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** **

 

** **

**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 December 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**

 

**Destination Maternity Corporation**

(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 mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 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 of shares outstanding of each of theissuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, $.01 par value 6,094,291 sharesoutstanding as of February 2, 2009

 

 

 

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**DESTINATION MATERNITY CORPORATIONAND SUBSIDIARIES**

**INDEX**

 
| PART I.  FINANCIAL INFORMATION |                                                                                        |
|------------------------------------------|---------------------------------------------------------------------------------------------|
| Item 1.                                  | Financial  Statements (unaudited)                                                           |   |
|                                     | 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 | 13 |
| 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 |

 

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

** **

**DESTINATION MATERNITY CORPORATIONAND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

(in thousands, except share and per shareamounts)

(unaudited)

 
| ** **                                                                                                                        | ** ** | **December 31, 2008** | ** ** | **September 30, 2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| **ASSETS**                                                                                                                        |       |                            |       |                             |       |
| Current assets:                                                                                                                   |       |                            |       |                             |       |
| Cash and cash equivalents                                                                                                         |       | $                               | 14,720     |                             | $          | 12,148 |   |
| Trade receivables                                                                                                                 |       | 6,936                           |       | 7,085                            |       |
| Inventories                                                                                                                       |       | 77,730                          |       | 88,056                           |       |
| Deferred income taxes                                                                                                             |       | 8,154                           |       | 8,154                            |       |
| Prepaid expenses and other current assets                                                                                         |       | 6,176                           |       | 6,777                            |       |
| Total current assets                                                                                                              |       | 113,716                         |       | 122,220                          |       |
| Property, plant and equipment, net                                                                                                |       | 65,770                          |       | 66,098                           |       |
| Assets held for sale                                                                                                              |       | —                          |       | 207                              |       |
| Other assets:                                                                                                                     |       |                            |       |                             |       |
| Goodwill                                                                                                                          |       | 3,389                           |       | 50,389                           |       |
| Deferred financing costs, net of accumulated  amortization of $405 and $358                                                       |       | 804                             |       | 929                              |       |
| Other intangible assets, net of accumulated amortization  of $2,084 and $2,105                                                    |       | 736                             |       | 695                              |       |
| Deferred income taxes                                                                                                             |       | 15,587                          |       | 15,411                           |       |
| Other non-current assets                                                                                                          |       | 310                             |       | 299                              |       |
| Total other assets                                                                                                                |       | 20,826                          |       | 67,723                           |       |
| Total assets                                                                                                                      |       | $                               | 200,312    |                             | $          | 256,248 |   |
|                                                                                                                              |       |                            |       |                             |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                    |       |                            |       |                             |       |
| Current liabilities:                                                                                                              |       |                            |       |                             |       |
| Line of credit borrowings                                                                                                         |       | $                               | —     |                             | $          | — |   |
| Current portion of long-term debt                                                                                                 |       | 1,239                           |       | 1,860                            |       |
| Accounts payable                                                                                                                  |       | 20,318                          |       | 20,937                           |       |
| Accrued expenses and other current liabilities                                                                                    |       | 38,862                          |       | 37,806                           |       |
| Total current liabilities                                                                                                         |       | 60,419                          |       | 60,603                           |       |
| Long-term debt                                                                                                                    |       | 67,138                          |       | 76,786                           |       |
| Deferred rent and other non-current liabilities                                                                                   |       | 31,163                          |       | 29,391                           |       |
| Total liabilities                                                                                                                 |       | 158,720                         |       | 166,780                          |       |
|                                                                                                                              |       |                            |       |                             |       |
| Commitments and contingencies (Note 12)                                                                                           |       |                            |       |                             |       |
|                                                                                                                              |       |                            |       |                             |       |
| Stockholders’ equity:                                                                                                        |       |                            |       |                             |       |
| Preferred stock, 2,000,000 shares authorized:                                                                                     |       |                            |       |                             |       |
| 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, 6,083,570 and 6,070,813 shares issued and outstanding,  respectively |       | 61                              |       | 61                               |       |
| Additional paid-in capital                                                                                                        |       | 83,214                          |       | 83,274                           |       |
| Retained earnings (deficit)                                                                                                       |       | (39,410                         | )          | 7,505                            |       |
| Accumulated other comprehensive loss                                                                                              |       | (2,273                          | )          | (1,372                           | )          |
| Total stockholders’ equity                                                                                                   |       | 41,592                          |       | 89,468                           |       |
| Total liabilities and stockholders’ equity                                                                                   |       | $                               | 200,312    |                             | $          | 256,248 |   |

 

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

 

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**DESTINATION MATERNITY CORPORATIONAND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(in thousands, except per share amounts)

(unaudited)

 
| ** **                                                   | ** ** | **Three Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net sales                                                    |       | $                                                   | 134,812    |   | $ | 142,876 |   |
| Cost of goods sold                                           |       | 66,957                                              |       | 70,914 |   |
| Gross profit                                                 |       | 67,855                                              |       | 71,962 |   |
| Selling, general and administrative expenses                 |       | 65,990                                              |       | 69,692 |   |
| Store closing, asset impairment and asset  disposal expenses |       | 2                                                   |       | 886 |   |
| Restructuring charges                                        |       | 171                                                 |       | — |   |
| Goodwill impairment expense                                  |       | 47,000                                              |       | — |   |
| Operating income (loss)                                      |       | (45,308                                             | )          | 1,384 |   |
| Interest expense, net                                        |       | 1,394                                               |       | 1,866 |   |
| Loss on extinguishment of debt                               |       | 66                                                  |       | — |   |
| Loss before income taxes                                     |       | (46,768                                             | )          | (482 | ) |
| Income tax provision (benefit)                               |       | 147                                                 |       | (130 | ) |
| Net loss                                                     |       | $                                                   | (46,915    | ) | $ | (352 | ) |
| Net loss per share—Basic and Diluted                    |       | $                                                   | (7.86      | ) | $ | (0.06 | ) |
| Average shares outstanding—Basic and Diluted            |       | 5,966                                               |       | 5,852 |   |

 

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

 

