Childrens Place, Inc. quarterly report, Q3 FY2010

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Business context and reporting period

The Children’s Place Retail Stores, Inc. operates children’s apparel stores and an e-commerce business in the U.S. and Canada. This 10-Q covers the 13 weeks and 39 weeks ended October 30, 2010. Note: the request metadata says “2009 Q3,” but the filing itself is for third-quarter 2010.

At quarter-end, the company operated 1,005 stores: 903 in the U.S. and 102 in Canada, versus 950 stores a year earlier. The company cautions that results are seasonal and interim performance may not indicate full-year results.

Financial performance and liquidity

  • Third quarter: Net sales were $453.4 million, down 2.1% year over year. Gross profit was $182.3 million, down 9.7%; gross margin fell to 40.2% from 43.6%. Operating income was $50.0 million versus $64.8 million; net income was $31.3 million versus $37.8 million. Diluted EPS was $1.15 versus $1.37.
  • Year to date: Net sales were $1,220.8 million, up 3.4%. Gross profit was $475.6 million versus $473.7 million, while gross margin declined to 39.0% from 40.1%. Operating income rose to $84.6 million from $82.1 million; net income declined to $51.0 million from $54.2 million. Diluted EPS was $1.84 versus $1.87.
  • Cash flow, 39 weeks: Operating cash flow was $135.7 million, up from $72.3 million. Investing cash use was $63.6 million, including $63.3 million of capital expenditures. Financing cash use was $72.1 million, including $80.4 million for share repurchases. Cash increased $2.1 million to $170.5 million.
  • Balance sheet and liquidity: Cash was $170.5 million; current assets were $497.9 million and current liabilities $177.5 million. Working capital was $320.4 million, compared with $292.2 million a year earlier. No revolving-credit borrowings were outstanding; borrowing-base availability was $145.5 million. The $85 million term loan had been fully repaid in 2009.
  • Capital returns and investment: The company repurchased about 1.7 million shares for approximately $80 million through October 30 under a $100 million authorization; subsequent purchases through November 30 brought the total to about $90 million. Fiscal 2010 capital expenditures were expected to be approximately $80–85 million.

Material changes and management commentary

  • Quarterly comparable retail sales fell 5.7%; year-to-date comparable retail sales fell 1.1%. Management attributed weakness principally to lower average transaction values, partly offset by more transactions, new-store sales and e-commerce growth.
  • Quarterly gross margin contracted 340 basis points, primarily because of higher markdowns, occupancy and warehouse-cost deleverage, and lower initial markup. Year-to-date margin contracted 110 basis points, mainly from markdowns.
  • U.S. e-commerce sales increased to 10.1% of sales in the quarter from 7.6%, and to 8.9% year to date from 7.3%. Canadian results benefited from favorable currency translation; year-to-date translation added $15.3 million to sales.
  • Management said the company was on plan to open 65 stores in fiscal 2010, compared with 38 in fiscal 2009, and expected cash on hand, operating cash flow and credit-facility availability to fund requirements over the next 12 months.
  • Year-to-date operating cash flow benefited from payment timing for accounts payable and other liabilities and lower inventory. These working-capital movements may not recur at the same level.
  • Year-to-date 2009 comparisons included unusual benefits and costs, including tax benefits from IRS matters and foreign tax credits, an employment-tax settlement gain, proxy-related fees, restructuring costs and term-loan repayment expenses.

Risks, contingencies and unusual items

  • A stockholder derivative lawsuit remained unresolved; the company said the outcome and any potential loss could not be estimated. It warned of possible litigation costs, management distraction and reputational impact.
  • A separate FACTA class-action settlement of $0.3 million received final court approval; the judgment became effective November 8, 2010. The company had accrued the settlement cost.
  • A Quebec sales-tax assessment of approximately C$2.3 million remained disputed; related restricted cash was $2.2 million at October 30, 2010.
  • The company reported no material change to previously disclosed risk factors. It does not hedge foreign-currency exposure; approximately 12% of sales and total costs and expenses are transacted in foreign currencies. It also cited reliance on merchandise imports from China.
  • Inventory markdown and shrink estimates, store impairment assumptions, insurance reserves and performance-award estimates could affect results. A 10% change in the markdown reserve was estimated to affect net income by about $0.9 million.
  • Management reported effective disclosure controls as of October 30, 2010, with no material quarterly change in internal control over financial reporting. No off-balance-sheet arrangements were reported.

Important facts for investors to verify

  1. Confirm the period: the filing reports the quarter ended October 30, 2010, despite the request metadata’s 2009 designation.
  2. Track comparable sales, average transaction size, markdown levels and gross-margin recovery, particularly as store expansion continues.
  3. Assess whether operating cash-flow strength is sustainable given the favorable working-capital timing, and monitor capital spending and remaining buyback authorization.
  4. Review the status and potential financial impact of the derivative lawsuit and the disputed Quebec tax assessment.
  5. Monitor currency movements, Canadian performance and foreign-currency cash exposure, as well as execution and returns from new stores and e-commerce investment.