SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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)

(201) 558-2400

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act: None.

Securities registered pursuant to Section 12(g) of the Act: Common Stock.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x   No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o   No x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

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 aggregate market value of common stock held by non-affiliates was $1,009,854,927 at the close of business on July 29, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter) based on the closing price of the common stock as reported on the Nasdaq Stock Market.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: Common Stock, par value $0.10 per share, outstanding at February 25, 2006:  28,006,842 shares.

Documents Incorporated by Reference: Portions of the Company’s Proxy Statement for its annual meeting of stockholders to be held on June 22, 2006, are incorporated partially in Part III hereof.

THE CHILDREN’S PLACE RETAIL STORES, INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FIFTY-TWO WEEKS ENDED JANUARY 28, 2006
TABLE OF CONTENTS

PART I

ITEM 1.—BUSINESS

This Annual Report on Form 10-K 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, 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.” 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 Annual Report on Form 10-K 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 audited financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.

Overview

The Children’s Place Retail Stores, Inc. and subsidiaries (the “Company” or “we”) is a leading specialty retailer of children’s merchandise. We design, contract to manufacture and sell high-quality, value-priced merchandise under our proprietary “The Children’s Place” and licensed “Disney Store” brand names. As of February 25, 2006, we owned and operated 802 The Children’s Place stores and 316 Disney Stores across North America and an Internet store at www.childrensplace.com.

In November 2004, we acquired, through two wholly-owned subsidiaries, the Disney Store retail chain in North America (the “DSNA Business”) from affiliates of The Walt Disney Company (“Disney”). (For clarification, the “DSNA Business” refers to the business we acquired from Disney as of November 21, 2004, whereas the “Disney Store business” refers to the Disney Store business we have operated since the acquisition.)  As a result of the acquisition, these subsidiaries acquired a total of 313 Disney Stores, consisting of all existing Disney Stores in the United States and Canada, other than “flagship” stores and stores located at Disney theme parks and other Disney properties, along with certain other assets used in the Disney Store business. In addition, the lease obligations for all 313 stores and other legal obligations became obligations of our subsidiaries. Subsequently, our subsidiaries acquired two Disney Store flagship stores, one in Chicago, Illinois and the other in San Francisco, California.

We are structured such that our administrative functions (e.g., finance, real estate, human resources, legal, information technology) are shared by both brands. Functions such as design, merchandising, marketing and store operations are run independently of each other to maintain clearly defined and differentiated brands. Each brand is overseen by a President who manages day-to-day operations and who reports directly to our Chairman and Chief Executive Officer.

The Children’s Place is a specialty retailer of apparel and accessories for children from newborn to ten years of age. The brand’s merchandising objective is to offer a unique, colorful, coordinated and balanced lifestyle assortment of high quality, basic and fashion merchandise, at prices that represent substantial value to our customers.

Disney Store originated the themed specialty retail environment when its first store opened in Glendale, California in 1987. Disney Store offers immediate access to unique Disney-branded products, such as apparel, toys, plush, and souvenirs in an emporium like setting.

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Our goal is to be the leading specialty retailer in the children’s space by making the very best products accessible to all children. Both The Children’s Place and Disney Store brands fit within this core purpose; however each is at a different point in its growth trajectory. The Children’s Place has enjoyed several years of profitable growth and market share gains while the Disney Store is currently implementing various merchandising, marketing and sourcing strategies in an effort to increase sales and earnings.

During fiscal 2005, we opened 55 The Children’s Place stores compared to 62 store openings in fiscal 2004. We also opened 18 Disney Stores in fiscal 2005 compared to none in fiscal 2004. We closed three The Children’s Place stores and seven Disney Stores in fiscal 2005, the same as in fiscal 2004. Our store growth plan in fiscal 2006 includes opening approximately 65 The Children’s Place stores and approximately 15 Disney Stores.

We believe that the following capabilities are critical to our long-term success:

Merchandising Strategy.   The Children’s Place merchandising strategy is built on offering an appealing collection of interchangeable outfits and accessories to create a coordinated look distinctive to the brand. We offer an updated, focused assortment of styles in a variety of colors and patterns, with the aim of consistently creating a fresh, youthful look at value prices that we believe distinguishes “The Children’s Place” brand. We divide the year into quarterly merchandising seasons: spring, summer, back-to-school and holiday. Within each season we typically deliver two merchandise lines. Each season is built around a theme that includes an assortment of coordinated basic and fashion apparel with matching accessories designed to encourage multiple item purchases and wardrobe building.

Our Disney Store merchandising strategy is to offer the whole family a unique, high quality, character driven merchandise assortment at value prices. During fiscal 2005, we weighted the merchandise mix towards children’s apparel and toys, and de-emphasized the adult apparel category. To date, the Disney Store business has been heavily concentrated in the Halloween and holiday seasons. To reduce the level of seasonality, we plan to offer more softlines merchandise during spring, summer and back-to-school. In addition, in the second half of fiscal 2006, we will re-introduce adult apparel, offer more freshness and innovation in our hardlines business and offer a “good,” “better,” “best” pricing strategy across most product categories to appeal to a broader audience. These changes in merchandising strategy are expected to primarily impact the second half of fiscal 2006.

High Quality/Value Pricing Strategy.   We believe that our high quality, value price positioning is an important component of our long-term strategy. We offer high-quality clothing and accessories under “The Children’s Place” brand name at prices below most of our direct mall-based competitors. We employ this value pricing strategy across our entire merchandise offering. Our value price points are an important factor in the broad consumer appeal that The Children’s Place brand has benefited from over the years. At Disney Store, we believe that combining the strong appeal of Disney characters with our unique merchandise offering at value prices will enhance the Disney Store business.

Brand Image.   We continue to build a strong brand image and customer loyalty for “The Children’s Place” by:

·       offering high-quality products at value prices;

·       providing a distinctive collection of coordinated and interchangeable outfits and accessories;

·       maintaining a uniform merchandise presentation;

·       emphasizing our fashionable, youthful image in our marketing visuals; and

·       selling our merchandise exclusively in our The Children’s Place stores and on our website.

The Disney Store business benefits from one of the strongest family brand names in North America. The Disney Store experience emphasizes the “magic” and memories of the Disney character portfolio.

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Low-Cost Sourcing.   We control the design, sourcing and presentation of our products sold at both The Children’s Place and Disney Store. We believe that this control is essential in assuring the consistency and quality of our merchandise and the image of each of our brands, as well as in our ability to deliver value to our customers. We have established long-standing relationships with our buying agents, vendors and material suppliers. Through these relationships and our extensive knowledge of low cost sourcing, we are able to offer our customers high-quality products at value prices. Furthermore, we believe that our integrated merchandise approach, from in-house design to in-store presentation, enables us to identify and respond to market trends, uphold rigorous product quality standards, manage the cost of our merchandise and strengthen our brands. Our offices in Hong Kong, Shanghai and New Delhi add to our ability to lower costs, capitalize on new sourcing opportunities, increase our control over product quality and enable us to respond to changing merchandise trends more effectively and efficiently. We are applying our low-cost sourcing expertise to Disney Store. These plans began to positively impact operating results in the second half of fiscal 2005; however the full effect of the change in sourcing strategy is expected to occur in fiscal 2006.

Experienced Management Team.   Our management team is led by Ezra Dabah, Chairman and Chief Executive Officer, who guides the management of the Company using his broad apparel merchandising and buying expertise, which includes over 20 years in the children’s segment of the market. In addition, the other members of our management team have an average of 17 years of retail or apparel industry experience and an average of six years with the Company.

Merchandising Process

While we have separate design and merchandising teams for each brand, the process and planning schedules are similar, albeit at different phases of implementation at each brand. To execute our merchandising strategies, we rely on the coordinated efforts of our design, merchandising, sourcing, planning and allocation teams. These teams, in conjunction with senior management, review prior season results, fashion trends, colors and designs that we will offer in upcoming seasons. Merchandising selects items for production from the assortment of merchandise designs that are created by the design team. In addition, the Disney Store design team assesses characters and attends toy shows and fairs to determine what toys to include in the assortment. Then, based upon detail design specifications, including production quantities determined by merchandising and planning, the sourcing team arranges for the issuance of purchase orders and manufacture of the selected items.

Our design and trend teams analyze and interpret current and emerging fashion trends, translating them into a broad selection of merchandise appropriate for upcoming seasons. In addition, our Disney Store design and trend teams evaluate the popularity and relevancy of existing characters, as well as the perceived customer receptivity to new characters, to create a unique and compelling merchandise assortment. Across both brands, work on each of our seasonal lines begins approximately one year before the season. However, the Company maintains, and at times exercises, the ability to develop and deliver product on an expedited timeline. The merchandising process includes gathering of samples and market intelligence on fashion trends, which involves extensive European and domestic market research, media, trade shows, fashion magazines, the services of fashion and color forecast organizations, and analysis of prior season performance. In addition, at Disney Store, we consult with Disney as part of daily operations. After the design teams present their ideas, the designers, with the direction of merchandising, translate those ideas into a merchandise assortment that reflects the theme of the season. These interpretations include variations in fabric and other materials, product color, decoration, character selection and age-appropriate silhouettes. Potential items are designed using computer aided design technology, which allows for a wide range of style and fashion options. In addition, our sourcing teams and Asian offices coordinate the production of apparel prototype samples which enable our merchandising teams to ensure that our merchandise will properly reflect our design concepts, and allow us to get the most accurate

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understanding of an item’s color, fit, texture and quality. We have also instituted a process that involves working with samples in a simulated in-store environment. This enables our design, merchandising, visual and marketing teams to create a cohesive, well balanced and fresh approach to each season.

The merchandise management teams create a detailed purchasing plan for the season covering each department, category and key item, based on historical, current and emerging category trends. The production process takes approximately four to six months from order confirmation to receipt of merchandise at our distribution facilities. Our planning teams monitor current and projected inventory levels on a weekly basis and analyze sales patterns to predict future demand for various categories. We regularly monitor sales and maintain some flexibility to adjust merchandise on order for future seasons or to accelerate delivery of merchandise. Our merchandise allocation teams are responsible for planning and allocating merchandise to each store based on sales levels, merchandise turns and other factors.

