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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

(Mark One)

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

For the quarterly period ended April 30, 2005

OR

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

For the transition period from ___________________ to _____________________

Commission file number   00019774

United Retail Group, Inc.
(Exact name of registrant as specified in its charter)

365 West Passaic Street, Rochelle Park, New Jersey 07662
(Address of principal executive offices) (Zip Code)

(201) 845-0880
Registrant's telephone number, including area code

_______________________________________________________________

(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 (the “Exchange Act”) 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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act subsequent to the distribution of securities under a plan confirmed by a court.

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

As of May 31, 2005, there were outstanding 12,680,134 units, each consisting of one share of the registrant’s common stock, $.001 par value per share, and one attached stock purchase right. The units are referred to herein as “shares.”

PART I - FINANCIAL INFORMATION

ITEM I - FINANCIAL STATEMENTS

UNITED RETAIL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements

UNITED RETAIL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
(Unaudited)

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements

UNITED RETAIL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)

The accompanying notes are an integral part of the Condensed Consolidated Financial Statements

UNITED RETAIL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.   Basis of Presentation

The consolidated financial statements include the accounts of United Retail Group, Inc. and its subsidiaries (the “Company”). All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements as of and for the thirteen weeks ended April 30, 2005 and May 1, 2004 are unaudited and are presented pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, the consolidated financial statements are condensed and do not include all disclosures required by generally accepted accounting principles for a full set of financial statements and should be read in conjunction with the financial statement disclosures contained in the Company’s 2004 Annual Report and 2004 Form 10-K. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments necessary to present fairly the financial position and results of operations and cash flows for the interim periods, but are not necessarily indicative of the results of operations for a full fiscal year.

The cost of shipping and handling internet orders has been reclassified from general, administrative and store operating expenses to cost of goods sold. This change was made to provide more clarity for trends in general, administrative and store operating expenses. Prior periods have been reclassified to conform with the current presentation.

2.   Net Earnings / (Loss) Per Share

Basic per share data has been computed based on the weighted average number of shares of common stock outstanding. Diluted per share data includes the weighted average effect of dilutive options on the weighted average shares outstanding. The computation of earnings per diluted share excludes options whose exercise prices were greater than the average market price of the common shares for the thirteen weeks ended April 30, 2005. The computation of (loss) per share for the thirteen weeks ended May 1, 2004 excludes options to purchase shares of common stock as inclusion of such shares would be anti-dilutive.

Options to purchase shares of common stock which were not included in the computation of diluted per share data were as follows:

The Company uses the intrinsic value method to account for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting For Stock Issued To Employees” (Opinion No. 25) and has adopted the disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting For Stock-Based Compensation” (SFAS No. 123). Under Opinion No. 25, compensation expense, if any, is measured as the excess of the market price of the stock over the exercise price on the measurement date. In accordance with Opinion No. 25, compensation expense is recorded ratably over the five-year vesting period of the options.

The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions under SFAS No. 123, “Accounting For Stock-Based Compensation” to stock-based employee compensation:

3.   Financing Arrangements

In 1994, the Company executed a fifteen-year $8.0 million loan bearing interest at 8.64%. Interest and principal are payable in equal monthly installments beginning May 1994. The loan is collateralized by a mortgage on the national distribution center owned by the Company in Troy, Ohio.

The Company and certain of its subsidiaries, (collectively, the “Companies”) are parties to a Financing Agreement, dated August 15, 1997 (the “Financing Agreement”), with The CIT Group/Business Credit, Inc.(“CIT”). The Financing Agreement was amended in December 2003 to increase the revolving line of credit from $40 million to $50 million and to extend the maturity date from August 15, 2005 to August 15, 2008. The revolving line of credit is used by the Companies to support trade letters of credit and standby letters of credit and to finance loans which could be used for working capital and general corporate purposes.

