxes paid of $7.4 million during the twenty-six weeks ended August 1, 2009 compared to $4.0 million of a net tax refund during the twenty-six weeks ended August 2, 2008.

 

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The above decreases were partially offset by the elimination of funding the subsidiaries in discontinued operations, which resulted in increased cash flow of approximately $18.0 million.

 

Cash used in operating activities of discontinued operations was $0.1 million in the twenty-six weeks ended August 1, 2009 compared to cash provided by operating activities of discontinued operations of $23.2 million in the twenty-six weeks ended August 2, 2008.  Cash used in operating activities of discontinued operations in the twenty-six weeks ended August 1, 2009 reflected the payment of professional fees offset by accrual reversals as the Hoop Entities wind down.  Cash provided by operating activities of discontinued operations in the twenty-six weeks ended August 2, 2008 reflected the usage of inventory on hand, the elimination of prepayments and reduced payments of liabilities (including intercompany liabilities) due to the Filings.

 

Cash flows used in investing activities were $27.1 million in the twenty-six weeks ended August 1, 2009 compared to $40.0 million during the twenty-six weeks ended August 2, 2008.

 

Cash flows used in investing activities of continuing operations were $27.1 million and $16.2 million in the twenty-six weeks ended August 1, 2009 and the twenty-six weeks ended August 2, 2008, respectively.  The increase in cash used in investing activities of continuing operations was primarily due to an increase in store openings.  During the twenty-six weeks ended August 1, 2009, we opened 21 stores compared to three new store openings in the twenty-six weeks ended August 2, 2008.  Additionally, the twenty-six weeks ended August 2, 2008 includes $2.3 million of proceeds from the sale of a store lease.

 

There were no cash flows from investing activities of discontinued operations during the twenty-six weeks ended August 1, 2009.  Cash flows used in investing activities of discontinued operations were $23.7 million in the twenty-six weeks ended August 2, 2008 reflecting the restriction of all cash to settle liabilities in bankruptcy and payments of capital expenditures, partially offset by the proceeds from the sale of Disney assets.

 

Cash flows used in financing activities were $45.4 million in the twenty-six weeks ended August 1, 2009 compared to $4.8 million used by financing activities in the twenty-six weeks ended August 2, 2008.

 

Cash flows used in financing activities of continuing operations were $45.4 million during the twenty-six weeks ended August 1, 2009 compared to cash flows provided by financing activities of continuing operations of $7.0 million during the twenty-six weeks ended August 2, 2008.  During the twenty-six weeks ended August 1, 2009, cash flows u