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** **

**DESTINATION MATERNITYCORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME(LOSS)**(in thousands)

**(unaudited)**

** **
| ** **                                                                      | ** ** | **Common Stock**  | ** ** | ** ** | ** ** | ** **                       | ** ** | **Accumulated**                   | ** ** | ** **                     | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|----------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                                                      | ** ** | **Number  of  Shares** | ** ** | **Amount** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings  (Deficit)** | ** ** | **Other  Comprehensive  Loss** | ** ** | **Total**  | ** ** | **Comprehensive  Income (Loss)** | ** ** |
| Balance as of September 30,  2008                                          |       | 6,071                  |       | $          | 61         |                             | $          | 83,274                            |       | $                              | 7,505      |       | $          | (1,372 | ) | $ | 89,468 |   |   |   |
| Net loss                                                                        |       | —                 |       | —     |       | —                           |       | (46,915                           | )          | —                         |       | (46,915    | )          | $ | (46,915 | ) |
| Amortization of  prior service cost for retirement plans, net of tax            |       | —                 |       | —     |       | —                           |       | —                            |       | 31                             |       | 31         |       | 31 |   |
| Change in fair value  of interest rate swap, net of tax                         |       | —                 |       | —     |       | —                           |       | —                            |       | (932                           | )          | (932       | )          | (932 | ) |
| Comprehensive  loss                                                             |       |                   |       |       |       |                             |       |                              |       |                           |       |       |       | $ | (47,816 | ) |
| Stock-based  compensation                                                       |       | 14                     |       | —     |       | 601                              |       | —                            |       | —                         |       | 601        |       |   |   |
| Tax benefit  shortfall from stock option exercises and restricted stock vesting |       | —                 |       | —     |       | (659                             | )          | —                            |       | —                         |       | (659       | )          |   |   |
| Repurchase and  retirement of common shares                                     |       | (1                     | )          | —     |       | (2                               | )          | —                            |       | —                         |       | (2         | )          |   |   |
| Balance as of  December 31, 2008                                           |       | 6,084                  |       | $          | 61         |                             | $          | 83,214                            |       | $                              | (39,410    | )          | $          | (2,273 | ) | $ | 41,592 |   |   |   |
|                                                                            |       |                   |       |       |       |                             |       |                              |       |                           |       |       |       |   |   |   |   |   |   |   |
|                                                                            |       |                   |       |       |       |                             |       |                              |       |                           |       |       |       |   |   |   |   |   |   |   |
| Balance as of  September 30, 2007                                          |       | 5,963                  |       | $          | 60         |                             | $          | 81,047                            |       | $                              | 8,820      |       | $          | (1,404 | ) | $ | 88,523 |   |   |   |
| Net loss                                                                        |       | —                 |       | —     |       | —                           |       | (352                              | )          | —                         |       | (352       | )          | $ | (352 | ) |
| Amortization of  prior service cost for retirement plans, net of tax            |       | —                 |       | —     |       | —                           |       | —                            |       | 25                             |       | 25         |       | 25 |   |
| Change in fair  value of interest rate swap, net of tax                         |       | —                 |       | —     |       | —                           |       | —                            |       | (621                           | )          | (621       | )          | (621 | ) |
| Unrealized loss  on investments, net of tax                                     |       | —                 |       | —     |       | —                           |       | —                            |       | (34                            | )          | (34        | )          | (34 | ) |
| Comprehensive  loss                                                             |       |                   |       |       |       |                             |       |                              |       |                           |       |       |       | $ | (982 | ) |
| Cumulative effect  of adoption of FIN No. 48 (Note 9)                      |       | —                 |       | —     |       | —                           |       | 74                                |       | —                         |       | 74         |       |   |   |
| Stock-based  compensation                                                       |       | 9                      |       | —     |       | 558                              |       | —                            |       | —                         |       | 558        |       |   |   |
| Exercise of stock  options                                                      |       | 3                      |       | —     |       | 32                               |       | —                            |       | —                         |       | 32         |       |   |   |
| Tax benefit  shortfall from stock option exercises and restricted stock vesting |       | —                 |       | —     |       | (583                             | )          | —                            |       | —                         |       | (583       | )          |   |   |
| Repurchase and  retirement of common shares                                     |       | (6                     | )          | —     |       | (107                             | )          | —                            |       | —                         |       | (107       | )          |   |   |
| Balance as of  December 31, 2007                                           |       | 5,969                  |       | $          | 60         |                             | $          | 80,947                            |       | $                              | 8,542      |       | $          | (2,034 | ) | $ | 87,515 |   |   |   |

 

The accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

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**DESTINATION MATERNITY CORPORATIONAND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                       | ** ** | **Three Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash Flows from Operating  Activities**                                        |       |                                                |       |   |   |
| Net loss                                                                         |       | $                                                   | (46,915    | ) | $ | (352 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                    |       | 3,945                                               |       | 4,002 |   |
| Stock-based compensation expense                                                 |       | 601                                                 |       | 558 |   |
| Loss on impairment of long-lived assets                                          |       | 163                                                 |       | 533 |   |
| Loss on impairment of goodwill                                                   |       | 47,000                                              |       | — |   |
| Loss (gain) on disposal of assets                                                |       | (287                                                | )          | 46 |   |
| Loss on extinguishment of debt                                                   |       | 66                                                  |       | — |   |
| Deferred income tax benefit                                                      |       | (369                                                | )          | (343 | ) |
| Amortization of deferred financing costs                                         |       | 58                                                  |       | 71 |   |
| Changes in assets and liabilities:                                               |       |                                                |       |   |   |
| Decrease (increase) in —                                                    |       |                                                |       |   |   |
| Trade receivables                                                                |       | 149                                                 |       | 5,319 |   |
| Inventories                                                                      |       | 10,326                                              |       | 3,696 |   |
| Prepaid expenses and other current assets                                        |       | 601                                                 |       | (71 | ) |
| Other non-current assets                                                         |       | (11                                                 | )          | 220 |   |
| Increase (decrease) in —                                                    |       |                                                |       |   |   |
| Accounts payable, accrued expenses and other  current liabilities                |       | 1,806                                               |       | (11,507 | ) |
| Deferred rent and other non-current liabilities                                  |       | 333                                                 |       | 1,880 |   |
| Net cash provided by operating activities                                        |       | 17,466                                              |       | 4,052 |   |
|                                                                             |       |                                                |       |   |   |
| **Cash Flows from Investing  Activities**                                        |       |                                                |       |   |   |
| Contribution to grantor trust                                                    |       | —                                              |       | (1,160 | ) |
| Capital expenditures                                                             |       | (4,068                                              | )          | (3,730 | ) |
| Proceeds from sale of assets held for sale                                       |       | 526                                                 |       | — |   |
| Purchase of intangible assets                                                    |       | (71                                                 | )          | — |   |
| Net cash used in investing activities                                            |       | (3,613                                              | )          | (4,890 | ) |
|                                                                             |       |                                                |       |   |   |
| **Cash Flows from Financing  Activities**                                        |       |                                                |       |   |   |
| Increase (decrease) in cash overdraft                                            |       | (1,010                                              | )          | 2,149 |   |
| Repayment of long-term debt                                                      |       | (10,269                                             | )          | (579 | ) |
| Repurchase of common stock                                                       |       | (2                                                  | )          | (107 | ) |
| Proceeds from exercise of stock options                                          |       | —                                              |       | 32 |   |
| Net cash provided by (used in) financing  activities                             |       | (11,281                                             | )          | 1,495 |   |
| **Net Increase in Cash and Cash  Equivalents**                                   |       | 2,572                                               |       | 657 |   |
| **Cash and Cash Equivalents,  Beginning of Period**                              |       | 12,148                                              |       | 10,130 |   |
| **Cash and Cash Equivalents, End  of Period**                                    |       | $                                                   | 14,720     |   | $ | 10,787 |   |
|                                                                             |       |                                                |       |   |   |
| Supplemental Disclosures of Cash Flow  Information:                              |       |                                                |       |   |   |
| Cash paid for interest                                                           |       | $                                                   | 1,141      |   | $ | 2,225 |   |
| Cash paid for income taxes                                                       |       | $                                                   | 215        |   | $ | 495 |   |