Sourcing and Procurement

We combine management’s extensive apparel sourcing experience with a cost-based buying strategy to control merchandise costs, infuse quality features into our product and deliver value to our customers. We believe we have a thorough understanding of the economics of apparel manufacturing, including costs of materials and components. This knowledge enables us to determine the most cost-effective country and manufacturer from which to source each item and obtain high quality at low product costs. Relying on our supplier relationships, our knowledge of manufacturing costs and our ability to leverage increasing volumes, we believe we have been able to arrange for the manufacture of high-quality apparel and accessories at low cost. With the addition of the Disney Store business, we are now sourcing “hardlines” merchandise such as toys, mugs, and snow globes using the same sourcing strategies.

Our sourcing team makes on-site visits to our independent agents and various manufacturers to negotiate product costs, finalize technical specifications for each product and confirm delivery of merchandise manufactured to our specifications. During fiscal 2005, more than 250 independent manufacturers located primarily in Asia produced merchandise sold at The Children’s Place and Disney Store to our specifications. Given the timing of the acquisition of the DSNA Business, we were unable to materially impact Disney Store merchandise sold during the first half of fiscal 2005; however merchandise that was sourced by us benefited the third and fourth quarters of fiscal 2005. To support our growing inventory needs and to control merchandise costs, we continue to pursue global sourcing opportunities and consider product quality and cost, reliability of the manufacturer, and service and product lead times, among other factors.

We have no exclusive or long-term contracts with our manufacturers and typically transact business on an item-by-item basis under purchase orders at freight on board cost in U.S. dollars. We are party to agency agreements with commissioned independent agents who oversee production, assist in sourcing and pre-production approval, provide quality inspection and ensure timely delivery of merchandise. During fiscal 2005, we purchased approximately 13% of our products from a commissioned, independent agent in Taiwan, and approximately 11% of our product through a Hong Kong-based trading company. This trading company is responsible for procurements from wholly-owned facilities as well as contract manufacturers located throughout Asia. We have developed long-term, continuous relationships with key individual manufacturers and material suppliers, which have yielded numerous benefits, including quality control, low costs, and flexible working arrangements. In addition, we believe our offices in Hong Kong, Shanghai and New Delhi enable us to obtain more favorable material and manufacturing costs and quickly identify and act on new sourcing and supplier opportunities. Our Asian offices also facilitate our prototype sample production and enable us to foster stronger relationships with our suppliers, manufacturers, agents and trading companies. During fiscal 2005, we purchased approximately 35% of our merchandise without the aid of commissioned buying agents or trading companies and approximately 40% of our goods were sourced from China. Together with our agents and key suppliers, we use tracking systems that enable us to

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anticipate potential delivery delays in our orders and take action to mitigate the impact of any delays. Using our purchase order, advanced shipping notification and tracking systems, our independent agents and our sourcing department actively monitor the status of each purchase order from order confirmation to merchandise receipt.

To ensure quality and promote consumer confidence in our products, we augment our manufacturers’ testing requirements with our own in-house quality assurance laboratory to test and evaluate fabric, trimming materials and pre-production samples against a comprehensive range of physical performance standards before production begins. The quality control personnel of our Asian offices, independent agents and trading company visit the various manufacturing facilities to monitor and improve the quality control and production process. Our Asian offices enhance our quality control by enabling us to monitor component and manufacturing quality at close range and address related problems at an early stage. With this focus on pre-production quality approval, we are generally able to detect and correct quality-related problems before bulk production begins. We do not accept finished goods until each purchase order receives formal certification of compliance from our agents or appointed third party inspectors.

In addition to our quality control procedures, we have implemented a social compliance program designed to promote compliance with local legal regulations, as well as ethical and socially responsible business practices. The program involves on-site facility visits by either our social compliance auditors or third party providers, review of documentation, and interviews of facility management and workers. Additionally, our program includes education and training of our associates and our suppliers in order to ensure the sustainability of our program.

Company Stores

Existing Stores.   As of February 25, 2006, we operated 802 The Children’s Place stores and 316 Disney Stores in North America. Most of The Children’s Place stores are clustered in and around major metropolitan areas in regional malls, with the exception of 98 strip center, 87 outlet and 46 street stores. All of our Disney Stores are in regional malls with the exception of 12 outlet stores and two street locations. The following table sets forth the number of stores in each state, Puerto Rico and Canadian province as of February 25, 2006:

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Store Type.

The Children’s Place.   Our average store is approximately 4,500 square feet. The majority of our Children’s Place stores are in our “Apple-Maple” prototype, which features light wood floors, fixtures and trim. The store is brightly lit, featuring floor-to-ceiling glass windows that allow our colorful fashions to attract customers from the outside. A customized grid system throughout the store’s upper perimeter displays featured merchandise, marketing photographs and promotions.

During fiscal 2002, we introduced a new “Technocolor” store prototype. The unique, fun and bright stores use color to create boutique-like settings that better differentiate the various departments within the store. The stores also feature wider aisles for customers with strollers, and more wall space allowing for enhanced merchandise presentation and ease of shopping. As of February 25, 2006, 205 stores were in this format, or approximately 26% of The Children’s Place store base. In fiscal 2006, all of our new stores and remodels (except for outlets) will be Technocolor stores.

Our street and strip center locations represent approximately 18% of The Children’s Place store base and provide opportunities for further penetration in established markets.

Our typical outlet stores are approximately 6,400 square feet and represent approximately 11% of The Children’s Place store base. Our outlet stores are mostly located in outlet centers and are strategically placed within each market to liquidate markdown merchandise from nearby stores. Given the brand’s value orientation, we also sell an assortment of full-priced merchandise in our outlet stores. We view our outlet business as an important component of our future growth.

Disney Store.   The average Disney Store is approximately 4,700 square feet. Currently, we have several Disney Store formats, as follows:

The Mickey and outlet prototypes were introduced in fiscal 2005. We are currently contemplating additional changes to the Mickey store prototype which we expect to finalize in fiscal 2006.

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Store Operations

Our store operations are organized into ten and five regions for The Children’s Place and Disney Store, respectively. For The Children’s Place brand, we have three Zone Vice Presidents that oversee our operations into whom regional managers report. At this time, the Disney Store business does not have Zone Vice Presidents. For both brands, a regional manager oversees each region and has several district managers’ reporting to him or her. Each district manager is responsible for approximately eight to ten stores, on average. Our stores are staffed by a store management team and approximately 10 part-time sales associates, with additional part-time associates hired to support seasonal needs. Across both brands, our store management teams spend a majority of their workweek on store selling floors providing direction, motivation, training and support to store personnel. To maximize selling productivity, we engage in an ongoing training process, which emphasizes customer service, selling skills, merchandise presentation, procedures and controls. In order to motivate our store management, we offer a monthly incentive compensation plan that awards bonuses for exceeding pre-established goals.

Store Expansion Program

To determine the location of new stores, we conduct onsite visits and analyses of potential store sites, taking into account the performance of our stores and other retailers in the area, as well as the demographics of the surrounding area. In addition, we consider the store’s location relative to consumer traffic patterns and proximity to other children’s retailers.

The Children’s Place.   During fiscal 2005 we opened 55 stores and closed three, compared to opening 62 stores and closing three in fiscal 2004. We plan to open approximately 65 stores and remodel approximately 20 Children’s Place stores in fiscal 2006. Over time, the Company believes The Children’s Place brand can grow up to approximately 1,200 stores across the United States, Canada and Puerto Rico.

The Company’s new store return on investment (defined as the return on investment for stores in which the then current fiscal year was their first full year of operation) for The Children’s Place chain for fiscal 2005, fiscal 2004 and fiscal 2003 approximated 81%, 87% and 56%, respectively. The Company defines return on investment as store level operating cash flow for new stores divided by new store investment. Store level operating cash flow for new stores is comprised of direct store contribution before the amortization of deferred rent, and depreciation and amortization expense. Fiscal 2005 average store level operating cash flow for new stores approximated $0.4 million, a 20% increase over fiscal 2004. Average store investment includes store capital expenditures, initial inventory and pre-opening costs less lease incentives and an estimate for merchandise payables. Fiscal 2005 average new store investment approximated $0.5 million a 29% increase from fiscal 2004. This increase in average new store investment primarily reflects higher construction costs and higher inventory investments. Fiscal 2005 new stores had average net sales of approximately $1.6 million, a 14% increase over fiscal 2004, which reflects the benefit of the higher inventory investments and various merchandise and store-level initiatives.

Disney Store.   In fiscal 2005 we opened 18 Disney Stores, closed seven, and remodeled 32, compared to the closing of seven Disney Stores in fiscal 2004. Our store growth plans in 2006 include opening approximately 15 Disney Stores.  Of these 15 new stores, approximately five will be outlet stores, a new channel of growth for the Disney Store business. In addition, the Company plans to remodel approximately 25 Disney Stores in fiscal 2006. Over time, the Company believes the Disney Store chain can grow up to approximately 600 stores across North America.

Consistent with our definition of new store return on investment, since there were no new Disney Stores opened by us in fiscal 2004, the Company has not computed an amount for the Disney Store business in fiscal 2005.

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Internet Sales

We believe the Internet is an effective sales, merchandising and marketing channel for our existing The Children’s Place customers in the United States, and is also effective in generating new customers from the portion of the U.S. population that may not have access to our store locations or who prefer to shop online. Our Internet business represented approximately 2.3% of The Children’s Place sales in fiscal 2005, compared to 1.7% of sales in fiscal 2004. This profitable business continues to grow at a rapid rate and we believe it is an integral part of our customer service and brand awareness strategies.

We anticipate operating an Internet store at www.disneystore.com beginning in April 2007.