The Companies are required to maintain unused at all times combined asset availability of at least $5 million. Except for the maintenance of a minimum availability of $5 million and a limit on capital expenditures, the Financing Agreement does not contain any significant financial covenants.

The Financing Agreement also includes certain restrictive covenants that impose limitations (subject to certain exceptions) on the Companies with respect to, among other things, making certain investments, declaring or paying dividends, making loans, engaging in certain transactions with affiliates, or consolidating, merging or making acquisitions outside the ordinary course of business.

In the event a loan is made to one of the Companies, interest is payable monthly based on a 360-day year at the Chase Manhattan Bank prime rate plus incremental percentages ranging from 0.00% to 0.75% or the LIBOR rate plus incremental percentages ranging from 1.75% to 2.50% as determined by the average excess availability each month per the Financing Agreement on a per annum basis. The borrower can select either the prime rate or the LIBOR rate as the basis for determining the interest rate. Payments of revolving loans are not required until termination of the agreement unless either 1) the outstanding balance of revolving loans and outstanding letters of credit exceeds the availability under the agreement, in which case the excess would be payable upon demand from CIT or 2) the Company is in default under the Financing Agreement.

The line of credit is collateralized by a security interest in i) inventory and its proceeds ii) bank credit card receivables and iii) the balance on deposit from time to time in a bank account that has been pledged to the lenders.

At April 30, 2005, the borrowing capacity of the Companies under the Financing Agreement with CIT, after satisfying the $5 million minimum availability requirement, was $17.6 million, trade letters of credit for the account of the Companies were outstanding in the amount of $20.8 million, standby letters of credit were outstanding in the amount of $6.1 million and no loan from CIT was outstanding. The Company’s balance sheet cash and cash equivalents of $18.6 million were unrestricted.

In January 2002, the Company executed a five-year $8.2 million sale and lease back agreement for certain fixtures in new and remodeled stores. The lease bears an interest rate of 7.0% per annum. The Company was required to pay sales tax as part of the agreement. The agreement provides for equal monthly rent payments of $163,344 beginning February 2002 and gives the Company the option of buying back the fixtures at the end of the term for a nominal price.

In January 2002 through January 2003, the Company executed a series of three-year capital lease agreements for call center systems at the Company’s national distribution center in Troy, Ohio, bearing interest at rates between 6.09% and 6.64% per annum aggregating approximately $1.4 million. The Company has the option of buying the systems at the end of the term for a nominal price.

4.   Income Taxes

In March 2005, the Company received $0.3 million to settle state income tax refund claims which was recorded as a benefit during the first fiscal quarter of 2005.

In November 2003, the Company agreed in principle with the Internal Revenue Service (“IRS”) on a settlement and the closure of its examination of the Company’s tax returns for the years through 1996.

In November 2003, the Company also agreed in principle with the IRS on the settlement of a matter related to tax refund claims the Company had filed for research credits and for deductions attributable to certain bank financing transactions during 1989 to 1992. In April 2004, the Company received payment from the IRS in the amount of $2.5 million which was initially deferred on the balance sheet. The Company subsequently received final clearance from the IRS regarding this amount. Consequently, the Company recognized the benefit of the refund claims, including the related interest thereon, during the second fiscal quarter of 2004. $1.1 million was recorded as an increase to additional paid-in capital as it related to stock warrant deductions, $1.2 million of interest income was recorded in the Company’s results of operations and $0.2 million in federal tax benefit was recorded related to research credits. An additional payment of $0.3 million was received in August 2004 in connection with further claims, of which $0.1 million of interest income was recorded in the Company’s third quarter results of operations and $0.2 million in federal tax benefit was recorded related to research credits.

