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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the Quarterly Period Ended October 30, 2010

OR

Commission File Number 0-21915

COLDWATER CREEK INC.

(Exact name of registrant as specified in its charter)

ONE COLDWATER CREEK DRIVE, SANDPOINT, IDAHO 83864

(Address of principal executive offices)

(208) 263-2266

(Registrant’s telephone number, including area code)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  o    NO  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

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

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

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Coldwater Creek Inc.

Quarterly Report on Form 10-Q

For the Fiscal Quarter Ended October 30, 2010

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“We,” “us,” “our,” “Company” and “Coldwater Creek,” unless the context otherwise requires, means Coldwater Creek Inc. and its subsidiaries.

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PART 1. FINANCIAL INFORMATION

ITEM 1.                              FINANCIAL STATEMENTS

COLDWATER CREEK INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except for share data)

The accompanying notes are an integral part of these interim financial statements.

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COLDWATER CREEK INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands except for per share data)

The accompanying notes are an integral part of these interim financial statements.

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COLDWATER CREEK INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these interim financial statements.

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COLDWATER CREEK INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Nature of Business and Basis of Presentation

Coldwater Creek Inc., a Delaware corporation together with its wholly-owned subsidiaries, headquartered in Sandpoint, Idaho, is a multi-channel specialty retailer of women’s apparel, accessories, jewelry and gift items. We operate in two operating segments: retail and direct. The retail segment consists of our premium retail stores, merchandise clearance outlet stores and day spas. The direct segment consists of sales generated through our e-commerce web site and from orders taken from customers over the phone or through the mail. Intercompany balances and transactions have been eliminated.

The accompanying condensed consolidated financial statements are unaudited and have been prepared by management pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted. The condensed consolidated balance sheet as of January 30, 2010 was derived from the audited consolidated balance sheet as of that date. The condensed consolidated financial statements, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes in our Annual Report on Form 10-K for the fiscal year ended January 30, 2010.

The condensed consolidated financial position, results of operations and cash flows for these interim periods are not necessarily indicative of the financial position, results of operations or cash flows to be realized in future periods.

2. Significant Accounting Policies

Accounting Policies

The complete summary of significant accounting policies is included in the notes to the consolidated financial statements as presented in our Annual Report on Form 10-K for the fiscal year ended January 30, 2010.

Comprehensive Loss

The following table provides a reconciliation of net loss to total other comprehensive loss (in thousands):

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and timing of revenue and expenses, the reported amounts and classification of assets and liabilities, and the disclosure of contingent assets and liabilities. These estimates and assumptions are embodied in our sales returns accrual, stock-based compensation, contingencies, income taxes, asset impairment, and our inventory obsolescence calculations. These estimates and assumptions are based on historical results as well as management’s future expectations. Actual results may vary from these estimates and assumptions.

Fair Value

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Assets and liabilities recorded at fair value are categorized using defined hierarchical levels related to the subjectivity associated with the inputs to fair value measurements as follows:

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·                  Level 1 — Quoted prices in active markets for identical assets or liabilities;

·                  Level 2 — Quoted prices for similar assets or liabilities in active markets or inputs that are observable;

·                  Level 3 — Unobservable inputs in which little or no market activity exists.

As of October 30, 2010, January 30, 2010, and October 31, 2009 we held $32.6 million, $81.1 million and $29.1 million in money market funds that are measured at fair value on a recurring basis using level 1 inputs.

During the three months ended October 30, 2010, we recorded impairment charges of $1.0 million for certain premium stores that we expect will be closed before their previous estimated useful life and computer software that we determined is no longer probable of being placed in service. These impairment charges were measured at fair value using Level 3 inputs (discounted cash flows).

We also have financial assets and liabilities, not required to be measured at fair value on a recurring basis, which primarily consist of cash, restricted cash, receivables, payables and financing obligations, the carrying value of which materially approximate their fair values.

Advertising Costs

Direct response advertising includes catalogs and national magazine advertisements that contain an identifying code which allows us to track related sales. All direct costs associated with the development, production and circulation of direct response advertisements are accumulated as prepaid marketing costs. Once the related catalog or national magazine advertisement is either mailed or first appears in print, these costs are reclassified to deferred marketing costs. These costs are then amortized to selling, general and administrative expenses over the expected sales realization cycle, typically several weeks. Direct response advertising expense was $12.8 million and $17.4 million for the three months ended October 30, 2010 and October 31, 2009, respectively and $34.3 million and $35.0 million for the nine months ended October 30, 2010 and October 31, 2009, respectively.