 

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

 

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**DESTINATION MATERNITYCORPORATION AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**December 31, 2008**

(unaudited)

 

**1.****                 BASIS OF FINANCIAL STATEMENT PRESENTATION**

 

The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with the requirements forForm 10-Q and Article 10 of Regulation S-X and, accordingly,certain information and footnote disclosures have been condensed oromitted.  Reference is made to the AnnualReport on Form 10-K as of and for the year ended September 30, 2008for Destination Maternity Corporation and subsidiaries (the “Company” or “DestinationMaternity”), as filed with the Securities and Exchange Commission (“SEC”), foradditional disclosures including a summary of the Company’s accountingpolicies.

 

In the opinion of management, theconsolidated financial statements contain all adjustments, consisting of normalrecurring adjustments, necessary to present fairly the consolidated financialposition, results of operations and cash flows of the Company for the periodspresented.  Since the Company’soperations are seasonal, the interim operating results of the Company may notbe indicative of operating results 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 2009” willend on September 30, 2009.  Certainreclassifications have been made to the prior year consolidated financialstatements to conform to the current year presentation.  In addition, the statement of cash flows forthe three months ended December 31, 2007 was revised to reflect the taxbenefit shortfall from stock option exercises and restricted stock vesting ason operating activity item rather than a financing activity item.  The effect was to decrease net cash providedby operating activities by $583,000 and increase net cash provided by financingactivities by $583,000.

 

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

 

Basic earnings (loss) per share (“Basic EPS”) is computed by dividingnet income (loss) by the weighted average number of common shares outstanding,excluding restricted stock for which the restrictions have not lapsed. Diluted earnings (loss) per share (“Diluted EPS”) is computed by dividing netincome (loss) by the weighted average number of common shares outstanding, aftergiving effect to the potential dilution, if applicable, from the assumed lapseof restrictions on restricted stock and from the assumed exercise ofoutstanding stock options.

 

Options and unvested restricted stock totaling 971,152 and 930,475shares of the Company’s common stock were outstanding as of December 31,2008 and 2007, respectively, but were not included in the computation ofDiluted EPS for the three months ended December 31, 2008 and 2007, due tothe Company’s net losses.  Had theCompany reported a profit for the three months ended December 31, 2008 and2007, the weighted average number of dilutive shares outstanding forcomputation of Diluted EPS would have been approximately 5,983,000 and5,999,000, respectively.

 

**3.**                 INVENTORIES

 

Inventories were comprised of the following (in thousands):

 
| ** **       | ** ** | **December 31, 2008** | ** ** | **September 30, 2008** | ** ** |
|------------------|------------|---------------------------------|------------|----------------------------------|------------|
| Finished goods   |       | $                               | 71,554     |                             | $          | 81,028 |   |
| Work-in-progress |       | 2,422                           |       | 2,904                            |       |
| Raw materials    |       | 3,754                           |       | 4,124                            |       |
|             |       | $                               | 77,730     |                             | $          | 88,056 |   |

 

**4.****                ****RESTRUCTURING CHARGES**

 

On July 1, 2008, the Company announcedthat it was streamlining its merchandise brands and store nameplates andimplementing cost reductions in order to simplify its business model, reduceoverhead costs and improve its merchandise assortments.  Pursuant to the strategic restructuring, theCompany is rebranding its Mimi Maternity® merchandise brand under its A Pea inthe Pod® brand beginning with the Spring 2009 collection, which initiallydebuted in November 2008.  TheCompany also is streamlining its store nameplates by renaming its single-brandMimi Maternity stores as A Pea in the Pod, and by renaming its multi-brand MimiMaternity stores as Destination Maternity®. In connection with the strategic restructuring the Company also reducedits corporate headcount. The Company incurred pretax expense of $936,000 fromits restructuring and cost reduction actions in fiscal 2008, consisting of$691,000 for cash severance expense and severance-related benefits, and$245,000 of expense for accelerated depreciation of existing store signsresulting from planned store

 

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signage changes.  The Companyincurred pretax expense of $171,000 in the first quarter of fiscal 2009,consisting of $43,000 for cash severance expense and $128,000 for accelerateddepreciation.  A summary of the chargesincurred and reserves recorded in connection with the restructuring activitiesis as follows (in thousands):

 
| ** **                                 | ** ** | **Balance  Accrued**         | ** ** | **Three Months Ended  December 31, 2008** | ** ** | **Balance  Accrued**       | ** ** | **Cumulative  Charges  Incurred to** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|---------------------------------------------------------------|------------|----------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | **September 30,  2008** | ** ** | **Charges  Incurred**                                         | ** ** | **Payments/  Adjustments** | ** ** | **December 31,  2008**               | ** ** | **December 31,  2008** | ** ** |
| Severance and related benefits             |       | $                            | 224        |                                                          | $          | 43                         |       | $                                         | (182       | ) | $ | 85 |   | $ | 734 |   |
| Accelerated depreciation of  store signage |       | —                       |       | 128                                                           |       | (128                       | )(1)       | —                                    |       | 373 |   |
| Total                                      |       | $                            | 224        |                                                          | $          | 171                        |       | $                                         | (310       | ) | $ | 85 |   | $ | 1,107 |   |

 

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**(1) Adjustmentto reduce net book value of associated property, plant and equipment**

 

**5.****                 GOODWILL IMPAIRMENT**

 