The Company recorded a $7.3 million non-cash charge to establish a valuation allowance for its net deferred tax assets, including its net operating loss carryforwards, in the fourth quarter of fiscal 2002. The valuation allowance was calculated in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), which places significant importance on the Company’s cumulative operating results in the most recent three-year period when assessing the need for a valuation allowance. The Company’s cumulative loss in the three-year period ended February 1, 2003, which included the net loss reported in the fourth quarter of fiscal 2002, was sufficient to require this full valuation allowance under the provisions of SFAS No. 109.

The Company recorded additional valuation allowances of $12.6 million, $4.3 million and $0.5 million in fiscal 2003, fiscal 2004 and thirteen week period ended April 30, 2005, respectively. The Company intends to maintain a valuation allowance for its net deferred tax assets and net operating loss carryforwards until sufficient positive evidence exists to support its reversal.

5.   Stock Appreciation Rights Plan

Commencing in May 2000 and annually thereafter, each nonmanagement Director received an award under the Company’s Stock Appreciation Rights Plan that provides for a cash payment by the Company when the Director exercises the stock option granted to him contemporaneously under the Company’s Stock Option Plans. The payment will be an amount equivalent to the after tax equity in the option that is being exercised, that is, the excess of the then current market price of the shares issued over the sum of 1) the exercise price of the corresponding option plus 2) any personal income tax withholding on the gain arising from the exercise. No such payments have been made to date.

6.   Supplemental Cash Flow Information

Net cash flow from operating activities reflects cash payments for interest and income taxes as follows (dollars in thousands):

7.   Contingencies

The Company is involved in legal actions and claims arising in the ordinary course of business. Management believes that such litigation and claims, net of reserves, will not have a material adverse effect on the Company’s financial position, annual results of operations or cash flows. Legal fees are typically expensed as incurred.

A subsidiary of United Retail Group, Inc., United Retail Incorporated (“URI”), is the defendant in a suit in California Superior Court, Los Angeles County, styled Erik Stanford vs. United Retail Incorporated, served on URI by two former store managers in California. The suit is purportedly a class action on behalf of certain current and former URI associates employed in California. The plaintiffs in the Stanford case assert wage and hour claims and related claims against URI with respect to the period since April 1999.

On December 29, 2004, in mediation proceedings, URI and the plaintiffs in the Stanford case entered into a Memorandum of Understanding that provided for a settlement in the total amount of up to approximately $2.3 million, including interest and payroll taxes, payable on a claims made basis in installments of approximately $1.3 million during the third quarter of fiscal 2005 and up to approximately $1.0 million on April 28, 2006. In connection with the settlement, compensation of store managers employed by the Company in California was converted from salaries to hourly wages in January 2005.

On March 18, 2005, URI and the plaintiffs in the Stanford case replaced the Memorandum of Understanding with a Stipulation and Settlement Agreement (“Settlement Agreement”), which provides for the same payment terms as the Memorandum of Understanding. The Settlement Agreement has received preliminary court approval.

A final Court hearing to rule on the fairness of the terms of the Settlement Agreement is scheduled to be held in the third quarter of fiscal 2005.

Total expense related to this matter was $0.7 million in fiscal 2003 and $1.6 million in fiscal 2004.

Management believes that the probable outcome of the case will be Court approval of the agreed-upon settlement.

In the event that the Court at the final hearing reverses its preliminary approval of the Settlement Agreement, the Company intends to oppose class certification strongly. To the extent that the plaintiffs successfully obtain class certification, the Company intends to defend the Stanford case vigorously on the merits at trial.

ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

EXECUTIVE SUMMARY

Introduction

The Executive Summary section of Management’s Discussion and Analysis of Financial Condition and Results of Operations provides a high level summary of the more detailed information elsewhere in this Report, an overview to put this information in context and a plan to return the Company to long-term profitability. This section is also an introduction to the discussion and analysis that follows. Accordingly, it necessarily omits details that appear elsewhere in this Report. It should not be relied upon separately from the balance of this Report.