Advertising costs other than direct response advertising include store and event promotions, signage expenses and other general customer acquisition activities. These advertising costs are expensed as incurred or when the particular store promotion begins. Advertising expenses other than those related to direct response advertising of $6.8 million and $6.2 million for the three months ended October 30, 2010 and October 31, 2009, respectively and $17.0 million and $14.8 million for the nine months ended October 30, 2010 and October 31, 2009, respectively, are included in selling, general and administrative expenses.

Income Taxes

In assessing the realizability of our deferred tax assets, we consider all available evidence to determine whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become realizable. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), and projected taxable income in assessing the realizability of deferred tax assets. In making such judgments, significant weight is given to evidence that can be objectively verified. Current or previous losses are given more weight than projected future performance. Consequently, based on all available evidence, in particular our three-year historical cumulative losses and recent operating losses, we have a valuation allowance against a significant portion of our net deferred tax assets. In order to fully realize the deferred tax assets, we will need to generate sufficient taxable income in future periods before the expiration of the deferred tax assets governed by the tax code.

The tax benefit for the three and nine months ended October 30, 2010 vary from the amount that would result from applying the statutory income tax rate to pre-tax income, primarily due to the effects of the change in valuation allowance and state taxes. During the three and nine months ended October 30, 2010, we recognized discrete benefits of $1.9 million and $2.5 million, respectively, related to valuation allowance adjustments and $0.9 million of true up adjustments primarily related to the filing of our 2009 Federal income tax return in the quarter. The provision for income taxes of $22.7 million and $16.2 million in the three and nine months ended October 31, 2009, respectively, reflects the establishment of valuation allowances for substantially all of our net deferred tax assets.

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The Internal Revenue Service is currently conducting an examination of our Federal income tax returns for fiscal years 2009, 2008, 2007 and 2006.

Stock-Based Compensation

Total stock-based compensation expense recognized primarily in selling, general and administrative expenses from stock options and restricted stock units (RSUs) during the three and nine months ended October 30, 2010 and October 31, 2009 was as follows (in thousands):

Options to purchase 697,800 and 916,000 shares of our common stock were granted to employees during the nine months ended October 30, 2010 and October 31, 2009, respectively. The weighted average fair value of those options was $2.87 and $3.21, respectively. Options to purchase 65,417 and 398,799 shares of our common stock were exercised during the nine months ended October 30, 2010 and October 31, 2009, respectively, with a total intrinsic value of $0.1 million and $2.2 million, respectively.

During the nine months ended October 30, 2010 and October 31, 2009, we granted 212,387 and 79,659 RSUs, respectively, with only service conditions at a weighted average grant date fair market value of $4.35 and $7.02, respectively.  During the nine months ended October 30, 2010, we also granted 263,000 RSUs that, in addition to service conditions also contained performance conditions, at a weighted average grant date fair value of $3.88. The awards with the additional performance conditions are subject to the achievement of combined earnings before interest expense and taxes (EBIT) target for the fiscal years ending 2010, 2011 and 2012, as well as continued employment with the Company and the receipt of satisfactory performance reviews. The number of shares actually awarded will range from 0 to 200 percent of the base award amount, depending on our EBIT during the performance period.

During the nine months ended October 31, 2009, we granted 156,000 RSUs that, in addition to service conditions also contained performance and market conditions, at a weighted average grant date fair value of $5.23. The awards with the additional performance and market conditions are independent of each other and equally weighted, and are based on three metrics: operating income, comparable store growth (CSG) relative to a peer group, and total shareholder return (TSR) relative to a peer group.  The fair value of the RSUs with operating income and CSG goals are based on the fair market value at the date of grant.  The fair value of the RSUs containing the TSR condition was determined using a statistical model that incorporates the probability of meeting performance targets based on historical returns relative to a peer group.

All awards with performance and market conditions are measured over the vesting period and are charged to compensation expense over the requisite service period based on the number of shares expected to vest. During the nine months ended October 30, 2010 and October 31, 2009, the total fair market value of RSUs vested was $0.4 million and $2.3 million, respectively.

