UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended October 29, 2005

or

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

For the transition period from ______________ to _______________

Commission File No. 000-07258

CHARMING SHOPPES, INC.
(Exact name of registrant as specified in its charter)

 
PENNSYLVANIA
 
23-1721355
 
 
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 

 
450 WINKS LANE, BENSALEM, PA 19020
 
(215) 245-9100
 
 
(Address of principal executive offices) (Zip Code)
 
(Registrant’s telephone number, including Area Code)
 

NOT APPLICABLE
(Former name, former address, and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Yes x No o
 
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):
Yes x No o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
Yes o No x
 
The number of shares outstanding of the issuer’s Common Stock (par value $.10 per share), as of December 1, 2005, was 121,344,205 shares.
 
 







CHARMING SHOPPES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS


   
Page
PART I.
 
     
Item 1.
2
     
   
 
2
     
   
 
3
 
4
     
   
 
5
     
 
6
     
Item 2.
20
     
 
20
     
 
22
     
 
23
     
 
24
     
 
25
     
 
32
     
 
35
     
 
36
     
 
37
     
Item 3.
37
     
Item 4.
37
     
PART II.
 
     
Item 1.
38
     
Item 2.
38
     
Item 6.
39
     
 
41




1


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CHARMING SHOPPES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS


   
October 29,
 
January 29,
 
(Dollars in thousands, except share amounts)
 
2005
 
2005
 
   
(Unaudited)
     
ASSETS
             
Current assets
             
Cash and cash equivalents 
 
$
151,676
 
$
273,049
 
Available-for-sale securities 
   
86,465
   
52,857
 
Merchandise inventories 
   
474,484
   
285,120
 
Deferred advertising 
   
29,128
   
0
 
Deferred taxes 
   
32,489
   
15,500
 
Prepayments and other 
   
93,934
   
86,382
 
Total current assets 
   
868,176
   
712,908
 
               
Property, equipment, and leasehold improvements - at cost 
   
863,287
   
786,028
 
Less accumulated depreciation and amortization 
   
511,885
   
465,365
 
Net property, equipment, and leasehold improvements 
   
351,402
   
320,663
 
               
Trademarks and other intangible assets 
   
248,908
   
169,818
 
Goodwill 
   
153,651
   
66,666
 
Available-for-sale securities 
   
240
   
240
 
Other assets 
   
40,928
   
33,476
 
Total assets 
 
$
1,663,305
 
$
1,303,771
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities
             
Short-term borrowings 
 
$
50,000
 
$
0
 
Accounts payable 
   
188,879
   
127,819
 
Accrued expenses 
   
210,823
   
154,681
 
Income taxes payable 
   
13,000
   
0
 
Current portion - long-term debt 
   
15,249
   
16,419
 
Total current liabilities 
   
477,951
   
298,919
 
               
Deferred taxes and other non-current liabilities 
   
152,443
   
101,743
 
Long-term debt 
   
245,227
   
208,645
 
               
Stockholders’ equity
             
Common Stock $.10 par value:
             
Authorized - 300,000,000 shares
             
Issued - 133,177,902 shares and 132,063,290 shares, respectively 
   
13,318
   
13,206
 
Additional paid-in capital 
   
269,059
   
249,485
 
Treasury stock at cost - 12,265,993 shares 
   
(84,136
)
 
(84,136
)
Deferred employee compensation 
   
(15,382
)
 
(8,715
)
Accumulated other comprehensive loss 
   
(2
)
 
0
 
Retained earnings 
   
604,827
   
524,624
 
Total stockholders’ equity 
   
787,684
   
694,464
 
Total liabilities and stockholders’ equity 
 
$
1,663,305
 
$
1,303,771
 
               
See Notes to Condensed Consolidated Financial Statements
             




2


 CHARMING SHOPPES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Unaudited)


   
Thirteen Weeks Ended
 
   
October 29,
 
October 30,
 
(In thousands, except per share amounts)
 
2005
 
2004
 
       
(Restated)
 
               
Net sales
 
$
663,322
 
$
541,759
 
               
Cost of goods sold, buying, catalog, and occupancy expenses
   
461,451
   
378,533
 
Selling, general, and administrative expenses
   
181,275
   
149,769
 
Expenses related to cost reduction plan
   
0
   
605
 
Total operating expenses
   
642,726
   
528,907
 
               
Income from operations
   
20,596
   
12,852
 
               
Other income
   
1,754
   
783
 
Interest expense
   
(4,797
)
 
(3,876
)
               
Income before income taxes
   
17,553
   
9,759
 
Income tax provision
   
6,791
   
3,406
 
               
Net income
   
10,762
   
6,353
 
               
Other comprehensive (loss)/income, net of tax
             
Unrealized (losses)/gains on available-for-sale securities, net of income tax benefit/(provision) of $1 in 2005 and ($49) in 2004
   
(2
)
 
77
 
Reclassification of amortization of deferred loss on termination of derivative, net of income tax benefit of $6 in 2004
   
0
   
11
 
Total other comprehensive (loss)/income, net of tax
   
(2
)
 
88
 
               
Comprehensive income
 
$
10,760
 
$
6,441
 
               
Basic net income per share
 
$
.09
 
$
.05
 
               
Diluted net income per share
 
$
.09
 
$
.05
 
 
See Notes to Condensed Consolidated Financial Statements
             





3



CHARMING SHOPPES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Unaudited)


   
Thirty-nine Weeks Ended
 
   
October 29,
 
October 30,
 
(In thousands, except per share amounts)
 
2005
 
2004
 
       
(Restated)
 
               
Net sales
 
$
1,954,937
 
$
1,746,234
 
               
Cost of goods sold, buying, catalog, and occupancy expenses
   
1,331,761
   
1,211,820
 
Selling, general, and administrative expenses
   
489,280
   
431,260
 
Expenses related to cost reduction plan
   
0
   
605
 
Total operating expenses
   
1,821,041
   
1,643,685
 
               
Income from operations
   
133,896
   
102,549
 
               
Other income
   
6,741
   
1,592
 
Interest expense
   
(13,434
)
 
(11,639
)
               
Income before income taxes
   
127,203
   
92,502
 
Income tax provision
   
47,000
   
32,841
 
               
Net income
   
80,203
   
59,661
 
               
Other comprehensive (loss)/income, net of tax
             
Unrealized (losses)/gains on available-for-sale securities, net of income tax benefit/(provision) of $1 in 2005 and ($147) in 2004
   
(2
)
 
230
 
Reclassification of amortization of deferred loss on termination of derivative, net of income tax benefit of $69 in 2004
   
0
   
128
 
Total other comprehensive (loss)/income, net of tax
   
(2
)
 
358
 
               
Comprehensive income
 
$
80,201
 
$
60,019
 
               
Basic net income per share
 
$
.67
 
$
.52
 
               
Diluted net income per share
 
$
.61
 
$
.48
 
               
See Notes to Condensed Consolidated Financial Statements
             





4



CHARMING SHOPPES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)


   
Thirty-nine Weeks Ended
 
   
October 29,
 
October 30,
 
(In thousands)
 
2005
 
2004
 
       
(Restated)
 
Operating activities
             
Net income 
 
$
80,203
 
$
59,661
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation and amortization 
   
65,036
   
57,681
 
Deferred income taxes 
   
(4,420
)
 
3,536
 
Tax benefit related to stock plans 
   
2,365
   
4,187
 
Net (gain)/loss from disposition of capital assets 
   
(785
)
 
646
 
Gain from securitization of Catherines portfolio 
   
(759
)
 
0
 
Loss on sales of available-for-sale securities 
   
0
   
185
 
Changes in operating assets and liabilities:
             
Merchandise inventories
   
(118,126
)
 
(68,960
)
Accounts payable
   
48,691
   
31,467
 
Deferred advertising
   
(17,249
)
 
0
 
Prepayments and other
   
8,902
   
(19,649
)
Accrued expenses and other
   
28,183
   
18,862
 
Income taxes payable
   
8,963
   
828
 
Net cash provided by operating activities 
   
101,004
   
88,444
 
               
Investing activities
             
Investment in capital assets 
   
(68,177
)
 
(42,078
)
Proceeds from sales of capital assets 
   
2,432
   
0
 
Proceeds from sales of available-for-sale securities 
   
17,714
   
45,571
 
Gross purchases of available-for-sale securities 
   
(51,325
)
 
(30,887
)
Acquisition of Crosstown Traders, Inc., net of cash acquired 
   
(256,702
)
 