For purposes of the Company’s impairmenttesting under Statement of Financial Accounting Standards (“SFAS”) No. 142,*Goodwill and Other Intangible Assets*,the Company has one reporting unit based on the Company’s reportingstructure.   The fair value of the Company’s singlereporting unit is determined based on a combination of the fair market value ofthe Company’s outstanding common stock on a control basis, a discounted cashflow analysis and other generally accepted valuation methodologies and, ifnecessary, with the assistance of an outside independent valuation specialist.  As a result of a substantial decrease in themarket price of the Company’s common stock subsequent to September 30,2008, reflecting deteriorating overall economic conditions and the verydifficult equity market conditions of recent months, the Company reassessed thecarrying value of its goodwill as of December 31, 2008, in accordance withthe interim period requirements of SFAS No. 142, and concluded that its goodwillwas impaired.  Consequently, the Companyrecorded a non-cash goodwill impairment charge of $47,000,000, on both a pretaxand after tax basis, in the first quarter of fiscal 2009.  The goodwill impairment charge reflects thepreliminary indication from the impairment analysis performed to date, issubject to finalization of certain fair value estimates being performed withthe assistance of an outside independent valuation specialist, and may beadjusted when all aspects of the analysis are completed.  The goodwill impairment analysisinvolves calculating the implied fair value of the Company’s goodwill byallocating the fair value of the Company’s single reporting unit to all assetsand liabilities other than goodwill (including both recognized and unrecognizedintangible assets) and comparing the residual amount to the carrying value ofgoodwill.  The Company currentlyexpects to finalize its goodwill impairment analysis during the second quarterof fiscal 2009.  If the final goodwillimpairment analysis indicates impairment in excess of the Company’s preliminaryestimate, the Company would be required to record additional goodwillimpairment expense of up to $3,389,000, the estimated remaining value of itsgoodwill as of December 31, 2008. Any adjustments to the Company’s preliminary estimate of impairment as aresult of completion of this evaluation are currently expected to be recordedin the Company’s consolidated financial statements for the second quarter offiscal 2009.  The non-cash goodwill impairmentcharge does not have any adverse effect on the covenant calculations under theCompany’s debt agreements or the Company’s overall compliance with thecovenants of the Company’s debt agreements.

 

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

 

Accrued expenses and other current liabilities were comprised of thefollowing (in thousands):

 
| ** **                                       | ** ** | **December 31, 2008** | ** ** | **September 30, 2008** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| Salaries, wages and employee  benefits           |       | $                               | 9,519      |                             | $          | 10,596 |   |
| Interest                                         |       | 888                             |       | 1,012                            |       |
| Deferred rent                                    |       | 3,986                           |       | 4,302                            |       |
| Sales taxes                                      |       | 2,848                           |       | 2,627                            |       |
| Insurance                                        |       | 1,446                           |       | 835                              |       |
| Audit and legal                                  |       | 1,736                           |       | 1,464                            |       |
| Accrued store construction  costs                |       | 350                             |       | 760                              |       |
| Gift certificates and store  credits             |       | 6,895                           |       | 4,960                            |       |
| futuretrust® college savings program        |       | 1,746                           |       | 1,811                            |       |
| Supplemental executive retirement plan  benefits |       | 1,560                           |       | 1,560                            |       |
| Other                                            |       | 7,888                           |       | 7,879                            |       |
|                                             |       | $                               | 38,862     |                             | $          | 37,806 |   |

 

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

 

On March 13, 2007, the Company entered into a Term Loan andSecurity Agreement (the “Term Loan Agreement”) for a $90,000,000 senior securedTerm Loan B due March 13, 2013 (the “Term Loan”), the proceeds of whichwere received on April 18, 2007 and were used to redeem the remaining$90,000,000 principal amount of its 111/4 % senior notes (the “Senior Notes”).  Theinterest rate on the Term Loan is equal to, at the Company’s election, either (i) theprime rate plus 1.00%, or (ii) the LIBOR rate plus the applicablemargin.  The applicable margin wasinitially fixed at 2.50% 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 the Company’sConsolidated Leverage Ratio (as defined). Based upon the Company’s applicable quarterly Consolidated LeverageRatio during the first three months of fiscal 2009, the applicable margin forLIBOR rate borrowings remained at 2.50% for the first three months of fiscal2009.  The Company is required to makeminimum repayments of the principal amount of the Term Loan in quarterlyinstallments of $225,000 each.  The Company is also required to make anannual principal repayment equal to 25% or 50% of Excess Cash Flow (as defined)in excess of $5,000,000 for each fiscal year, with the 25% or 50% factordepending on our Consolidated Leverage Ratio. The required principal repaymentfor fiscal 2008, which was calculated based on the 50% factor, was $622,000 andwas paid in December 2008. Additionally, the Term Loan can beprepaid at the Company’s option, in part or in whole, at any time without anyprepayment premium or penalty.  Duringthe first three months of fiscal 2009, the Company prepaid $10,000,000 of theoutstanding Term Loan, including the $622,000 prepayment required under theannual excess cash flow provision of the Term Loan.  At December 31, 2008, the Company’sindebtedness under the Term Loan Agreement was $65,425,000.

 

The Term Loan is secured by a security interest in the Company’s accounts receivable, inventory, real estate interests,letter of credit rights, cash, intangibles and certain other assets. Thesecurity interest granted to the Term Loan lenders is, in certain respects, subordinateto the security interest granted to the lender under the Credit Facility (definedbelow).  The Term Loan Agreementimposes certain restrictions on the Company’s ability to, among other things,incur additional indebtedness, pay dividends, repurchase stock, and enter intoother various types of transactions.  TheTerm Loan Agreement also contains quarterly financial covenants that requirethe Company 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 the Company has been in compliance with all covenants ofthe Term Loan Agreement.

 

In order to mitigate the Company’s floating rate interest risk on thevariable rate Term Loan, the Company entered into an interest rate swapagreement with the agent bank for the Term Loan that commenced on April 18,2007, the date the $90,000,000 Term Loan proceeds were received, and expires onApril 18, 2012.  The interest rateswap agreement effectively converts a specified amount of the Term Loan (equalto the notional amount of the interest rate swap) from a floating interest rateof LIBOR 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).  The notional amount of theinterest rate swap was $75,000,000 at the inception of the swap agreement anddecreases over time to a notional amount of $5,000,000 at the expirationdate.  The notional amount of the swapwas $50,000,000 as of December 31, 2008 and over the next eighteen monthsdecreases as follows:  to $42,500,000starting April 20, 2009; to $35,000,000 starting October 19, 2009;and to $27,500,000 starting April 19, 2010.

 

In connection with the Term Loan transaction, the Company amended itsexisting $60,000,000 revolving credit facility (the “Credit Facility”) in orderto permit the new Term Loan financing. This amendment 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 three months of fiscal 2009and 2008, the Company exceeded the minimum requirements for ExcessAvailability.  As of December 31,2008, the Company had no outstanding borrowings under the Credit Facility and$13,496,000 in letters of credit, with $35,938,000 of availability under thecredit line based on Borrowing Base limitations.