Marketing

We strive to enhance our brands’ reputation and image in the marketplace and build recognition and equity by marketing our image, product and value message primarily through our store front windows, direct mail, in-store marketing, magazine advertising and “The Children’s Place” private label credit card. Our direct mail marketing programs are designed to increase sales, promote brand loyalty and create customer excitement. In fiscal 2005, we utilized television advertising at The Children’s Place in support of the back-to-school season. In fiscal 2006, we expect to focus on increasing the frequency and depth of our direct mail campaigns which have effectively driven sales and traffic. We also plan to increase magazine advertising as a means to communicate The Children’s Place brand message to new and existing customers. Our Disney Store business benefits indirectly from Disney’s substantial advertising efforts.

We view The Children’s Place private label credit card as an important marketing and communication tool. Pursuant to a merchant services agreement, private label credit cards are issued to our customers for use exclusively at The Children’s Place stores and credit is extended to such customers on a non-recourse basis to us. Our private label credit card accounts for approximately 12% of The Children’s Place net sales. We believe that our private label credit card promotes affinity and loyalty among those customers who use the card and facilitates communication with such customers through delivery of coupons and promotional materials.

Logistics

We currently support both The Children’s Place stores and Disney Stores with a 525,000 square foot distribution center in South Brunswick Township, New Jersey; a 250,000 square foot distribution center in Ontario, California; and a 95,000 square foot distribution center in Ontario, Canada. Our distribution centers utilize automated warehouse systems, which employ radio frequency technology and automated conveyor systems. Our approximately 150,000 square foot fulfillment center in Secaucus, New Jersey is used to support our Internet business. In addition, we operate other leased facilities on a seasonal basis to support warehousing needs. Given our current growth plans, we are in active search for an additional distribution center.

Competition

The children’s apparel, toy and media retail markets are highly competitive. We compete in substantially all of our markets with GapKids, babyGap and Old Navy (each of which is a division of The Gap, Inc.); The Gymboree Corporation; Too, Inc.; Babies “R” Us and Toys “R” Us (each of which is a division of Toys “R” Us, Inc.); J.C. Penney Company, Inc.; Sears (a division of Sears Holdings Corporation); Kohl’s and other department stores as well as discount stores such as Wal-Mart Stores, Inc.; Target Corporation; and K-Mart (a division of Sears Holdings Corporation). We also compete with a wide variety of specialty stores, other national and regional retail chains, catalog companies and Internet retailers. In our Disney Store business, we compete with the Disney theme parks and with third parties selling Disney-branded merchandise under license. In addition, media items such as compact discs and DVDs can be purchased in virtually every retail channel. One or more of our competitors are present in substantially all of the areas in which we have stores.

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We believe we have the principal factors to compete effectively in our markets: high quality merchandise at value prices, compelling merchandise assortments, brand name recognition, good customer service, and easy-to-shop store environments.

Trademarks and Service Marks

“The Children’s Place,” “babyPLACE,” “Place,” “The Place,” “TCP,” “PLC” and certain other marks have been registered as trademarks and/or service marks with the United States Patent and Trademark Office. The registration of the trademarks and the service marks may be renewed to extend the original registration period indefinitely, provided the marks are still in use. We intend to continue to use and protect our trademarks and service marks and maintain their registrations. We have also registered our trademarks in Canada and other countries and are continuing to take steps to register our trademarks in certain other foreign countries. We believe our trademarks and service marks have received broad recognition and are of significant value to our business.

License Agreement With Disney

In connection with the acquisition of the DSNA Business, two of our subsidiaries entered into a license and conduct of business agreement with an affiliate of Disney (the “License Agreement”) under which our subsidiaries have the right to use certain Disney intellectual property to operate the Disney Store retail chain in exchange for ongoing royalty payments. The agreement allows our subsidiaries to operate retail stores in the United States and Canada using the “Disney Store” name and to contract, manufacture, source, offer and sell merchandise featuring Disney-branded characters, past, present and future. Our subsidiaries will make royalty payments to Disney beginning in November 2006 equal to 5% of net sales from physical Disney Store locations, subject to an additional royalty holiday period with respect to a limited number of stores. Beginning in April 2007, our subsidiaries will operate the www.disneystore.com Internet store, which will feature a select assortment of merchandise offered in the physical Disney Store locations. The initial term of the License Agreement is through January 2020, and if certain financial performance and other conditions are satisfied, it may be extended at our option for up to three additional ten-year terms.

Employees

As of February 25, 2006, we had approximately 21,400 employees, of whom approximately 1,400 are based at our corporate headquarters in Secaucus, New Jersey; our Disney Store office in Glendale, California; our distribution centers; and international offices. We have approximately 3,600 full-time store employees and approximately 16,400 part-time store employees. None of our employees are covered by a collective bargaining agreement. We believe we have good relations with our employees.

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Executive Officers and Directors

The following table lists the current executive officers and directors of the Company:

On March 8, 2006, so that he may pursue other interests, Hiten Patel, Senior Vice President, Chief Financial Officer, announced his resignation effective as of April 15, 2006. Upon his resignation, Susan Riley, Senior Vice President, Finance, who joined the Company on March 13, 2006, will assume the responsibilities of Chief Financial Officer and will report directly to Ezra Dabah, Chairman and Chief Executive Officer.

On April 6, 2006, so that he may pursue other interests, Mario Ciampi, President, Disney Store North America, announced his resignation effective as of April 29, 2006. While the Company has not identified a successor, the Company is actively recruiting to fill the position. In the interim, Ezra Dabah, Chairman and Chief Executive Officer, will assume responsibilities for the Disney Store business.

Internet Access to Reports

The Company makes its corporate governance materials, ethics policy and periodic filings with the Securities and Exchange Commission available on its website, www.childrensplace.com. These documents are free of charge and are available for viewing as soon as reasonably practical.

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ITEM 1A.—RISK FACTORS

Investors in the Company should consider the following risk factors as well as the other information contained herein:

Ability to Reposition Disney Store

A significant portion of our future success involves integrating, developing and growing the Disney Store business. The realization of any revenue growth, cost savings or synergies will depend largely upon our ability to:

·       secure additional merchandise cost reductions from vendors and suppliers;

·       remodel and update the current store fleet and successfully operate the stores;

·       source hardlines merchandise at favorable prices; and

·       execute our strategies for Disney Store without adversely impacting the existing The Children’s Place business.

There can be no assurance that we can successfully operate the Disney Stores in accordance with the terms of the License Agreement, including taking the steps necessary to obtain all required consents and approvals thereunder. In addition, there can be no assurance that we can successfully execute any of the actions above or that our strategies for Disney Store will achieve the results necessary to generate profits. If we fail to adequately integrate the Disney Store operation or cannot successfully execute its growth strategy, our results of operations will be adversely impacted.

Ability to Anticipate and Respond to Merchandise Trends

Our continued success will depend in part on our ability to anticipate and respond to fashion trends and consumer preferences. Our design, manufacturing and distribution process generally takes up to one year, during which time fashion trends and consumer preferences may change. Failure to anticipate, identify or respond to future fashion trends may adversely affect customer acceptance of our products or require substantial markdowns, which could have a material adverse effect on our business.

Ability to Maintain Profitable Growth

Our future operating results will depend largely upon our ability to manage a larger business profitably and open and operate new stores successfully. We anticipate opening approximately 80 stores during fiscal 2006, which will include approximately 65 The Children’s Place stores and approximately 15 Disney Stores. Our ability to open and operate new stores successfully depends on many factors, including, among others, the availability of suitable store locations, the ability to negotiate acceptable lease terms, the ability to timely complete necessary construction, the ability to successfully integrate new stores into our existing operations, the ability to hire and train store personnel and the ability to recognize and respond to regional and climate-related differences in customer preferences.

We cannot assure you that we will achieve our planned expansion on a timely and profitable basis or that we will be able to achieve results similar to those achieved in existing locations in prior periods. In fiscal 2005, our total store base grew by 6% compared to 53% (reflecting the Disney Store acquisition) during fiscal 2004, and is anticipated to grow by approximately 7% in fiscal 2006. Operating margins may also be adversely affected during periods in which we have incurred expenses in anticipation of new store openings. We may not be able to sustain the new store return on investment we experienced in fiscal 2005 of approximately 81%. Furthermore, we need to continually evaluate the adequacy of our store management and our information and distribution systems to manage our planned expansion. Any failure to successfully and profitably execute our expansion plans could have a material adverse effect on our business.

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We believe that cash on hand, cash generated from operations and funds available under our credit facilities will be sufficient to fund our capital and other cash flow requirements for our business for at least the next 12 months. However, it is possible that we may be required to seek additional funds for our capital and other cash flow needs, and we cannot assure you that we will be able to obtain such funds on terms favorable to us or at all.

Risks of Using Foreign Manufacturers; Possible Adverse Impact of Unaffiliated Manufacturers’ Failure to Comply with Acceptable Labor Practices

Our business is subject to the risks generally associated with purchasing from foreign countries, particularly China, from where a large percentage of our merchandise is imported. Some of these risks are foreign governmental regulations, political instability, currency and exchange risks, quotas on the amounts and types of merchandise which may be imported into the United States and Canada from other countries, pressures from non-governmental organizations, disruptions or delays in shipments and changes in economic conditions in countries in which our manufacturing sources are located. We cannot predict the effect that such factors will have on our business arrangements with foreign manufacturing sources. If any of these factors rendered the conduct of business in a particular country undesirable or impractical, or if our current foreign manufacturing sources ceased doing business with us for any reason, our business could be materially adversely affected. Our business is also subject to the risks associated with changes in U.S. and Canadian legislation and regulations relating to imported apparel products, including quotas, duties, taxes and other charges or restrictions on imported apparel. Such changes or other changes or restrictions with regard to China could have a material adverse impact on our business. We cannot predict whether such changes or other charges or restrictions will be imposed upon the importation of our products in the future.

We require our independent manufacturers to operate in compliance with applicable laws and regulations and our internal requirements. While our purchasing guidelines promote ethical business practices, we do not control these manufacturers or their labor practices. Any violation of labor or other laws by one of the independent manufacturers we use or any divergence of an independent manufacturer’s labor practices from those generally accepted as ethical in the United States and Canada could have a material adverse effect on our business.