0
 
Purchase of Catherines receivables portfolio 
   
(56,582
)
 
0
 
Securitization of Catherines receivables portfolio 
   
56,582
   
0
 
Securitization of Crosstown apparel-related receivables 
   
50,000
   
0
 
Increase in other assets 
   
(2,455
)
 
(5,610
)
Net cash used by investing activities 
   
(308,513
)
 
(33,004
)
               
Financing activities
             
Proceeds from short-term borrowings 
   
261,311
   
150,298
 
Repayments of short-term borrowings 
   
(211,311
)
 
(150,298
)
Proceeds from long-term borrowings 
   
50,000
   
13,098
 
Repayments of long-term borrowings 
   
(18,480
)
 
(12,813
)
Payments of deferred financing costs 
   
(1,371
)
 
(350
)
Proceeds from issuance of common stock 
   
5,987
   
23,722
 
Net cash provided by financing activities 
   
86,136
   
23,657
 
               
Increase (decrease) in cash and cash equivalents 
   
(121,373
)
 
79,097
 
Cash and cash equivalents, beginning of period 
   
273,049
   
123,781
 
Cash and cash equivalents, end of period 
 
$
151,676
 
$
202,878
 
               
Non-cash financing and investing activities
             
Equipment acquired through capital leases 
 
$
3,892
 
$
5,399
 
               
Certain prior-year amounts have been reclassified to conform to the current-year presentation.
See Notes to Condensed Consolidated Financial Statements
             





5

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 1. Condensed Consolidated Financial Statements

We have prepared our condensed consolidated balance sheet as of October 29, 2005, our condensed consolidated statements of operations and comprehensive income for the thirteen weeks and thirty-nine weeks ended October 29, 2005 and October 30, 2004, and our condensed consolidated statements of cash flows for the thirty-nine weeks ended October 29, 2005 and October 30, 2004 without audit. In our opinion, we have made all adjustments (which, except for the restatement discussed in Note 2 below, include only normal recurring adjustments) necessary to present fairly our financial position, results of operations, and cash flows. We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles. These financial statements and related notes should be read in conjunction with our financial statements and related notes included in our January 29, 2005 Annual Report on Form 10-K. As a result of our acquisition of Crosstown Traders, Inc. (“Crosstown”) (see “Note 3. Acquisition of Crosstown Traders, Inc.” below), the following information on accounting policies related to segment reporting, revenue recognition, inventories, and deferred advertising has been updated to reflect certain critical accounting policies followed by Crosstown. The results of operations for the thirteen weeks and thirty-nine weeks ended October 29, 2005 and October 30, 2004 are not necessarily indicative of operating results for the full fiscal year.

As used in these notes, the terms “Fiscal 2006” and “Fiscal 2005” refer to our fiscal year ending January 28, 2006 and our fiscal year ended January 29, 2005, respectively. The term “Fiscal 2007” refers to our fiscal year ending February 3, 2007. The terms “Fiscal 2006 Third Quarter” and “Fiscal 2005 Third Quarter” refer to the thirteen weeks ended October 29, 2005 and October 30, 2004, respectively. The terms “Fiscal 2006 Fourth Quarter” and “Fiscal 2005 Fourth Quarter” refer to the thirteen weeks ending January 28, 2006 and the thirteen weeks ended January 29, 2005, respectively. The terms “the Company,” “we,” “us,” and “our” refer to Charming Shoppes, Inc. and, where applicable, its consolidated subsidiaries.

Segment Reporting

Effective with our acquisition of Crosstown, we operate and report in two segments, Retail Stores and Direct-to-Consumer, which are consistent with the way our chief operating decision-makers review our results of operations. The Retail Stores segment derives its revenues from sales through retail stores and E-commerce under our LANE BRYANT, FASHION BUG, and CATHERINES PLUS SIZES brands. The Direct-to-Consumer segment derives its revenues from catalog sales and catalog-related E-commerce sales under our Crosstown catalogs. See “Note 11. Segment Reporting” below for further information regarding our segment reporting.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in the Financial Statements,” as amended. Our revenues from merchandise sales are net of returns and allowances and exclude sales tax. We record a reserve for estimated future sales returns based on an analysis of actual returns and we defer recognition of layaway sales to the date of delivery. A change in our actual rates of sales returns and layaway sales experience would affect the level of revenue recognized.




6

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 1. Condensed Consolidated Financial Statements (Continued)

Revenue Recognition (Continued)

Catalog and E-commerce revenues include shipping and handling fees billed to customers. These revenues are recognized after the following have occurred: the customer’s order has been executed; authorization of the customer’s credit card has been received; and the product has been shipped to and received by the customer. We record a reserve for estimated future sales returns based on an analysis of actual returns. In addition, we record a reserve for estimated sales shipped but not yet received by customers. A change in our actual rates of sales returns and/or days it takes for customers to receive our products would affect the level of revenue recognized.

Inventories

We value our merchandise inventories at the lower of cost or market, using the retail inventory method (average cost basis) for our Retail Stores and our Direct-to-Consumer segment inventories.

Deferred Advertising (Catalog)

With the exception of direct-response advertising, we expense advertising costs when the related event takes place. In accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 93-7, “Reporting on Advertising Costs,” we accumulate all direct costs incurred in the development, production, and circulation of our direct-mail catalogs on our consolidated balance sheet until such time as the related catalog is mailed. These capitalized costs are subsequently amortized as a component of cost of goods sold, buying, catalog, and occupancy expenses over the expected sales realization cycle, generally within one to six months. Our initial estimation of the expected sales realization cycle for a particular catalog merchandise offering is based on, among other possible considerations, our historical sales and sell-through experience with similar catalog merchandise offerings, our understanding of then-prevailing fashion trends and influences, our assessment of prevailing economic conditions, and various competitive factors.  We continually track our subsequent sales realization, compile customer feedback for indications of future performance, reassess the marketplace, compare our findings to our previous estimate, and adjust our amortization accordingly.

Cash Consideration Received from Vendors

We account for cash consideration received from vendors in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) Issue 02-16, “Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor.” Accordingly, cash consideration received from vendors is recognized when the related merchandise is sold.

Stock-based Compensation
 
We account for stock-based compensation using the intrinsic value method, in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related interpretations. We amortize deferred compensation expense attributable to stock awards and stock options having an exercise price less than the market price on the date of grant on a straight-line basis over the vesting period of the award or option. We do not recognize compensation expense for options having an exercise price equal to the market price on the date of grant or for shares purchased under our Employee Stock Purchase Plan.


7

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 1. Condensed Consolidated Financial Statements (Continued)

The following table reconciles net income and net income per share as reported, using the intrinsic value method under APB No. 25, to pro forma net income and net income per share using the fair value method under FASB Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-based Compensation:”

   
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
 
(In thousands, except per share amounts)
 
October 29,
2005
 
October 30,
2004
 
October 29,
2005
 
October 30,
2004
 
       
(Restated)
     
(Restated)
 
                           
Net income as reported 
 
$
10,762
 
$
6,353
 
$
80,203
 
$
59,661
 
Add stock-based employee compensation using intrinsic value method, net of income taxes 
   
1,140
   
317
   
3,033
   
1,081
 
Less stock-based employee compensation using fair value method, net of income taxes 
   
(1,159
)
 
(982
)
 
(3,323
)
 
(2,780
)
Pro forma net income 
 
$
10,743
 
$
5,688
 
$
79,913
 
$
57,962
 
                           
Basic net income per share:
                         
As reported 
 
$
.09
 
$
.05
 
$
.67
 
$
.52
 
Pro forma 
   
.09
   
.05
   
.67
   
.50
 
Diluted net income per share:
                         
As reported 
   
.09
   
.05
   
.61
   
.48
 
Pro forma 
   
.09
   
.05
   
.61
   
.46
 

 
Note 2. Restatement of Financial Statements

In the Fiscal 2005 Fourth Quarter, we restated our financial statements for the prior quarters of Fiscal 2005 to correct our accounting for landlord allowances, calculation of straight-line rent expense, recognition of rent holiday periods, and depreciation of leasehold improvements for our retail stores. See “Item 8. Financial Statements and Supplementary Data; Note 2. Restatement of Financial Statements” of our Report on Form 10-K for the fiscal year ended January 29, 2005 for additional information.