 

**8.**                 **FAIR VALUE MEASUREMENTS**

 

The Company adopted SFAS No. 157, *Fair ValueMeasurements*, on October 1, 2008.  SFAS No. 157 defines fair value as theprice that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants at the measurementdate.  The standard establishes a frameworkfor measuring fair value focused on exit price and creates a fair valuehierarchy in order to increase the consistency and comparability of fair valuemeasurements as follows:

 

·     Level1 – Quoted market prices in active markets for identical assets or liabilities

 

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·     Level 2 – Observable market-based inputs orinputs that are corroborated by observable market data

 

·     Level 3 – Unobservable inputs that are notcorroborated by market data

 

The Company’s interest rate swap is required to be measured at fairvalue on a recurring basis.  At December 31,2008, the interest rate swap was a liability with a fair value of $2,891,000, includedin Deferred rent and other non-current liabilities in the accompanyingConsolidated Balance Sheet.  The fairvalue of the interest rate swap was derived from a discounted cash flowanalysis utilizing an interest rate yield curve that is readily available tothe public or can be derived from information available in publicly quotedmarkets, which the Company considers to be Level 2 inputs.

 

The Company adopted SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities*,on October 1, 2008. SFAS No. 159 provides a company with the option to report selectedfinancial assets and liabilities on an instrument-by-instrument basis at fairvalue and requires such company to display the fair value of those assets andliabilities for which the company has chosen to use fair value on the face ofthe balance sheet.  In accordance with SFAS No. 159implementation options, the Company chose not to elect the fair value optionfor its financial assets and liabilities that had not been previously measuredat fair value.

 

**9.****                 INCOME TAXES**

 

In June 2006, the Financial Accounting Standards Board (“FASB”)issued FASB Interpretation (“FIN”) No. 48, *Accountingfor Uncertainty in Income Taxes*.  FIN No. 48clarifies the accounting for income taxes by prescribing the minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements.  FIN No. 48 applies toall tax positions related to income taxes subject to SFAS No. 109, *Accounting for Income Taxes*.  Under FIN No. 48,recognition of a tax benefit occurs when a tax position is more-likely-than-notto be sustained 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.

 

The Company adopted the provisions of FIN No. 48 effective as of October 1,2007.  In accordance with FIN No. 48, the Company recorded acumulative effect adjustment of $74,000, decreasing the liability forunrecognized tax benefits and increasing the September 30, 2007 balance ofretained earnings.

 

As of December 31, 2008, the Company had $2,364,000 ofunrecognized tax benefits, including accrued interest and penalties of$1,078,000.  The Company records interest and penalties related tounrecognized tax benefits in income tax provision (benefit).  Ifrecognized, the portion of the liabilities for unrecognized tax benefits thatwould impact the Company’s effective tax rate was $1,662,000.

 

Duringthe twelve months subsequent to September 30, 2008, it is reasonablypossible that the gross unrecognized tax benefits could potentially decrease byapproximately $221,000 (of which approximately $152,000 would affect theeffective tax rate, net of federal benefit) for federal and state tax positionsrelated to the effect of expiring statutes of limitations and settlements.

 

The Company’s U.S. Federal income tax returns for the years ended September 30,2006 and beyond remain subject to examination by the U.S. Internal RevenueService.  The Company also files returns in numerous statejurisdictions, which have varying statutes oflimitations.  Generally, state tax returns for the years ended September 30,2004 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 2004.

 

**10.****          RETIREMENT PLANS**

 

On March 2, 2007, the Company entered into Supplemental ExecutiveRetirement Agreements (the “SERP Agreements”) with Dan W.Matthias, the Company’s Chairman of the Board and then Chief Executive Officer(“CEO”) and Rebecca Matthias, the Company’s President and Chief CreativeOfficer (the “SERP Executives”).  The Company’s Transition Agreementwith Mr. Matthias in connection with his retirement as CEO effective September 30,2008, amended his SERP Agreement to provide for full vesting of the benefitspayable to Mr. Matthias and to increase the total of the amounts payableunder the SERP Agreement to approximately 10% more than the amount that wouldhave been payable on September 30, 2012 (the date the SERP Agreement hadotherwise been expected to fully vest). The SERP Agreement benefits, totaling$3,960,000, will be paid to Mr. Matthias in installments over a period offour years commencing in April 2009. Benefits payable to Ms. Matthias under her SERP Agreement vest overtime based on service rendered and are expected to fully vest by September 30,2012.

 

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The components of net periodic pension cost on a pretax basis were asfollows (in thousands):

 

| ** **                          | ** ** | **Three Months Ended  December 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Service cost                        |       | $                                                   | 143        |   | $ | 243 |   |
| Interest cost                       |       | 79                                                  |       | 45 |   |
| Amortization of prior service  cost |       | 49                                                  |       | 88 |   |
| Total net periodic benefit cost     |       | $                                                   | 271        |   | $ | 376 |   |

 

On May 20, 2008, the Company enteredinto (i) a Letter Agreement with the SERP Executives and the trustee (the “Trustee”)for the grantor trust, which was established for the purpose of accumulatingassets in anticipation of the Company’s payment obligations under the SERPAgreements (the “Grantor Trust”), and (ii) an amendment to the GrantorTrust agreement with the Trustee (collectively the “Agreements”).  TheAgreements amended the SERP Agreements and the Grantor Trust agreement toprovide for the Company to deliver an irrevocable standby letter of credit tothe Trustee in an amount equal to the Company’s then current funding obligationunder the SERP Agreements, which was $3,885,000.  The amendments affectedby the Agreements also allow for, at the Company’s option, the issuance fromtime to time of irrevocable standby letters of credit, or the increase of sizeof an irrevocable standby letter of credit already held by the Trustee, in lieuof any deposit to the Grantor Trust otherwise required in the future.  Inaddition, the Agreements permit the Company, from time to time at its solediscretion, to reduce the size of any irrevocable standby letter of creditissued to the Trustee, so long as the Company simultaneously funds the GrantorTrust with an amount of cash equal to the amount of the reduction of the letterof credit.  In October 2008, the Company increasedthe irrevocable standby letter of credit issued to the Trustee to a total of$6,779,000, in lieu of deposits to the Grantor Trust, in connection with thefull vesting of Mr. Matthias’ benefits under the Transition Agreement andthe annual increase in vesting of Ms. Matthias’ benefits.