On September 12, 2009, our former director, President and Chief Executive Officer (CEO) resigned. As a result, we recorded stock-based compensation of $2.1 million during the three and nine months ended October 31, 2009 related to the acceleration of all our former CEO’s unvested equity awards, per the original terms of the agreement.

Interest, net, and other

Interest, net, and other consists of the following (in thousands):

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Recently Issued Accounting Standard

In October 2009, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force. This ASU provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. The amendments in this ASU replace the term “fair value” in the revenue allocation guidance with “selling price” to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendments in this ASU also establish a selling price hierarchy for determining the selling price of a deliverable. The amendments in this ASU eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The amendments in this ASU will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. We do not expect the initial adoption of this ASU to have a material impact on our revenue recognition policies, particularly our co-branded credit card program.

3. Receivables

Receivables consist of the following (in thousands):

We evaluate the credit risk associated with our receivables to determine if an allowance for doubtful accounts is necessary. At October 30, 2010, allowance for doubtful accounts was $0.9 million. At January 30, 2010 and October 31, 2009 no allowance for doubtful accounts was deemed necessary.

4. Property and Equipment, net

Property and equipment, net, consist of the following (in thousands):

5. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

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6. Net Earnings (Loss) Per Common Share

Basic net earnings (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net earnings (loss) per common share is computed by dividing net income (loss) by the combination of other potentially dilutive common shares and the weighted average number of common shares outstanding during the period. Other potentially dilutive weighted average common shares include the dilutive effect of stock options, RSUs and shares to be purchased under our Employee Stock Purchase Plan for each period using the treasury stock method. Under the treasury stock method, the exercise price of a share, the amount of compensation expense, if any, for future service that has not yet been recognized, and the amount of benefits that would be recorded in additional paid-in-capital, if any, when the share is exercised are assumed to be used to repurchase shares in the current period.

The following table sets forth the computation of basic and diluted net loss per common share (in thousands, except for per share data):

The computation of the dilutive effect of other potential common shares excluded options to purchase 3.0 million and 2.9 million shares of common stock for the three months ended October 30, 2010 and October 31, 2009, respectively, and 2.6 million and 3.4 million shares of common stock for the nine months there ended, respectively.  Under the treasury stock method, the inclusion of these options would have resulted in lower loss per share, causing their effect to be antidilutive.

7. Supplemental Executive Retirement Plan

Net periodic benefit cost is comprised of the following components for the three and nine months ended October 30, 2010 and October 31, 2009 (in thousands):

As of October 30, 2010, we had $0.4 million of prior service costs and actuarial losses recognized in accumulated other comprehensive loss.

As the SERP is an unfunded plan, we were not required to make any contributions during the three and nine months ended October 30, 2010 and October 31, 2009. No benefit payments were made during the nine months ended October 30, 2010. Benefit payments of $0.3 million, funded by operating cash flows, were made during the nine months ended October 31, 2009. We do not expect to pay any cash out during the remainder of fiscal 2010.

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8. Commitments

Leases

During the three months ended October 30, 2010 and October 31, 2009, we incurred aggregate rent expense under operating leases of $20.1 million and $19.9 million, respectively, including $3.9 million and $3.8 million, respectively, of common area maintenance costs (CAM), $0.1 million and $0.1 million, respectively, of rent expense classified as store pre-opening costs and an immaterial amount of contingent rent expense for each period. Aggregate rent expense under operating leases does not include related real estate taxes of $2.9 million and $2.7 million for the three months ended October 30, 2010 and October 31, 2009, respectively. During the nine months ended October 30, 2010 and October 31, 2009, we incurred aggregate rent expense under operating leases of $59.6 million and $59.1 million, respectively, including $11.7 million and $11.4 million, respectively, of CAM, $0.3 million and $0.6, respectively, of rent expense classified as store pre-opening costs and an immaterial amount of contingent rent expense for each period. Aggregate rent expense under operating leases does not include related real estate taxes of $8.4 million and $7.9 million for the nine months ended October 30, 2010 and October 31, 2009, respectively.