Prior to the restatement, we classified construction allowances received from landlords in connection with our store leases as a reduction of property, equipment, and leasehold improvements on our consolidated balance sheets and as a reduction of capital expenditures on our consolidated statements of cash flows. In addition, when accounting for leases with renewal options, we historically recorded rent expense on a straight-line basis over the initial non-cancelable lease term, beginning with the lease commencement date. However, we depreciated leasehold improvements over their estimated useful life of ten years, which, in many cases, may have included both the initial non-cancelable lease term and option renewal periods provided for in the lease. Also, we historically recognized rent holiday periods on a straight-line basis over the lease term commencing with the initial occupancy date instead of the date we took possession of the leased space for construction purposes, which is generally two months prior to a store opening date.


8

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 2. Restatement of Financial Statements (Continued)

As a result of the restatement, we record construction allowances as a deferred rent liability on our consolidated balance sheets rather than as a reduction of the cost of leasehold improvements, and recognize construction allowances as an operating activity on our consolidated statements of cash flows rather than as a reduction of our investment in capital assets. In addition, we amortize construction allowances over the related lease term as a reduction of rent expense rather than as a reduction of depreciation expense, commencing on the date we take possession of the leased space for construction purposes. The lease term we use to record straight-line rent expense and depreciation of leasehold improvements includes lease option renewal periods only in instances in which the exercise of the option period is reasonably assured and the failure to exercise such an option would result in an economic penalty. We depreciate leasehold improvements over the shorter of the lease term or the assets’ estimated useful lives. The lease terms we use to determine straight-line rent expense include pre-opening store build-out periods (commonly referred to as “rent holidays”), where applicable. These corrections resulted in the accelerated recognition of certain annual rent expense and depreciation expense on leasehold improvements, which are included in “cost of goods sold, buying, catalog, and occupancy expenses” on the consolidated statements of operations and comprehensive income.

The effects of the restatement on our condensed consolidated financial statements, as previously reported in our Fiscal 2005 Form 10-K, are summarized as follows:

   
Thirteen Weeks Ended October 30, 2004
 
   
As Previously
     
As
 
(In thousands, except per share amounts)
 
Reported
 
Adjustments
 
Restated
 
                     
Condensed Consolidated Statement of Operations:
                   
Cost of goods sold, buying, catalog, and occupancy expenses 
 
$
377,457
 
$
1,076
 
$
378,533
 
Income tax provision 
   
3,803
   
(397
)
 
3,406
 
Net income 
   
7,032
   
(679
)
 
6,353
 
Basic net income per share 
 
$
.06
 
$
(.01
)
$
.05
 
Diluted net income per share 
 
 
.06
 
 
(.01
)
 
.05
 

   
Thirty-nine Weeks Ended October 30, 2004
 
   
As Previously
     
As
 
(In thousands, except per share amounts)
 
Reported
 
Adjustments
 
Restated
 
                     
Condensed Consolidated Statement of Operations:
                   
Cost of goods sold, buying, catalog, and occupancy expenses 
 
$
1,208,592
 
$
3,228
 
$
1,211,820
 
Income tax provision 
   
34,032
   
(1,191
)
 
32,841
 
Net income 
   
61,698
   
(2,037
)
 
59,661
 
Basic net income per share 
 
$
.53
 
$
(.01
)
$
.52
 
Diluted net income per share 
 
 
.49
 
 
(.01
)
 
.48
 
                     


9

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 2. Restatement of Financial Statements (Continued)

   
Thirty-nine Weeks Ended October 30, 2004
 
   
As Previously
     
As
 
(In thousands)
 
Reported(1)
 
Adjustments
 
Restated
 
                     
Condensed Consolidated Statement of Cash Flows:
                   
Operating activities:
                   
Net income 
 
$
61,698
 
$
(2,037
)
$
59,661
 
Adjustments to reconcile net income to net cash provided by operating activities:
                   
Depreciation and amortization 
   
51,426
   
6,255
   
57,681
 
Deferred income taxes 
   
4,727
   
(1,191
)
 
3,536
 
Changes in operating assets and liabilities:
                   
Accrued expenses and other
   
14,987
   
3,875
   
18,862
 
Net cash provided by operating activities 
   
81,542
   
6,902
   
88,444
 
                     
Investing activities:
                   
Investment in capital assets 
   
(35,176
)
 
(6,902
)
 
(42,078
)
Net cash used by investing activities 
   
(26,102
)
 
(6,902
)
 
(33,004
)
___________________
                   
(1) Certain amounts have been reclassified to conform to the current-year presentation.


Note 3. Acquisition of Crosstown Traders, Inc.

On June 2, 2005, we acquired 100% of the outstanding stock of Crosstown Traders, Inc. ("Crosstown"), a direct marketer of women’s apparel, footwear, accessories, and specialty gifts, from JPMorgan Partners, the private equity arm of J.P. Morgan Chase & Co.

Crosstown Traders, Inc. operates multiple catalog titles and related websites, with revenues of approximately $460 million for the fiscal year ended January 29, 2005. The majority of Crosstown’s revenues are derived from the catalog sales of women’s apparel, footwear, and accessories, of which plus-sizes are an important component. Crosstown also derives revenues from the catalog sales of food and gifts, the majority of which occur during the fourth quarter of the fiscal year. The acquisition of Crosstown provides us with an infrastructure for the development and expansion of our Direct-to-Consumer segment, which will include our catalog and catalog-related E-commerce sales distribution channels.

Under the terms of the agreement, we paid $218,015,000 in cash for Crosstown and assumed Crosstown’s debt of $40,728,000. We also incurred direct costs related to the acquisition (primarily advisory, legal, and statutory fees) of approximately $3,774,000. Subsequent to the acquisition, we securitized Crosstown’s apparel-related accounts receivable under a new conduit funding facility established specifically for funding the Crosstown receivables. The majority of the proceeds of approximately $50,000,000 from the securitization were used to retire Crosstown’s debt.

We financed the acquisition with $108,015,000 of our existing cash and cash equivalents and $110,000,000 of borrowings under our then-existing revolving credit facility. Subsequent to the acquisition, we amended our credit facility (see "Note 5. Short-term Borrowings and Long-term Debt" below).


10

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 3. Acquisition of Crosstown Traders, Inc. (Continued)

We accounted for the acquisition under the purchase method of accounting, and included the results of operations of Crosstown in our results of operations from the date of acquisition. Prior-period results have not been restated for the acquisition. Amounts recognized for assets acquired and liabilities assumed are based on preliminary purchase price allocations and on certain management judgments. These preliminary allocations are based on an analysis of the estimated fair values of assets acquired and liabilities assumed, including identifiable tangible and intangible assets, deferred tax assets and liabilities, and estimates of the useful lives of tangible and amortizable intangible assets. The final purchase price allocations will be completed after we obtain third-party appraisals, review all available data, and complete our own internal assessments. Any additional adjustments resulting from finalization of the purchase price allocations for Crosstown will affect the amount assigned to goodwill.

In accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” the acquired trademarks, tradenames, and internet domain names will not be amortized, but will be subject to annual reviews for impairment or for indicators of a limited useful life. Other intangible assets acquired, consisting of Crosstown customer relationships, are being amortized over their estimated useful life of four years. 

The excess of the cost of the acquisition over the estimated fair value of the identifiable net assets acquired will be allocated to goodwill. In accordance with the requirements of SFAS No. 142, the goodwill will not be amortized, but will be subject to an annual review for impairment.

The preliminary purchase price allocation for the identifiable tangible and intangible assets and liabilities of Crosstown Traders is as follows:

   
Purchase
 
   
Price
 
(In thousands)
 
Allocation
 
         
Fair value of assets acquired 
 
$
177,256
 
Fair value of liabilities acquired 
   
(56,598
)
Intangible assets subject to amortization 
   
10,700
 
Intangible assets not subject to amortization 
   
70,000
 
Deferred tax effect of acquisition 
   
(25,826
)
Goodwill 
   
86,985
 
Total purchase price 
 
$
262,517
 

Contemporaneous with the completion of the acquisition, we started preparing a formal integration plan. Management’s plans are preliminary, and may include exiting or consolidating certain activities of Crosstown, lease terminations and unfavorable contract costs, severance, and certain other exit costs. Upon completion of our plans, we anticipate that expenses may total approximately $5,000,000. As such, this amount has been recorded as a component of the purchase price of the acquisition in accordance with EITF Issue 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.”