 

**11.****          NEW ACCOUNTING PRONOUNCEMENTS**

 

SFAS No. 161

 

InMarch 2008, the FASB issued SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities*.  SFAS No. 161 requires companies toprovide qualitative disclosures about the objectives and strategies for usingderivatives, quantitative data about the fair value of and gains and losses onderivative contracts, and details of credit-risk-related contingent features inhedged positions.  SFAS No. 161 iseffective for financial statements issued for fiscal years beginning after November 15,2008, and interim periods within those fiscal years.  The adoption of SFAS No. 161 is notexpected to have a material impact on our consolidated financial position orresults of operations.

 

**12.****          COMMITMENTS AND CONTINGENCIES**

 

From time to time, the Company is named as a defendant in legal actionsarising from normal business activities. Litigation is inherently unpredictableand although the amount of any liability that could arise with respect tocurrently pending actions cannot be accurately predicted, the Company does notbelieve that the resolution of any pending action will have a material adverseeffect on its financial position, results of operations or liquidity.

 

**13.**          SEGMENT ANDENTERPRISE WIDE DISCLOSURES

 

***Operating Segment***.  Under SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information*,a company may be required to report segmented information about separatelyidentifiable parts of its business, which both (i) meet the definition ofan “operating segment” under SFAS No. 131, and (ii) exceed certainquantitative thresholds established in SFAS No. 131.  The Company has determined that its businessis comprised of one operating segment: the design, manufacture and sale ofmaternity apparel and related accessories. While the Company offers a wide range of products for sale, thesubstantial portion of its products are initially distributed through the samedistribution facilities, many of the Company’s products are manufactured atcommon contract manufacturer production facilities, the Company’s products aremarketed through a common marketing department, and these products are sold toa similar customer base, consisting of expectant mothers.

 

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

 

| ** **                              | ** ** | **Three Months Ended  December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Net Sales to Unaffiliated Customers** |       |                                                |       |   |   |
| United States                           |       | $                                                   | 129,985    |   | $ | 137,821 |   |
| Foreign                                 |       | 4,827                                               |       | 5,055 |   |
|                                         |            |                                                     |            |  |  |  |  |

 

| ** **            | ** ** | **December 31,  2008** | ** ** | **September 30,  2008** | ** ** |
|-----------------------|------------|-----------------------------|------------|------------------------------|------------|
| **Long-Lived Assets** |       |                        |       |                         |       |
| United States         |       | $                           | 64,262     |                         | $          | 64,699 |   |
| Canada                |       | 2,244                       |       | 2,094                        |       |
| Costa Rica            |       | —                      |       | 207                          |       |
|                       |            |                             |            |                              |            |  |  |

 

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

 

**14.**          INTERESTEXPENSE, NET

 

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

 

| ** **            | ** ** | **Three Months Ended  December 31,** | ** ** |
|-----------------------|------------|-----------------------------------------------------|------------|
| ** **            | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Interest expense      |       | $                                                   | 1,399      |   | $ | 1,956 |   |
| Interest income       |       | (5                                                  | )          | (90 | ) |
| Interest expense, net |       | $                                                   | 1,394      |   | $ | 1,866 |   |

 

**15.**   SUBSEQUENT EVENT

 

On January 23, 2009, the Company’s stockholders approved anamendment to the Company’s 2005 Equity Incentive Plan, as amended and restated(the “2005 Plan”), which authorizes the Company to grant an additional 200,000shares of common stock in respect of awards under the 2005 Plan, with 100,000of such additional shares of common stock issuable in respect of awards ofrestricted stock or restricted stock units.

 

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

 

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 2009” will end on September 30, 2009.

 

**Restructuring**

 

On July 1, 2008, we announced that we were streamlining our merchandisebrands and store nameplates and implementing cost reductions in order tosimplify our business model, reduce overhead costs and improve and tighten ourmerchandise assortments.  Pursuant to thestrategic restructuring, we are rebranding our Mimi Maternity® merchandisebrand under our A Pea in the Pod® brand beginning with the Spring 2009collection, which initially debuted in November 2008.  We are also streamlining our storenameplates, which began in November 2008, by renaming our single-brand MimiMaternity stores as A Pea in the Pod, and by renaming our multi-brand MimiMaternity stores as Destination Maternity®. We incurred pretax expense of approximately $0.9 million from ourrestructuring and cost reduction actions in the fourth quarter of fiscal 2008,consisting of approximately $0.7 million for cash severance expense andseverance-related benefits, and approximately $0.2 million of non-cash expensefor accelerated depreciation of existing store signs resulting from plannedstore signage changes.   We incurredpretax expense of approximately $0.2 million in the first quarter of fiscal2009, consisting of approximately $43,000 for cash severance expense and $0.1million of non-cash expense for accelerated depreciation.  We expect to realize approximately $5.0million of annualized pretax expense savings from the cost reductionsassociated with our strategic restructuring actions, and we began to realizethese savings in the fourth quarter of fiscal 2008.

** **

**Goodwill Impairment**

 

For purposes of our impairment testing under SFAS No. 142, *Goodwill and Other Intangible Assets*, we have one reportingunit based on our reporting structure.  The fair value of our single reporting unit is determined based on acombination of the fair market value of our outstanding common stock on acontrol basis, a discounted cash flow analysis and other generally acceptedvaluation methodologies and, if necessary, with the assistance of an outsideindependent valuation specialist.  As aresult of a substantial decrease in the market price of our common stocksubsequent to September 30, 2008, reflecting deteriorating overalleconomic conditions and the very difficult equity market conditions of recentmonths, we reassessed the carrying value of our goodwill as of December 31,2008, in accordance with the interim period requirements of SFAS No. 142,and concluded that our goodwill was impaired. Consequently, we recorded a non-cash goodwill impairment charge of $47.0million, on both a pretax and after tax basis, in the first quarter of fiscal2009.  The goodwill impairment chargereflects the preliminary indication from the impairment analysis performed todate, is subject to finalization of certain fair value estimates beingperformed with the assistance of an outside independent valuation specialist,and may be adjusted when all aspects of the analysis are completed.  The goodwill impairment analysisinvolves calculating the implied fair value of our goodwill by allocating thefair value of our single reporting unit to all assets and liabilities otherthan goodwill (including both recognized and unrecognized intangible assets)and comparing the residual amount to the carrying value of goodwill.  We currently expect to finalize ourgoodwill impairment analysis during the second quarter of fiscal 2009.  If the final goodwill impairment analysisindicates impairment in excess of our preliminary estimate, we would berequired to record additional goodwill impairment expense of up to $3.4 million,the estimated remaining value of our goodwill as of December 31,2008.  Any adjustments to our preliminaryestimate of impairment as a result of completion of this evaluation arecurrently expected to be recorded in our consolidated financial statements forthe second quarter of fiscal 2009.  Thenon-cash goodwill impairment charge does not have any adverse effect on thecovenant calculations under our debt agreements or our overall compliance withthe covenants of our debt agreements.

