**United StatesSecurities and Exchange Commission**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **x**                                                  | ** ** | **Quarterly Report Pursuant to Section 13  or 15(d) of the Securities Exchange Act of 1934**   |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                             | ** ** | ** **                                                                                               |
| **For the quarterly period ended March 31, 2008** |
| ** **                                             | ** ** | ** **                                                                                               |
| **Or**                                                 |
| ** **                                             | ** ** | ** **                                                                                               |
| **o**                                                  | ** ** | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |

 

**For the transition period from           to**

 

**Commission file number 0-21196**

 

**MOTHERS WORK, INC.**

(Exact name of registrant as specified in itscharter)

 
| **Delaware**                                                    | ** ** | **13-3045573**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (IRS Employer Identification No.) |
|                                                            |       |                              |
| **456 North 5th Street,  Philadelphia, Pennsylvania**           | ** ** | **19123**                         |
| (Address of principal executive offices)                        |       | (Zip code)                        |

 

Registrant’s telephone number, including areacode **(215) 873-2200**

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x No o

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 ofthe Exchange Act.
| Large  accelerated filer o              |   | Accelerated  filer x         |
|---------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|
| Non-accelerated  filer   o (Do not check if a smaller reporting company)                            |   | Smaller  reporting company o |

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o No x

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

Common Stock, $.01 par value 6,069,381 sharesoutstanding as of May 1, 2008

 

 

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**INDEX**

 
| PART I.   FINANCIAL INFORMATION |   |                                                                                        |
|-------------------------------------------|--------|---------------------------------------------------------------------------------------------|
| Item 1.                                   |   | Financial  Statements (unaudited)                                                           |   | 3 |
|                                      |   | Consolidated Balance Sheets                                                                 |   | 3 |
|                                      |   | Consolidated Statements of Operations                                                       |   | 4 |
|                                      |   | Consolidated  Statements of Stockholders’ Equity and Comprehensive Income (Loss)       |   | 5 |
|                                      |   | Consolidated Statements of Cash Flows                                                       |   | 6 |
|                                      |   | Notes to Consolidated Financial Statements                                                  |   | 7 |
| Item 2.                                   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | 12 |
| Item 3.                                   |   | Quantitative  and Qualitative Disclosures About Market Risk                                 |   | 21 |
| Item 4.                                   |   | Controls and  Procedures                                                                    |   | 22 |
|                                      |   |                                                                                        |   |   |
| PART II.  OTHER INFORMATION     |   |                                                                                        |
| Item  1.                                  |   | Legal  Proceedings                                                                          |   | 23 |
| Item  1A.                                 |   | Risk  Factors                                                                               |   | 23 |
| Item 2.                                   |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                |   | 23 |
| Item 6.                                   |   | Exhibits                                                                                    |   | 23 |
|                                      |   |                                                                                        |   |   |
| Signatures                                |   |                                                                                        |   | 24 |

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

(in thousands, except share and per shareamounts)

(unaudited)

 
| ** **                                                                                                                        | ** ** | **March 31, 2008** | ** ** | **September 30, 2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **ASSETS**                                                                                                                        |       |                         |       |                             |       |
| Current assets:                                                                                                                   |       |                         |       |                             |       |
| Cash and cash equivalents                                                                                                         |       | $                            | 7,774      |                             | $          | 10,130 |   |
| Trade receivables, net                                                                                                            |       | 7,701                        |       | 12,094                           |       |
| Inventories                                                                                                                       |       | 100,177                      |       | 100,485                          |       |
| Deferred income taxes                                                                                                             |       | 7,123                        |       | 7,123                            |       |
| Prepaid expenses and other current assets                                                                                         |       | 7,669                        |       | 6,603                            |       |
| Total current assets                                                                                                              |       | 130,444                      |       | 136,435                          |       |
| Property, plant and equipment, net                                                                                                |       | 67,568                       |       | 68,651                           |       |
| Assets held for sale                                                                                                              |       | 207                          |       | 207                              |       |
| Other assets:                                                                                                                     |       |                         |       |                             |       |
| Goodwill                                                                                                                          |       | 50,389                       |       | 50,389                           |       |
| Deferred financing costs, net of accumulated  amortization of $251 and $133                                                       |       | 1,109                        |       | 1,251                            |       |
| Other intangible assets, net of accumulated  amortization of $2,291 and $2,478                                                    |       | 590                          |       | 576                              |       |
| Deferred income taxes                                                                                                             |       | 16,375                       |       | 15,189                           |       |
| Other non-current assets                                                                                                          |       | 3,086                        |       | 3,227                            |       |
| Total other assets                                                                                                                |       | 71,549                       |       | 70,632                           |       |
| Total assets                                                                                                                      |       | $                            | 269,768    |                             | $          | 275,925 |   |
|                                                                                                                              |       |                         |       |                             |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                    |       |                         |       |                             |       |
| Current liabilities:                                                                                                              |       |                         |       |                             |       |
| Line of credit borrowings                                                                                                         |       | $                            | —     |                             | $          | — |   |
| Current portion of long-term debt                                                                                                 |       | 1,225                        |       | 1,534                            |       |
| Accounts payable                                                                                                                  |       | 27,327                       |       | 28,345                           |       |
| Accrued expenses and other current liabilities                                                                                    |       | 37,575                       |       | 41,633                           |       |
| Total current liabilities                                                                                                         |       | 66,127                       |       | 71,512                           |       |
| Long-term debt                                                                                                                    |       | 86,107                       |       | 91,646                           |       |
| Deferred rent and other non-current liabilities                                                                                   |       | 30,057                       |       | 24,244                           |       |
| Total liabilities                                                                                                                 |       | 182,291                      |       | 187,402                          |       |
|                                                                                                                              |       |                         |       |                             |       |
| Commitments and contingencies (Note 9)                                                                                            |       |                         |       |                             |       |
|                                                                                                                              |       |                         |       |                             |       |
| Stockholders’ equity:                                                                                                        |       |                         |       |                             |       |
| Preferred stock, 2,000,000 shares authorized                                                                                      |       |                         |       |                             |       |
| Series A cumulative convertible preferred  stock, $.01 par value; 41,000 shares  authorized, none outstanding                |       | —                       |       | —                           |       |
| Series B junior participating preferred  stock, $.01 par value; 300,000 shares authorized,  none outstanding                 |       | —                       |       | —                           |       |
| Common stock, $.01 par value; 20,000,000 shares  authorized, 6,069,643 and 5,963,434 shares issued and outstanding,  respectively |       | 61                           |       | 60                               |       |
| Additional paid-in capital                                                                                                        |       | 82,158                       |       | 81,047                           |       |
| Retained earnings                                                                                                                 |       | 8,152                        |       | 8,820                            |       |
| Accumulated other comprehensive loss                                                                                              |       | (2,894                       | )          | (1,404                           | )          |
| Total stockholders’ equity                                                                                                   |       | 87,477                       |       | 88,523                           |       |
| Total liabilities and stockholders’ equity                                                                                   |       | $                            | 269,768    |                             | $          | 275,925 |   |

 

The accompanying notes are an integral part ofthese Consolidated Financial Statements.

 

3

----

 

**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(in thousands, except per share amounts)

(unaudited)

 
| ** **                                   | ** ** | **Three Months Ended   March 31,** | ** ** | **Six Months Ended   March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **2008**                                               | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                    |       | $                                                      | 139,005    |                                                 | $          | 143,857 |   | $ | 281,881 |   | $ | 292,341 |   |
| Cost of goods sold                           |       | 69,319                                                 |       | 67,797                                               |       | 140,233 |   | 139,231 |   |
| Gross profit                                 |       | 69,686                                                 |       | 76,060                                               |       | 141,648 |   | 153,110 |   |
| Selling, general and administrative expenses |       | 68,339                                                 |       | 69,065                                               |       | 138,917 |   | 138,613 |   |
| Operating income                             |       | 1,347                                                  |       | 6,995                                                |       | 2,731 |   | 14,497 |   |
| Interest expense, net                        |       | 1,858                                                  |       | 2,790                                                |       | 3,724 |   | 5,922 |   |
| Loss on extinguishment of debt               |       | 38                                                     |       | —                                               |       | 38 |   | 2,093 |   |
| Income (loss) before income taxes            |       | (549                                                   | )          | 4,205                                                |       | (1,031 | ) | 6,482 |   |
| Income tax provision (benefit)               |       | (159                                                   | )          | 1,640                                                |       | (289 | ) | 2,528 |   |
| Net income (loss)                            |       | $                                                      | (390       | )                                                    | $          | 2,565 |   | $ | (742 | ) | $ | 3,954 |   |
|                                         |       |                                                   |       |                                                 |       |   |   |   |   |
| Net income (loss) per share—Basic       |       | $                                                      | (0.07      | )                                                    | $          | 0.44 |   | $ | (0.13 | ) | $ | 0.69 |   |
| Average shares outstanding—Basic        |       | 5,937                                                  |       | 5,824                                                |       | 5,894 |   | 5,765 |   |
| Net income (loss) per share—Diluted     |       | $                                                      | (0.07      | )                                                    | $          | 0.41 |   | $ | (0.13 | ) | $ | 0.64 |   |
| Average shares outstanding—Diluted      |       | 5,937                                                  |       | 6,227                                                |       | 5,894 |   | 6,183 |   |

 

The accompanying notes are an integral part ofthese Consolidated Financial Statements.

 

4

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**MOTHERS WORK, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)**(in thousands)