11

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 3. Acquisition of Crosstown Traders, Inc. (Continued)

The following unaudited pro forma information is based on historical data, and gives effect to our acquisition of Crosstown as if the acquisition had occurred on January 31, 2004. The pro forma information includes adjustments having a continuing impact on our consolidated results of operations as a result of using the purchase method of accounting for the acquisition. These adjustments consist of: additional depreciation of fair value adjustments for property, equipment, and leasehold improvements; amortization of the fair value of customer relationships acquired; additional interest expense from borrowings incurred to finance the acquisition and amortization of deferred financing costs related to amending our credit facility; reduced interest expense from the repayment of Crosstown’s debt; and a reduction in interest income from the use of cash and cash equivalents to fund a portion of the acquisition cost.

The unaudited pro forma information has been prepared based on preliminary purchase price allocations, using assumptions that our management believes are reasonable. It is not necessarily indicative of the actual results of operations that would have occurred if the acquisition had occurred as of January 31, 2004, and is not necessarily indicative of the results that may be achieved in the future. The unaudited pro forma information does not reflect adjustments for the effect of non-recurring items or for operating synergies that we may realize as a result of the acquisition. 

Unaudited pro forma results of operations:
 
   
Thirteen
     
   
Weeks Ended
 
Thirty-nine Weeks Ended
 
   
October 30,
 
October 29,
 
October 30,
 
(In thousands, except per share amounts)
 
2004
 
2005
 
2004
 
   
(Restated)
     
(Restated)
 
                     
Net sales 
 
$
628,702
 
$
2,103,952
 
$
2,032,800
 
Net income 
   
6,048
   
77,150
   
57,948
 
                     
Net income per share:
                   
Basic
 
$
.05
 
$
.65
 
$
.50
 
Diluted
   
.05
   
.59
   
.46
 


Note 4. Trademarks and Other Intangible Assets

   
October 29,
 
January 29,
 
(In thousands)
 
2005
 
2005
 
               
Trademarks, tradenames, and internet domain names 
 
$
238,800
 
$
168,800
 
Customer lists, customer relationships, and covenant not to compete 
   
14,000
   
3,300
 
Total at cost 
   
252,800
   
172,100
 
Less accumulated amortization of customer lists, customer relationships, and covenant not to compete 
   
3,892
   
2,282
 
Net trademarks and other intangible assets 
 
$
248,908
 
$
169,818
 




12

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 5. Short-term Borrowings and Long-term Debt

   
October 29,
 
January 29,
 
(In thousands)
 
2005
 
2005
 
               
Short-term borrowings
             
Revolving credit facility 
 
$
50,000
 
$
0
 
               
Long-term debt
             
4.75% Senior Convertible Notes, due June 2012 
 
$
150,000
 
$
150,000
 
Revolving credit facility 
   
50,000
   
0
 
Capital lease obligations 
   
27,871
   
34,825
 
6.07% mortgage note, due October 2014 
   
12,404
   
12,821
 
6.53% mortgage note, due November 2012 
   
9,800
   
10,850
 
7.77% mortgage note, due December 2011 
   
9,183
   
9,564
 
Variable rate mortgage note, due March 2006 
   
0
   
5,605
 
Other long-term debt 
   
1,218
   
1,399
 
Total long-term debt 
   
260,476
   
225,064
 
Less current portion 
   
15,249
   
16,419
 
Long-term debt 
 
$
245,227
 
$
208,645
 

On July 28, 2005, we amended our existing $300,000,000 revolving credit facility, which was scheduled to expire on August 15, 2008. The amended facility agreement provides for a revolving credit facility with a maximum availability of $375,000,000, subject to certain limitations as defined in the facility agreement, and provides that up to $300,000,000 of the facility may be used for letters of credit. In addition, we may request, subject to compliance with certain conditions, additional revolving credit commitments up to an aggregate of $500,000,000. The amended facility agreement expires on July 28, 2010. In connection with the amendment, we capitalized approximately $1,371,000 of fees that are being amortized on a straight-line basis over the life of the amended facility agreement. Of the $110,000,000 borrowed under the facility in connection with the acquisition of Crosstown Traders, Inc. (see “Note 3. Acquisition of Crosstown Traders, Inc.” above), $10,000,000 has been repaid and $50,000,000 of borrowings has been classified as short-term borrowings, as it is our intention to re-pay such borrowings within 12 months.

The interest rate on borrowings under the facility is Prime for Prime Rate Loans, and LIBOR as adjusted for the Reserve Percentage (as defined in the facility agreement) plus 1.0% to 1.5% per annum for Eurodollar Rate Loans. The applicable rate is determined monthly, based on our average excess availability, as defined in the facility agreement. As of October 29, 2005, the applicable rates on borrowings under the facility were 6.75% for Prime Rate Loans and 5.07% (LIBOR plus 1%) for Eurodollar Rate Loans. All borrowings outstanding under the facility as of October 29, 2005 were Eurodollar Rate Loans, with a weighted-average interest rate of 4.81% (LIBOR plus 1%).

The amended facility includes provisions for customary representations and warranties and affirmative covenants, and includes customary negative covenants providing for certain limitations on, among other things, sales of assets; indebtedness; loans, advances and investments; acquisitions; guarantees; and dividends and redemptions. Under certain circumstances involving a decrease in “Excess Availability” (as defined in the facility agreement), we may be required to maintain a minimum “Fixed Charge Coverage Ratio” (as defined in the facility agreement).

On August 8, 2005, we repaid the variable rate mortgage note, due March 2006.

13

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 6. Stockholders’ Equity

   
Thirty-nine
 
   
Weeks Ended
 
   
October 29,
 
(Dollars in thousands)
 
2005
 
         
Total stockholders’ equity, beginning of period
 
$
694,464
 
Net income
   
80,203
 
Issuance of common stock (1,114,612 shares)
   
5,987
 
Tax benefit related to stock plans
   
2,365
 
Unrealized losses on available-for-sale securities, net of tax 
   
(2
)
Amortization of deferred compensation expense 
   
4,667
 
Total stockholders’ equity, end of period
 
$
787,684
 


Note 7. Customer Loyalty Card Programs

We offer various loyalty card programs to our Retail Stores segment customers. Customers who join these programs are entitled to various benefits, including discounts and rebates on purchases during the membership period. Customers generally join these programs by paying an annual membership fee. We recognize revenue from these loyalty programs as sales over the life of the membership period based on when the customer earns the benefits and when the fee is no longer refundable. We recognize costs we incur in connection with administering these programs as cost of goods sold when incurred. During the thirteen weeks and thirty-nine weeks ended October 29, 2005 we recognized revenues of $3,878,000 and $11,309,000, respectively, in connection with our loyalty card programs. During the thirteen weeks and thirty-nine weeks ended October 30, 2004 we recognized revenues of $3,722,000 and $11,168,000, respectively, in connection with our loyalty card programs.


Note 8. Net Income Per Share

   
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
   
October 29,
 
October 30,
 
October 29,
 
October 30,
 
(In thousands)
 
2005
 
2004
 
2005
 
2004
 
       
(Restated)
     
(Restated)
 
                           
Basic weighted average common shares outstanding 
   
120,102
   
117,217
   
119,513
   
115,474
 
Dilutive effect of assumed conversion of convertible notes 
   
15,182
   
0
   
15,182
   
15,182
 
Dilutive effect of stock options and awards 
   
2,268
   
1,416
   
1,939
   
1,744
 
Diluted weighted average common shares and equivalents outstanding 
   
137,552
   
118,633
   
136,634
   
132,400
 
                           
Net income 
 
$
10,762
 
$
6,353
 
$
80,203
 
$
59,661
 
Decrease in interest expense from assumed conversion of notes, net of income taxes 
   
1,128
   
0
   
3,385
   
3,404
 
Net income used to determine diluted net income per share 
 
$
11,890
 
$
6,353
 
$
83,588
 
$
63,065
 

14

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 8. Net Income Per Share (Continued)

   
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
   
October 29,
 
October 30,
 
October 29,
 
October 30,
 
(In thousands, except per share amounts)
 
2005
 
2004
 
2005
 
2004
 
                           
Options with weighted average exercise price greater than market price, excluded from computation of net income per share:
                         
Number of shares 
   
0
   
446
   
0
   
432
 
Weighted average exercise price per share 
 
$
0.00
 
$
8.23
 
$
0.00
 
$
8.28
 


Note 9. Income Taxes

The effective income tax rate was 36.9% for the thirty-nine weeks ended October 29, 2005, as compared to 35.5% for the thirty-nine weeks ended October 30, 2004. The tax rate for the thirty-nine weeks ended October 29, 2005 was unfavorably affected by taxes on the repatriation of profits from international operations on which incremental United States income taxes had not been previously accrued (see below), and was favorably affected by charitable contributions of inventories to hurricane relief efforts. The tax rate for the thirty-nine weeks ended October 29, 2004 was favorably affected by the finalization of certain prior-year tax audits.