Products and Purchasing

The Company is a leading specialty retailer of women’s fashions featuring its proprietary AVENUE® brand. Its product line features AVENUE® brand large size (14 or larger) women’s wearing apparel, AVENUE BODY® brand large size women’s undergarments and lingerie and CLOUDWALKERS® brand women’s footwear, as well as AVENUE® brand accessories and gifts.

Most of the Company’s products are made for the Company by contract manufacturing abroad.

Customer Base

The Company serves the mass market in the United States and targets fashion conscious women between 25 and 55 years of age who wear large size apparel. Management believes that the number of women in this age range who wear large size apparel has increased in recent years.

Merchandising and Marketing

Design is an important aspect of the Company’s products. Many AVENUE® and AVENUE BODY® products are custom designed. The Company emphasizes a contemporary brand image and consistency of merchandise quality and fit.

The Company has used direct mail, print media advertising, credit card statement inserts, in-store signage, and e-mail messages in its marketing activities.

Channel of Distribution

The Company’s channel of distribution is retail stores using its AVENUE® trade name. At April 30, 2005, it leased 512 stores in 37 states. See, “Stores.” The Company also operates a website at www.avenue.com that sells a selection of the merchandise that is also on sale in the stores (referred to as “Shop @ Home” operations).

Increased Competition

The women’s retail apparel and shoe industries are highly competitive. Operating results of businesses in these industries, especially businesses that emphasize fashionable merchandise, can vary materially from year to year. The Company’s competition includes other specialty retailers, mass merchants, department stores, discount stores, mail order companies, television shopping channels and Internet websites. Management believes that total sales of large size women’s apparel from these sources of supply increased in recent years.

Deflationary Price Trend in Apparel Industry

The Consumer Price Index published by the U.S. Dept. of Labor, Bureau of Labor Statistics city average for women’s and girls’ apparel (the “CPI”) declined 5.0% in fiscal 2001, 1.9% in fiscal 2002, 1.8% in fiscal 2003 and 0.6% in fiscal 2004, comparing January 31^st each year with that date in the previous year. During the 10 years ended January 31, 2005, the CPI declined 14.6%. There is no assurance that this deflationary trend will not continue.

Company Sales Fluctuations

Sales figures and merchandise margins are central to the Company’s long term profitability. The Company conducts a weekly interdisciplinary review of sales and merchandise margins and prepares budgets for two six-month seasons each year, the Fall season, which ends on the Saturday closest to January 31^st each year, for example, on January 31, 2004 and January 29, 2005, and the Spring season, which ends six months earlier. Management uses comparable store sales (for stores open at least 12 months at the time) as an analytical tool.

Seasonal store sales data follow with sales improvements versus the previous comparable period in bold type:

*Excluding sales on the Internet and, until March 2003, through a catalog.
**A store that is relocated within the same shopping center or mall is considered comparable. However, if the store is relocated elsewhere, it is considered a new store and not comparable. A store that is expanded or contracted is still comparable, i.e., the sales from the remodeled store are considered comparable. Stores that are closed are not considered comparable. The comparable store sales calculation is not adjusted for changes in the store sales return reserve.

Seasonal Operating Results

The declines in sales per average store from the Fall 2002 season through the Spring 2004 season adversely affected operating results.

The Company had net income of $0.4 million in fiscal 2001 and incurred net losses of $23.1 million in fiscal 2002, $19.1 million in fiscal 2003 and $10.5 million in fiscal 2004. The Company had operating income of $0.6 million in fiscal 2001 and incurred operating losses of $22.8 million in fiscal 2002, $18.8 million in fiscal 2003 and $13.0 million in fiscal 2004. Excluding a one-time goodwill write-off, the operating loss in fiscal 2002 was $17.2 million. Operating income (loss) included loss from Shop @ Home operations before unallocated corporate expenses and net interest income (expense) of $6.9 million in fiscal 2001 and $5.9 million in fiscal 2002. As a result of the suspension of the catalog early in fiscal 2003, the Company had only one reportable segment for fiscal 2003 and fiscal 2004.