**(unaudited)**

** **
| ** **                                                                      | ** ** | **Common Stock**      | ** ** | ** ** | ** ** | ** **              | ** ** | **Accumulated** | ** ** | ** **               | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------------|------------|-----------------|------------|--------------------------|------------|------------|------------|
| ** **                                                                      | ** ** | **Number   of ** | ** ** | ** ** | ** ** | **Additional  Paid-in** | ** ** | **Retained**    | ** ** | **Other  Comprehensive** | ** ** | ** ** | ** ** | **Comprehensive Income  (Loss)** | ** ** |
| ** **                                                                      | ** ** | **Shares**                 | ** ** | **Amount** | ** ** | **Capital**             | ** ** | **Earnings**    | ** ** | **Loss**                 | ** ** | **Total**  | ** ** | **Quarter** | ** ** | **Year to Date** | ** ** |
| Balance as of September 30, 2007                                           |       | 5,963                      |       | $          | 60         |                    | $          | 81,047          |       | $                        | 8,820      |       | $          | (1,404 | ) | $ | 88,523 |   |   |   |   |   |
| Net loss                                                                        |       | —                     |       | —     |       | —                  |       | (742            | )          | —                   |       | (742       | )          | $ | (390 | ) | $ | (742 | ) |
| Amortization of prior service cost for retirement plans, net of tax             |       | —                     |       | —     |       | —                  |       | —          |       | 81                       |       | 81         |       | 56 |   | 81 |   |
| Change in fair value of interest rate swap, net of tax                          |       | —                     |       | —     |       | —                  |       | —          |       | (1,488                   | )          | (1,488     | )          | (867 | ) | (1,488 | ) |
| Unrealized loss on investments, net of tax                                      |       | —                     |       | —     |       | —                  |       | —          |       | (83                      | )          | (83        | )          | (49 | ) | (83 | ) |
| Comprehensive loss                                                              |       |                       |       |       |       |                    |       |            |       |                     |       |       |       | $ | (1,250 | ) | $ | (2,232 | ) |
| Cumulative effect of adoption of FIN No. 48, Note 6                        |       | —                     |       | —     |       | —                  |       | 74              |       | —                   |       | 74         |       |   |   |   |   |
| Stock-based compensation                                                        |       | 41                         |       | —     |       | 1,126                   |       | —          |       | —                   |       | 1,126      |       |   |   |   |   |
| Exercise of stock options                                                       |       | 73                         |       | 1          |       | 683                     |       | —          |       | —                   |       | 684        |       |   |   |   |   |
| Tax benefit shortfall from stock option exercises and restricted  stock vesting |       | —                     |       | —     |       | (581                    | )          | —          |       | —                   |       | (581       | )          |   |   |   |   |
| Repurchase and retirement of common shares                                      |       | (7                         | )          | —     |       | (117                    | )          | —          |       | —                   |       | (117       | )          |   |   |   |   |
| Balance as of March 31, 2008                                               |       | 6,070                      |       | $          | 61         |                    | $          | 82,158          |       | $                        | 8,152      |       | $          | (2,894 | ) | $ | 87,477 |   |   |   |   |   |
|                                                                            |       |                       |       |       |       |                    |       |            |       |                     |       |       |       |   |   |   |   |
| Balance as of September 30, 2006                                           |       | 5,624                      |       | $          | 56         |                    | $          | 71,431          |       | $                        | 9,213      |       | $          | — |   | $ | 80,700 |   |   |   |   |   |
| Net income                                                                      |       | —                     |       | —     |       | —                  |       | 3,954           |       | —                   |       | 3,954      |       | $ | 2,565 |   | $ | 3,954 |   |
| Initial prior service cost for retirement plans, net of tax                     |       | —                     |       | —     |       | —                  |       | —          |       | (1,202                   | )          | (1,202     | )          |   |   |   |   |
| Amortization of prior service cost for retirement plans, net of tax             |       | —                     |       | —     |       | —                  |       | —          |       | 17                       |       | 17         |       | 17 |   | 17 |   |
| Comprehensive income                                                            |       |                       |       |       |       |                    |       |            |       |                     |       |       |       | $ | 2,582 |   | $ | 3,971 |   |
| Stock-based compensation                                                        |       | 107                        |       | 1          |       | 988                     |       | —          |       | —                   |       | 989        |       |   |   |   |   |
| Exercise of stock options                                                       |       | 208                        |       | 2          |       | 3,559                   |       | —          |       | —                   |       | 3,561      |       |   |   |   |   |
| Excess tax benefit from stock option exercises                                  |       | —                     |       | —     |       | 2,462                   |       | —          |       | —                   |       | 2,462      |       |   |   |   |   |
| Reclassification of equity award from liabilities                               |       | —                     |       | —     |       | 1,422                   |       | —          |       | —                   |       | 1,422      |       |   |   |   |   |
| Balance as of March 31, 2007                                               |       | 5,939                      |       | $          | 59         |                    | $          | 79,862          |       | $                        | 13,167     |       | $          | (1,185 | ) | $ | 91,903 |   |   |   |   |   |

** **

The accompanying notes are an integral part ofthese Consolidated Financial Statements.

 

5

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                                              | ** ** | **Six Months Ended   March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **Cash Flows from Operating  Activities**                                                               |       |                                                 |       |   |   |
| Net income (loss)                                                                                       |       | $                                                    | (742       | ) | $ | 3,954 |   |
| Adjustments to reconcile net income (loss) to  net cash provided by operating activities:               |       |                                                 |       |   |   |
| Depreciation and amortization                                                                           |       | 7,957                                                |       | 7,812 |   |
| Stock-based compensation expense                                                                        |       | 1,126                                                |       | 989 |   |
| Loss on impairment of long-lived assets                                                                 |       | 946                                                  |       | 390 |   |
| Loss (gain) on disposal of assets                                                                       |       | 238                                                  |       | (163 | ) |
| Loss on extinguishment of debt                                                                          |       | 38                                                   |       | 2,093 |   |
| Accretion of discount on senior notes                                                                   |       | —                                               |       | 82 |   |
| Deferred income tax benefit                                                                             |       | (758                                                 | )          | (432 | ) |
| Amortization of deferred financing costs                                                                |       | 125                                                  |       | 297 |   |
| Changes in assets and liabilities:                                                                      |       |                                                 |       |   |   |
| Decrease (increase) in —                                                                           |       |                                                 |       |   |   |
| Trade receivables                                                                                       |       | 4,393                                                |       | (2,420 | ) |
| Inventories                                                                                             |       | 308                                                  |       | (4,176 | ) |
| Prepaid expenses and other current assets                                                               |       | (1,480                                               | )          | 4,251 |   |
| Other non-current assets                                                                                |       | 168                                                  |       | 12 |   |
| Increase (decrease) in —                                                                           |       |                                                 |       |   |   |
| Accounts payable, accrued expenses and other  current liabilities                                       |       | (6,256                                               | )          | (546 | ) |
| Deferred rent and other non-current liabilities                                                         |       | 3,646                                                |       | (1,671 | ) |
| Net cash provided by operating activities                                                               |       | 9,709                                                |       | 10,472 |   |
|                                                                                                    |       |                                                 |       |   |   |
| **Cash Flows from Investing  Activities**                                                               |       |                                                 |       |   |   |
| Purchase of short-term investments                                                                      |       | —                                               |       | (19,550 | ) |
| Proceeds from sale of short-term investments                                                            |       | —                                               |       | 28,975 |   |
| Contribution to grantor trust                                                                           |       | (160                                                 | )          | — |   |
| Capital expenditures                                                                                    |       | (8,206                                               | )          | (9,116 | ) |
| Proceeds from sale of property, plant and  equipment                                                    |       | —                                               |       | 85 |   |
| Purchase of intangible assets                                                                           |       | (88                                                  | )          | (9 | ) |
| Net cash (used in) provided by investing  activities                                                    |       | (8,454                                               | )          | 385 |   |
|                                                                                                    |       |                                                 |       |   |   |
| **Cash Flows from Financing  Activities**                                                               |       |                                                 |       |   |   |
| Increase (decrease) in cash overdraft                                                                   |       | 2,272                                                |       | (885 | ) |
| Repayment of long-term debt                                                                             |       | (5,848                                               | )          | (25,330 | ) |
| Premium on repurchase of long-term debt                                                                 |       | —                                               |       | (1,406 | ) |
| Deferred financing costs                                                                                |       | (21                                                  | )          | (1,019 | ) |
| Repurchase of common stock                                                                              |       | (117                                                 | )          | — |   |
| Proceeds from exercise of stock options                                                                 |       | 684                                                  |       | 3,561 |   |
| Excess tax benefit (tax benefit shortfall) from  exercise of stock options and restricted stock vesting |       | (581                                                 | )          | 2,462 |   |
| Net cash used in financing activities                                                                   |       | (3,611                                               | )          | (22,617 | ) |
| **Net Decrease in Cash and Cash  Equivalents**                                                          |       | (2,356                                               | )          | (11,760 | ) |
| **Cash and Cash Equivalents,  Beginning of Period**                                                     |       | 10,130                                               |       | 18,904 |   |
| **Cash and Cash Equivalents, End  of Period**                                                           |       | $                                                    | 7,774      |   | $ | 7,144 |   |
|                                                                                                    |       |                                                 |       |   |   |
| Supplemental Disclosures of Cash Flow  Information:                                                     |       |                                                 |       |   |   |
| Cash paid for interest                                                                                  |       | $                                                    | 4,066      |   | $ | 6,275 |   |
| Cash paid (received) for income taxes                                                                   |       | $                                                    | 495        |   | $ | (1,972 | ) |

 

The accompanying notes are an integral part ofthese Consolidated Financial Statements.

 

6

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**March 31, 2008**

(unaudited)

 

**1.      BASIS OF FINANCIAL STATEMENT PRESENTATION**

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith the requirements for Form 10-Q and Article 10 ofRegulation S-X and, accordingly, certain information and footnotedisclosures have been condensed or omitted. Reference is made to the Annual Report on Form 10-K as of and forthe year ended September 30, 2007 for Mothers Work, Inc. andsubsidiaries (the “Company” or “Mothers Work”), as filed with the Securitiesand Exchange Commission (“SEC”), for additional disclosures including a summaryof the Company’s accounting policies.

 

In the opinion of management, the consolidated financialstatements contain all adjustments, consisting of normal recurring adjustments,necessary to present fairly the consolidated financial position, results ofoperations and cash flows of the Company for the periods presented.  Since the Company’s operations are seasonal,the interim operating results of the Company may not be indicative of operatingresults for the full year.

 

The Company operates on a fiscal year ending September 30of each year.  All references to fiscalyears of the Company refer to fiscal years, or periods within such fiscalyears, ended on September 30 in those years.  For example, the Company’s “fiscal 2008” willend on September 30, 2008.  Certainreclassifications have been made to the prior year consolidated financialstatements to conform to the current year presentation.

 

**2.      EARNINGS PER SHARE (EPS)**

 

Basicearnings per share (“Basic EPS”) is computed by dividing net income (loss) bythe weighted average number of common shares outstanding, excluding restrictedstock awards for which the restrictions have not lapsed.  Diluted earningsper share (“Diluted EPS”) is computed by dividing net income (loss) by theweighted average number of common shares outstanding, after giving effect tothe potential dilution, if applicable, from the assumed lapse of restrictionson restricted stock awards and from the assumed exercise of stock options.