On October 22, 2004, the President of the United States of America signed into law H.R. 4250, “The American Jobs Creation Act of 2004” (the “Act”). The Act includes among its provisions certain tax benefits related to the repatriation to the United States of profits from a company’s international operations provided that certain criteria are met, including the implementation of a qualifying reinvestment plan for the repatriated earnings. The Act permits the repatriation of profits from international operations at a tax rate not to exceed 5.25% for approximately a one-year period, subject to certain limitations.

We did not previously record a provision for incremental United States income taxes on profits from our international operations, as it was our intention to permanently reinvest such undistributed profits in our international operations. Based on a preliminary evaluation approved by our Board of Directors during the Fiscal 2006 Third Quarter, it is reasonably possible that we will repatriate profits from international operations in the range of $35,000,000 to $45,000,000, which would result in the payment of income taxes in the range of $1,000,000 to $2,000,000, net of applicable foreign tax credits. Accordingly, the tax provision for the thirty-nine weeks ended October 29, 2005 includes $1,390,000 related to the planned repatriation of international profits. As of October 29, 2005, we have not finalized our formal plan for the reinvestment of any repatriated profits. We will finalize the repatriation of any such profits and our formal plan for the reinvestment of such profits before the end of Fiscal 2006.


Note 10. Asset Securitization

Our FASHION BUG and CATHERINES proprietary credit card receivables are originated by Spirit of America National Bank (our wholly-owned credit card bank), which transfers its interest in the receivables to the Charming Shoppes Master Trust (the “Trust”) through a special-purpose entity. The Trust is an unconsolidated qualified special-purpose entity (“QSPE”).

15

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 10. Asset Securitization (Continued)

In March 2005, Spirit of America National Bank purchased the CATHERINES credit card portfolio. The final purchase price for the portfolio was $54,600,000. The purchase was funded through our securitization facilities, including a portion of the proceeds from the sale of certificates under our Series 2004-1 securitization facility. Prior to purchasing the portfolio, we had a non-recourse agreement, scheduled to expire in March 2005, under which a third party provided an accounts receivable proprietary credit card sales accounts receivable funding facility for the CATHERINES proprietary credit cards. In accordance with the terms of the Merchant Services Agreement pursuant to which the CATHERINES proprietary credit cards were issued, we gave the requisite notice of our intent to exercise our option to purchase the CATHERINES portfolio upon the expiration of the agreement. The Merchant Services Agreement provided us with the ability to purchase the CATHERINES portfolio at par value. The purchase of the portfolio at par value and the subsequent securitization of the purchased portfolio resulted in the recognition of a gain of approximately $2,400,000, which is included in selling, general, and administrative expenses for the thirty-nine weeks ended October 29, 2005.

Subsequent to our acquisition of Crosstown Traders, Inc., we securitized Crosstown’s apparel-related catalog proprietary credit card receivables under a new conduit funding facility established with an initial term of one year specifically for funding the Crosstown accounts receivable. The majority of the $50,000,000 in proceeds from the securitization was used to retire Crosstown’s debt. Crosstown’s credit card receivables are originated in a non-bank program by Crosstown, which transfers its interest in the receivables through a special-purpose entity to an unconsolidated QSPE that is separate and distinct from the Trust.

The QSPEs can sell interests in these receivables on a revolving basis for a specified term. At the end of the revolving period, an amortization period begins during which the QSPEs make principal payments to the parties that have entered into the securitization agreements with the QSPEs.


Note 11. Segment Reporting

With the acquisition of Crosstown, we now operate in two segments, Retail Stores and Direct-to-Consumer, which are consistent with the way our chief operating decision-makers review our results of operations. The Retail Stores segment derives its revenues from sales through retail stores and E-commerce under our LANE BRYANT, FASHION BUG, and CATHERINES PLUS SIZES brands. The Direct-to-Consumer segment derives its revenues from catalog sales and catalog-related E-commerce sales under our Crosstown catalogs.

The accounting policies of the segments are generally the same as those described in Item 8. Financial Statements and Supplementary Data; Note 1. Summary of Significant Accounting Policies” in our January 29, 2005 Annual Report on Form 10-K. Our direct-response advertising production costs are expensed over the estimated revenue stream, generally within one to six months. We use income before interest and taxes excluding unallocated corporate costs to evaluate segment profitability. Corporate costs that are currently allocated to the Retail Stores segment include shared service center costs, information systems and support costs, and warehousing costs. The following financial information for the Direct-to-Consumer segment for Fiscal 2006 does not include allocations of corporate costs. We expect to include corporate cost allocations for the Direct-to-Consumer segment in the future. Unallocated costs include corporate general and administrative costs, corporate depreciation and amortization, corporate occupancy costs, costs of administering our proprietary credit card operations, interest, taxes, and other non-routine charges. Unallocated assets include corporate cash and cash equivalents, the net book value of corporate facilities, deferred income taxes, and other corporate long-lived assets.


16

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 11. Segment Reporting (Continued)


Selected financial information for our operations by reportable segments and a reconciliation of the information by segment to our consolidated totals is as follows:

   
Retail
 
Direct-to-
 
Corporate
     
(in thousands)
 
Stores
 
Consumer(1)
 
and Other
 
Consolidated
 
                           
Thirteen weeks ended October 29, 2005
                         
Net sales 
 
$
568,922
 
$
93,613
 
$
787
 
$
663,322
 
Depreciation and amortization 
   
10,877
   
440
   
11,824
   
23,141
 
Income before interest and taxes 
   
30,213
   
2,444
   
(10,307
)
 
22,350
 
Interest expense 
               
(4,797
)
 
(4,797
)
Income tax provision 
               
(6,791
)
 
(6,791
)
Net income 
   
30,213
   
2,444
   
(21,895
)
 
10,762
 
Capital expenditures 
   
23,398
   
1,048
   
6,338
   
30,784
 
                           
Thirty-nine weeks ended October 29, 2005
                         
Net sales 
 
$
1,810,907
 
$
143,052
 
$
978
 
$
1,954,937
 
Depreciation and amortization 
   
31,159
   
717
   
33,160
   
65,036
 
Income before interest and taxes 
   
162,455
   
2,510
   
(24,328
)
 
140,637
 
Interest expense 
               
(13,434
)
 
(13,434
)
Income tax provision 
               
(47,000
)
 
(47,000
)
Net income 
   
162,455
   
2,510
   
(84,762
)
 
80,203
 
Capital expenditures 
   
51,249
   
1,345
   
15,583
   
68,177
 
                           
As of October 29, 2005
                         
Total assets 
 
$
852,798
 
$
316,061
 
$
494,446
 
$
1,663,305
 
                           
Thirteen weeks ended October 30, 2004(2)
                         
Net sales 
 
$
540,825
       
$
934
 
$
541,759
 
Depreciation and amortization 
   
10,295
         
8,833
   
19,128
 
Income before interest and taxes 
   
25,181
         
(11,546
)
 
13,635
 
Interest expense 
               
(3,876
)
 
(3,876
)
Income tax provision 
               
(3,406
)
 
(3,406
)
Net income 
   
25,181
         
(18,828
)
 
6,353
 
Capital expenditures 
   
12,269
         
5,924
   
18,193
 
                           
Thirty-nine weeks ended October 30, 2004(2) 
                         
Net sales 
 
$
1,744,948
       
$
1,286
 
$
1,746,234
 
Depreciation and amortization 
   
32,384
         
25,297
   
57,681
 
Income before interest and taxes 
   
132,439
         
(28,298
)
 
104,141
 
Interest expense 
               
(11,639
)
 
(11,639
)
Income tax provision 
               
(32,841
)
 
(32,841
)
Net income 
   
132,439
         
(72,778
)
 
59,661
 
Capital expenditures 
   
23,537
         
18,541
   
42,078
 
____________________
                         
(1) From date of acquisition of Crosstown Traders, Inc. on June 2, 2005.
(2) Results have been restated - see“Note 2. Restatement of Financial Statements” above.