Product Repositioning Plan

In the women’s retail specialty apparel industry, sales, especially in businesses that emphasize fashionable merchandise, can vary significantly over time. Sales are volatile because of shifts in consumer spending patterns, consumer preferences and overall economic conditions; the impact of competition; variations in weather patterns; fluctuations in consumer acceptance of products; changes in the ability to develop new merchandise; differences in promotional strategies; and movements in consumer confidence levels. These variables caused the Company’s sales per average store to fluctuate in the past, declining from the Fall 2002 season through the Spring 2004 season and increasing in the Fall 2004 season. Thus, recent sales performance is not necessarily indicative of future sales performance. As a result, management believes that long-term sales projections within a defined narrow range are not reliable.

The Company incurred net losses in fiscal 2002, fiscal 2003 and fiscal 2004. The Company has sought to absorb normal cost inflation and return to long-term profitability through a goal of increased sales per average store with higher merchandise margins. This financial goal was translated into an integrated operational plan early in fiscal 2003 that was designed to reposition the Company’s product offering. (This plan has four principal components: (i) to improve the design of the Company’s merchandise and thereby differentiate it from competitors’ merchandise, (ii) to market more items together as coordinated outfits rather than separately as individual garments, (iii) to put more emphasis on fashionable merchandise and less on basic items, and (iv) to raise the level of merchandise presentation in the store to make shopping easier and to encourage outfit buying.) This plan relies primarily on the Company’s intellectual capital. Only small amounts of financial capital are required to execute the plan. The infrastructure to support implementation of the plan is already in place.

This section constitutes forward-looking information under the Private Securities Litigation Reform Act (the “Reform Act”), which is subject to the variables, uncertainties and other risk factors referred to under the caption “Future Results.”

Decline in Annual Store Count

Store counts averaged 557 stores, 546 stores and 531 stores, respectively, for fiscal 2002, 2003 and 2004. In fiscal 2004, the Company opened two stores and closed 23 stores. In fiscal 2005, the Company is planning to close approximately 15-20 stores as part of its normal lease maintenance program and to open one new store. Thus, the average number of stores is expected to decline further in fiscal 2005.

The annual capital expenditure budgets after fiscal 2005 will provide for new store construction and other infrastructure development priorities. Prioritization will be based, among other things, on overall profitability and the availability of suitable locations at rents and on terms that fit the Company’s financial model for new store construction. This paragraph constitutes forward-looking information under the Reform Act, which is subject to the variables, uncertainties and other risk factors referred to under the caption “Future Results.”

Liquidity

United Retail Group, Inc. and certain of its subsidiaries (collectively, the “Companies”) are parties to a Financing Agreement, dated August 15, 1997, as amended (the “Financing Agreement”), with The CIT Group/Business Credit, Inc. (“CIT”). The Financing Agreement provides credit on a revolving basis.

In early fiscal 2003, the Company adopted an integrated operational plan designed to reposition the Company’s product offering. This plan has four principal components: (i) to improve the design of the Company’s merchandise and thereby differentiate it from competitors’ merchandise, (ii) to market more items together as coordinated outfits rather than separately as individual garments, (iii) to put more emphasis on fashionable merchandise and less on basic items; and (iv) to raise the level of merchandise presentation in the store to make shopping easier and to encourage outfit buying.

The Company plans to use the Financing Agreement for its immediate and future working capital needs. Management believes that the borrowing capacity under the Financing Agreement, together with cash on hand and current and anticipated cash flow from operations, will be adequate to meet the Company’s working capital and capital expenditure requirements for at least the next 12 months.

This section constitutes forward-looking information under the Reform Act and is subject to the variables, uncertainties and other risk factors referred to under the caption “Future Results.”

DISCUSSION AND ANALYSIS

(This section provides details about the material line items in the Company’s statements of operations.)