 

The following tables summarize the Basic EPSand Diluted EPS calculations (in thousands, except per share amounts):

 
| ** **                                                                            | ** ** | **Three Months Ended   March 31, 2008** | ** ** | **Three Months Ended   March 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Net   Loss**                                              | ** ** | **Shares**                                                       | ** ** | **EPS** | ** ** | **Net   Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic EPS                                                                             |       | $                                                                | (390       | )                                                                | 5,937      |   | $ | (0.07 | ) | $ | 2,565 |   | 5,824 |   | $ | 0.44 |   |
| Incremental shares from the assumed lapse of  restrictions on restricted stock awards |       | —                                                           |       | —                                                           |       | — |   | — |   | 101 |   | (0.01 | ) |
| Incremental shares from the assumed exercise of  outstanding stock options            |       | —                                                           |       | —                                                           |       | — |   | — |   | 302 |   | (0.02 | ) |
|                                                                                  |       |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Diluted EPS                                                                           |       | $                                                                | (390       | )                                                                | 5,937      |   | $ | (0.07 | ) | $ | 2,565 |   | 6,227 |   | $ | 0.41 |   |

 

7

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| ** **                                                                            | ** ** | **Six Months Ended   March 31, 2008** | ** ** | **Six Months Ended   March 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Net   Loss**                                            | ** ** | **Shares**                                                     | ** ** | **EPS** | ** ** | **Net   Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic EPS                                                                             |       | $                                                              | (742       | )                                                              | 5,894      |   | $ | (0.13 | ) | $ | 3,954 |   | 5,765 |   | $ | 0.69 |   |
| Incremental shares from the assumed lapse of  restrictions on restricted stock awards |       | —                                                         |       | —                                                         |       | — |   | — |   | 67 |   | (0.01 | ) |
| Incremental shares from the assumed exercise of  outstanding stock options            |       | —                                                         |       | —                                                         |       | — |   | — |   | 351 |   | (0.04 | ) |
|                                                                                  |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |
| Diluted EPS                                                                           |       | $                                                              | (742       | )                                                              | 5,894      |   | $ | (0.13 | ) | $ | 3,954 |   | 6,183 |   | $ | 0.64 |   |

 

For the three months and six months ended March 31,2007, options for 43,000 and 25,500 shares were excluded from the calculationof Diluted EPS as their effect would have been antidilutive.  Options and unvested restricted stocktotaling 872,266 shares of the Company’s common stock were outstanding as of March 31,2008, but were not included in the computation of Diluted EPS for the threemonths and six months ended March 31, 2008, due to the Company’s netloss.  Had the Company reported a profitfor the three months and six months ended March 31, 2008, the weightedaverage number of dilutive shares outstanding for computation of Diluted EPSwould have been approximately 6,070,000 and 6,035,000.

 

**3.      INVENTORIES**

** **

Inventories were comprised of the following(in thousands):

 

| ** **       | ** ** | **March 31, 2008** | ** ** | **September 30, 2007** | ** ** |
|------------------|------------|------------------------------|------------|----------------------------------|------------|
| Finished goods   |       | $                            | 91,464     |                             | $          | 91,860 |   |
| Work-in-progress |       | 3,419                        |       | 2,947                            |       |
| Raw materials    |       | 5,294                        |       | 5,678                            |       |
|             |       | $                            | 100,177    |                             | $          | 100,485 |   |

 

**4.      ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES**

 

Accrued expenses and other currentliabilities were comprised of the following (in thousands):

 

| ** **                                                        | ** ** | **March 31, 2008** | ** ** | **September 30, 2007** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| Salaries, wages and employee benefits                             |       | $                            | 11,365     |                             | $          | 11,106 |   |
| Income taxes payable                                              |       | —                       |       | 1,768                            |       |
| Interest                                                          |       | 1,033                        |       | 1,562                            |       |
| Deferred rent                                                     |       | 4,193                        |       | 4,014                            |       |
| Sales taxes                                                       |       | 3,793                        |       | 3,561                            |       |
| Insurance                                                         |       | 1,309                        |       | 1,664                            |       |
| Audit and legal                                                   |       | 1,894                        |       | 4,814                            |       |
| Remaining payout for redemption of  Series A Preferred Stock |       | 679                          |       | 679                              |       |
| Accrued store construction costs                                  |       | 554                          |       | 442                              |       |
| Gift certificates and store credits                               |       | 5,371                        |       | 4,591                            |       |
| Other                                                             |       | 7,384                        |       | 7,432                            |       |
|                                                              |       | $                            | 37,575     |                             | $          | 41,633 |   |

 

**5.      LONG-TERM DEBT AND LINE OF CREDIT**

 

InNovember 2006, the Company’s Board of Directors authorized the repurchaseof $25,000,000 principal amount of the Company’s 111¤4% senior notes(the “Senior Notes”).  On December 8, 2006, the Companycompleted the repurchase of the authorized amount at 105.625% of the$25,000,000 principal amount, plus accrued and unpaid interest.  In connection with the December 2006repurchase, the Company recorded a pre-tax charge totaling $2,093,000,representing the premium paid of $1,406,000 plus the write-off of unamortizeddebt issuance discount and deferred financing costs of $687,000.  On April 18, 2007, the Company completedthe redemption of the remaining outstanding amount of its Senior Notes at105.625% of the $90,000,000 principal amount, plus accrued and unpaid interest.  In connection with the April 2007

 

8

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redemption,the Company recorded a pre-tax charge totaling $7,330,000, representing thepremium paid of $5,063,000 plus the write-off of unamortized debt issuancediscount and deferred financing costs of $2,267,000.

 

OnMarch 13, 2007, the Company entered into a Term Loan and SecurityAgreement (the “Term Loan Agreement”) for a $90,000,000 senior secured TermLoan B due March 13, 2013 (the “Term Loan”), the proceeds of which werereceived on April 18, 2007 and were used to redeem the remaining$90,000,000 principal amount of the Senior Notes.  The interest rate on the Term Loan is equalto, at the Company’s election, either (i) the prime rate plus 1.00%, or (ii) theLIBOR rate plus the applicable margin. The applicable margin was initially fixed at 2.50% through and includingthe fiscal quarter ended September 30, 2007.  Thereafter, the applicable margin for LIBORrate borrowings is either 2.25% or 2.50%, depending on the Company’sConsolidated Leverage Ratio (as defined). Based upon the Company’s Consolidated Leverage Ratio as of September 30,2007 and December 31, 2007, the applicable margin for LIBOR rateborrowings remained at 2.50% for the first six months of fiscal 2008.  The Company is required to make minimumrepayments of the principal amount of the Term Loan in quarterly installmentsof $225,000 each.  Additionally, the TermLoan can be prepaid at the Company’s option, in part or in whole, at any timewithout any prepayment premium or penalty. On March 19, 2008, the Company prepaid $5,000,000 of theoutstanding Term Loan.  At March 31,2008, the Company’s indebtedness under the Term Loan Agreement was $84,100,000.

 

TheTerm Loan is secured by a security interestin the Company’s accounts receivable, inventory, real estate interests, letterof credit rights, cash, intangibles and certain other assets. The securityinterest granted to the Term Lenders is, in certain respects, subordinate tothe security interest granted to the Credit Facility Lender.  The Term Loan Agreement imposescertain restrictions on the Company’s ability to, among other things, incuradditional indebtedness, pay dividends, repurchase stock, and enter into othervarious types of transactions.  The TermLoan Agreement also contains quarterly financial covenants that require theCompany to maintain a specified maximum permitted Consolidated Leverage Ratioand a specified minimum permitted Consolidated Interest Coverage Ratio (asdefined).  Since the inception of theTerm Loan Agreement, including the six month period ended March 31, 2008,the Company was in compliance with the financial covenants of its Term LoanAgreement.

 

Inorder to mitigate the Company’s floating rate interest risk on the variablerate Term Loan, the Company entered into an interest rate swap agreement withthe Agent bank for the Term Loan that commenced on April 18, 2007, thedate the $90,000,000 Term Loan proceeds were received, and expires on April 18,2012.  The interest rate swap agreementenables the Company to effectively convert an amount of the Term Loan equal tothe notional amount of the interest rate swap from a floating interest rate ofLIBOR plus 2.50% (subject to reduction to LIBOR plus 2.25% if the Companyachieves a specified leverage ratio), to a fixed interest rate of 7.50%(subject to reduction to 7.25% if the Company achieves a specified leverageratio) for the significant majority of the Term Loan.  The notional amount of the interest rate swapwas $75,000,000 at the inception of the swap agreement and decreases over timeto a notional amount of $5,000,000 at the expiration date.  The notional amount of the swap was$65,000,000 as of March 31, 2008 and over the next eighteen monthsdecreases as follows:  to $57,500,000starting April 18, 2008; to $50,000,000 starting October 20, 2008;and to $42,500,000 starting April 20, 2009.

 

Inconnection with the Term Loan transaction, the Company amended its existing$60,000,000 revolving credit facility (the “Credit Facility”) in order topermit the new Term Loan financing.  Thisamendment of the Credit Facility also extended its maturity from October 15,2009 to March 13, 2012, increased its size to $65,000,000, and reduced theLIBOR-based interest rate option under the facility by 0.25%.  There are no financial covenant requirementsunder the Credit Facility provided that Excess Availability (as defined) doesnot fall below 10% of the Borrowing Base (as defined).  If Excess Availability were to fall below 10%of the Borrowing Base, the Company would be required to meet a specifiedminimum Fixed Charge Coverage Ratio (as defined).  During the first six months of fiscal 2008and 2007, the Company exceeded the minimum requirements for ExcessAvailability.

 

**6.      INCOME TAXES**

 

In June 2006, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accountingfor Uncertainty in Income Taxes.”  FIN No. 48 clarifies theaccounting for income taxes by prescribing the minimum recognition threshold atax position is required to meet before being recognized in the financialstatements.  FIN No. 48 applies to all tax positions related toincome taxes subject to Statement of Financial Accounting Standards (“SFAS”) No. 109,“Accounting for Income Taxes.”  Under FIN No. 48, recognition ofa tax benefit occurs when a tax position is more-likely-than-not to besustained upon examination, based solely on its technicalmerits.  Derecognition of a previously recognized tax position wouldoccur if it is subsequently determined that the tax position no longer meetsthe more-likely-than-not threshold of being sustained.

 

9

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The Company adopted the provisions of FIN No. 48effective as of October 1, 2007.  In accordance with FIN No. 48,the Company recorded a cumulative effect adjustment of $74,000, decreasing theliability for unrecognized tax benefits and increasing the September 30,2007 balance of retained earnings.

 

As of October 1, 2007, the Company had$2,315,000 of unrecognized tax benefits, including accrued interest andpenalties of $946,000.  The Company records interest and penaltiesrelated to unrecognized tax benefits in income tax provision(benefit).  If recognized, the portion of the liabilities forunrecognized tax benefits that would impact the Company’s effective tax ratewas $1,623,000.

 

During the twelve months subsequent to October 1,2007, it is reasonably possible that the gross unrecognized tax benefits couldpotentially decrease by approximately $382,000 (of which approximately $114,000would affect the effective tax rate) for federal and state tax positionsrelated to the effect of expiring statutes of limitations and expectedsettlements.

 

The Company’s U.S. Federal income tax returnsfor the years ended September 30, 2004 and beyond remain subject toexamination by the U.S. Internal Revenue Service.  The Company alsofiles returns in numerous state jurisdictions, which have varying statutes oflimitations.  Generally, state tax returns for the years ended September 30,2003 and beyond, depending upon the jurisdiction, remain subject toexamination.  However, the statutes of limitations on certain of theCompany’s state returns remain open for years prior to fiscal 2003.

 

**7.      RETIREMENT PLANS**

 

On March 2, 2007, the Company entered intoSupplemental Executive Retirement Agreements (the “SERP Agreements”) with itsChairman of the Board and Chief Executive Officer and its President and ChiefCreative Officer (the “SERP Executives”).

