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The Children’s Place (NASDAQ: PLCE) is violating Securities and Exchange Commission Regulation G governing non-GAAP financial measures in its financial reports. In its most recent earnings release for Q1 2009, Children’s Place reported a non-GAAP financial measure known as “Adjusted income from continuing operations net of income taxes” which is computed by eliminating certain “unusual or one-time items” less the related income tax effect from “Income from continuing operations net of income taxes.”

However, as I will detail below, SEC Regulation G prohibits:

…adjusting a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when (1) the nature of the charge or gain is such that it is reasonably likely to recur within two years, or (2) there was a similar charge or gain within the prior two years.

Note: Bold print and italics added by me.

Two such "items identified as non-recurring, infrequent or unusual" by Children's Place, namely restructuring costs and impairment charges were improperly eliminated from the company's non-GAAP financial measure because the company reported such charges "within the prior two years." Based on my calculations, Children's Place improperly reported a $1.1 million increase in “Adjusted income from continuing operations net of income taxes,” rather than a $ 0.1 million decrease.

The company made the following disclosure:

Excluding the unusual or one-time items mentioned above from the first quarters of both years, adjusted income from continuing operations after tax was $21.8 million, or $0.74 per diluted share, in the first quarter of 2009, compared to $20.7 million, or $0.71 per diluted share, in the first quarter of 2008. The first quarter income from continuing operations excluding these items is a non-GAAP measure. The Company believes the excluded items are not indicative of the performance of its core business and that by providing this supplemental disclosure to investors it will facilitate comparisons of its past and present performance. A reconciliation of income from continuing operations as reported is included in this press release in Table 3.

Note: Bold print and italics added by me.

Excerpts from Table 3 (referred to above) are presented below:

Reconciliation of Non-GAAP Financial Information to GAAP (in $ millions)

First Quarter Ended May 2, 2009

First Quarter Ended May 3, 2008

Income from continuing operations net of income taxes

23.7

19.4

Significant one-time items pre-tax:
Restructuring Costs

2.6

1.3

Deferred financing fees write-off

0.9

0

Impairment charge

0.8

0

Professional fees

0

0.8

Aggregate expense from significant one-time items

4.3

2.1

Less income tax effect from significant one-time items

-1.7

-0.8

One-time tax benefit resulting from resolution of an IRS income tax audit

-4.5

0

Adjusted (gain) expense from significant one-time items after taxes

-1.9

1.3

Adjusted income from continuing operations net of income taxes

21.8

20.7

As detailed above, Children’s Place improperly eliminated “restructuring costs” and “impairment charges” from its non-GAAP “Adjusted income from continuing operations net of income taxes” because there was a “similar charge…within the prior two years.” Below is my computation of "adjusted income from continuing operations net of income taxes" based on my analysis of Regulation G.

Correcting adjusted income from continuing operations net of income taxes (in $ millions)

First Quarter Ended May 2, 2009

First Quarter Ended May 3, 2008

Adjusted income from continuing operations net of income taxes (improperly computed by Children's Place)

21.8

20.7

Deduct restructuring costs

-2.6

-1.3

Deduct impairment charge

-0.8

0

Add estimated income tax effect of restructuring costs and impairment charges

1.4

0.5

Adjusted income from continuing operations net of income taxes (computed by me)

19.8

19.9

In Q1 2008, Children’s Place reported restructuring costs totaling $1.3 million (see 8-K disclosure above) and during fiscal year 2008, the company reported impairment charges totaling $14.8 million (Source: Q4 2008 8-K report). Therefore, both “restructuring costs” and “impairment charges” cannot be eliminated from “adjusted income from continuing operations net of income taxes” because such charges were reported within the previous two years.

Therefore, if Children’s Place properly computed “Adjusted income from continuing operations net of income taxes,” based on my calculations there should have been a reduction of $0.1 million in its non-GAAP financial measure instead of the $1.1 improvement, as improperly reported by the company.

Children's Place is now on notice to clean up its non-GAAP financial measures.

Disclosure: No position in Children’s Place securities, long or short.

Source: Children's Place in Violation of SEC Regulation G?