First Quarter Fiscal 2005 Versus First Quarter Fiscal 2004

Net sales for the first quarter of fiscal 2005 increased 9.2% from the first quarter of fiscal 2004, to $106.5 million from $97.5 million.

The sources of net sales growth were as follows:

Comparable store sales increases in regions of the country with warmer weather were higher than average.

Compared to the first quarter of fiscal 2004, units sold per average store increased 20.8%, average price per unit sold decreased 7.0% and transactions per average store increased 22.7%.

There was better customer acceptance of denim, accessories and woven tops, which, together with the introduction of Spring sweaters to the merchandise assortment, collectively increased net sales by $9.2 million in comparison to the first quarter of fiscal 2004.

The average number of stores decreased from 534 in the first quarter of the previous year to 513 in the first quarter of fiscal 2005. The average number of stores is expected to continue to decrease. See, “Stores.”

Gross profit increased to $25.7 million in the first quarter of fiscal 2005 from $20.8 million in the first quarter of fiscal 2004, increasing as a percentage of net sales to 24.1% from 21.3%. Gross profit as a percentage of net sales increased because (i) rent and occupancy costs declined as a percentage of net sales (230 basis points as a percentage of net sales) and (ii) merchandise margins increased (60 basis points). Rent and occupancy costs declined in percentage terms principally because average store sales increased. Higher merchandise margins were the result of lower cost of goods sold. Gross profit levels in the future will be subject to the variables, uncertainties and other risk factors referred to under the caption “Future Results.” The amount of rent and occupancy costs is expected to decline further as the average number of stores decreases.

The cost of shipping and handling Shop @ Home orders was included in general, administrative and store operating expenses in previous periods but has been reclassified as cost of goods sold and reflected in the gross profit line in the financial statements contained in this Report. This change was made to provide more clarity for trends in general, administrative and store operating expenses. Prior periods have been reclassified to conform with the current presentation.

General, administrative and store operating expenses increased to $24.8 million in the first quarter of fiscal 2005 from $23.9 million in the first quarter of fiscal 2004. The increase in the amount of expenses was for legal and consulting fees totaling $0.9 million in connection with preparations for a potential proxy contest that has since been satisfactorily resolved. However, expenses decreased as a percentage of net sales to 23.3% from 24.5%, principally from a reduction in store payroll (110 basis points). There is no assurance that general, administrative and store operating expenses will continue to decrease in percentage terms. In addition to general cost inflation, the Company expects consulting and professional fees and Finance Department payroll to increase because of additional resources required to support new regulatory compliance. Also, although the number of associates employed in stores is expected to decrease as a result of routine store closings, possible increases in minimum wages may put pressure on the wage rates paid to the remaining store associates.

The Company had operating income of $0.9 million in the first quarter of fiscal 2005 and incurred an operating loss of $3.1 million in the first quarter of the previous year.

The Company had a benefit from income taxes of $0.3 million in the first quarter of fiscal 2005, in the form of a state income tax refund.

There is a valuation allowance provided for the Company’s net operating loss (“NOL”) carryforwards and other net deferred tax assets. In the first quarter of fiscal 2005, the Company’s tax valuation allowance was increased by $0.5 million.

The Company had net income of $1.0 million in the first quarter of fiscal 2005 and incurred a net loss of $3.4 million in the first quarter of fiscal 2004.

See, “Critical Accounting Policies” for a discussion of estimates made by management in preparing financial statements in accordance with generally accepted accounting principles.

May Sales

Net sales for May 2005 increased 8.6% from May 2004 to $39.1 million from $36.0 million. Comparable store sales for the month increased 10.2%. Average number of stores decreased from 533 to 512.

Increased Competition

The women’s retail apparel and shoe industries are highly competitive. Operating results of businesses in these industries, especially businesses that emphasize fashionable merchandise, can vary materially from year to year. The Company’s competition includes other specialty retailers, mass merchants, department stores, discount stores, mail order companies, television shopping channels and Internet websites. Management believes that total sales of large size women’s apparel from these sources of supply increased in recent years.