 

The components of net periodic pension cost on apre-tax basis were as follows (in thousands):

 

| ** **                         | ** ** | **Three Months Ended,   March 31,** | ** ** | **Six Months Ended   March 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                                | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service cost                       |       | $                                                       | 243        |                                                 | $          | 131 |   | $ | 486 |   | $ | 131 |   |
| Interest cost                      |       | 45                                                      |       | 10                                                   |       | 90 |   | 10 |   |
| Amortization of prior service cost |       | 88                                                      |       | 29                                                   |       | 176 |   | 29 |   |
| Total net periodic benefit cost    |       | $                                                       | 376        |                                                 | $          | 170 |   | $ | 752 |   | $ | 170 |   |

 

On April 30, 2007, the Company made an initialrequired contribution of $2,662,000 to a grantor trust, which wasestablished for the purpose of accumulating assets in anticipation of theCompany’s payment obligations under the SERP Agreements.  On November 27,2007, the Company made an additional required contribution to the grantor trustof $1,160,000.  In order to impact positively the Company’s ability to comply with theConsolidated Leverage Ratio covenant of its Term Loan Agreement at March 31,2008 (see Note 5), with the consent of the SERP Executives the Company withdrew$1,000,000 from the grantor trust on March 28, 2008.  The withdrawn funds were used to repayindebtedness under the Credit Facility. The Company is obligated to replenish the withdrawn grantor trust fundsby November 29, 2008 in accordance with the Company’s normal fundingobligations under the SERP Agreements. The Company is not obligated to make any additional contributions to thegrantor trust during fiscal 2008.  TheCompany may, but is not obligated to, recontribute all or a portion of thewithdrawn funds before the end of fiscal 2008.

 

As of March 31, 2008, investments in the grantortrust, included in other non-current assets in the consolidated balance sheet,amounted to $2,814,000.  The grantortrust investments were classified as available-for-sale and consisted primarilyof fixed income mutual funds with cost that approximated the fair value.

 

**8.     NEW ACCOUNTING PRONOUNCEMENTS**

 

SFAS No. 157

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in U.S. generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years, for financial assets andliabilities that are measured at fair value on a recurring basis.  The FASB issued a one-year deferral of SFAS No. 157’sfair value measurement requirements for non-financial assets and liabilitiesthat are not required or permitted to be measured at fair value on a recurringbasis.

 

10

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The impact from adoption of SFAS No. 157, if any, on the Company’sconsolidated financial position or results of operations has not yet beendetermined.

 

SFAS No. 159

 

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities.”  SFAS No. 159 provides companies with anoption to report selected financial assets and liabilities at fair value andrequires entities to display the fair value of those assets and liabilities forwhich the company has chosen to use fair value on the face of the balancesheet.  SFAS No. 159 is effectivefor financial statements issued for fiscal years beginning after November 15,2007.  The impact from adoption ofSFAS No. 159, if any, on the Company’s consolidated financial position orresults of operations has not yet been determined.

 

**9.      COMMITMENTS AND CONTINGENCIES**

 

From time to time, the Companyis named as a defendant in legal actions arising from normal businessactivities. Litigation is inherently unpredictable and although the amount ofany liability that could arise with respect to currently pending actions cannotbe accurately predicted, the Company does not believe that the resolution ofany pending action will have a material adverse effect on its financial position,results of operations or liquidity.

 

**10.   SEGMENTAND ENTERPRISE WIDE DISCLOSURES**

 

***Operating Segment***.  Under SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information,” a company may berequired to report segmented information about separately identifiable parts ofits business, which both (i) meet the definition of an “operating segment”under SFAS No. 131, and (ii) exceed certain quantitative thresholdsestablished in SFAS No. 131.  TheCompany has determined that its business is comprised of one operating segment:the design, manufacture and sale of maternity apparel and relatedaccessories.  While the Company offers awide range of products for sale, the substantial portion of its products areinitially distributed through the same distribution facilities, many of theCompany’s products are manufactured at common contract manufacturer productionfacilities, the Company’s products are marketed through a common marketingdepartment, and these products are sold to a similar customer base, consistingof expectant mothers.

 

***Geographic Information***.  Information concerning theCompany’s operations by geographic area was as follows (in thousands):

 
| ** **                              | ** ** | **Three Months Ended,   March 31,** | ** ** | **Six Months Ended   March 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                                | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Net Sales to Unaffiliated Customers** |       |                                                    |       |                                                 |       |   |   |   |   |
| United States                           |       | $                                                       | 134,423    |                                                 | $          | 140,079 |   | $ | 272,244 |   | $ | 284,296 |   |
| Canada                                  |       | $                                                       | 4,582      |                                                 | $          | 3,778 |   | $ | 9,637 |   | $ | 8,045 |   |

 
| ** **            | ** ** | **March 31,   2008** | ** ** | **September 30,  2007** | ** ** |
|-----------------------|------------|--------------------------------|------------|------------------------------|------------|
| **Long-Lived Assets** |       |                           |       |                         |       |
| United States         |       | $                              | 65,854     |                         | $          | 67,125 |   |
| Canada                |       | $                              | 2,304      |                         | $          | 2,102 |   |
| Costa Rica            |       | $                              | 207        |                         | $          | 207 |   |

 

***Major Customers*****. **For theperiods presented, the Company didnot have any one customer who represented more than 10% of its net sales.

 

**11.   INTERESTEXPENSE, NET**

 

Interest expense, net was comprised of the following (in thousands):

 
| ** **            | ** ** | **Three Months Ended,   March 31,** | ** ** | **Six Months Ended   March 31,** | ** ** |
|-----------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **            | ** ** | **2008**                                                | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest expense      |       | $                                                       | 1,859      |                                                 | $          | 2,847 |   | $ | 3,816 |   | $ | 6,217 |   |
| Interest income       |       | (1                                                      | )          | (57                                                  | )          | (92 | ) | (295 | ) |
| Interest expense, net |       | $                                                       | 1,858      |                                                 | $          | 2,790 |   | $ | 3,724 |   | $ | 5,922 |   |

 

11

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

 

**Results of Operations**

 

The following tables set forth certain operating data as a percentageof net sales and as a percentage change for the three and six months ended March 31:

 
| ** **                                        | ** ** | ** **                                 | ** ** | ** **                  | ** ** | ** **              | ** ** | ** **              | ** ** | **% Period to Period   Increase (Decrease)** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                        | ** ** | ** **                                 | ** ** | ** **                  | ** ** | **Three **         | ** ** | **Six **           | ** ** |
| ** **                                        | ** ** | **% of Net Sales (1)** | ** ** | **Months**** **        | ** ** | **Months **        | ** ** |
| ** **                                        | ** ** | **Three **                            | ** ** | **Six **               | ** ** | **Ended **         | ** ** | **Ended**               | ** ** |
| ** **                                        | ** ** | **Months Ended **                | ** ** | **Months Ended ** | ** ** | **March 31,**      | ** ** | **March 31,**      | ** ** |
| ** **                                        | ** ** | **March 31,**                         | ** ** | **March 31,**          | ** ** | **2008 vs. ** | ** ** | **2008 vs. ** | ** ** |
| ** **                                        | ** ** | **2008**                                   | ** ** | **2007**                    | ** ** | **2008**                | ** ** | **2007**                | ** ** | **2007**                                                              | ** ** | **2007** | ** ** |
| Net sales                                         |       | 100.0                                      | %          | 100.0                       | %          | 100.0                   | %          | 100.0                   | %          | (3.4                                                                  | )%         | (3.6 | )% |
| Cost of goods sold (2)                            |       | 49.9                                       |       | 47.1                        |       | 49.7                    |       | 47.6                    |       | 2.2                                                                   |       | 0.7 |   |
| Gross profit                                      |       | 50.1                                       |       | 52.9                        |       | 50.3                    |       | 52.4                    |       | (8.4                                                                  | )          | (7.5 | ) |
| Selling, general and  administrative expenses (3) |       | 49.2                                       |       | 48.0                        |       | 49.3                    |       | 47.4                    |       | (1.1                                                                  | )          | 0.2 |   |
| Operating income                                  |       | 1.0                                        |       | 4.9                         |       | 1.0                     |       | 5.0                     |       | (80.7                                                                 | )          | (81.2 | ) |
| Interest expense, net                             |       | 1.3                                        |       | 1.9                         |       | 1.3                     |       | 2.0                     |       | (33.4                                                                 | )          | (37.1 | ) |
| Loss on extinguishment of debt                    |       | 0.0                                        |       | —                      |       | 0.0                     |       | 0.7                     |       | N.M.                                                                  |       | (98.2 | ) |
| Income before income taxes                        |       | (0.4                                       | )          | 2.9                         |       | (0.4                    | )          | 2.2                     |       | (113.1                                                                | )          | (115.9 | ) |
| Income tax provision (benefit)                    |       | (0.1                                       | )          | 1.1                         |       | (0.1                    | )          | 0.9                     |       | (109.7                                                                | )          | (111.4 | ) |
| Net income                                        |       | (0.3                                       | )%         | 1.8                         | %          | (0.3                    | )%         | 1.4                     | %          | (115.2                                                                | )          | (118.8 | ) |

 

----

N.M.—Notmeaningful

(1)   Componentsmay not add to total due to rounding.

(2)   The “Cost of goods sold”line item includes merchandise costs (including customs duty expenses),expenses related to inventory shrinkage, product related corporate expenses(including expenses related to our payroll, benefit costs and operatingexpenses of our buying departments), inventory reserves (including lower ofcost or market reserves), inbound freight charges, purchasing and receivingcosts, inspection costs, warehousing costs, internal transfer costs, and theother costs of our distribution network.

(3)   The “Selling, generaland administrative expenses” line item includes**advertisingand marketing expenses, corporate administrative expenses, store expenses(including store payroll and store occupancy expenses), store opening and storeclosing expenses, and store asset impairment charges.

 

Thefollowing table sets forth certain information concerning the number of ourstores and leased departments for the periods indicated:

 
| ** **                | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31, 2008**     | ** ** | **March 31, 2007** | ** ** |
| **Retail Locations** | ** ** | **Stores**                       | ** ** | **Leased   Departments** | ** ** | **Total Retail   Locations** | ** ** | **Stores** | ** ** | **Leased   Departments** | ** ** | **Total Retail   Locations** | ** ** |
| Beginning of period       |       | 772                              |       | 772 |   | 1,544 |   | 807 |   | 787 |   | 1,594 |   |
| Opened                    |       | 10                               |       | 2 |   | 12 |   | 7 |   | 59 |   | 66 |   |
| Closed                    |       | (16                              | )          | (3 | ) | (19 | ) | (19 | ) | (25 | ) | (44 | ) |
| End of period             |       | 766                              |       | 771 |   | 1,537 |   | 795 |   | 821 |   | 1,616 |   |

 
| ** **                | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **March 31, 2008**   | ** ** | **March 31, 2007** | ** ** |
| **Retail Locations** | ** ** | **Stores**                     | ** ** | **Leased   Departments** | ** ** | **Total Retail   Locations** | ** ** | **Stores** | ** ** | **Leased   Departments** | ** ** | **Total Retail   Locations** | ** ** |
| Beginning of period       |       | 781                            |       | 795 |   | 1,576 |   | 810 |   | 731 |   | 1,541 |   |
| Opened                    |       | 17                             |       | 4 |   | 21 |   | 10 |   | 119 |   | 129 |   |
| Closed                    |       | (32                            | )          | (28 | ) | (60 | ) | (25 | ) | (29 | ) | (54 | ) |
| End of period             |       | 766                            |       | 771 |   | 1,537 |   | 795 |   | 821 |   | 1,616 |   |

 

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Our fiscal year ends on September 30.  All references in this discussion to ourfiscal years refer to the fiscal year, or periods within the fiscal year, endedon September 30 in the year mentioned. For example, our “fiscal 2008” will end on September 30, 2008.