Potential Disruptions in Receiving and Distribution

Our merchandise is shipped directly from manufacturers through freight consolidators to our distribution and fulfillment centers. Our operating results depend in large part on the orderly operation of our receiving and distribution process, which depends on manufacturers’ adherence to shipping schedules and our effective management of our distribution facilities and capacity. Furthermore, it is possible that events beyond our control, such as a military action, strike, natural disaster or other disruption, could result in delays in delivery of merchandise to our stores. Any such event could have a material adverse effect on our business.

Sensitivity to Economic, Regional and Other Business Conditions

Our business is sensitive to customers’ spending patterns which are subject to prevailing regional and national economic conditions such as consumer confidence, recession, interest rates, energy prices and taxation. We are, and will continue to be, susceptible to changes in national and regional economic conditions, raw material costs, weather conditions, demographic and population characteristics, hourly wage legislation, consumer preferences and other regional factors.

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Changes in Comparable Store Sales Results from Period to Period

Numerous factors affect our comparable store sales results, including, among others, merchandise assortment, retail prices, fashion trends, weather conditions, macro-economic conditions, the retail sales environment and our success in executing our business strategy. During fiscal 2005, we reported a comparable store sales increase of 9%, on top of a 16% comparable store sales increase achieved during fiscal 2004. Our monthly comparable store sales results have fluctuated significantly in the past and we anticipate that our monthly comparable store sales will continue to fluctuate in the future. Moreover, comparable store sales for any particular period may decrease in the future. Further, in February 2006, 260 Disney Stores were added to our comparable store sales base, which may adversely impact our consolidated comparable store sales performance. Disney Stores’ comparable stores sales results may be more volatile than those of The Children’s Place given one time events that occur from year to year such as major theatrical movie releases or DVD releases. The investment community often follows comparable store sales results closely and significant fluctuations in these results may affect the price of our common stock. Any variations in our comparable store sales results could have a material adverse effect on the market price of our common stock.

Effect of Fluctuations in Quarterly Results and Seasonality on Income

As is the case with many retailers, we experience seasonal fluctuations in our net sales and net income. Our net sales and net income are generally weakest during the first two fiscal quarters, and are lower during the second fiscal quarter than during the first fiscal quarter. For example, in fiscal 2005, 22%, 19%, 26% and 32% of our consolidated net sales occurred in the first, second, third and fourth quarters, respectively. In fiscal 2005, we experienced a second quarter loss and expect to experience a second quarter loss in fiscal 2006. It is possible that we will continue to experience second quarter losses in future periods. It is also possible that we could experience losses in other quarters. Our first quarter results are heavily dependent upon sales during the period leading up to the Easter holiday. Our third quarter results are heavily dependent upon back-to-school sales at The Children’s Place and upon Halloween sales at Disney Store. Our fourth quarter results are heavily dependent upon sales during the holiday season. Weak sales during any of these periods could have a material adverse effect on our business.

Our quarterly results of operations may also fluctuate significantly from quarter to quarter as a result of a variety of other factors, including overall macro-economic conditions, the timing of new store openings and related pre-opening and other start-up costs, net sales contributed by new stores, increases or decreases in comparable store sales, weather conditions, shifts in the timing of certain holidays, changes in our merchandise mix and pricing strategy. Moreover, a significant portion of Disney Store net sales are generated during the third and fourth quarters of the fiscal year, which may make our consolidated seasonality more heavily weighted to those quarters. Any failure by us to meet our business plans for, in particular, the third and fourth quarter of any fiscal year would have a material adverse effect on our earnings, which in all likelihood would not be offset by satisfactory results achieved in other quarters of the same fiscal year. In addition, because our expense levels are based in part on expectations of future sales levels, a shortfall in expected sales could result in a disproportionate decrease in our net income.

Dependence on The Walt Disney Company Character Franchise and Brand

The Disney Store business is driven largely by customers’ interests in apparel, toys and other products featuring Disney characters. New characters featured prominently in movies and home videos and national marketing campaigns heighten consumers’ interests and in-store traffic. While traditional licensed properties such as Mickey & Friends, the Pooh Family and Disney Princess may sustain store sales throughout the year, new characters enthuse young children and lead to increased customer traffic. Our ability to grow the Disney Store business is thus dependent on Disney’s ability to continue to create new and likable characters.

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The Disney Store business is strongly aligned with the “Disney” brand, the maintenance and cultivation of which is outside of our control. The Disney Store business is subject to certain risks because it relies heavily on the strong brand identification of the Disney logo, the beloved nature of the Disney characters and the Disney brand name. All of the products within the Disney Stores are intrinsically tied to consumers’ image of the Disney brand. While the Disney brand is among the world’s most recognized and highly regarded brands, it is subject to changes in public opinion and ever changing consumer preferences. If unfavorable events occur that negatively impact the consumers’ perception of Disney or the Disney brand/logo, our future results of operation and financial condition could be adversely affected.

Competition

The children’s apparel, toy and media retail markets are highly competitive. We compete in substantially all of our markets with GapKids, babyGap and Old Navy (each of which is a division of The Gap, Inc.); The Gymboree Corporation; Too, Inc.; Babies “R” Us and Toys “R” Us (each of which is a division of Toys “R” Us, Inc.); J.C. Penney Company, Inc.; Sears (a division of Sears Holdings Corporation); Kohl’s and other department stores, as well as discount stores such as Wal-Mart Stores, Inc.; Target Corporation; and K-Mart (a division of Sears Holdings Corporation). We also compete with a wide variety of specialty stores, other national and regional retail chains, catalog companies and Internet retailers. In our Disney Store business, we compete with the Disney theme parks and with third parties selling Disney-branded merchandise under license. In addition, media items such as compact discs and DVDs can be purchased in virtually every retail channel. One or more of our competitors are present in substantially all of the areas in which we have stores. Many of our competitors are larger than us and have access to significantly greater financial, marketing and other resources than we have. We cannot assure you that we will be able to continue to compete successfully against existing or future competition.

Segregation of Liquidity

The terms of the License Agreement and/or our credit facilities, among other things, restrict the commingling of funds between The Children’s Place and the Disney Store business, and borrowings and certain distributions from the Disney Store business to The Children’s Place. Therefore, we have maintained segregation of all cash receipts and disbursements, investments, and credit facility borrowings and letter of credit activity. This segregation could lead to a liquidity need in one business while there is adequate liquidity in the other business. There is no guarantee that if such a liquidity need were to arise, we would have the ability to make the appropriate inter-company distributions. In addition, there can be no guarantee that external funds would be available in a timely manner, at an appropriate cost or in a manner that would meet the requirements of the parties to the License Agreements or our credit facilities. If required funds could not be provided to either of our businesses, through internal or external sources, our financial position and results of operations could be materially adversely impacted.

Foreign Currency Fluctuations

While our business is primarily conducted in U.S. dollars, we do operate in certain foreign currencies. However, because we purchase substantially all of our products overseas, the cost of these products may be affected by changes in the values of the relevant currencies. To date, we have not significantly hedged against foreign currency fluctuations; however we may pursue hedging alternatives in the future. Since our expansion into Canada in fiscal 2002, our exposure to the risk of foreign currency fluctuations has increased. Foreign currency fluctuations could have a material adverse effect on our business and results of operations.

Dependence on Unaffiliated Manufacturers and Independent Agents

We do not own or operate any manufacturing facilities, and therefore, are dependent upon independent third parties for the manufacture of all of our products. Our products are currently

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manufactured to our specifications, pursuant to purchase orders, by more than 250 independent manufacturers located primarily in Asia. We have no exclusive or long-term contracts with our manufacturers and compete with other companies for manufacturing facilities. In addition, we have no formal written agreement with the Hong Kong-based trading company through which we purchased approximately 11% of our products in fiscal 2005. We also purchased approximately 13% of our products in fiscal 2005 from a single agent in Taiwan, which has an exclusive arrangement with us, but is not obligated to sell exclusively to us. Although we believe that we have established close relationships with our trading company, independent agents and principal manufacturers, the inability to maintain such relationships or to find additional sources to support future growth could have a material adverse effect on our business.

Material Breach of Disney License Agreement

The Disney Store business operates under a License Agreement with an affiliate of Disney, under which we have the right to use certain Disney intellectual property in the Disney Store business in exchange for ongoing royalty payments. Upon the occurrence of certain specified events, including an uncured breach of royalty non-payment and other repeated material breaches of the License Agreement by our subsidiaries, certain material breaches by us of a guaranty and commitment, and certain changes in ownership or control of The Children’s Place Retail Stores, Inc. or the subsidiaries that own and operate the Disney Store business, Disney will have the right to terminate the License Agreement. Some of these events may be beyond our control. If the License Agreement is terminated, the Disney affiliate may require us to sell the Disney Store business back to Disney or one of its affiliates or to a third party at a price to be determined by appraisal or, in the absence of such sale, to wind down the Disney Store business in an orderly manner.

Risk of Operating Stores in Foreign Countries

During fiscal 2002, we opened our first The Children’s Place stores in Canada and during fiscal 2004 we opened our first The Children’s Place stores in Puerto Rico. We cannot assure you that we will be able to address in a timely fashion the risks of operating stores in foreign countries such as governmental requirements over merchandise importation, employment, taxation and multi-lingual requirements.

Threat of Terrorism or Military Actions

We are dependent upon the continued popularity of malls as shopping destinations and the ability of mall anchor tenants and other attractions to generate customer traffic in the malls where our stores are located. Any terrorist act that decreases the level of mall traffic or other shopping traffic could have a material adverse effect on our business. In addition, military actions could negatively impact mall traffic, which would have a material adverse effect on our business.

Reliance on Information Technology

We rely on various information systems to manage our operations and regularly make investments to upgrade, enhance or replace such systems. Any delays or difficulties in transitioning to these or other new systems, or in integrating these systems with our current systems, or any other disruptions affecting our information systems, could have a material adverse effect on our business.