As of October 30, 2010 our minimum operating lease payment requirements, which include the predetermined fixed escalations of the minimum rentals and exclude contingent rental payments, CAM, real estate taxes, and the amortization of lease incentives for our operating leases totaled $564.5 million.

Credit Facility

Our credit facility with Wells Fargo Retail Finance, LLC, which is collateralized by substantially all of our assets, provides a revolving line of credit up to $70.0 million with subfacilities for the issuance of up to $70.0 million in letters of credit and swingline advances of up to $10.0 million. The credit facility has a maturity date of February 13, 2012. The actual amount of credit that is available from time to time under the Agreement is limited to a borrowing base amount that is determined according to, among other things, a percentage of the value of eligible inventory plus a percentage of the value of eligible credit card receivables, as reduced by certain reserve amounts that may be required by the lender. The proceeds of any borrowings under the credit facility are available for working capital and other general corporate purposes. As of October 30, 2010, January 30, 2010 and October 31, 2009, we had no borrowings outstanding under the credit facility.  As of October 30, 2010, we had $27.9 million in letters of credit issued resulting in $42.1 million available for borrowing under our credit facility.

Borrowings under the Agreement will generally accrue interest at a margin ranging from 2.25% to 2.75% (determined according to the average unused availability under the credit facility) over a reference rate of, at our election, either LIBOR or a base rate, as defined in the agreement. Letters of credit under the credit facility accrue fees at a rate equal to the interest margin that is in effect from time to time. Commitment fees accrue at a rate of 0.50%, which is assessed on the average unused portion of the credit facility maximum amount.

The credit facility has financial covenants that are limited to capital expenditures, minimum inventory book value and maximum facility usage as a percentage of the borrowing base value. The credit facility also contains various restrictive covenants relating to customary matters, such as indebtedness, liens, investments, acquisitions, mergers, dispositions and dividends.  We were in compliance with all covenants for all periods presented.

The credit facility generally contains customary events of default for credit facilities of this type. Upon an event of default that is not cured or waived within any applicable cure periods, in addition to other remedies that may be available to the lender, the obligations under the credit facility may be accelerated, outstanding letters of credit may be required to be cash collateralized and remedies may be exercised against the collateral.

Other

As of October 30, 2010, we had approximately $180.0 million of future non-cancelable inventory purchase commitments and $1.6 million committed under our letter of credit related to the lease of our distribution center.

9. Contingencies

Legal Proceedings

We are, from time to time, involved in various legal proceedings incidental to the conduct of business. Actions filed against us from time to time include commercial, intellectual property infringement, customer and employment claims, including class action lawsuits alleging that we violated federal and state wage and hour and other laws. We believe that we have meritorious defenses to all lawsuits and legal proceedings currently pending against us. Though we will continue to vigorously defend such lawsuits and legal

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proceedings, we are unable to predict with certainty whether or not we will ultimately be successful. However, based on management’s evaluation, we believe that the resolution of these matters, taking into account existing contingency accruals and the availability of insurance and other indemnifications, will not materially impact our consolidated financial position, results of operations or cash flows.

On September 12, 2006, as amended on April 25, 2007, Brighton Collectibles, Inc. (“Brighton”) filed a complaint against us in the United States District Court for the Southern District of California. The complaint alleged, among other things, that we violated trade dress and copyright laws. On November 21, 2008, a jury found us liable to Brighton for copyright and trade dress infringement. In January 2009, the court entered a judgment in the total amount of $8.0 million, which includes damages of $2.7 million on the trade dress claim, $4.1 million in damages and profits on the copyright claim and $1.2 million in attorneys’ fees. We have appealed the judgment as we believe there are legitimate grounds to overturn the judgment. Pending the appeal, the court entered a temporary stay of execution conditioned on us posting an $8.0 million bond, which has been posted. We currently have insurance coverage and have been provided defense by our insurance carrier.

On December 12, 2008, as amended on September 17, 2009, Brighton filed another complaint against us in the United States District Court for the Southern District of California. The complaint alleges copyright infringement of three different Brighton designs. We are vigorously defending this matter. We believe it is without merit and are asserting various defenses to the action. We also currently have insurance coverage and have been provided defense by our insurance carrier.

We believe that the amount of loss, if any, related to these legal proceedings is adequately reserved for or covered by insurance.