 

**Three Months Ended March 31, 2008 and2007**

 

***Net Sales.***  Our netsales for the second quarter of fiscal 2008 decreased by 3.4%, or $4.9 million,to $139.0 million from $143.9 million for the second quarter of fiscal2007.  The decrease in net sales versuslast year resulted primarily from a decrease in comparable store sales and, toa lesser extent, reduced sales volume from the ongoing closure of certainunderperforming stores and decreased sales from the Company’s leased departmentand licensed relationships.  Comparablestore sales decreased by 1.7% for the second quarter of fiscal 2008, based on1,394 retail locations, versus a comparable store sales decrease of 1.6% forthe second quarter of fiscal 2007, based on 1,412 retail locations. The comparable store sales decrease of 1.7% for the second quarter offiscal 2008 was favorably impacted by approximately 1 to 2 percentage pointsdue to having an extra day in February 2008 compared to February 2007and, to a lesser extent, the earlier timing of Easter (March 23, 2008compared to April 8, 2007).  Thecomparable store sales decrease of 1.6% for the second quarter of fiscal 2007was favorably impacted by approximately 1 percentage point due to having onemore Saturday in the second quarter of fiscal 2007 compared to the secondquarter of fiscal 2006.  Weattribute the decrease in comparable store sales for the quarter to theextremely weak overall economic and retail environment, unseasonably coldweather in the last month of the quarter, and to a lesser extent, some negativeimpact from the more pregnancy-friendly fit of certain non-maternity fashiontrends.

 

As of March 31, 2008, we operated a total of 766 stores and 1,537total retail locations, compared to 795 stores and 1,616 total retail locationsas of March 31, 2007.  In addition,our Oh Baby by MotherhoodTM collection is available at Kohl’s® stores throughoutthe United States.  During the secondquarter of fiscal 2008, we opened 10 stores and closed 16 stores, with one ofthe store closings related to a multi-brand store opening.

 

***Gross Profit.***  Our grossprofit for the second quarter of fiscal 2008 decreased by 8.4%, or $6.4million, to $69.7 million from $76.1 million for the second quarter of fiscal2007, primarily reflecting the effect of our lower sales volume and increased pricepromotional activity compared to last year. Gross profit as a percentage of net sales (gross margin) for the second quarterof fiscal 2008 was 50.1% compared to 52.9% for the second quarter of fiscal2007.  The decrease in gross margin of 2.8 percentage pointscompared to the prior year resulted primarily from more price promotionalactivity compared to last year, increased product costs and the effect ofspreading fixed product overhead costs over a lower sales volume.

 

***Selling, General and AdministrativeExpenses.***  Our selling, general and administrativeexpenses for the second quarter of fiscal 2008 decreased by 1.1%, orapproximately $0.8 million, to $68.3 million from $69.1 million for thesecond quarter of fiscal 2007.  Thisdecrease in expense for the quarter resulted primarily from decreases in legalexpenses and employee benefits costs, partially offset by increased impairmentcharges for write-downs of store long-lived assets.  As a percentage of net sales, selling,general and administrative expenses increased to 49.2% for the second quarterof fiscal 2008 compared to 48.0% for second quarter of fiscal 2007.  This increase in the expense percentage forthe quarter resulted primarily from negative expense leverage from the decreasein sales, partially offset by the $0.8 million decrease in selling, general andadministrative expenses.  We incurredimpairment charges for write-downs of store long-lived assets of $0.4 millionfor the second quarter of fiscal 2008, as compared to $0.1 million for thesecond quarter of fiscal 2007.  Werecorded charges of $0.1 million related to store closings for the secondquarter of fiscal 2008, as compared to a gain of $0.1 from store closings inthe second quarter of fiscal 2007.

 

***Operating Income.***  Our operating income for the secondquarter of fiscal 2008 decreased by 80.7%, or approximately $5.7 million, to$1.3 million from $7.0 million for the second quarter of fiscal 2007, dueto the lower sales volume and associated gross profit reduction, partially offsetby lower selling, general and administrative expenses.  Operating income as a percentage of net sales(operating income margin) for thesecond quarter of fiscal 2008 decreased to 1.0% from 4.9% for the secondquarter of fiscal 2007.  The decrease inoperating income margin was due to our lower gross margin and our higheroperating expense ratio compared to the second quarter of fiscal 2007.

 

***Interest Expense, Net.***  Our netinterest expense for the second quarter of fiscal 2008 decreased by 33.4%, or$0.9 million, to $1.9 million from $2.8 million for the second quarter offiscal 2007.  This decrease was primarilydue to the lower interest rate on our new $90.0 million Term Loan compared tothe interest rate on our Senior Notes and, to a much lesser extent, our lowerdebt level, partially offset by higher average borrowings under our creditfacility.  During the second quarter offiscal 2008, our average level of direct borrowings under our credit facilitywas $8.3 million, but we did not have any direct borrowings under our creditfacility as of March 31, 2008. During the second quarter of fiscal 2007, our average level of directborrowings under our credit facility was $1.2 million.

 

13

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***Loss on Extinguishment of Debt*. **In March 2008, we prepaid $5.0 millionprincipal amount of our outstanding Term Loan. The $5.0 million Term Loan prepayment resulted in a second quarterfiscal 2008 pre-tax charge of $38,000, representing the write-off ofunamortized deferred financing costs.

 

***Income Tax Provision.***  Oureffective tax rate was a benefit of 29.0% for the second quarter of fiscal 2008and a provision of 39.0% for the second quarter of fiscal 2007.  Our benefit rate for the second quarter offiscal 2008 reflects the effect of additional income tax expense (includinginterest and penalties) recognized during the quarter in connection with theaccounting requirements of FIN No. 48. We expect our effective tax rate for the full year fiscal 2008 to beapproximately 40%.

 

***Net Income (Loss).***  Net lossfor the second quarter of fiscal 2008 was $0.4 million, or $(0.07) per share(diluted), compared to net income of $2.6 million, or $0.41 per share(diluted), for the second quarter of fiscal 2007.

 

Our average diluted shares outstanding of5,937,000 for the second quarter of fiscal 2008 was 4.7% lower than the6,227,000 average diluted shares outstanding for the second quarter of fiscal2007.  The decrease in average diluted shares outstandingreflects the elimination of the dilutive impact of outstanding stock optionsand restricted stock in the second quarter of fiscal 2008 due to the net loss,compared to the dilutive impact of outstanding stock options and restrictedstock awards in the second quarter of fiscal 2007, when we generated netincome, partially offset by higher shares outstanding in the second quarter offiscal 2008 compared to the second quarter of fiscal 2007, as a result of stockoption exercises and vesting of restricted stock awards.

 

**Six Months Ended March 31, 2008 and 2007**

 

***Net Sales.***  Our netsales for the first six months of fiscal 2008 decreased by 3.6%, orapproximately $10.4 million, to $281.9 million from $292.3 million for thefirst six months of fiscal 2007.  Thedecrease in net sales versus last year resulted primarily from a decrease incomparable store sales and, to a lesser extent, reduced sales volume from theongoing closure of certain underperforming stores and decreased sales from theCompany’s leased department and licensed relationships.  Comparable store sales decreased by2.9% for the first six months of fiscal 2008, based on 1,330 retail locations,versus a comparable store sales decrease of 1.9% for the first six months offiscal 2007, based on 1,395 retail locations.

 

During the first six months of fiscal 2008, we opened 17 stores,including two multi-brand store openings, and closed 32 stores, with nine ofthe store closings related to multi-brand store openings.  In addition, during the first six months offiscal 2008, the Company closed 24 leased department locations within Sears®stores, pursuant to mutual agreement with Sears.  As of March 31, 2008, the Companyoperates 477 leased departments within Sears stores and, as we disclosed in September 2007,our relationship with Sears will end in June 2008, resulting in theclosure of our remaining leased departments within Sears stores.

 

***Gross Profit.***  Our grossprofit for the first six months of fiscal 2008 decreased by 7.5%, or $11.5million, to $141.6 million from $153.1 million for the first six months offiscal 2007, primarily reflecting the effect of our lower sales volume andincreased price promotional activity compared to last year.  Gross profit as a percentage of net sales(gross margin) for the first six months of fiscal 2008 was 50.3%, compared to52.4% for the first six months of fiscal 2007.  The decrease ingross margin of 2.1 percentage points compared to the prior year resultedprimarily from more price promotional activity compared to last year, increasedproduct costs and the effect of spreading fixed product overhead costs over alower sales volume.

 

***Selling, General andAdministrative Expenses.***  Our selling, general andadministrative expenses for the first six months of fiscal 2008 increased by0.2%, or $0.3 million, to $138.9 million from $138.6 million for the firstsix months of fiscal 2007.  This slightincrease in expense for the six-month period resulted primarily from increasesin retirement plan expense, store closing costs and impairment charges forwrite-downs of store long-lived assets, offset by decreased legal expenses andlower variable incentive compensation and employee benefits costs .  As a percentage of net sales, selling,general and administrative expenses for the first six months of fiscal 2008 were49.3% compared to 47.4% for the first six months of fiscal 2007.  This increase in the expense percentage forthe six-month period resulted primarily from negative expense leverage from thedecrease in sales, and to a much lesser extent the $0.3 million increase inselling, general and administrative expenses. We incurred impairment charges for write-downs of store long-livedassets of $0.9 million for the first six months of fiscal 2008, as compared to$0.4 million for the first six months of fiscal 2007.  We recorded charges of $0.5 million relatedto store closings for the first six months of fiscal 2008, as compared to again of $0.1 million from store closings in the first six months of fiscal2007.

 

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***Operating Income.***  Our operating income for the first sixmonths of fiscal 2008 decreased by 81.2%, or $11.8 million, to $2.7 millionfrom $14.5 million for the first six months of fiscal 2007, due to thelower sales volume and associated gross profit reduction, and to a much lesserextent, slightly higher selling, general and administrative expenses.  Operating income as a percentage of net sales(operating income margin) for thefirst six months of fiscal 2008 decreased to 1.0% from 5.0% for the first sixmonths of fiscal 2007.  The decrease inoperating income margin was due to our lower gross margin and our higheroperating expense ratio compared to the first six months of fiscal 2007.

 

***Interest Expense, Net.***  Our netinterest expense for the first six months of fiscal 2008 decreased by 37.1%, or$2.2 million, to $3.7 million from $5.9 million for the first six monthsof fiscal 2007.  This decrease wasprimarily due to the lower interest rate on our new $90.0 million Term Loan,which was used to redeem the remaining outstanding balance of our Senior Notesand, to a lesser extent, our lower debt level, as a result of the repurchase of$25.0 million of our Senior Notes on December 8, 2006, partially offset byhigher average borrowings under our credit facility.  During the first six months of fiscal 2008,our average level of direct borrowings under our credit facility was $6.3million, but we did not have any direct borrowings under our credit facility asof March 31, 2008.  During the firstsix months of fiscal 2007, our average level of direct borrowings under ourcredit facility was $0.6 million.