Dependence on Key Personnel

The leadership and expertise of Ezra Dabah, Chairman and Chief Executive Officer, has been instrumental in our success. The loss of the services of Mr. Dabah could have a material adverse effect on our business. We have entered into an employment agreement with Mr. Dabah, but we cannot assure you that we will be able to retain his services. In addition, other members of management have substantial

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experience and expertise in our business and have made significant contributions to its growth and success. Most of these members of management do not have employment agreements with us. The loss of services of one or more of these individuals, or the inability to attract additional qualified managers or other personnel, could have a material adverse effect on our business. We are not protected by any key-man or similar life insurance for any of our executive officers.

Control by Certain Stockholders

Ezra Dabah, Chairman and Chief Executive Officer, and certain members of his family beneficially own a significant percentage of our outstanding common stock. As a result, Mr. Dabah has, and will continue to have, significant influence on the election of our directors and on determining the outcome of any matter submitted to a vote of our stockholders for approval.

Stock Price Volatility

Our common stock, which is quoted on the Nasdaq National Market, has experienced and is likely to experience significant price and volume fluctuations, which could adversely affect the market price of the common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in our financial results, our comparable store sales results, announcements by other retailers or Disney, the overall economy, the geopolitical environment and the condition of the financial markets could cause the price of our common stock to fluctuate substantially.

Legislative Actions and New Accounting Pronouncements

In order to comply with the Sarbanes-Oxley Act of 2002 and any subsequent guidance that may come from the Public Company Accounting Oversight Board, future changes in listing standards by Nasdaq, or future accounting guidance or disclosure requirements by the Securities and Exchange Commission, we may be required to enhance our internal controls, hire additional personnel and utilize additional outside legal, accounting and advisory services, all of which could cause our general and administrative expenses to increase. Effective in the first quarter of fiscal 2006, we will be required to recognize compensation expense for stock-based compensation, which will negatively impact future operating results. Proposed changes in the accounting rules, including legislative and other proposals could increase the expenses we report under generally accepted accounting principles in the United States and affect our operating results.

Anti-Takeover Provisions of Applicable Delaware Law and Our Certificate of Incorporation and Bylaws

Certain provisions of our Amended and Restated Certificate of Incorporation (the “Certificate of Incorporation”) and Amended and Restated By-laws (the “By-laws”) may have anti-takeover effects and discourage, delay or prevent a takeover attempt that a stockholder might consider in the stockholder’s best interest. These provisions, among other things:

·       classify our Board of Directors into three classes, each of which will serve for different three year periods;

·       provide that only the Chairman of the Board of Directors may call special meetings of the stockholders;

·       provide that a director may be removed by stockholders only for cause by a vote of the holders of more than two-thirds of the shares entitled to vote;

·       provide that all vacancies on our Board of Directors, including any vacancies resulting from an increase in the number of directors, may be filled by a majority of the remaining directors, even if the number is less than a quorum;

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·       establish certain advance notice procedures for nominations of candidates for election as directors and for stockholder proposals to be considered at stockholders’ meetings; and

·       require a vote of the holders of more than two-thirds of the shares entitled to vote in order to amend the foregoing provisions and certain other provisions of the Certificate of Incorporation and By-laws.

In addition, the Board of Directors, without further action of the stockholders, is permitted to issue and fix the terms of preferred stock, which may have rights senior to those of the common stock. Moreover, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, as amended, which would require a two-thirds vote of stockholders for any business combination (such as a merger or sales of all or substantially all of our assets) between The Children’s Place and an “interested stockholder,” unless such transaction is approved by a majority of the disinterested directors or meets certain other requirements. In certain circumstances, the existence of these provisions, which inhibit or discourage takeover attempts, could reduce the market value of our common stock.

ITEM 1B.—UNRESOLVED STAFF COMMENTS

None.

ITEM 2.—PROPERTIES

We currently support both The Children’s Place stores and Disney Stores with a 525,000 square foot distribution center in South Brunswick Township, New Jersey; a 250,000 square foot distribution center in Ontario, California; and a 95,000 square foot distribution center in Ontario, Canada. Our distribution centers utilize automated warehouse systems, which employ radio frequency technology and automated conveyor systems. Our approximately 150,000 square foot fulfillment center in Secaucus, New Jersey is used to support our Internet business. In addition, we operate other leased facilities on a seasonal basis to support warehousing needs as well as our headquarters, in Secaucus, New Jersey and Glendale, California. We also have offices in Hong Kong, Shanghai and New Delhi to capitalize on new and existing sourcing opportunities and monitor product quality. Given our current growth plans, we are in active search for an additional distribution center and corporate office facility.

We lease all of our existing store locations, with the store lease terms expiring through 2023. The average unexpired store lease term for The Children’s Place and Disney Store is 5.5 and 4.4 years, respectively. The leases for most of our existing stores are for initial terms of 10 years and provide for contingent rent based upon a percentage of sales in excess of specific minimums. Leases for future stores will likely include similar contingent rent provisions.

ITEM 3.—LEGAL PROCEEDINGS

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

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

None.

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PART II

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

Our common stock is listed on the Nasdaq National Market under the symbol “PLCE.”  The following table sets forth the range of high and low sales prices on the Nasdaq National Market of our common stock for the fiscal periods indicated.

On February 25, 2006, the last reported sale price of our common stock was $44.26 per share, the number of holders of record of our common stock was approximately 110 and the number of beneficial holders of our common stock was approximately 17,000.

We have never paid dividends on our common stock or purchased any of our common stock. Our Board of Directors presently intends to retain any future earnings to finance our operations and the expansion of the Company. Our credit facilities and/or License Agreement prohibit any payment of dividends and limit the amount of purchases of our common stock. Any determination in the future to pay dividends or purchase any of our common stock will depend upon our earnings, financial condition, cash requirements, future prospects, covenants in our credit facilities and any future debt instruments and such other factors as the Board of Directors deems appropriate at the time.

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ITEM 6.—SELECTED FINANCIAL DATA

The following table sets forth certain historical financial and operating data for The Children’s Place Retail Stores, Inc. and subsidiaries. The selected historical financial data is qualified by reference to, and should be read in conjunction with, Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the financial statements and notes thereto included elsewhere in this report.

(1)           All references to our fiscal years refer to the 52- or 53-week year ended on the Saturday nearest to January 31 of the following year. For example, references to fiscal 2005 mean the fiscal year ended January 28, 2006.

(2)           The statement of operations data for fiscal 2004 includes ten weeks of operations for the Disney Stores from their acquisition date of November 21, 2004. The Disney Stores were not included in average net sales per store and

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average net sales per gross foot during fiscal 2004 since we did not own them for the full fiscal period. The Disney Stores were also not included in comparable store sales in fiscal 2004 and fiscal 2005.

(3)           In fiscal 2005, we retrospectively applied the new accounting principle regarding expensing occupancy costs incurred during the construction period. (See Note 4—Retrospective Application of Construction Period Occupancy Costs in the accompanying consolidated financial statements.)

(4)           Asset impairment charges represent the write down of fixed assets in under performing stores to fair value. We impaired assets in one store in fiscal 2005, one store in fiscal 2004, one store in fiscal 2003 and 19 stores in fiscal 2002.

(5)           The extraordinary gain represents the fair value of net assets acquired in excess of the purchase price paid for the DSNA Business, after all long-lived assets were written off.

(6)           We define comparable store sales as net sales from stores that have been open for at least 14 full months and that have not been substantially remodeled during that time.

(7)           Average net sales per store represents net sales from stores open throughout the full period divided by the number of such stores.

(8)           Average square footage per store represents the square footage of stores open on the last day of the period divided by the number of such stores.

(9)           Average net sales per gross square foot represents net sales from stores open throughout the full period divided by the gross square footage of such stores.

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ITEM 7.—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our audited financial statements and notes thereto included in Item 15. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in “Risk Factors.”

The accompanying consolidated financial statements have been adjusted as described in Note 4—Retrospective Application of Construction Period Occupancy Costs and the following discussion has been revised to reflect the effects of the retrospective application.

Overview

The Children’s Place Retail Stores, Inc. and subsidiaries (the “Company” or “we”) is a specialty retailer of merchandise for children from newborn to ten years of age. We design, contract to manufacture and sell high-quality, value priced apparel and accessories and other children’s-oriented merchandise under two brands and store concepts—“The Children’s Place” and “Disney Store.” As of February 25, 2006, we operated 802 The Children’s Place stores in the United States, Canada and Puerto Rico and 316 Disney Stores in the United States and Canada. In addition, we currently operate an Internet store at www.childrensplace.com.

During fiscal 2005, as a result of the execution of our strategic initiatives, we achieved strong financial results. Net sales in fiscal 2005 increased $511.2 million, or 44%, to $1.669 billion, compared to net sales of $1.158 billion reported in fiscal 2004. During fiscal 2005, net sales from our The Children’s Place business increased $176.9 million, an 18% increase over fiscal 2004. In addition, net sales from our Disney Store business increased $334.3 milion, a 205% increase over fiscal 2004, reflecting a full year of operations in fiscal 2005 versus 10 weeks of operations in fiscal 2004.

During fiscal 2005, The Children’s Place brand’s comparable store sales increased 9% compared to a 16% increase in fiscal 2004. Correspondingly, we believe our market share in children’s apparel according to NPD increased to 4.2% in fiscal 2005 from 3.7% in fiscal 2004.

Net income in fiscal 2005 was $65.6 million, or $2.27 per diluted share, compared to net income of $42.8 million, or $1.55 per diluted share in fiscal 2004.

During fiscal 2005, our strategy was to build on our progress at The Children’s Place stores by continuing to focus on increasing store productivity and elevating our brand awareness. We opened 55 The Children’s Place stores in fiscal 2005, and closed three.

The Disney Store business’ focus in fiscal 2005 was on improving gross margin through reduced product sourcing costs and better markdown control, while providing our guest with improved merchandise quality at lower retail prices. Due to the long lead time of our merchandise purchases, we began to impact our gross margin in the back-to-school season. During fiscal 2005, we opened 18 Disney Stores, remodeled 32 Disney Stores, and closed seven.