Other

Our multi-channel business model subjects us to state and local taxes in numerous jurisdictions, including franchise, and sales and use tax. We collect these taxes in jurisdictions in which we have a physical presence. While we believe we have paid or accrued for all taxes based on our interpretation of applicable law, tax laws are complex and interpretations differ from state to state. In the past, we have been assessed additional taxes and penalties by various taxing jurisdictions, asserting either an error in our calculation or an interpretation of the law that differed from our own. It is possible that taxing authorities may make additional assessments in the future. In addition to taxes, penalties and interest, these assessments could cause us to incur legal fees associated with resolving disputes with taxing authorities.

Additionally, changes in state and local tax laws, such as temporary changes associated with “tax holidays” and other programs, require us to make continual changes to our collection and reporting systems that may relate to only one taxing jurisdiction. If we fail to update our collection and reporting systems in response to these changes, any over collection or under collection of sales taxes could subject us to interest and penalties, as well as private lawsuits and damage to our reputation. In the opinion of management, resolutions of these matters will not have a material impact on our consolidated financial position, results of operations or cash flows.

10. Co-Branded Credit Card Program

Deferred marketing fees and revenue sharing

The following table summarizes the deferred marketing fee and revenue sharing activity for the three and nine months ended October 30, 2010 and October 31, 2009 (in thousands):

The amortization schedule of deferred marketing fees is based upon current estimates and assumptions of the expected period the customer will use the credit card while the deferred revenue sharing is based upon the expected life of the co-branded credit card

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program, and are therefore subject to change. The following table provides an estimate of when we expect to amortize the deferred marketing fees and the deferred revenue sharing as of October 30, 2010 into revenue (in thousands):

Sales Royalty

The amount of sales royalty recognized as revenue during the three months ended October 30, 2010 and October 31, 2009 was $1.8 million and $2.1 million, respectively.  During the nine months ended October 30, 2010 and October 31, 2009 sales royalty revenue recognized was $5.5 and $4.5 million, respectively.  The amount of deferred sales royalty recorded in accrued liabilities was $2.9 million, $3.3 million and $3.7 million at October 30, 2010, January 30, 2010 and October 31, 2009, respectively.

11. Segment Reporting

The following table provides certain financial data for the retail and direct segments as well as reconciliations to the condensed consolidated financial statements (in thousands):

There were no inter-segment sales between the retail and direct segments during the periods presented.

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The following discussion contains various statements regarding our current strategies, financial position, results of operations, cash flows, operating and financial trends and uncertainties, as well as certain forward-looking statements regarding our future expectations. When used in this discussion, words such as “anticipate,” “believe,” “estimate,” “expect,” “could,” “may,” “will,” “should,” “plan,” “predict,” “potential,” and similar expressions are intended to identify such forward-looking statements. Our forward-looking statements are based on our current expectations and are subject to numerous risks and uncertainties. As such, our actual future results, performance or achievements may differ materially from the results expressed in, or implied by, our forward-looking statements. Please refer to our “Risk Factors” in our most recent Annual Report on Form 10-K for the fiscal year ended January 30, 2010, as well as in this Quarterly Report on Form 10-Q and other reports we file with the Securities and Exchange Commission. We assume no future obligation to update our forward-looking statements or to provide periodic updates or guidance.

We encourage you to read this Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the accompanying condensed consolidated financial statements and related notes.

Overview

Coldwater Creek Inc. is a specialty retailer of women’s apparel, accessories, jewelry and gift items. Founded in 1984 as a catalog company, today we are a multi-channel specialty retailer generating sales through our retail stores, as well as our catalog and e-commerce channels. Our proprietary merchandise assortment reflects a sophisticated yet relaxed and casual lifestyle. A commitment to providing superior customer service is manifest in all aspects of our business. Our merchandise assortment, retail stores, catalogs and e-commerce web site are designed to appeal to women who are 35 years of age and older with average annual household incomes in excess of $75,000.

Our mission is to become one of the premier specialty retailers for women 35 years of age and older in the United States by offering our customers a compelling merchandise assortment with superior customer service through all our sales channels.

References to a fiscal year are to the calendar year in which the fiscal year begins. We currently have two operating segments: retail and direct.  Retail sales consists of sales generated at our premium retail stores and outlet stores along with our day spa locations.  Direct sales consist of sales generated through our e-commerce web site and from orders taken over the phone or through the mail.