 

***Loss on Extinguishment of Debt*. **In March 2008, we prepaid $5.0 millionprincipal amount of our outstanding Term Loan. The $5.0 million Term Loan prepayment resulted in a second quarterfiscal 2008 pre-tax charge of $38,000, representing the write-off ofunamortized deferred financing costs.  In December 2006, we repurchased $25.0million principal amount of our outstanding Senior Notes.  The $25.0 million Senior Note repurchaseresulted in a first quarter fiscal 2007 pre-tax charge of $2.1 million, representingthe premium paid plus the write-off of unamortized debt issuance discount anddeferred financing costs.

 

***Income Tax Provision.***  Oureffective tax rate was a benefit of 28.0% for the first six months of fiscal2008 and a provision of 39.0% for the first six months of fiscal 2007.  Our benefit rate for the first six months offiscal 2008, reflects the effect of additional income tax expense (includinginterest and penalties) recognized during the six-month period in connectionwith the implementation and ongoing accounting requirements of FIN No. 48.

 

***Net Income (Loss).***  Net lossfor the first six months of fiscal 2008 was $0.7 million, or $(0.13) per share(diluted), compared to net income of $4.0 million, or $0.64 per share(diluted), for the first six months of fiscal 2007.  Net loss for the first six months of fiscal2008 includes an after-tax debt extinguishment charge of $23,000, or $0.00 pershare (diluted).  Net income for thefirst six months of fiscal 2007 includes an after-tax debt extinguishmentcharge of $1.3 million, or $0.21 per share (diluted).

 

Our average diluted shares outstanding of5,894,000 for the first six months of fiscal 2008 was 4.7% lower than the6,183,000 average diluted shares outstanding for the first six months of fiscal2007.  The decrease in average diluted shares outstandingreflects the elimination of the dilutive impact of outstanding stock optionsand restricted stock in for the first six months of fiscal 2008 due to the netloss, compared to the dilutive impact of outstanding stock options andrestricted stock awards in the first six months of fiscal 2007, when wegenerated net income, partially offset by higher shares outstanding in thefirst six months of fiscal 2008 compared to the first six months of fiscal2007, as a result of stock option exercises and vesting of restricted stockawards.

 

**Seasonality**

 

Our business, like that of many otherretailers, is seasonal.  Our quarterly net sales have historically beenhighest in our third fiscal quarter, corresponding to the Spring sellingseason, followed by the first fiscal quarter, corresponding to the Fall/holidayselling season.  Given the typicallyhigher gross margin we experience in the third fiscal quarter compared to otherquarters, the relatively fixed nature of most of our operating expenses andinterest expense, and the historically higher sales level in the third quarter,we have typically generated a very significant percentage of our full yearoperating income and net income during the third quarter.  Results for any quarter are notnecessarily indicative of the results that may be achieved for a full fiscalyear.  Quarterly results may fluctuate materially depending upon, amongother things, the timing of new store openings and new leased departmentopenings, net sales and profitability contributed by new stores and leaseddepartments, increases or decreases in comparable store sales, the timing ofthe fulfillment of purchase orders under our product and license arrangements,adverse weather conditions, shifts in the timing of certain holidays andpromotions, changes in inventory and production levels and the timing ofdeliveries of inventory, and changes in our merchandise mix.

 

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**Liquidity and Capital Resources**

 

Our cash needs have primarily been for (i) debt service, (ii) capitalexpenditures, including leasehold improvements, fixtures and equipment for newstores, store relocations and expansions of our existing stores, as well asimprovements and new equipment for our distribution and corporate facilitiesand information systems, and (iii) working capital, including inventory tosupport our business.  We have historicallyfinanced these capital requirements from cash flows from operations, borrowingsunder our credit facility or available cash balances.

 

In November 2006, our Board of Directors authorized the repurchaseof $25.0 million principal amount of our Senior Notes.  This was in addition to the repurchase of$10.0 million principal amount of our Senior Notes completed during August andSeptember 2006.  On December 8,2006, we completed the repurchase of the authorized amount at 105.625% of the$25.0 million principal amount, plus accrued and unpaid interest.  On April 18, 2007, we completed theredemption of the remaining $90.0 million principal amount of our outstandingSenior Notes through a new Term Loan financing. The new Term Loan extended the maturity for $90.0 million principalamount of our debt from August 1, 2010 (the maturity date of the redeemedSenior Notes) to March 13, 2013 (the maturity date of the new Term Loan),with quarterly required principal payments of $225,000.  The December 2006 redemption of theSenior Notes, which was at a price of 105.625% of principal amount, plusaccrued interest, resulted in “Loss on extinguishment of debt” of $2.1 millionon a pre-tax basis for the first quarter of fiscal 2007, consisting of the $1.4million cash redemption premium and $0.7 million of non-cash expense from thewrite-off of unamortized deferred financing costs and debt issuance costs.

 

In March 2007, we entered intoSupplemental Executive Retirement Agreements (the “SERP Agreements”) withour Chairman of the Board and Chief Executive Officer and our President andChief Creative Officer (the “SERPExecutives”).  In April 2007, wemade an initial required contribution of $2.7 million to a grantor trust,which was established for the purpose of accumulating assets in anticipation ofour payment obligations under the SERP Agreements.  In November 2007, we made an additionalrequired contribution to the grantor trust of $1.2 million.  In orderto impact positively our ability to comply with the Consolidated Leverage Ratiocovenant of our Term Loan Agreement at March 31, 2008, with the consent ofthe SERP Executives we withdrew $1.0 million from the grantor trust on March 28,2008.  The withdrawn funds were used torepay indebtedness under our credit facility. We are obligated to replenish the withdrawn grantor trust funds by November 29,2008 in accordance with our normal funding obligations under the SERPAgreements.  We are not obligated to makeany additional contributions to the grantor trust during fiscal 2008.  We may, but are not obligated to,recontribute all or a portion of the withdrawn funds before the end of fiscal2008.

 

Cash and cash equivalents decreased by $2.4million during the first six months of fiscal 2008 compared to a decrease of $11.8million for the first six months of fiscal 2007.  Cash provided byoperations of $9.7 million for the first six months of fiscal 2008 decreased by$0.8 million from the $10.5 million cash provided by operations for the firstsix months of fiscal 2007.  This decrease in cash providedby operations was primarily the result of: (i) the net loss in the firstsix months of fiscal 2008 compared to net income for the first six months offiscal 2007, and (ii) an increase in prepaid expenses and other current assets,compared to a decrease in the first six months of fiscal 2007.  These decreases in cash provided byoperations were partially offset by increased cash provided by a decrease inaccounts receivable and inventories in the first six months of fiscal 2008compared to an increase in the first six months of fiscal 2007.  During the first six months of fiscal 2008,we used a significant majority of our cash provided by operations to pay forcapital expenditures.  We funded repayments of long-term debt, includingthe $5.0 million prepayment of our Term Loan in March 2008, with thedrawdown of a portion of our cash balance, cash generated from cash overdrafttiming, the remaining cash provided by operations and cash from the exercise ofstock options.  During the firstsix months of fiscal 2007, we used a significant majority of our cash providedby operations to pay for capital expenditures.  We funded the $25.0 millionrepurchase of our Senior Notes by utilizing available cash, cash generated bynet proceeds from the sales (net of purchases) of short-term investments,cash generated from stock option exercises, as well as the remaining cashprovided by operations.

 

For the first six months of fiscal 2008, we spent $8.2 million oncapital expenditures, including $6.0 million for leasehold improvements,fixtures and equipment principally for new store facilities, as well asimprovements to existing stores, and $2.2 million for our informationsystems and distribution and corporate facilities.  This compares to $9.1 million in capitalexpenditures for the first six months of fiscal 2007, of which$5.7 million was spent for new store facilities and improvements toexisting stores and retail locations, and $3.4 million for our informationsystems and distribution and corporate facilities.

 

On March 13, 2007, we entered into a Term Loan Agreement for a$90.0 million senior secured Term Loan B due March 13, 2013, the proceedsof which were received on April 18, 2007 and were used to redeem theremaining $90.0 million principal amount of our Senior Notes.  The interest rate on the Term Loan is equalto, at our election, either (i) the prime rate plus 1.00%, or (ii) theLIBOR rate plus the applicable margin. The applicable margin was initially fixed at 2.50% 

 

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through and including the fiscal quarter ended September 30,2007.  Thereafter, the applicable marginfor LIBOR rate borrowings is either 2.25% or 2.50%, depending on ourConsolidated Leverage Ratio (as defined). Based upon our Consolidated Leverage Ratio as of September 30, 2007and December 31, 2007, the applicable margin for LIBOR rate borrowingsremained at 2.50% for the first six months of fiscal 2008.  We are required to make minimum repayments ofthe principal amount of the Term Loan in quarterly installments of $225,000each.  Additionally, the Term Loan can beprepaid at our option, in part or in whole, at any time without any prepaymentpremium or penalty.  On March 19,2008, we prepaid $5.0 million of the outstanding Term Loan.  At March 31, 2008, our indebtednessunder the Term Loan Agreement was $84.1 million.

 

The Term Loan is secured by a security interest in our accountsreceivable, inventory, real estate interests, letter of credit rights, cash,intangibles and certain other assets. The security interest granted to the TermLenders is, in certain respects, subordinate to the security interest grantedto the Credit Facility Lender.  TheTerm Loan Agreement imposes certain restrictions on our ability to, among otherthings, incur additional indebtedness, pay dividends, repurchase stock, andenter into other various types of transactions. The Term Loan Agreement also contains quarterly financial covenants thatrequire us to maintain a specified maximum permitted Consolidated LeverageRatio and a specified minimum permitted Consolidated Interest Coverage Ratio(as defined).  Since the inception of theTerm Loan Agreement, including all of the six month period ended March 31,2008, we were in compliance with all covenants of our Term Loan Agreement.

 

In order to mitigate our floating rate interest risk on the variablerate Term Loan, we entered into an interest rate swap agreement with the Agentbank for the Term Loan that commenced on April 18, 2007, the date the$90,000,000 Term Loan proceeds were received, and expires on April 18,2012.  The interest rate swap agreementenables us to effectively convert an amount of the Term Loan equal to thenotional amount of the interest rate swap from a floating interest rate ofLIBOR plus 2.50% (subject to reduction to LIBOR plus 2.25% if we achieve aspecified leverage ratio), to a fixed interest rate of 7.50% (subject toreduction to 7.25% if we achieve a specified leverage ratio) for thesignificant majority of the Term Loan. The notional amount of the interest rate swap was $75.0 million at theinception of the swap agreement and decreases over time to a notional amount of$5.0 million at the expiration date.  Thenotional amount of the swap was $65.0 million as of March 31, 2008 andover the next eighteen months decreases as follows:  to $57.5 million starting April 18,2008; to $50.0 million starting October 20, 2008; and to $42.5 millionstarting April 20, 2009.