Product Repositioning Plan

In the women’s retail specialty apparel industry, sales, especially in businesses that emphasize fashionable merchandise, can vary significantly over time. Sales are volatile because of shifts in consumer spending patterns, consumer preferences and overall economic conditions; the impact of competition; variations in weather patterns; fluctuations in consumer acceptance of products; changes in the ability to develop new merchandise; differences in promotional strategies; and movements in consumer confidence levels. These variables caused the Company’s sales per average store to fluctuate in the past, declining from the Fall 2002 season through the Spring 2004 season and increasing in the Fall 2004 season. Thus, recent sales performance is not necessarily indicative of future sales performance. As a result, management believes that long-term sales projections that fall within a defined narrow range are not reliable.

The Company incurred net losses in fiscal 2002, fiscal 2003 and fiscal 2004. The Company has sought to absorb normal cost inflation and return to long-term profitability through a goal of increased sales per average store with higher merchandise margins. This financial goal was translated into an integrated operational plan early in fiscal 2003 that was designed to reposition the Company’s product offering. (This plan has four principal components: (i) to improve the design of the Company’s merchandise and thereby differentiate it from competitors’ merchandise, (ii) to market more items together as coordinated outfits rather than separately as individual garments, (iii) to put more emphasis on fashionable merchandise and less on basic items, and (iv) to raise the level of merchandise presentation in the store to make shopping easier and to encourage outfit buying.) This plan relies primarily on the Company’s intellectual capital. Only small amounts of financial capital are required to execute the plan. The infrastructure to support implementation of the plan is already in place.

This section constitutes forward-looking information under the Reform Act, which is subject to the variables, uncertainties and other risk factors referred to under the caption “Future Results.”

Liquidity and Capital Resources

This section provides details about the Company’s sources of liquidity.

Cash Flow

Net cash provided from operating activities increased to $5.0 million in the first quarter of fiscal 2005 from $1.1 million in the first quarter of the previous year, principally as a result of (i) a smaller increase in inventory levels during the first quarter of fiscal 2005 ($3.4 million) compared with the increase during the first quarter of fiscal 2004 ($11.7 million) and (ii) net income of $1.0 million for the first quarter of fiscal 2005 versus a net loss of $3.4 million for the first quarter of fiscal 2004, partially offset by (i) a smaller increase in accounts payable and accrued expenses during the first quarter of fiscal 2005 ($4.5 million) compared with the first quarter of fiscal 2004 ($9.9 million) and (ii) a smaller net increase in cash flow from the other assets and liabilities category in the first quarter of fiscal 2005 ($0.1 million) compared with the first quarter of fiscal 2004 ($2.6 million).

Balance Sheet Sources of Liquidity

The Company’s cash and cash equivalents increased to $18.6 million at April 30, 2005 from $14.3 million at May 1, 2004 and $12.6 million at January 29, 2005.

Inventories were stated at $53.0 million at April 30, 2005, $60.8 million at May 1, 2004 and $49.5 million at January 29, 2005. Inventory per selling square foot excluding Shop @ Home inventories decreased 10.3% from May 1, 2004 to April 30, 2005. (See, “Critical Accounting Policies – Inventory” for a discussion of estimates made by management in stating inventories in financial statements prepared in accordance with generally accepted accounting principles.)

Property and equipment decreased to $75.7 million at April 30, 2005 from $88.0 million at May 1, 2004 and $79.0 million at January 29, 2005, principally from depreciation. The Company expects property and equipment to decrease further during the remainder of fiscal 2005, principally from depreciation.

Other Liquidity Sources

Purchases of merchandise directly imported by the Company are made in U.S. dollars and generally financed by trade letters of credit.