 

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**Results of Operations**

 

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

 
| ** **                                                   | ** ** | **% of Net Sales (1)** | ** ** | **% Increase  (decrease)** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                   | ** ** | **2007**                        | ** ** | **2008 vs. 2007** | ** ** |
|                                                         |       |                                       |       |                            |       |   |   |
| Net sales                                                    |       | 100.0                                      | %          | 100.0                           | %          | (5.6 | )% |
| Cost of goods sold (2)                                       |       | 49.7                                       |       | 49.6                            |       | (5.6 | ) |
| Gross profit                                                 |       | 50.3                                       |       | 50.4                            |       | (5.7 | ) |
| Selling, general and  administrative expenses (3)            |       | 48.9                                       |       | 48.8                            |       | (5.3 | ) |
| Store closing, asset impairment and asset  disposal expenses |       | 0.0                                        |       | 0.6                             |       | (99.8 | ) |
| Restructuring charges                                        |       | 0.1                                        |       | —                          |       | N.M. |   |
| Goodwill impairment expense                                  |       | 34.9                                       |       | —                          |       | N.M. |   |
| Operating income (loss)                                      |       | (33.6                                      | )          | 1.0                             |       | N.M. |   |
| Interest expense, net                                        |       | 1.0                                        |       | 1.3                             |       | (25.3 | ) |
| Loss on extinguishment of debt                               |       | 0.0                                        |       | —                          |       | N.M. |   |
| Loss before income taxes                                     |       | (34.7                                      | )          | (0.3                            | )          | N.M. |   |
| Income tax provision (benefit)                               |       | 0.1                                        |       | (0.1                            | )          | (213.1 | ) |
| Net loss                                                     |       | (34.8                                      | )%         | (0.2                            | )%         | N.M. | % |

 

----

N.M.—Notmeaningful

(1)    Components may not add tototal due to rounding.

(2)    The “Cost of goods sold” line item includesmerchandise costs (including customs duty expenses), expenses related toinventory shrinkage, product related corporate expenses (including expensesrelated to our payroll, benefit costs and operating expenses of our buyingdepartments), inventory reserves (including lower of cost or market reserves),inbound freight charges, purchasing and receiving costs, inspection costs,warehousing costs, internal transfer costs, and the other costs of ourdistribution network.

(3)    The “Selling, general and administrative expenses” line itemincludes**advertising and marketing expenses,corporate administrative expenses, store expenses (including store payroll andstore occupancy expenses), and store opening expenses.

 

The following table sets forth certaininformation concerning the number of our stores and leased departments for theperiods indicated:

 
| ** **                | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **December 31, 2008**  | ** ** | **December 31, 2007** | ** ** |
| **Retail Locations** | ** ** | **Stores**                       | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning of period       |       | 754                              |       | 278 |   | 1,032 |   | 781 |   | 795 |   | 1,576 |   |
| Opened                    |       | 7                                |       | 5 |   | 12 |   | 7 |   | 2 |   | 9 |   |
| Closed                    |       | (11                              | )          | — |   | (11 | ) | (16 | ) | (25 | ) | (41 | ) |
| End of period             |       | 750                              |       | 283 |   | 1,033 |   | 772 |   | 772 |   | 1,544 |   |

 

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

 

***Net Sales.***  Our netsales for the first quarter of fiscal 2009 decreased by 5.6%, or $8.1 million,to $134.8 million from $142.9 million for the first quarter of fiscal2008.  The decrease in sales versus lastyear resulted primarily from a decrease in Sears® leased department sales, due to the closure ofall of the Company’s remaining leased departments within Sears stores duringthe month of June 2008 and, to a much lesser extent, from reduced salesvolume from the ongoing closure of certain underperforming stores and a slightdecrease in comparable store sales. Comparable store sales decreased by 0.5% for the first quarter of fiscal2009, based on 964 retail locations, versus a comparable store sales decreaseof 4.1% for the first quarter of fiscal 2008, based on 1,352 retail locations.

 

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As of December 31, 2008, we operated a total of 750 stores and1,033 total retail locations, compared to 772 stores and 1,544 total retaillocations as of December 31, 2007. In addition, our Oh Baby by MotherhoodTM collection is available at Kohl’s®stores throughout the United States. During the first quarter of fiscal 2009, we opened seven stores,including two multi-brand store openings, and closed 11 stores, with three ofthe store closings related to multi-brand store openings.  The decrease in leased department locationsat the end of December 2008 versus the end of December 2007predominantly reflects the closure of the leased departments within Searsstores as compared to the 478 Sears leased departments operated by the Companyat the end of December 2007.

 

***Gross Profit.***  Our grossprofit for the first quarter of fiscal 2009 decreased by 5.7%, or $4.1 million,to $67.9 million from $72.0 million for the first quarter of fiscal 2008,primarily reflecting the effect of our lower sales volume compared to lastyear.  Gross profit as a percentage of net sales (gross margin) for thefirst quarter of fiscal 2009 was 50.3% compared to 50.4% for the first quarterof fiscal 2008.  The slight decrease in gross margin for the firstquarter of fiscal 2009 compared to the first quarter of fiscal 2008 reflectsthe effect of spreading fixed product overhead costs over a smaller salesvolume, substantially offset by lower markdowns.

 

***Selling, General andAdministrative Expenses.***  Our selling, general andadministrative expenses for the first quarter of fiscal 2009 decreased by 5.3%,or $3.7 million, to $66.0 million from $69.7 million for the first quarterof fiscal 2008.  This decrease in expensefor the quarter resulted primarily from a decrease in store occupancy, payrolland employee benefit costs, reflecting our reduced number of stores and leaseddepartments, and lower corporate payroll and employee benefits from our restructuring.  As a percentage of net sales, selling,general and administrative expenses increased slightly to 48.9% for the firstquarter of fiscal 2009 compared to 48.8% in the first quarter of fiscal 2008.

 

***Store Closing, Asset Impairmentand Asset Disposal Expenses*.**** Our store closing, asset impairment, and assetdisposal expenses for the first quarter of fiscal 2009 decreased significantlyto $0.0 million from $0.9 million for the first quarter of fiscal 2008.  We recognized a gain of $0.3 million from thesale of the remaining Costa Rica facility acquired in a fiscal 2002 businesspurchase.  We incurred lower impairmentcharges for write-downs of long-lived assets of $0.2 million for thefirst quarter of fiscal 2009, as compared to $0.5 million for the firstquarter of fiscal 2008.  We incurredcharges relating to store closings and other asset disposals of $0.2 millionfor the first quarter of fiscal 2009, as compared to $0.4 million for the firstquarter of fiscal 2008.