 

In connection with the Term Loan transaction, we amended our existing$60.0 million Credit Facility in order to permit the new Term Loanfinancing.  This amendment of the CreditFacility also extended its maturity from October 15, 2009 to March 13,2012, increased its size to $65.0 million, and reduced the LIBOR-based interestrate option under the facility by 0.25%. There are no financial covenant requirements under the Credit Facilityprovided that Excess Availability (as defined) does not fall below 10% of theBorrowing Base (as defined).  If ExcessAvailability were to fall below 10% of the Borrowing Base, we would be requiredto meet a specified minimum Fixed Charge Coverage Ratio (as defined).  During the first six months of fiscal 2008and 2007, we exceeded the minimum requirements for Excess Availability.

 

As of March 31, 2008, wehad no outstanding borrowings under the Credit Facility and $6.8 million inletters of credit, with $58.2 million of availability under our creditline.  We had average directborrowings of $6.3 million under our Credit Facility for the first sixmonths of fiscal 2008, compared to average direct borrowings of $0.6 millionduring the first six months of fiscal 2007.

 

Our management believes thatour current cash and working capital positions, expected operating cash flowsand available borrowing capacity under our Credit Facility, will be sufficientto fund our working capital, capital expenditures and debt repaymentrequirements and to fund stock and/or debt repurchases, if any, for at leastthe next twelve months.

 

###### **Critical AccountingPolicies and Estimates**

###### ** **

Our consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States. These generally accepted accounting principles requiremanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of our consolidated financial statements and the reported amountsof net sales and expenses during the reporting period.

 

Our significant accounting policies aredescribed in Note 2 of “Notes to Consolidated Financial Statements” in ourAnnual Report on Form 10-K for the year ended September 30,2007.  We believe that the followingdiscussion addresses our critical accounting policies, which are those that aremost important to the portrayal of our financial condition and results ofoperations and require management’s most difficult, subjective and complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. If actual results 

 

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were to differ significantly from estimates made, future reportedresults could be materially affected. However, we are not currently aware of any reasonably likely events orcircumstances that would result in materially different results.  Except as disclosed below and in thefinancial statements and accompanying notes included in Item 1of this report,there were no material changes in, or additions to, our critical accountingpolicies or in the assumptions or estimates we used to prepare the financialinformation appearing in this report.

 

Our senior management has reviewed these critical accounting policiesand estimates and the related Management’s Discussion and Analysis of FinancialCondition and Results of Operations with the Audit Committee of our Board ofDirectors.

 

***Inventories.***  Wevalue our inventories, which consist primarily of maternity apparel, at thelower of cost or market. Cost is determined on the first-in, first-out method(FIFO) and includes the cost of merchandise, freight, duty and brokerfees.  A periodic review of inventoryquantities on hand is performed in order to determine if inventory is properlyvalued at the lower of cost or market. Factors related to current inventories such as future consumer demandand fashion trends, current aging, current analysis of merchandise based onreceipt date, current and anticipated retail markdowns or wholesale discounts,and class or type of inventory are analyzed to determine estimated netrealizable values.  Criteria utilized byus to quantify aging trends include factors such as the amount of merchandisereceived within the past twelve months, merchandise received more than one yearbefore with quantities on-hand in excess of 12 months of sales, andmerchandise currently selling below cost. A provision is recorded to reduce the cost of inventories to itsestimated net realizable value, if required. Inventories as of March 31, 2008 and September 30, 2007totaled $100.2 million and $100.5 million, respectively, representing37.1% and 36.4% of total assets, respectively. Given the significance of inventories to our consolidated financialstatements, the determination of net realizable values is considered to be acritical accounting estimate.  Anysignificant unanticipated changes in the factors noted above could have asignificant impact on the value of our inventories and our reported operatingresults.

 

***Long-Lived Assets.***  Ourlong-lived assets consist principally of store leasehold improvements (includedin the “Property, plant and equipment, net” line item in our consolidatedbalance sheets) and, to a much lesser extent, lease acquisition costs (includedin the “Other intangible assets, net” line item in our consolidated balancesheets).  These long-lived assets arerecorded at cost and are amortized using the straight-line method over theshorter of the lease term or their useful life. Net long-lived assets as of March 31, 2008 and September 30,2007 totaled $68.2 million and $69.2 million, respectively,representing 25.3% and 25.1% of total assets, respectively.

 

In assessing potential impairment of these assets, we periodicallyevaluate the historical and forecasted operating results and cash flows on astore-by-store basis.  Newly openedstores may take time to generate positive operating and cash flow results.  Factors such as: (i) store type, thatis, company store or leased department, (ii) store concept, that is,Motherhood Maternity®, Mimi Maternity®, A Pea in the Pod® or DestinationMaternity®, (iii) store location, for example, urban area versus suburb, (iv) currentmarketplace awareness of our brands, (v) local customer demographic data, (vi) anchorstores within the mall in which our store is located and (vii) currentfashion trends are all considered in determining the time frame required for astore to achieve positive financial results, which is assumed to be within twoyears from the date a store location is opened. If economic conditions are substantially different from ourexpectations, the carrying value of certain of our long-lived assets may becomeimpaired.  As a result of our impairmentassessment, we recorded write-downs of long-lived assets of $0.9 million forthe first six months of fiscal 2008, and $0.4 million for the first six monthsof fiscal 2007, respectively.

 

***Goodwill*.** The purchase method of accounting for business combinations requires theuse of estimates and judgments to allocate the purchase price paid foracquisitions to the fair value of the net tangible and identifiable intangibleassets.  Goodwill represents the excessof the aggregate purchase price over the fair value of net assets acquired inbusiness combinations and is separately disclosed in our consolidated balancesheets.  As of both March 31, 2008and September 30, 2007, goodwill totaled $50.4 million, representing18.7% and 18.3% of total assets, respectively. In June 2001, the FASB issued SFAS No. 142, “Goodwill andOther Intangible Assets.”  SFAS No. 142requires that goodwill no longer be amortized, but instead be tested forimpairment at least annually or as impairment indicators arise.

 

The impairment test requires us to compare the fair value of businessreporting units to their carrying value, including assigned goodwill.  In assessing potential impairment ofgoodwill, we have determined that we have one reporting unit for purposes ofapplying SFAS No. 142 based on our reporting structure.  The fair value of our single reporting unitis determined based on the fair market value of our outstanding common stock ona control basis and, if necessary, an outside independent valuation is obtainedto determine the fair value.  The carryingvalue of our single reporting unit, expressed on a per share basis, isrepresented by the book value per share of our outstanding common stock.  The results of the annual impairment testperformed as of September 30, 2007, indicated the fair value of thereporting unit exceeded its carrying

 

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value.  If the per share fair value of our singlereporting unit were less than the book value per share on September 30,2007, our goodwill could potentially have been impaired.

 

***Accounting for Income Taxes.***  We adopted the provisions ofFIN No. 48 effective as of October 1, 2007 (see “Notes toConsolidated Financial Statements; Note 6. Income Taxes”).

 

Aspart of the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate.  This process requires us toestimate our actual current tax exposure (including interest and penalties)together with assessing temporary differences resulting from differingtreatment of items, such as depreciation of property and equipment andvaluation of inventories, for tax and accounting purposes.  We establish reserves for certain taxpositions that we believe are supportable, but such tax positions arepotentially subject to successful challenge by the applicable taxingauthority.  We determine our provisionfor income taxes based on federal and state tax laws and regulations currentlyin effect, some of which have been recently revised.  Legislation changes currently proposed bycertain of the states in which we operate, if enacted, could increase ourtransactions or activities subject to tax. Any such legislation that becomes law could result in an increase in ourstate income tax expense and our state income taxes paid, which could have a materialand adverse effect on our net income or cash flow.

 

Thetemporary differences between the book and tax treatment of income and expensesresult in deferred tax assets and liabilities, which are included within ourconsolidated balance sheets.  We mustthen assess the likelihood that our deferred tax assets will be recovered fromfuture taxable income.  Actual resultscould differ from our assessments if adequate taxable income is not generatedin future periods.  Net deferred taxassets as of March 31, 2008 and September 30, 2007 totaled $23.5 millionand $22.3 million, respectively, representing 8.7% and 8.1% of totalassets, respectively.  To the extent webelieve that recovery is not more likely than not, we must establish avaluation allowance.  To the extent weestablish a valuation allowance or change the allowance in a future period,income tax expense will be impacted.

 

***Accounting for Contingencies*****.**  From time totime, we are named as a defendant in legal actions arising from our normalbusiness activities.  We account forcontingencies such as these in accordance with SFAS No. 5, “Accounting forContingencies,” including the provisions of Emerging Issues Task Force IssueD-77, “Accounting for Legal Costs Expected to Be Incurred in Connection with aLoss Contingency.”  SFAS No. 5 requiresus to record an estimated loss contingency when information available prior toissuance of our financial statements indicates that it is probable that anasset has been impaired or a liability has been incurred at the date of thefinancial statements and the amount of the loss can be reasonablyestimated.  An interpretation of SFAS No. 5further states that when there is a range of loss and no amount within thatrange is a better estimate than any other, then the minimum amount of the rangeshall be accrued.  Accounting forcontingencies arising from contractual or legal proceedings requiresmanagement, after consultation with outside legal counsel, to use its bestjudgment when estimating an accrual related to such contingencies.  As additional information becomes known, ouraccrual for a loss contingency could fluctuate, thereby creating variability inour results of operations from period to period.  Likewise, an actual loss arising from a losscontingency which significantly exceeds the amount accrued for in our financialstatements could have a material adverse impact on our operating results forthe period in which such actual loss becomes known.

 

**Recent Accounting Pronouncements**

 

SFAS No. 157

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in U.S. generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years, for financial assets andliabilities that are measured at fair value on a recurring basis.  The FASB issued a one-year deferral of SFAS No. 157’sfair value measurement requirements for non-financial assets and liabilitiesthat are not required or permitted to be measured at fair value on a recurringbasis.  The impact from adoption ofSFAS No. 157, if any, on our consolidated financial position or results ofoperations has not yet been determined.

 

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SFASNo. 159

 

*In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities.”  SFAS No. 159provides companies with an option to report selected financial assets andliabilities at fair value and requires entities to display the fair value ofthose assets and liabilities for which the company has chosen to use fair valueon the face of the balance sheet.  SFAS No. 159is effective for financial statements issued for fiscal years beginning after November 15,2007.  The impact from adoption of SFAS No. 159,if any, on our consolidated financial position or results of operations has notyet been determined.*

* *

**Forward-Looking Statements**

 

Some of the information in this report,including the information incorporated by reference (as well as informationincluded in oral statements or other written statements made or to be made byus), contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Theforward-looking statements involve a number of risks and uncertainties. Anumber of factors could cause our actual results, performance, achievements orindustry results to be materially different from any future results,performance or achievements expressed or implied by these forward-lookingstatements. These factors include, but are not limited to the following: ourability to successfully manage various business initiatives, our ability tosuccessfully manage and retain our leased department and licensed relationshipsand marketing partnerships, future sales trends in our existing retaillocations, weather, changes in consumer spending patterns, raw material priceincreases, consumer preferences and overall economic conditions, our ability toanticipate and respond to fashion trends and consumer preferences, unanticipatedfluctuations in our operating results, impact of competition and pricing,availability of suitable store locations, continued availability of capital andfinancing, our ability to hire and develop senior management and salesassociates, our ability to develop and source merchandise, our ability toreceive production from foreign sources on a timely basis, potential stockrepurchases, potential debt prepayments, changes in market interest rates, waror acts of terrorism, and other factors referenced in our Annual Report on Form 10-K,including those set forth under the caption “Risk Factors.”