Executive Summary

Our operating results for the three months ended October 30, 2010 were driven by an unfavorable customer response to our fall merchandise assortments which led to a significant decline in sales, margins and profitability. Net loss for the three months ended October 30, 2010 was $10.9 million, or $0.12 per share, compared with a net loss of $34.0 million, or $0.37 per share, for the three months ended October 31, 2009. We expect the challenges we experienced as a result of our fall assortment to continue during the fourth quarter.

Net sales decreased to $232.4 million for the three months ended October 30, 2010, compared to $266.7 million for the three months ended October 31, 2009. This 12.8 percent decrease in net sales was primarily driven by a decrease in comparable premium retail store sales(1) of 20.1 percent in our retail segment and a decrease in our direct segment sales of 2.1 percent.

Our gross margin rate for the three months ended October 30, 2010 was 30.5 percent, compared with 36.4 percent for the three months ended October 31, 2009. This 5.9 percentage point decrease in the gross margin rate was primarily due to increased promotional activity and deleveraging of occupancy expenses as compared to last year, which was partially offset by improvements in initial merchandise markups.

(1)  We define comparable premium stores as those stores in which the gross square footage has not changed by more than 20 percent in the previous 16 months and which have been open for at least 16 consecutive months (provided that store has been considered comparable for the entire quarter) without closure for seven consecutive days or moving to a different temporary or permanent location. Due to the extensive promotions that occur as part of the opening of a premium store, we believe waiting sixteen months rather than twelve months to consider a store to be comparable provides a better view of the growth pattern of the premium retail store base. During the three months ended October 30, 2010, the comparable premium retail store base included 344 premium retail stores compared to 307 premium retail stores for the same period of fiscal 2009. The calculation of comparable store sales varies across the retail industry and as a result, the calculations of other retail companies may not be consistent with our calculation.

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Selling, general and administrative expenses (SG&A) for the three months ended October 30, 2010 were $85.4 million, or 36.8 percent of net sales, compared with $108.2 million, or 40.6 percent of net sales, for the three months ended October 31, 2009. The decline in SG&A was driven primarily by lower employee-related expenses, marketing expenses, and other fixed and variable costs. Employee-related expenses for the three months ended October 31, 2009 included separation agreement charges of $6.0 million.

We ended the third quarter of fiscal 2010 with $51.7 million in cash and cash equivalents, compared to $69.6 million at the end of the third quarter of fiscal 2009. Working capital increased by $15.9 million to $105.8 million at October 30, 2010 from $89.9 million at October 31, 2009. Premium retail inventory, including the retail inventory in our distribution center, decreased 8.0 percent per square foot compared to the third quarter of fiscal 2009. Total inventory increased 2.3 percent to $197.5 million at the end of the third quarter of fiscal 2010 from $193.0 million at the end of the third quarter of fiscal 2009.

Company Initiatives

During the fourth quarter of fiscal 2009, we began implementing initiatives to position us for improved performance. These initiatives, which we will continue to refine during the remainder of fiscal 2010 and in fiscal 2011, are focused on improving our overall transaction volume and our average price per unit. Our initiatives include improving our merchandise mix, adjusting our pricing strategy, modifying our approach to our periodic sale events, revitalization of our brand creative and growing our direct business. The most important change we need to make in order to improve our sales and profitability is to offer our core and target customer an assortment that she finds more appealing.

Over the last two years we shifted our merchandise assortment to more basic items in a broad range of colors and styles, and away from our core strength of a diverse assortment across a variety of categories. In addition, through focus groups and customer feedback, we learned that customers thought our most recent fall merchandise assortments included prints and patterns that were too large and bold, and that many of our styles were not updated enough. Because we recognize that our customers are focused on a more updated fashion orientation, we are working to provide fashionable looks and current styles interpreted appropriately for our customer in an effort to improve sales and gross profit. We are in the process of repositioning the Coldwater Creek brand to better address the needs of both our core and target customer demographic and over the past few months have made several key changes to our merchandising and design teams. As we move into 2011, the new design aesthetic will begin to be reflected in the summer collection, which arrives in late March and early April.