The Financing Agreement was extended and expanded during fiscal 2003. The term was extended three years to August 15, 2008. The line of credit was increased from $40 million to $50 million for the Companies, subject to availability of credit as described in the following paragraphs. The line of credit may be used on a revolving basis by any of the Companies to support trade letters of credit and standby letters of credit and to finance loans. At April 30, 2005, trade letters of credit for the account of the Companies and supported by CIT were outstanding in the amount of $20.8 million and standby letters of credit were outstanding in the amount of $6.1 million. Standby letters of credit were used principally in connection with insurance policies issued to the Company.

Subject to the following paragraph, the availability of credit (within the aggregate $50 million line of credit) to any of the Companies at any time is the excess of its borrowing base over the aggregate outstanding amount of its letters of credit and its revolving loans, if any. The borrowing base, as to any of the Companies is (i) the sum of (x) a percentage of the book value of its eligible inventory (both on hand and unfilled purchase orders financed with letters of credit), ranging from 65% to 75% depending on the time of year, (y) the balance from time to time in an account in its name that has been pledged to the lenders (a “Pledged Account”) and (z) 85% of certain receivables from credit card companies less (ii) reserves for rent for stores located in the states of Pennsylvania, Virginia and Washington and liens other than permitted liens and, at CIT’s option, a reserve for sales taxes collected but not yet paid.

The provisions of the preceding paragraph to the contrary notwithstanding, the Companies are required to maintain unused at all times combined availability of at least $5 million. Except for the maintenance of a minimum availability of $5 million and a limit on capital expenditures, the Financing Agreement does not contain any significant financial covenants.

The combined borrowing capacity of the Companies is cyclical due to the seasonality of the retail industry. At April 30, 2005, the combined borrowing capacity of the Companies, after satisfying the $5 million minimum availability requirement, was $17.6 million; the Pledged Account had a zero balance; no loan was outstanding; and the Companies’ balance sheet cash and cash equivalents of $18.6 million were unrestricted.

The line of credit is collateralized by a security interest in (i) inventory and its proceeds, (ii) receivables from credit card companies and (iii) the balance, if any, from time to time in the Pledged Account. Further, the Company has agreed with CIT to have its subsidiary, Avenue Giftcards, Inc. (which issues AVENUE® giftcards), maintain a minimum level of high-grade liquid investments. These investments amounted to $0.5 million at April 30, 2005 and were classified as restricted cash on the balance sheet. The amount of these investments will fluctuate each quarter in relation to the volume of net issuances of AVENUE® giftcards and merchandise credits during the previous six months. (The volume of net issuances is seasonal.)

The Financing Agreement includes certain restrictive covenants that impose limitations (subject to certain exceptions) on the Companies with respect to making certain investments, declaring or paying dividends, making loans, engaging in certain transactions with affiliates, or consolidating, merging or making acquisitions outside the ordinary course of business.

The Company has drawn on the revolving loan facility under the Financing Agreement from time to time to meet its peak working capital requirements. Interest is payable monthly based on a 360-day year either at the prime rate plus an incremental percentage up to 0.75% per annum or at the LIBOR rate plus an incremental percentage ranging from 1.75% to 2.50% per annum. The borrower can select either the prime rate or the LIBOR rate as the basis for determining the interest rate. In either case, the incremental percentage is determined by the average excess availability. Payment of revolving loans is not required until termination of the agreement unless either (1) the outstanding balance of revolving loans and outstanding letters of credit exceeds the combined borrowing capacity of the Companies, in which case the excess would be payable upon demand from CIT or (2) a default under the Financing Agreement arises.

Short-term trade credit represents a significant source of financing for merchandise purchases other than merchandise directly imported by the Company. Trade credit arises from the willingness of the Company’s vendors of these products to grant extended payment terms for inventory purchases and is generally financed either by the vendor or a third-party factor. The availability of trade credit depends on the Company’s having other sources of liquidity, as well. In particula