 

Inaddition, these forward-looking statements necessarily depend upon assumptions,estimates and dates that may be incorrect or imprecise and involve known andunknown risks, uncertainties and other factors. Accordingly, anyforward-looking statements included in this report do not purport to bepredictions of future events or circumstances and may not be realized.Forward-looking statements can be identified by, among other things, the use offorward-looking terms such as “believes,” “expects,” “may,” “will,” “should,” “seeks,”“pro forma,” “anticipates,” “intends,” “continues,” “could,” “estimates,” “plans,”“potential,” “predicts,” “goal,” “objective,” or the negative of any of theseterms, or comparable terminology, or by discussions of our outlook, plans,goals, strategy or intentions. Forward-looking statements speak only as of thedate made. Except as required by applicable law, including the securities lawsof the United States and the rules and regulations of the Securities andExchange Commission, we assume no obligation to update any of theseforward-looking statements to reflect actual results, changes in assumptions orchanges in other factors affecting these forward-looking statements.

 

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**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Mothers Work is exposed to market risk from changes ininterest rates.  We have not entered into any market sensitive instrumentsfor trading purposes.  The analysis below presents the sensitivity of themarket value of our financial instruments to selected changes in marketinterest rates.  The range of changes presented reflects our view of changesthat are reasonably possible over a one-year period.

 

Asof March 31, 2008, we had cash and cash equivalents of $7.8 million and anadditional $2.8 million in a grantor trust. Our cash equivalents consist of money market accounts that bear interestat variable rates.  Our investments inthe grantor trust consist primarily of fixed income mutual funds with cost thatapproximates fair value.  A change in market interest rates earned on ourinvestments  impacts the interestincome and cash flows, but does not materially impact the fair market value ofthe financial instruments.  Due to theaverage maturity and conservative nature of our investment portfolio, webelieve a sudden change in interest rates would not have a material effect onthe value of our investment portfolio.

 

As of March 31, 2008, the principal components ofour debt portfolio were the $84.1 million Term Loan and the$65.0 million Credit Facility, both of which are denominated in U.S.dollars.  The fair market value of the debt portfolio is referred to asthe “Debt Value.”

 

Our Credit Facility carries a variable interest ratethat is tied to market indices.  As of March 31, 2008, we had nodirect borrowings and $6.8 million of letters of credit outstanding under ourCredit Facility.  Borrowings under the Credit Facility would have resultedin interest at a rate between approximately 3.70% and 5.25% per annum as of March 31,2008.  Interest on any future borrowings under the Credit Facility would,to the extent of outstanding borrowings, be affected by changes in marketinterest rates.  A change in marketinterest rates on the variable rate portion of the debt portfolio impacts theinterest expense incurred and cash flows, but does not impact the Debt Value ofthe financial instrument.

 

The Term Loan carries a variable interest rate that istied to market indices.  The sensitivityanalysis as it relates to this portion of our debt portfolio assumes aninstantaneous 100 basis point move in interest rates from their levels as of March 31,2008, with all other variables held constant.  The Debt Value of the TermLoan is approximately $84.1 million, its principal amount.  A 100basis point increase in market interest rates would result in additionalannual interest expense on the Term Loan of approximately $0.8 million.  A 100 basis point decline in marketinterest rates would correspondingly lower our annual interest expenseon the Term Loan by approximately $0.8 million.

 

Inorder to mitigate our floating rate interest risk on the variable rate TermLoan, we entered into an interest rate swap agreement with the Agent bank forthe Term Loan that commenced on April 18, 2007.  The interest rate swap agreement enables usto effectively convert an amount of the Term Loan equal to the notional amountof the interest rate swap from a floating interest rate (LIBOR plus 2.50%), toa fixed interest rate (7.50%).  Thenotional amount of the interest rate swap was $75.0 million at inception of theswap agreement and decreases over time to a notional amount of $5.0 million at theexpiration date.  The notional amount ofthe swap was $65,000,000 as of March 31, 2008 and over the next twelvemonths decreases as follows:  to$57,500,000 starting April 18, 2008; and to $50,000,000 starting October 20,2008.  Based on the scheduled swapnotional amount during the next 12 months of the swap agreement, a 100 basis point increase in market interestrates would result in interest expense savings for the year ofapproximately $0.5 million.  A 100basis point decline in market interest rates would correspondinglyincrease our interest expense for the year by approximately $0.5 million.  Thus, a100 basis point increase in market interest rates during the next 12 months ofthe swap agreement would result in additional interest expense for theyear of approximately $0.3 million on the Term Loan and swap agreement combined.  A 100 basis point decline in marketinterest rates during the next 12 months of the swap agreement would correspondinglylower our interest expense for the year by approximately $0.3 million on theTerm Loan and swap agreement combined.

 

Basedon the limited other variable rate debt included in our debt portfolio as of March 31,2008, a 100 basis point increase in interest rates would result in additionalinterest incurred for the year of less than $0.1 million.  A 100 basis point decrease in interest rateswould correspondingly lower our interest expense for the year by less than $0.1million.

 

Other than as described above, we do not believe thatthe market risk exposure on other financial instruments is material.

 

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**Item 4.  Controls and Procedures**

 

***Disclosure Controls and Procedures***

*** ***

Our disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that are filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.  These disclosure controls and proceduresinclude controls and procedures designed to ensure that information required tobe disclosed under the Exchange Act is accumulated and communicated to ourmanagement on a timely basis to allow decisions regarding required disclosure.  We evaluated the effectiveness of the designand operation of our disclosure controls and procedures as of March 31,2008.  Based on this evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat as of March 31, 2008, these controls and procedures were effective.

 

***Internal Control over Financial Reporting***

*** ***

There have been no changes in internalcontrol over financial reporting identified in connection with the foregoingevaluation that occurred during the fiscal quarter ended March 31, 2008,that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Fromtime to time, the Company is named as a defendant in legal actions arising fromits normal business activities.  Althoughthe amount of any liability that could arise with respect to currently pendingactions cannot be accurately predicted, the Company does not believe that theresolution of any pending action will have a material adverse effect on itsfinancial position, results of operations or liquidity.

 

**Item 1A.  Risk Factors**

 

Inaddition to the other information set forth in this Form 10-Q, you shouldcarefully consider the factors discussed in Part I, Item 1A “RiskFactors” of our Form 10-K for the year ended September 30,2007.  The risks described in our Form 10-K are not the only risksthat we face.  Additionalrisks not presently known to us or that we do notcurrently consider significant may also have anadverse effect on us. If any of the risks actuallyoccur, our business, results of operations, cash flows or financialcondition could suffer.

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

 

The following table provides informationabout purchases by us during the quarter ended March 31, 2008 of equitysecurities that are registered by us pursuant to Section 12 of theSecurities Exchange Act of 1934:

 
| **Period**                                | ** ** | **Total   Number of   Shares   Purchased (1)** | ** ** | **Average Price   Paid per Share** | ** ** | **Total Number of   Shares Purchased as  Part of a Publicly   Announced Program (2)** | ** ** | **Maximum   Approximate Dollar   Value of Shares that  May Yet Be Purchased   Under the Program (2)** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1 to January 31, 2008   |       | 549                                                                     |       | $                                                      | 15.10      |                                                                                                                                         | —     |                                                                                                                                                                   | —     |   |
| February 1 to February 29, 2008 |       | 72                                                                      |       | $                                                      | 18.75      |                                                                                                                                         | —     |                                                                                                                                                                   | —     |   |
| March 1 to March 31, 2008       |       | 54                                                                      |       | $                                                      | 16.97      |                                                                                                                                         | —     |                                                                                                                                                                   | —     |   |
| Total                                     |       | 675                                                                     |       | $                                                      | 15.64      |                                                                                                                                         | —     |                                                                                                                                                                   | —     |   |

 

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(1) Represents sharesrepurchased directly from certain employees to satisfy income tax withholdingobligations for such employees in connection with restricted stock awards thatvested during the period.

 

(2) During the quarterended March 31, 2008, the Company did not have a publicly announcedprogram for repurchase of shares of its common stock and did not repurchase anyof its common stock in open-market transactions outside of such a program.

 

**Item 6.  Exhibits**

 
| **Exhibit  No.** | ** ** | **Description** |
|------------------|------------|-----------------|
|             |       |            |
| 10.1             | *          |            | Confidentiality  Agreement dated March 10, 2008, by and among Mothers Work, Inc., Crescendo  Partners II, L.P., Series K, Crescendo Investments II, LLC, Crescendo  Partners III, L.P., and Crescendo Investments III, LLC (Exhibit 10.1  to the March 10, 2008 Form 8-K). |
| 10.2             | *          |            | Letter Agreement dated  March 28, 2008, among Dan Matthias, Rebecca Matthias, Wachovia Bank,  National Association and Mothers Work, Inc. (Exhibit 10.1 to the  March 28, 2008 Form 8-K). |
| 31.1             |       |            | Certification  of the Chief Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
| 31.2             |       |            | Certification  of the Chief Operating Officer & Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1             |       |            | Certification  of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2             |       |            | Certification  of the Chief Operating Officer & Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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*         Incorporatedby reference.

 

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**Signatures**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                   |   | MOTHERS WORK, INC.                                            |     |
|------------------------|--------|---------------------------------------------------------------|----------|
|                   |   |                                                          |     |
| Date: May 8, 2008 | By:    | ** /s/ DAN W. MATTHIAS**                                 |
|                   |   | Dan W. Matthias                                               | * * |
|                   |   | *Chairman of the Board and  Chief Executive Officer*          | * * |
|                   |   |                                                          | * * |
|                   |   |                                                          |     |
| Date: May 8, 2008 | By:    | ** /s/ EDWARD M. KRELL**                                 |
|                   |   | Edward M. Krell                                          | * * |
|                   |   | *Chief Operating Officer &**Chief Financial Officer* | * * |

 

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**INDEX OF EXHIBITS FILED WITH**

**FORM 10-Q OF MOTHERS WORK, INC.**

**FOR THE QUARTER ENDED MARCH 31, 2008**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                        |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                   |
| 31.1             |       | Certification  of the Chief Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                         |
| 31.2             |       | Certification  of the Chief Operating Officer & Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
| 32.1             |       | Certification  of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                     |
| 32.2             |       | Certification  of the Chief Operating Officer & Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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