17

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 12. Impact of Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs - an Amendment of Accounting Research Bulletin No. 43, Chapter 4.” SFAS No. 151 clarifies, among other things, that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials costs should be recognized as current-period expenses rather than being capitalized into inventory. SFAS No. 151 will be effective as of the beginning of Fiscal 2007. We do not expect the adoption of SFAS No. 151 to have a material effect on our financial condition or results of operations.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R” or the “Statement”), a revision of SFAS No. 123. SFAS No. 123R supersedes APB Opinion No. 25, and amends SFAS No. 95, “Statement of Cash Flows.” The accounting for share-based payments under SFAS No. 123R is similar to the fair value method in SFAS No. 123, except that we will be required to recognize the fair value of share-based payments as compensation expense in our financial statements (pro forma disclosure will no longer be allowed). See Item 8. Financial Statements and Supplementary Data; Note 1. Summary of Significant Accounting Policies” in our January 29, 2005 Annual Report on Form 10-K.

In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107, “Share-Based Payment,” which provides guidance regarding the interaction between SFAS No. 123R and certain SEC rules and regulations, and may simplify some of the more complex implementation requirements of SFAS No. 123R. In addition, on April 15, 2005, the SEC issued a rule entitled “Amendment to Rule 4-01(a) of Regulation S-X Regarding the Compliance Date for Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment” (the “Rule”). The Rule amends the dates by which SEC registrants are required to comply with the provisions of SFAS No. 123R. Under the provisions of SFAS No. 123R, we would have been required to adopt SFAS No. 123R as of the beginning of the Fiscal 2006 Third Quarter for options and awards granted after the date of adoption. As a result of the issuance of the Rule, we will be required to adopt the provisions of SFAS No. 123R as of the beginning of Fiscal 2007.

In November, 2005, the FASB issued FASB Staff Position (“FSP”) FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” FSP FAS 123(R)-3 provides a practical alternative transition election related to accounting for the tax effects of share-based payment awards to employees.

Our adoption of SFAS No. 123R will result in the recognition of additional compensation expense for stock-based compensation in periods subsequent to January 28, 2006. However, beginning in Fiscal 2005, we changed the composition of our stock-based compensation awards to include more restricted stock awards and fewer stock options. This change has resulted in the recognition of additional compensation expense under our current accounting policies (APB Opinion No. 25 “intrinsic value” method), and will reduce the incremental impact of adopting SFAS No. 123R. In addition, as a result of the increased use of restricted stock awards, we expect to continue using the Black-Scholes valuation model and straight-line amortization of compensation expense, which we currently use for our pro forma disclosures under SFAS No. 123, upon adoption of SFAS No. 123R.


18

CHARMING SHOPPES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Note 12. Impact of Recent Accounting Pronouncements (Continued)

Although we are not able to reliably estimate the nature and amounts of stock-based awards to be issued in future periods, we believe the future impact of adoption of SFAS No. 123R will not be materially different from the pro forma results disclosed in accordance with the provisions of SFAS No. 123. See “Note 1. Condensed Consolidated Financial Statements” above for pro forma disclosure of stock-based compensation expense determined in accordance with the provisions of SFAS No. 123 for the thirteen weeks and thirty-nine weeks ended October 29, 2005 and October 30, 2004. We have not yet determined whether we will adopt the modified-prospective-transition method or the modified-retrospective-transition method.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 replaces APB Opinion No. 20, “Accounting Changes,” and supersedes SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements - an amendment of APB Opinion No. 28.” SFAS No. 154 generally requires retrospective application to prior-period financial statements of a change in accounting principle unless it is impracticable to determine either the period-specific effects or cumulative effects of the change. SFAS No. 154 will be effective as of the beginning of Fiscal 2007. We do not expect the adoption of SFAS No. 154 to have a material effect on our financial position or results of operations.

In June 2005, the FASB ratified EITF Issue 05-6, “Determining the Amortization Period for Leasehold Improvements.” EITF Issue 05-6 requires that leasehold improvements purchased subsequent to the inception of the lease or acquired in a business combination be amortized over the lesser of the useful life of the assets or a lease term that includes renewals that are reasonably assured at the date of the purchase or business combination. The guidance in Issue 05-6 is effective as of the beginning of our Fiscal 2006 Third Quarter. Adoption of EITF Issue 05-6 has not had a material effect on our financial position or results of operations.

In October 2005, the FASB issued FSP FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period.” FSP FAS 13-1 concludes that rental costs incurred during and after a construction period are for the right to control the use of a leased asset during and after construction of a lessee asset. There is no distinction between the right to use a leased asset during the construction period and the right to use that asset after the construction period. Therefore, rental costs associated with ground or building operating leases that are incurred during a construction period shall be recognized as rental expense and included in income from continuing operations. FSP FAS 13-1 is effective as of the beginning of Fiscal 2007, with early adoption permitted for financial statements that have not yet been issued. We do not expect the adoption of FSP FAS 13-1 to have a material effect on our financial position or results of operations.





19



 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and accompanying notes included in Item 1 of this report. It should also be read in conjunction with the management’s discussion and analysis of financial condition and results of operations, financial statements, and accompanying notes appearing in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005. Information on certain critical accounting policies related to segment reporting, revenue recognition, inventories, and deferred advertising followed by Crosstown Traders, Inc. (“Crosstown”) (see “RECENT DEVELOPMENTS” below) is included under the caption “CRITICAL ACCOUNTING POLICIES” below. As used in this management’s discussion and analysis, the terms “Fiscal 2006” and “Fiscal 2005” refer to our fiscal year ending January 28, 2006 and our fiscal year ended January 29, 2005, respectively. The terms “Fiscal 2006 Third Quarter” and “Fiscal 2005 Third Quarter” refer to the thirteen weeks ended October 29, 2005 and October 30, 2004, respectively. The terms “Fiscal 2006 Fourth Quarter” and “Fiscal 2005 Fourth Quarter” refer to the thirteen weeks ending January 28, 2006 and the thirteen weeks ended January 29, 2005, respectively. The term “Fiscal 2006 First Quarter” refers to the thirteen weeks ended April 30, 2005. The terms “the Company,” “we,” “us,” and “our” refer to Charming Shoppes, Inc. and, where applicable, its consolidated subsidiaries.


FORWARD-LOOKING STATEMENTS

With the exception of historical information, the matters contained in the following analysis and elsewhere in this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may include, but are not limited to, projections of revenues, income or loss, cost reductions, capital expenditures, liquidity, financing needs or plans, and plans for future operations, as well as assumptions relating to the foregoing. The words “expect,” “should,” “project,” “estimate,” “predict,” “anticipate,” “plan,” “believes,” and similar expressions are also intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which we cannot predict or quantify. Future events and actual results, performance, and achievements could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. We assume no obligation to update or revise any forward-looking statement to reflect actual results or changes in, or additions to, the factors affecting such forward-looking statements.

Factors that could cause our actual results of operations or financial condition to differ from those described in this report include, but are not necessarily limited to, the following:
 
·  
Our business is dependent upon our being able to accurately predict rapidly changing fashion trends, customer preferences, and other fashion-related factors, which we may not be able to successfully accomplish in the future.
 
·  
A slowdown in the United States economy, an uncertain economic outlook, and escalating energy costs could lead to reduced consumer demand for our products in the future.
 
·  
The women’s specialty retail apparel industry is highly competitive and we may be unable to compete successfully against existing or future competitors.
 
·  
We may be unable to successfully integrate the operations of Crosstown Traders, Inc. with the operations of Charming Shoppes, Inc. In addition, we cannot assure the successful implementation of our business plan for Crosstown Traders, Inc.
 
·  
We cannot assure the successful implementation of our business plan for increased profitability and growth in our Retail Stores or Direct-to-Consumer segments.
 
·  
Our business plan is largely dependent upon continued growth in the plus-size women’s apparel market, which may not occur.
 

20




·  
We depend on key personnel, particularly our Chief Executive Officer, Dorrit J. Bern, and we may not be able to retain or replace these employees or recruit additional qualified personnel.
 
·  
We depend on our distribution and fulfillment centers, and could incur significantly higher costs and longer lead times associated with distributing our products to our stores and shipping our products to our E-commerce and catalog customers if operations at any of these distribution and fulfillment centers were to be disrupted for any reason.
 
·  
We depend on the availability of credit for our working capital needs, including credit we receive from our suppliers and their agents, and on our credit card securitization facilities. If we were unable to obtain sufficient financing at an affordable cost, our ability to merchandise our stores and catalogs would be adversely affected.
 