As of January 28, 2006, consolidated merchandise inventories at cost increased by $52.7 million, or approximately 33% (26% on a per square foot basis) versus January 29, 2005. For The Children’s Place, inventory at cost increased 15% on a per square foot basis due primarily to the earlier flow of our spring inventory. Disney Store inventory at cost was up approximately 57% on a per square foot basis, reflecting our depressed levels of inventory at the end of fiscal 2004, our planned unit increase in support of our value pricing strategy and earlier future season flows.

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We expect The Children’s Place business to end the first quarter of fiscal 2006 with inventory per square foot up approximately 30% versus a 9% decline last year, which reflects earlier summer and back-to-school flows; increased investment in summer merchandise; and increased levels of basic denim as we cycle out of our existing program and prepare for a new denim assortment. At Disney Store, we expect to end the first quarter with inventory per square foot up in the low 20 percent range, reflecting our increased investment in apparel merchandise and to support our value pricing strategy.

During the nine-week period ended April 1, 2006, we reported total sales of $287.3 million, a 10% increase compared to sales of $261.5 million during the nine-week period ended April 2, 2005. Sales for the nine-week period included $217.9 million from The Children’s Place and $69.4 million from Disney Store. Our consolidated comparable store sales increased by 4% during the nine weeks ended April 1, 2006. The Children’s Place business recorded a comparable store sales increase of 3%, compared to a 15% increase in the corresponding nine-week period last year. For the nine-week period ended April 1, 2006, our Disney Store business recorded a comparable store sales increase of 6%. In February 2006, the Disney Stores entered our comparable store sales base, therefore, a prior year comparable store sales figure is not available. We define comparable store sales as net sales from stores that have been open at least 14 months and have not been substantially remodeled during that time. Disney Stores’ comparable stores sales results may be more volatile than those of The Children’s Place given one time events that occur from year to year such as major theatrical movie releases or DVD releases.

Retrospective Application of Construction Period Occupancy Costs

In October 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP)” FAS No. 13-1, “Accounting for Rental Costs Incurred during a Construction Period” (“FSP FAS No. 13-1”). The FASB concluded that rental costs incurred during and after the construction period are for the right to control the use of a leased asset and must be recognized as rental expense. These costs were previously capitalizable if a company had a policy to do so. Our policy had been to capitalize occupancy costs incurred during construction and amortize these costs over the life of the lease.

Since we would have been required to expense construction period occupancy costs at the beginning of fiscal 2006, we have retrospectively applied FSP FAS No. 13-1 to consistently charge occupancy costs incurred during construction as a period expense. The net effect of this application increases pre-opening expense, which is included in our selling, general and administrative expenses, in the period we take possession of a new store, distribution center or office facility. Since these costs are no longer capitalized, the retrospective application eliminated the related depreciation expense over the lease term.

In fiscal 2004 and fiscal 2003, selling, general and administrative expenses increased by $3.6 million and $2.8 million, respectively. Depreciation expense decreased by $2.8 million in fiscal 2004 and $2.4 million in fiscal 2003. Net income for fiscal 2004 and fiscal 2003 is now $42.8 million, or diluted net income per share of $1.55, and $22.7 million, or diluted net income per share of $0.84, respectively. In addition to the changes in net income, adjusted net property and equipment, total assets and total stockholders’ equity as of January 29, 2005 were $204.4 million, $616.2 million and $300.9 million, respectively.

While the retrospective application did not change our total cash position, cash flow from operations decreased in the period that occupancy costs were incurred during construction, partially offset by lower depreciation expense. In addition, cash flows used in investing activities were lower as a result of no longer capitalizing occupancy costs during construction. For fiscal 2004 and fiscal 2003, cash flows provided by operating activities decreased by approximately $3.7 million and $2.8 million, respectively. Cash flows used in investing activities decreased approximately $3.7 million and $2.8 million in fiscal 2004 and fiscal 2003, respectively.

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Critical Accounting Policies

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

Revenue Recognition—Sales are recognized upon purchase by customers at our retail stores or when received by the customer if the product was purchased via the Internet, net of coupon redemptions and anticipated sales returns. Actual sales return rates have historically been within our expectations and the allowance established. However, in the event that the actual rate of sales returns by customers increased significantly, our operational results could be adversely affected. Our net sales include the 7% commission we receive from a subsidiary of The Walt Disney Company on the sale of Walt Disney WorldÒ Resort and DisneylandÒ Resort tickets.

Our policy with respect to gift cards is to record revenue as gift cards are redeemed for merchandise. Prior to their redemption, unredeemed gift cards for The Children’s Place business are recorded as a liability, included within accrued expenses and other current liabilities. During fiscal 2005, we recognized $1.3 million as income from gift cards that are not expected to be redeemed based upon an extended period of dormancy. For the Disney Store, we act as an agent on behalf of a subsidiary of The Walt Disney Company for gift cards sold to customers. Therefore, we do not record a customer gift card liability for the Disney Store. However, we recognize a trade payable to Disney for the net purchase of Disney gift cards.

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

Inventory Valuation—Merchandise inventories are stated at the lower of average cost or market, using the retail inventory method. Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are calculated by applying a cost-to-retail ratio by merchandise department to the retail value of inventories. At any one time, inventories include items that have been marked down to our best estimate of their fair market value and an estimate of our inventory shrinkage.

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. To the extent that our markdown estimates are not adequate, additional markdowns may have to be recorded, which could reduce our gross margins and operating results. Our success is largely dependent upon our ability to gauge the fashion taste of our customers, including the popularity and relevancy of the Disney characters, and to provide a well-balanced merchandise assortment that satisfies customer demand. Any inability to provide the proper quantity of appropriate merchandise in a timely manner could increase future markdown rates.

We adjust our inventory balance based on an annual physical inventory and we estimate our shrinkage rate based on the historical results of our physical inventories in consideration of current year facts and circumstances. To the extent our shrinkage estimate is not adequate, we would be required to reduce our gross profits and operating results.

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

We were granted a royalty holiday for all stores until November 2006. In addition, depending on the specific store location, certain stores have an extension of the royalty holiday for up to eight years from the date of the License Agreement. The actual value of the royalty holiday is not determinable until the completion of the royalty holiday period, and may differ materially from our current estimate. Estimates for the royalty holiday are adjusted on a periodic basis, and the cumulative adjustment is recorded in such period. The amortization of the estimated value of the royalty holiday is recognized on a straight-line basis as a reduction of royalty expense over the term of the License Agreement. Royalty expense, and the associated amortization of the royalty holiday, is recorded in selling, general and administrative expenses.

The royalty percentage does not increase over the term of the License Agreement. We expect to pay a 9% royalty on Internet sales, and in some instances, 10%. In fiscal 2006, we expect net royalty expense to approximate 4.3% of Disney Store net sales.

Insurance and Self-Insurance Liabilities—Based on our assessment of risk and cost efficiency, we self-insure and purchase insurance policies to provide for workers’ compensation, general liability, and property losses, as well as director’s and officer’s 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. While we believe that our risk assessments are appropriate, to the extent that future occurrences and claims differ from our historical experience, additional charges for insurance may be recorded in future periods.

Accounting for Acquisitions—The acquisition of the DSNA Business was accounted for under the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations (“SFAS 141”). As such, we analyzed the fair value of identified tangible and intangible assets acquired and liabilities assumed, and determined the excess of fair value of net assets acquired over cost. This excess was recorded as an extraordinary gain in fiscal 2005 and fiscal 2004.

Stock Options—Historically, we have not recorded compensation expense for stock-based compensation since we grant stock options at prices that equal or exceed the fair market value of our common stock at the date of the grant. Beginning in the first quarter of fiscal 2006, we will be required to recognize compensation expense in an amount equal to the fair value of the stock-based compensation granted to employees, recognized ratably over the vesting period. In fiscal 2005, to minimize the impact of past option grants on future operating results, we accelerated the vesting of approximately 2.1 million stock options and recorded a share-based compensation charge of $2.1 million, which represented our estimate of intrinsic value that would have been forfeited had we not accelerated option vesting. Reflecting prior option grants and expected fiscal 2006 equity grants, in fiscal 2006, we anticipate that shared-based compensation expense will approximate $13 million, assuming 100% achievement of certain performance-based equity awards.

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

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Results of Operations

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

Year Ended January 28, 2006 Compared to Year Ended January 29, 2005

Net sales increased $511.2 million, or 44%, to $1.669 billion during fiscal 2005 from $1.158 billion during fiscal 2004. Sales for fiscal 2005 were comprised of $1.171 billion from The Children’s Place business, an 18% increase over the $994.1 million reported in fiscal 2004 and $497.7 million in sales from the Disney Store business, a 205% increase over the $163.4 million reported in fiscal 2004. Disney Store results in fiscal 2005 reflect a full year of operation versus 10 weeks of operations in fiscal 2004. Our fiscal 2005 net sales increase resulted from $429.7 million in net sales from new stores and other stores that did not qualify as comparable stores and $81.5 million in net sales from comparable stores. We define comparable store sales as net sales from stores that have been open at least 14 full months and that have not been substantially remodeled during that time. Comparable store sales increased 9% as compared to a 16% comparable store sales increase in fiscal 2004. During fiscal 2005, our comparable store sales increase was the result of a 6% increase in our average dollar transaction size and a 3% increase in the number of comparable store sales transactions. Due to the acquisition of the DSNA Business in fiscal 2004, the Disney Store business did not have any comparable stores in fiscal 2005. 260 Disney Stores entered our comparable store base in February 2006.

During fiscal 2005, we achieved comparable store sales increases across all geographical regions, departments, and store types in The Children’s Place business. Our West, Southwest, Southeast, and Canadian regions reported the strongest comparable store sales increases. By department, our comparable store sales increases were in line with the chain average, except for our newborn department, which reported a low single-digit comparable store sales increase.