In early fiscal 2010, we began to realign our pricing to properly reflect the unique quality and design of our merchandise and increased our initial markup. As a result, we experienced meaningful improvement in our average transaction value and merchandise margin during the first half of fiscal 2010. We continue to see that the price increases we have introduced throughout 2010 are not meeting with any significant price resistance when the products are desirable; however, we believe that we need to offer more opening price points in key categories to provide our customer with great looks and quality across a broader range of pricing. For the fourth quarter of fiscal 2010, we have increased the level of opening price points in many categories, establishing what we believe is a more balanced assortment of pricing options for the November and December holiday shopping season.

We also adjusted our approach to our sale events as we discovered during fiscal 2009 that our customers were not responding to these events as they had in the past, resulting in a decrease in our merchandise margins. For our spring and summer sale events, which took place during the first and second quarters of fiscal 2010, respectively, we took a sharper first markdown(2) and reduced the duration of the sale event, which was effective in improving sales volume and merchandise margins. Given the results, we expect to continue a similar strategy going forward.

We have also made efforts to restore our direct segment business, which significantly deteriorated during fiscal years 2009 and 2008. We believe this was largely due to our decision to reduce catalog circulation in response to economic conditions. During the first half of fiscal 2010, we made renewed investments in catalog and email circulation, as well as national magazine advertising, resulting in increased traffic to, and time spent on, our web site. While we believe these improvements delivered positive results in the first half of fiscal 2010, this trend did not continue in the third fiscal quarter, as the direct segment net sales during the quarter declined $1.2 million, or 2.1 percent, compared to the same period last year.

We implemented a new creative direction to the Coldwater Creek brand concurrent with the arrival of our fall 2010 collection. This new creative direction includes changes to our store windows, our floor visuals, our web site, and our marketing programs. While we believe some of these fashion orientation messages were out of our core customer’s comfort zone, we believe long term that these enhancements will allow us to offer one consistent message to our customer across all channels, reflecting an updated and elevated level to both our product and our store experience.

(2)  We define markdowns generally as permanent reductions from the original selling price.

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While we believe that the changes to our merchandise strategy, rebalancing of our pricing strategy, adjustment of our promotional cadence and sale events, revitalization of our brand creative, and restoration of our direct segment business will position us for improved long-term performance and growth, we recognize we are in a transition period and the full effect of these changes we are implementing will take time to be realized.

Outlook

Our operating results for the third quarter of fiscal 2010 were negatively impacted by our fall merchandise assortment which was not well received by our customers. We expect the challenges we experienced with our fall assortment to continue during the fourth quarter. In addition, weakness in consumer spending persists as a result of continued uncertain macroeconomic conditions reflected in reduced incomes, high unemployment and deterioration in household net worth. We believe these conditions continue to have a negative impact on our sales, gross margin and operating performance. As long as these conditions continue, we expect that consumer spending will remain subdued. As such, we will continue to focus our efforts on expense and inventory control.

During the third quarter of fiscal 2010, we made significant efforts to clear excess inventory by utilizing our major sale event in October, as well as other promotional events in our stores, outlets, and on our web site. We expect total inventory at the end of fiscal 2010 to be down in the mid-single digit percent range compared to our inventory level at the end of fiscal 2009. We have made loss provisions for certain inventory items as of October 30, 2010 based upon current forecasts which consider current and future selling prices.

We continue to believe that retail expansion will be a key driver for our long term growth. However, we have pursued a scaled-back store rollout program compared to the years prior to 2009 until the economic outlook improves. During the first nine months of fiscal 2010, we opened 17 new premium retail stores and closed one, ending the third quarter with 372 premium retail stores. We also opened two new merchandise clearance outlet stores and closed one during the same period, ending the third quarter with 37 merchandise clearance outlet stores. As of December 2, 2010, we completed our 2010 store expansion plan with 19 new premium retail stores opened since the beginning of the fiscal year. In addition, we plan to limit new store openings in fiscal 2011 to six stores to which we have previously committed and to close between eight and 12 stores. As a result, our capital expenditures in 2011 will be substantially lower than our capital expenditures in fiscal 2010.

Other Developments

On June 2, 2010, we announced that Georgia Shonk Simmons, President and Chief Merchandising Officer, will retire effective May 1, 2011. Ms. Shonk Simmons will also resign from our board of directors effective May 1, 2011.