·  
We rely significantly on foreign sources of production and face a variety of risks generally associated with doing business in foreign markets and importing merchandise from abroad. Such risks include (but are not necessarily limited to) political instability; imposition of, or changes in, duties or quotas; trade restrictions; increased security requirements applicable to imports; delays in shipping; increased costs of transportation; and issues relating to compliance with domestic or international labor standards.
 
·  
Our Retail Stores and Direct-to-Consumer segments experience seasonal fluctuations in net sales and operating income. Any decrease in sales or margins during our peak sales periods, or in the availability of working capital during the months preceding such periods, could have a material adverse effect on our business. In addition, extreme or unseasonable weather conditions may have a negative impact on our sales.
 
·  
Natural disasters, as well as war, acts of terrorism, or the threat of either may negatively impact availability of merchandise and customer traffic to our stores, or otherwise adversely affect our business.
 
·  
We may be unable to obtain adequate insurance for our operations at a reasonable cost.
 
·  
We may be unable to protect our trademarks and other intellectual property rights, which are important to our success and our competitive position.
 
·  
We may be unable to hire and retain a sufficient number of suitable sales associates at our stores.
 
·  
Our manufacturers may be unable to manufacture and deliver merchandise to us in a timely manner or to meet our quality standards.
 
·  
Our Retail Stores segment sales are dependent upon a high volume of traffic in the strip centers and malls in which our stores are located, and our future retail store growth is dependent upon the availability of suitable locations for new stores.
 
·  
We may be unable to successfully implement our plan to improve merchandise assortments in our Retail Stores or Direct-to-Consumer segments.
 
·  
The carrying amount and/or useful life of intangible assets related to acquisitions are subject to periodic valuation tests. An adverse change in interest rates or other factors could have a significant impact on the results of the valuation tests, resulting in a write-down of the carrying value or acceleration of amortization of acquired intangible assets.
 
·  
We may be unable to manage significant increases in certain costs, including postage and paper, which could adversely affect our results of operations.
 
·  
Response rates to our catalogs and access to new customers could decline, which would adversely affect our net sales and results of operations.
 

21




·  
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include our assessment of the effectiveness of our internal control over financial reporting in our annual reports. Our independent registered public accounting firm is also required to attest to whether or not our assessment is fairly stated in all material respects and to separately report on whether or not they believe that we maintained, in all material respects, effective internal control over financial reporting. If we are unable to maintain effective internal control over financial reporting, or if our independent registered public accounting firm is unable to timely attest to our assessment, we could be subject to regulatory sanctions and a possible loss of public confidence in the reliability of our financial reporting. Such a failure could result in our inability to provide timely and/or reliable financial information and could adversely affect our business.


RESTATEMENT OF FINANCIAL STATEMENTS

In the Fiscal 2005 Fourth Quarter, we restated our financial statements for the prior quarters of Fiscal 2005 to correct our accounting for landlord allowances, calculation of straight-line rent expense, recognition of rent holiday periods, and depreciation of leasehold improvements for our retail stores. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations; RESTATEMENT OF FINANCIAL STATEMENTS” of our Report on Form 10-K for the fiscal year ended January 29, 2005 for additional details regarding the restatement.

Prior to the restatement, we classified construction allowances received from landlords in connection with our store leases as a reduction of property, equipment, and leasehold improvements on our consolidated balance sheets and as a reduction of capital expenditures on our consolidated statements of cash flows. In addition, when accounting for leases with renewal options, we historically recorded rent expense on a straight-line basis over the initial non-cancelable lease term, beginning with the lease commencement date. However, we depreciated leasehold improvements over their estimated useful life of ten years, which, in many cases, may have included both the initial non-cancelable lease term and option renewal periods provided for in the lease. Also, we historically recognized rent holiday periods on a straight-line basis over the lease term commencing with the initial occupancy date instead of the date we took possession of the leased space for construction purposes, which is generally two months prior to a store opening date.

As a result of the restatement, we record construction allowances as a deferred rent liability on our consolidated balance sheets rather than as a reduction of the cost of leasehold improvements, and recognize construction allowances as an operating activity in our consolidated statements of cash flows rather than as a reduction of our investment in capital assets. In addition, we amortize construction allowances over the related lease term as a reduction of rent expense rather than as a reduction of depreciation expense, commencing on the date we take possession of the leased space for construction purposes. The lease term we use to record straight-line rent expense and depreciation of leasehold improvements includes lease option renewal periods only in instances in which the exercise of the option period is reasonably assured and the failure to exercise such an option would result in an economic penalty. We depreciate leasehold improvements over the shorter of the lease term or their estimated useful lives. The lease terms we use to determine straight-line rent expense include pre-opening store build-out periods (commonly referred to as “rent holidays”), where applicable. These corrections resulted in the accelerated recognition of certain annual rent expense and depreciation expense on leasehold improvements, which are included in “cost of goods sold, buying, catalog, and occupancy expenses” on the consolidated statements of operations and comprehensive income.

See “Item 1. Financial Statements; NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited); Note 2. Restatement of Financial Statements” above for the effect of the restatement on our condensed consolidated financial statements for the thirteen and thirty-nine weeks ended October 30, 2004. 


22



 
CRITICAL ACCOUNTING POLICIES

Our critical accounting policies are discussed in the management’s discussion and analysis of financial condition and results of operations and notes accompanying the consolidated financial statements that appear in our Annual Report on Form 10-K for the fiscal year ended January 29, 2005. Except as indicated below or otherwise disclosed in the financial statements and accompanying notes included in this report, there were no material changes in, or additions to, our critical accounting policies or in the assumptions or estimates we used to prepare the financial information appearing in this report.

Segment Reporting

With our acquisition of Crosstown Traders, Inc. (see “RECENT DEVELOPMENTS” below), we now operate in two segments, Retail Stores and Direct-to-Consumer, which are consistent with the way our chief operating decision-makers review our results of operations. The Retail Stores segment derives its revenues from sales through retail stores and E-commerce under our LANE BRYANT, FASHION BUG, and CATHERINES PLUS SIZES brands. The Direct-to-Consumer segment derives its revenues from catalog sales and catalog-related E-commerce sales under our Crosstown catalogs. See “Item 1. Notes To Condensed Consolidated Financial Statements (Unaudited); Note 11. Segment Reporting” above for further information regarding our segment reporting.

Inventories

We value our merchandise inventories at the lower of cost or market, using the retail inventory method (average cost basis) for our Retail Stores and Direct-to-Consumer segment inventories.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in the Financial Statements,” as amended. Our revenues from merchandise sales are net of returns and allowances and exclude sales tax. We record a reserve for estimated future sales returns based on an analysis of actual returns and we defer recognition of layaway sales to the date of delivery. A change in our actual rates of sales returns and layaway sales experience would affect the level of revenue recognized.

Catalog and E-commerce revenues include shipping and handling fees billed to customers. These revenues are recognized after the following have occurred: execution of the customer’s order, authorization of the customer’s credit card has been received, and the product has been shipped to and received by the customer. We record a reserve for estimated future sales returns based on an analysis of actual returns. In addition, we record a reserve for estimated sales shipped but not yet received by customers. A change in our actual rates of sales returns and/or days it takes for customers to receive our products would affect the level of revenue recognized.


23



Deferred Advertising Costs

We accumulate all direct costs incurred in the development, production, and circulation of our direct-mail catalogs on our consolidated balance sheet until such time as the related catalog is mailed. These capitalized costs are subsequently amortized as a component of cost of goods sold, buying, catalog, and occupancy expenses over the expected sales realization cycle, generally within one to six months. Our initial estimation of the expected sales realization cycle for a particular catalog merchandise offering is based on, among other possible considerations, our historical sales and sell-through experience with similar catalog merchandise offerings, our understanding of then-prevailing fashion trends and influences, our assessment of prevailing economic conditions, and various competitive factors. We continually track our subsequent sales realization, compile customer feedback for indications of future performance, reassess the marketplace, compare our findings to our previous estimate, and adjust our amortization accordingly.


RECENT DEVELOPMENTS

Acquisition of Crosstown Traders, Inc.

On June 2, 2005, we completed our acquisition of Crosstown Traders, Inc. (“Crosstown”), a direct marketer of women’s apparel, footwear, accessories, and specialty gifts, from JPMorgan Partners, the private equity arm of J.P. Morgan Chase & Co.