During fiscal 2005, we opened 55 The Children’s Place stores, 41 in the United States, 10 in Canada and four in Puerto Rico. We also opened 18 Disney Stores, 16 in the United States and two in Canada. We closed three The Children’s Place stores and seven Disney Stores in fiscal 2005.

Consolidated gross profit increased by $209.3 million to $661.2 million during fiscal 2005 from $451.9 million during fiscal 2004. As a percentage of net sales, gross profit increased to 39.6% during fiscal 2005 from 39.0% during fiscal 2004. This increase in gross profit, as a percentage of net sales, was comprised primarily of a higher merchandise margin of 1.2% of net sales and the impact of the sell through of acquired Disney Store inventory, which was favorable to fiscal 2004 by 0.3% of net sales, partially offset by higher distribution and occupancy costs of 0.9% of net sales due to costs associated with our new

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distribution center facility. During fiscal 2005, the sell through of acquired Disney Store inventory unfavorably impacted gross margin by $1.2 million, or 0.1% of net sales, as compared to an unfavorable impact of $5.0 million, or 0.4% of net sales during fiscal 2004. In accounting for the acquisition of the DSNA Business, we were required to write-up acquired inventory to its fair value from the value determined under the retail inventory method. For The Children’s Place business, our gross margin was higher in fiscal 2005 than in fiscal 2004 due to a higher initial markup, lower markdowns and the leveraging of occupancy expenses, partially offset by higher distribution costs. While Disney Store continues to have a lower gross margin structure than The Children’s Place business, it has benefited from improved markdown performance and the implementation of our low-cost sourcing strategies.

Selling, general and administrative expenses increased $172.0 million to $505.7 million during fiscal 2005 from $333.7 million during 2004. As a percentage of net sales, selling, general and administrative expenses increased 1.5% to 30.3% of net sales during fiscal 2005 from 28.8% of net sales during fiscal 2004. This increase, as a percentage of net sales, was due primarily to Disney Store expenses that we did not have last year such as royalty expense, which was $12.9 million higher than last year, and remodel expenses. In addition, higher repair, maintenance and utility expense, and higher payroll expense, partially offset by favorable medical costs, contributed to the increase as a percentage of sales. In fiscal 2005, Disney royalty and remodel expenses represented approximately 0.8% of net sales. During fiscal 2005, we remodeled 32 Disney Stores. During fiscal 2005, repair, maintenance and utility expenses were approximately 0.6% higher as a percentage of net sales due to our continued focus on enhancing the store environment, and increased utility costs. During fiscal 2005, store and administrative payroll was approximately 0.4% higher as a percentage of net sales, and medical costs were approximately 0.3% lower as compared to fiscal 2004.

Depreciation and amortization amounted to $52.9 million or 3.1% of net sales, during fiscal 2005, as compared to $49.0 million, or 4.2% of net sales, during fiscal 2004. Excluding the $1.7 million of depreciation expense associated with the Disney Store business, depreciation and amortization as a percentage of The Children’s Place brand sales approximated 4.4% in fiscal 2005, which reflects higher fiscal 2005 infrastructure capital expenditures such as our new distribution center and enterprise software platforms. Fiscal 2005 depreciation and amortization expense for the Disney Store business represents the expense for assets put in service during the year as we remodeled and opened new stores. No depreciation expense was recorded on acquired property and equipment since the fair value of net assets acquired exceeded the amounts paid for the DSNA Business.

Our income tax provision was $39.3 million during fiscal 2005 as compared to $26.6 million during fiscal 2004 due to our increased profitability. Our effective tax rate was 38.1% during fiscal 2005 versus 38.5% in fiscal 2004. The improvement in the effective tax rate reflects tax efficiencies that were identified in the course of our global operations review, partially offset by the $1.9 million expense associated with our approximately $45 million repatriation under the American Jobs Creation Act.

During fiscal 2005, we recorded a $1.7 million extraordinary gain, net of taxes. This extraordinary gain represented the incremental gain required to be recognized upon the finalization of purchase accounting for the DSNA Business. The extraordinary gain arose because the fair value of net assets acquired was in excess of the amounts paid to acquire the DSNA Business.

Due to factors discussed above, net income for fiscal 2005 increased $22.8 million to $65.6 million from $42.8 million in fiscal 2004.

Year Ended January 29, 2005 Compared to Year Ended January 31, 2004

Net sales increased by $359.6 million, or 45%, to $1.158 billion during fiscal 2004 from $797.9 million during fiscal 2003. Net sales include $163.4 million from the ten weeks we operated the Disney Stores since their acquisition on November 21, 2004. Net sales from our The Children’s Place business increased $196.2 million, or 25% during fiscal 2004. Comparable store sales increased 16% and contributed $116.8

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million of our net sales increase during fiscal 2004. During fiscal 2004, our comparable store sales increase was the result of a 13% increase in the number of comparable store sales transactions and a 2% increase in our average dollar transaction size. Comparable store sales increased 4% during fiscal 2003. Net sales for our new stores as well as other stores that did not qualify as comparable stores increased our net sales by $79.4 million.

During fiscal 2004, we opened 62 The Children’s Place stores, 43 in the United States, 13 in Canada and six in Puerto Rico. In addition, we closed three The Children’s Place stores and seven Disney Stores in fiscal 2004.

During fiscal 2004, we achieved double-digit comparable store sales increases across all geographical regions, departments and store types in The Children’s Place business. Our West and Southwest regions reported the strongest comparable store sales increases. By department, our accessories and boys departments achieved the highest comparable store sales increases.

Gross profit increased $130.9 million to $451.9 million during fiscal 2004 from $321.0 million during fiscal 2003. As a percentage of net sales, gross profit decreased to 39.0% during fiscal 2004 from 40.2% during fiscal 2003. The decrease in gross profit, as a percentage of net sales, was principally due to lower merchandise margins and the impact of the fair value write-up of Disney Store inventory, partially offset by the leveraging of occupancy costs over a larger sales base. For The Children’s Place business, as a percentage of net sales, our merchandise margins were 2.0% lower than last year due to a lower initial markup partially offset by lower markdowns. Our Disney Store business merchandise margins are lower than The Children’s Place business; this unfavorably impacted gross margin by 1.4%, as a percentage of net sales. Overall, the Disney Store business has a lower initial markup than The Children’s Place business. As mentioned above, gross profit during fiscal 2004 was unfavorably impacted by a $5.0 million charge, or 0.4% of net sales, for the write-up of the acquired Disney Store inventory sold during the ten weeks ended January 29, 2005 to its fair value from the value determined under the retail inventory method. Approximately $1.2 million in fair value inventory write-up remained on our balance sheet as of January 29, 2005, which was charged to cost of sales during the first quarter of fiscal 2005. The remaining unfavorable gross margin variance, as a percentage of net sales, resulted primarily from higher distribution and buying expenses. During fiscal 2004, occupancy costs, as a percentage of net sales, decreased 3.0% as a result of our comparable store sales increase and larger sales base.

Selling, general and administrative expenses increased $95.1 million to $333.7 million during fiscal 2004 from $238.6 million during fiscal 2003. Selling, general and administrative expenses were 28.8% of net sales during fiscal 2004 as compared to 29.9% of net sales during fiscal 2003. As a percentage of net sales, selling, general and administrative expenses decreased due to lower store payroll and the leveraging of store expense, partially offset by Disney Store royalty expense and transition services associated with the acquisition of the Disney Stores. Due to our strong comparable store sales performance during fiscal 2004, our store payroll expenses were 1.4% lower, as a percentage of net sales, than fiscal 2003. Disney Store royalty expense and transition costs represented approximately 1.0% of net sales during fiscal 2004. The remainder of our favorable selling, general and administrative expenses, as a percentage of net sales, resulted primarily from the leveraging of store expenses.

Depreciation and amortization amounted to $49.0 million, or 4.2% of net sales, during fiscal 2004, as compared to $46.3 million, or 5.8% of net sales, during fiscal 2003. The decrease in depreciation and amortization, as a percentage of net sales, is the result of the leveraging of the expense over a larger sales base and the absence of depreciation and amortization for the DSNA Business. Excluding Disney Store sales, fiscal 2004 depreciation and amortization as a percentage of sales approximates 4.9% versus 5.8% of sales in fiscal 2003. This improvement in percentage of net sales relates primarily to the 16% same store sales improvement. Consistent with US GAAP, since the fair value of net assets acquired exceeded the

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amounts paid to acquire the DSNA Business, we recorded no basis in the property and equipment we acquired with the DSNA Business, and therefore no depreciation expense was recorded.

Our provision for income taxes for fiscal 2004 was $26.6 million, as compared to a $13.6 million provision in fiscal 2003. The increase in our tax provision was primarily due to our increased profitability in fiscal 2004, as well as an increase in our effective tax rate. Our effective tax rate was 38.5% in fiscal 2004 compared to 37.5% in fiscal 2003. Our effective tax rate in fiscal 2003 was favorably impacted by the reversal of a $1.6 million valuation allowance on a prior year loss incurred by our Canadian subsidiary.

During fiscal 2004, we recorded a $0.3 million extraordinary gain, net of taxes. This extraordinary gain represents the preliminary fair value of net assets acquired in excess of amounts paid to acquire the DSNA Business.

Due to the factors discussed above, net income in fiscal 2004 increased $20.1 million to $42.8 million from $22.7 million in fiscal 2003.

Liquidity and Capital Resources

Debt Service/Liquidity

Our working capital needs follow a seasonal pattern, peaking during the second and third quarters when inventory is purchased for the back-to-school and holiday selling seasons. Our primary uses of cash are financing new store openings and providing for working capital, which principally represent the purchase of inventory. We have been able to meet our cash needs principally by using cash on hand, cash flows from operations and seasonal borrowings under our credit facilities.