Results of Operations

Comparison of the Three Months Ended October 30, 2010 with the Three Months Ended October 31, 2009

The following table sets forth certain information regarding the components of our condensed consolidated statements of operations for the three months ended October 30, 2010 as compared to the three months ended October 31, 2009. It is provided to assist in assessing differences in our overall performance (in thousands):

* Comparisons from negative to positive values are not considered meaningful.

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Net Sales

Net sales consist of retail and direct sales, which include revenue from our co-branded credit card program. In addition, shipping fees received from customers for delivery of merchandise are included in the direct segment.

Net sales decreased during the three months ended October 30, 2010 as compared with the three months ended October 31, 2009 primarily due to a decrease in comparable premium retail store sales of 20.1 percent in our retail segment and a decrease in sales in our direct segment of 2.1 percent, partially offset by the impact of new stores.  During the three months ended October 30, 2010, our premium retail stores experienced a decline in comparable premium retail store traffic of 14.6 percent and an 8.2 percent decrease in comparable premium retail store conversion rate, offset by an increase of 2.9 percent in average transaction value as compared to the same period in 2009. During the three months ended October 30, 2010, catalog circulation decreased by 6.2 million, or 23.2 percent, compared to the three months ended October 31, 2009, which we believe contributed to the decrease in order volume and sales in our direct business.

Shipping fees received from customers for delivery of merchandise increased by $0.6 million to $6.2 million for the three months ended October 30, 2010 from $5.6 million for the three months ended October 31, 2009, which is primarily associated with an increase in realized shipping rates. Revenue from our co-branded credit card program decreased $0.4 million for the three months ended October 30, 2010 as compared with the three months ended October 31, 2009.

Cost of Sales/Gross Profit

The gross profit rate decreased by 5.9 percentage points during the three months ended October 30, 2010 as compared to the three months ended October 31, 2009.  The decrease in our gross profit rate was primarily the result of a 2.2 percentage point decrease attributable to an increase in promotional discounts(3) and our markdown rate, which was partially offset by higher initial merchandise markups. The remainder of the decrease in our gross profit rate was the result of higher occupancy costs, buying & distribution costs and shipping & handling costs of 2.4, 1.1 and 0.2 percentage points, respectively.

Selling, General and Administrative Expenses

SG&A decreased $22.8 million in the three months ended October 30, 2010 as compared with the same period in the prior year, primarily driven by decreased employee-related expenses, marketing expenses and other fixed and variable costs. As a percentage of net sales, SG&A expense decreased by 3.8 percentage points in the three months ended October 30, 2010 as compared with the three months ended October 31, 2009. This decrease in SG&A rate was the result of a 3.0 percentage point decrease in employee-related expenses, a 0.4 percentage point decrease in marketing expenses and a 0.4 percentage point decrease in other fixed and variable costs. The decrease in employee-related expenses and other fixed and variable costs as a percentage of sales is primarily the result of our continued efforts to control expenses.  Employee-related expenses for the three months ended October 31, 2009 included separation agreement charges of $6.0 million. The decrease in marketing expenses as a percentage of net sales was driven primarily by decreased catalog circulation and national magazine advertising.

Loss on asset impairments

During the three months ended October 30, 2010 we recorded impairment charges of $1.0 million related to leasehold improvements and furniture and fixtures at certain premium retail store locations and certain computer software. We did not have any impairment charges during the three months ended October 31, 2009.

(3)  We define promotional discounts generally as temporary offerings. These include coupons and in-store promotions to customers for specified dollar or percentage discounts.

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Interest, Net and Other

The decrease in interest, net and other for the three months ended October 30, 2010 as compared with the same period in the prior year is primarily the result of a decrease in interest expense on our capital lease and other financing obligations.

Provision for Income Taxes

The tax benefit for the three months ended October 30, 2010 includes the effects of $1.9 million of valuation allowance adjustments and $0.9 million of true up adjustments primarily related to the filing of our 2009 Federal income tax return in the quarter. The provision for income taxes of $22.7 million in the three months ended October 31, 2009 reflects the establishment of valuation allowances for substantially all of our net deferred tax assets.

Segment Results

We evaluate the performance of our operating segments based upon segment operating income, which is shown below along with segment net sales (in thousands):