Crosstown Traders, Inc. operates multiple catalog titles and related websites, with revenues of approximately $460 million for the fiscal year ended January 29, 2005. The majority of Crosstown’s revenues are derived from the catalog sales of women’s apparel, footwear, and accessories, of which plus-sizes are an important component. Crosstown also derives revenues from the catalog sales of food and gifts, the majority of which occur during the fourth quarter of the fiscal year. As a result of the acquisition, our operations will consist of two business segments: the Retail Stores segment and the Direct-to-Consumer segment. This acquisition is a major step in our long-term growth strategy of becoming a multi-channel retailer, and we expect it to be accretive to our earnings per share beginning in Fiscal 2006. The acquisition of Crosstown provides us with an infrastructure for the development and expansion of our Direct-to-Consumer segment, which will include our catalog and catalog-related E-commerce sales distribution channels. The development of our Direct-to-Consumer segment is a key step in the preparation for the planned launch of our own catalog for the LANE BRYANT brand in the fall of 2007, when the LANE BRYANT catalog trademark reverts to us.
 
Under the terms of the agreement, we paid approximately $218.0 million in cash for Crosstown and assumed Crosstown’s debt of approximately $40.7 million. We also incurred direct costs related to the acquisition (primarily advisory, legal, and statutory fees) of approximately $3.8 million. Subsequent to the acquisition, we securitized Crosstown’s apparel-related accounts receivable under a new conduit funding facility established specifically for funding the Crosstown receivables. The majority of the proceeds of approximately $50.0 million from the securitization were used to retire Crosstown’s debt.

We financed the acquisition with approximately $108 million of our existing cash and cash equivalents and $110 million of borrowings under our then-existing revolving credit facility. Subsequent to this transaction, we amended our credit facility (see "FINANCING; Revolving Credit Facility" below).


24



Hurricane Katrina

Hurricane Katrina, which struck on August 29, 2005, caused extensive damage to portions of the southeast United States where certain of our retail stores are located. Following the hurricane, four CATHERINES PLUS SIZES stores and four LANE BRYANT stores sustained considerable damage and remain closed until further notice. We carry property and casualty insurance on our leasehold improvements, fixtures, and inventory at our retail store locations. As a result of insurance claims related to damages caused by Hurricane Katrina, we recognized a net gain of $1.8 million in the Fiscal 2006 Third Quarter.

VISA/MasterCard Antitrust Litigation

We expect to receive a share of the proceeds from the $3 billion VISA/MasterCard antitrust settlement. We recognized a gain of approximately $1.3 million in the Fiscal 2006 Third Quarter in connection with our receipt of a notification of an initial payment to us related to the settlement.


RESULTS OF OPERATIONS

The following table shows our results of operations expressed as a percentage of net sales and on a comparative basis:

       
Percentage
     
Percentage
 
   
Thirteen Weeks Ended(1)
 
Change
 
Thirty-nine Weeks Ended(1)
 
Change
 
   
October 29,
 
October 30,
 
From Prior
 
October 29,
 
October 30,
 
From Prior
 
   
2005(2)
 
2004
 
Period
 
2005(2)
 
2004
 
Period
 
       
(Restated)
         
(Restated)
     
                                       
Net sales 
   
100.0
%
 
100.0
%
 
22.4
%
 
100.0
%
 
100.0
%
 
12.0
%
Cost of goods sold, buying, catalog, and occupancy expenses 
   
69.6
   
69.9
   
21.9
   
68.1
   
69.4
   
9.9
 
Selling, general, and administrative expenses 
   
27.3
   
27.6
   
21.0
   
25.0
   
24.7
   
13.5
 
Income from operations 
   
3.1
   
2.4
   
60.3
   
6.8
   
5.9
   
30.6
 
Other income 
   
0.3
   
0.1
   
124.0
   
0.3
   
0.1
   
323.4
 
Interest expense 
   
0.7
   
0.7
   
23.8
   
0.7
   
0.7
   
15.4
 
Income tax provision 
   
1.0
   
0.6
   
99.4
   
2.4
   
1.9
   
43.1
 
Net income 
   
1.6
   
1.2
   
69.4
   
4.1
   
3.4
   
34.4
 
____________________
                                     
(1) Results may not add due to rounding.
(2) Includes the results of operations of Crosstown Traders, Inc. from the date of acquisition on June 2, 2005.

The following table shows details of our consolidated total net sales:

   
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
   
October 29,
 
October 30,
 
October 29,
 
October 30,
 
(In millions)
 
2005
 
2004
 
2005
 
2004
 
                           
FASHION BUG® 
 
$
240.9
 
$
236.7
 
$
790.6
 
$
787.9
 
LANE BRYANT® 
   
247.1
   
229.9
   
757.2
   
715.6
 
CATHERINES® 
   
80.9
   
74.3
   
263.1
   
241.4
 
Total Retail Stores segment sales 
   
568.9
   
540.9
   
1,810.9
   
1,744.9
 
Total direct-to-consumer segment sales(1) 
   
93.6
   
0.0
   
143.0
   
0.0
 
Corporate and other(2) 
   
0.8
   
0.9
   
1.0
   
1.3
 
Total net sales 
 
$
663.3
 
$
541.8
 
$
1,954.9
 
$
1,746.2
 
____________________
                         
(1) Includes the results of operations of Crosstown Traders, Inc. from the date of acquisition on June 2, 2005.
(2) Revenue related to loyalty card fees.

25


 
The following table shows information related to the change in our consolidated total net sales:

   
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
   
October 29,
 
October 30,
 
October 29,
 
October 30,
 
   
2005
 
2004
 
2005
 
2004
 
                           
Retail Stores segment
                         
Increase (decrease) in comparable store sales(1) :
                         
Consolidated retail stores
   
3
%
 
1
%
 
2
%
 
2
%
FASHION BUG
   
1
   
(3
)
 
0
   
2
 
CATHERINES
   
9
   
(5
)
 
8
   
(5
)
LANE BRYANT
   
4
   
7
   
2
   
5
 
                           
Sales from new stores and E-commerce as a percentage of total consolidated prior-period sales:
                         
FASHION BUG
   
2
   
1
   
1
   
1
 
CATHERINES
   
1
   
1
   
1
   
1
 
LANE BRYANT
   
4
   
3
   
4
   
3
 
                           
Prior-period sales from closed stores as a percentage of total consolidated prior-period sales:
                         
FASHION BUG
   
(1
)
 
(2
)
 
(1
)
 
(2
)
CATHERINES
   
(1
)
 
(0
)
 
(1
)
 
(0
)
LANE BRYANT
   
(1
)
 
(1
)
 
(1
)
 
(1
)
                           
Increase in Retail Stores segment sales 
   
5
   
2
   
4
   
3
 
                           
Direct-to-Consumer segment
                         
Sales as a percentage of total consolidated prior-period sales(2) 
   
17
   
-
   
8
   
-
 
                           
Increase in total net sales 
   
22
   
2
   
12
   
3
 
____________________
                         
(1) “Comparable store sales” is not a measure that has been defined under generally accepted accounting principles. The method of calculating comparable store sales varies across the retail industry and, therefore, our calculation of comparable store sales is not necessarily comparable to similarly-titled measures reported by other companies. We define comparable store sales as sales from stores operating in both the current and prior-year periods. New stores are added to the comparable store sales base 13 months after their open date. Sales from stores that are relocated within the same mall or strip-center, remodeled, or have a legal square footage change of less than 20% are included in the calculation of comparable store sales. Sales from stores that are relocated outside the existing mall or strip-center, or have a legal square footage change of 20% or more, are excluded from the calculation of comparable store sales until 13 months after the relocated store is opened. Stores that are temporarily closed for a period of 4 weeks or more are excluded from the calculation of comparable store sales for the applicable periods in the year of closure and the subsequent year. Non-store sales, such as catalog and internet sales, are excluded from the calculation of comparable store sales.
(2) Includes catalog sales and catalog-related E-commerce sales from Crosstown Traders, Inc. from the date of acquisition on June 2, 2005.


26



    The following table sets forth information with respect to our year-to-date retail store activity for Fiscal 2006 and planned store activity for all of Fiscal 2006:

   
FASHION
 
LANE
         
   
BUG
 
BRYANT
 
CATHERINES
 
Total
 
                           
Fiscal 2006 Year-to-Date(1):
                         
Stores at January 29, 2005
   
1,028
   
722
   
471
   
2,221
 
                           
Stores opened