We manage liquidity for The Children’s Place and Disney Stores separately, including cash receipts and disbursements, investments, and credit facility borrowings and letter of credit activity. The terms of the License Agreement, the Hoop Loan Agreement (as defined below) and the Amended Loan Agreement (as defined below), among other things, restrict the commingling of funds between The Children’s Place and the Hoop Operating Entities, and borrowings and certain distributions from the Hoop Operating Entities to The Children’s Place. Therefore, we have maintained segregation of all cash receipts and disbursements, investments, and credit facility borrowings and letter of credit activity. This segregation could lead to a liquidity need in one business while there is adequate liquidity in the other business. We believe that cash flow from operations and availability and borrowings under their respective credit facilities will be adequate to fund the growth needs and operations of each division. At this time, we do not foresee a need for The Children’s Place business to provide additional capital to the Disney Store business for that business to meet its growth objectives or operating commitments, nor do we foresee a need for the Disney Store business to make a distribution to its parent, other than normal payment of intercompany operating obligations, in order for The Children’s Place business to meet its growth objectives or operating commitments.

We entered into a Guaranty and Commitment (the “Guaranty and Commitment”) dated as of November 21, 2004, in favor of the Hoop Operating Entities and Disney. As required by the Guaranty and Commitment, we invested $50 million in the Hoop Operating Entities concurrently with the consummation of the acquisition, and agreed to invest up to an additional $50 million to enable the Hoop Operating Entities to comply with their obligations under the License Agreement and otherwise fund the operations of the Hoop Operating Entities.  To date, we have not been required to invest any of this additional $50 million in the Hoop Operating Entities in order to comply with the terms of the License Agreement. We also agreed to guarantee the payment and performance of the Hoop Operating Entities (for their royalty payment and other obligations to Disney), subject to a maximum guaranty liability of $25 million, plus expenses.

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

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

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

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

In the normal course of business, the Hoop Operating Entities have reimbursed intercompany services but have not paid any dividends or made other distributions. During the fourth quarter of fiscal 2006, we plan to evaluate the Hoop Operating Entities’ ability to reimburse the Company for all or a portion of the $61.9 million described above. We do not expect the Hoop Operating Entities to pay dividends to the Company during the next 12 months. The Hoop Operating Entities cash on hand and cash generated from operations will be utilized to finance store remodels and provide working capital. The License Agreement also restricts the incurrence of indebtedness in excess of certain permitted amounts.

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

The Amended Loan Agreement is secured by a first priority security interest in substantially all of our assets, other than assets in Canada and assets owned by our subsidiaries that were formed in connection with the acquisition of the DSNA Business.   Amounts outstanding under the Amended Loan Agreement bear interest at a floating rate equal to the prime rate or, at our option, a LIBOR rate plus a pre-determined margin. The LIBOR margin is 1.50% to 3.00%, and the unused line fee under the Amended Loan Agreement is 0.38%. The Amended Loan Agreement also contains covenants, which include limitations on our annual capital expenditures, maintenance of certain levels of excess collateral and a prohibition on the payment of dividends.

As of January 28, 2006, there were no borrowings under the Amended Loan Agreement as compared to $37.3 million in borrowings as of January 29, 2005. During fiscal 2005, our maximum borrowings under the Amended Loan Agreement were $58.2 million. Availability under the Amended Loan Agreement as of January 28, 2006 was $74.1 million as compared to availability of $15.3 million as of January 29, 2005. Letters of credit outstanding under the Amended Loan Agreement as of January 28, 2006 were $49.2 million as compared with $42.2 million as of January 29, 2005.  The interest rates charged under the Amended Loan Agreement were 7.25% and 5.25% per annum as of January 28, 2006 and January 29, 2005, respectively.

As of November 21, 2004, the domestic Hoop Operating Entity entered into a Loan and Security Agreement (the “Hoop Loan Agreement”) with certain financial institutions and Wells Fargo, as

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administrative agent, establishing a senior secured credit facility for the Hoop Operating Entities. The Hoop Loan Agreement provides for borrowings up to $100 million (including a sublimit for letters of credit of $90 million), subject to the amount of eligible inventory and accounts receivable of the domestic Hoop Operating Entity. The term of the facility extends until November 21, 2007.

The Hoop Loan Agreement contains various covenants, including limitations on indebtedness, maintenance of certain levels of excess collateral and restrictions on the payment of dividends and indebtedness. Credit extended under the Hoop Loan Agreement is secured by a first priority security interest in substantially all the assets of Hoop USA and Hoop Canada as well as a pledge of a portion of the equity interests in Hoop Canada. Borrowings and letters of credit under the Hoop Loan Agreement are used by Hoop USA and its subsidiary Hoop Canada for working capital purposes for the DSNA Business. Amounts outstanding under the Hoop Loan Agreement bear interest at a floating rate equal to the prime rate plus a pre-determined margin or, at Hoop Operating Entity’s option, the LIBOR rate plus a pre-determined margin. The prime rate margin is 0.25% and the LIBOR margin is 2.0% or 2.25%, depending on the domestic Hoop Operating Entity’s level of excess availability.

As of January 28, 2006 and as of January 29, 2005, we had no borrowings under the Hoop Loan Agreement. Letters of credit outstanding were $25.8 million and $35.4 million as of January 28, 2006 and January 29, 2005, respectively. Availability under the Hoop Loan Agreement was $16.3 million and $4.4 million as of January 28, 2006 and January 29, 2005, respectively. During fiscal 2005, there were no borrowings under the Hoop Loan Agreement other than letters of credit that cleared after business hours. The average loan balance under the Hoop Loan Agreement during fiscal 2005 approximated $435,000. The maximum overnight borrowings during fiscal 2005 were $4.8 million. The interest rate charged under the Hoop Loan Agreement was 7.50% and 5.50% per annum as of January 28, 2006 and January 29, 2005, respectively.

During fiscal 2006, we expect to have seasonal borrowings under the Amended Loan Agreement and the Hoop Loan Agreement. We expect to use both credit facilities to support letters of credit throughout fiscal 2006.

We were in compliance with all of the covenants, as amended, under the Amended Loan Agreement and the Hoop Loan Agreement as of January 28, 2006. Noncompliance with these covenants could result in additional fees, affect our ability to borrow or require us to repay the outstanding balance.

Cash Flows/Capital Expenditures

Cash flows provided by operating activities were $115.9 million, $209.2 million, and $77.2 million in fiscal 2005, fiscal 2004 and fiscal 2003, respectively. In fiscal 2005, cash flow from operations were driven by net income of $65.6 million. Significant non-cash expenses included $52.9 million of depreciation and amortization expense and $20.0 million of net royalty expense. In fiscal 2005, we were in the royalty holiday period for our Disney Stores, and therefore, all of the royalty expense was non-cash. The major operating asset that was used in operating activities was inventories, which accounted for approximately $51.4 million. This increase in inventories primarily reflected the earlier flow of our spring inventory for both businesses, and for Disney Stores, our planned unit increase in support of our value pricing strategy. Offsetting this use of cash flows in operating activities were a $38.7 million increase in taxes payable resulting from our higher taxable income in fiscal 2005 and the timing of estimated tax payments, and a $24.1 million increase in deferred rent liabilites primarily reflecting the growth in landlord incentives received for new stores opened at The Children’s Place. In fiscal 2004, cash flow from operating activities increased primarily as a result of the cash conversion of acquired Disney Store net working capital, which was primarily inventory, and increases in our current liabilities and operating earnings. In fiscal 2003, cash flow from operating activities was driven by the non-cash expenses such as depreciation and amortization

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expense, and investments in inventory offset by increases in accrued expenses, interest and other current liabilities and deferred rent, which included landlord incentives.

Cash flows used in investing activities were $89.0 million, $142.9 million, and $63.0 million in fiscal 2005, fiscal 2004 and fiscal 2003, respectively. During fiscal 2005, capital expenditures increased $31.4 million due to our increased number of new stores and remodels; investments made for our new distribution center in South Brunswick, New Jersey; upgrades in our other distribution centers to support the Disney Store acquisition; our new office facility in Pasadena, California; and other information technology infrastructure investments required to operate our significantly larger business. During fiscal 2004, cash flows used in investing activities increased primarily due to the acquisition of the DSNA Business for $107.3 million; capital expenditures related to store openings and remodelings; and investments in our logistics and information technology infrastructure, partially offset by the net sale of $22.3 million of auction rate securities. The number of new store openings and remodelings have a significant impact on our cash flows used in investing activities. In fiscal 2005, fiscal 2004 and fiscal 2003, we opened 73, 62 and 53 stores, respectively while remodeling 38, 13 and 11 stores, respectively. During fiscal 2003, cash flows used in investing activities also included a net $22.3 million investment in auction rate securities.

Cash flows (used in) provided by financing activities were $(21.3) million, $44.3 million, and $1.8 million in fiscal 2005, fiscal 2004 and fiscal 2003, respectively. During fiscal 2005, cash flows used in financing activities represented the repayment of borrowings under our revolving credit facilities, which reflects repayments of borrowings to fund the acquisition of the DSNA Business, offset by higher exercises of employee stock options and employee stock purchases. During fiscal 2004, cash flows provided by financing activities reflected funds received from borrowings under our revolving credit facilities, partly used to fund the acquisition of the DSNA Business, and funds received from the exercise of employee stock options and employee stock purchases. During fiscal 2003, cash flows provided by financing activities reflected funds received from the exercise of employee stock options and employee stock purchases.

We anticipate that total capital expenditures will approximate $146 million in fiscal 2006. We also anticipate receiving $26 million in lease incentives in fiscal 2006. The capital expenditures will relate primarily to the opening of approximately 65 The Children’s Place stores and approximately 15 Disney Stores, and the remodeling of approximately 20 The Children’s Place stores and 25 Disney Stores. During fiscal 2006, we also plan to expand our administrative office facilities and make improvements to our distribution centers. We believe that cash on hand, cash generated from operations and funds available under our credit facilities will be sufficient to fund our capital and other cash flow requirements for at least the next 12 months. Our ability to meet our capital requirements will depend on our ability to generate cash flows from operations. In addition, we may consider additional sources of financing to fund our long-term growth.

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Contractual Obligations and Commercial Commitments

The following tables summarize our contractual and commercial obligations as of January 28, 2006 (in thousands):