 

***Restructuring Charges. ****In thefirst quarter of fiscal 2009, we*incurred pretaxexpense of $0.2 million from our strategic restructuring and cost reductionactions.

 

***Goodwill Impairment Expense. ***We recorded anon-cash goodwill impairment charge of $47.0 million, in the first quarter offiscal 2009 to reflect the preliminary indication of reduced fair value for ourgoodwill from the impairment analysis performed to date.  The estimated impairment charge is subject tofinalization of certain fair value estimates being performed with the assistanceof an outside independent valuation specialist, and may be adjusted when allaspects of the analysis are completed.

 

***Operating Loss.***  We had an operating loss of $(45.3)million for the first quarter of fiscal 2009. Excluding the goodwill impairment charge, our operating income for thefirst quarter of fiscal 2009 was $1.7 million, an increase of 22.3% or $0.3million, from the $1.4 million operating income for the first quarter offiscal 2008, which had no goodwill impairment charge.  The increase in operating income, excludingthe goodwill impairment charge, was primarily due to lower selling,general and administrative expenses, and lower store closing, asset impairmentand asset disposal costs, partially offset by the lower sales volume and associatedgross profit reduction.  Operating income, excluding the goodwillimpairment charge, as a percentage of net sales  for the first quarter of fiscal 2009 increased to 1.3% from 1.0% for thefirst quarter of fiscal 2008.  Theincrease in operating income, excluding the goodwill impairment charge, as apercentage of net sales was primarily due to our lower store closing,asset impairment and asset disposal costscompared to the first quarter of fiscal 2008.

 

***Interest Expense, Net.***  Our netinterest expense for the first quarter of fiscal 2009 decreased by 25.3%, or$0.5 million, to $1.4 million from $1.9 million for the first quarter offiscal 2008.  This decrease was due toour lower debt level, primarily as a result of the $23.0 million of Term Loanprepayments we made in the previous 12 months, and to a lesser extent, lowerinterest rates and lower credit line borrowings.  During the first quarter of fiscal 2009, ouraverage daily level of direct borrowings under our credit facility was $0.1million compared to $4.3 million for the first quarter of fiscal 2008.  We did not have any direct borrowingsoutstanding under our credit facility as of December 31, 2008.

 

***Loss on Extinguishment of Debt*. **In the first quarter of fiscal 2009, we prepaid$10.0 million principal amount of our outstanding Term Loan, which resulted ina charge of $66,000, representing the write-off of unamortized deferredfinancing costs.

 

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***Income Tax Provision.***  There wasno tax benefit associated with our $47.0 million goodwill impairmentcharge.  Excluding the goodwillimpairment charge, our income before income taxes was $0.2 million and oureffective tax rate was a provision of 63.4% for the first quarter of fiscal2009.  We had a tax benefit rate of 27.0%for the first quarter of fiscal 2008. Our effective tax rates reflect the effect of additional income taxexpense recognized during the fiscal 2009 and 2008 quarters in connection withFIN No. 48.  We expect our effectivetax rate for the full year fiscal 2009 to be approximately 42%, excluding theeffect of goodwill impairment charges.

 

***Net Loss.***  Net lossfor the first quarter of fiscal 2009 was $(46.9) million, or $(7.86) per share(diluted).  Net loss for the firstquarter of fiscal 2009 includes the goodwill impairment charge of $47.0million, or $(7.87) per diluted share. Excluding the goodwill impairment charge, our net income was $0.1 millionor $0.01 per share (diluted), compared to a net loss of $(0.4) million or  $(0.06) per share (diluted) for the firstquarter of fiscal 2008, which had no goodwill impairment charge.

 

Our average shares outstanding (basic anddiluted) of 5,966,000 for the first quarter of fiscal 2009 were 1.9% higherthan the 5,852,000 average shares outstanding (basic and diluted) for the firstquarter of fiscal 2008.  The increase in average sharesoutstanding reflects the higher shares outstanding in the first quarter offiscal 2009 compared to the first quarter of fiscal 2008, primarily as a resultof vesting of restricted stock.  Had wereported a profit for the three month periods ended December 31, 2008 and2007, the weighted average number of dilutive shares outstanding forcomputation of Diluted EPS would have been approximately 5,983,000 and5,999,000, respectively.

 

Following is a reconciliation of net loss andnet loss per share (diluted) to net income (loss) excluding goodwill impairmentexpense for the three months ended December 31, 2008 and 2007 (inthousands, except per share amounts):

 
| ** **                                                                            | ** ** | **Three Months Ended  December 31, 2008** | ** ** | **Three Months Ended  December 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Net  Income  (Loss)**                                       | ** ** | **Shares**                                                    | ** ** | **Diluted  EPS** | ** ** | **Net  Income  (Loss)** | ** ** | **Shares** | ** ** | **Diluted  EPS** | ** ** |
| ** **                                                                            | ** ** | ** **                                                    | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                              |       | $                                                             | (46,915    | )                                                             | 5,966      |   | $ | (7.86 | ) | $ | (352 | ) | 5,852 |   | $ | (0.06 | ) |
| Goodwill impairment expense,  net of tax                                              |       | 47,000                                                        |       | —                                                        |       |   |   | — |   |   |   |   |   |
| Incremental shares from the  assumed lapse of restrictions on restricted stock awards |       | —                                                        |       | 14                                                            |       |   |   | — |   | — |   |   |   |
| Incremental shares from the  assumed exercise of outstanding stock options            |       | —                                                        |       | 3                                                             |       |   |   | — |   | — |   |   |   |
| Net income (loss) excluding goodwill  impairment expense                              |       | $                                                             | 85         |                                                          | 5,983      |   | $ | 0.01 |   | $ | (352 | ) | 5,852 |   | $ | (0.06 | ) |

 

**Seasonality**

 

Our business, like that of many other retailers,is seasonal.  Our quarterlynet sales have historically been highest in our third fiscal quarter,corresponding to the Spring selling season, followed by the first fiscalquarter, corresponding to the Fall/holiday selling season.  Given the typically higher gross margin weexperience in the third fiscal quarter compared to other quarters, therelatively fixed nature of most of our operating expenses and interest expense,and the historically higher sales level in the third quarter, we have typicallygenerated a very significant percentage of our full year operating income andnet income during the third quarter.  Results for any quarter are not necessarilyindicative of the results that may be achieved for a full fiscal year. Quarterly results may fluctuate materially depending upon, among other things,the timing of new store openings and new leased department openings, net salesand profitability contributed by new stores and leased departments, increasesor decreases in comparable store sales, the timing of the fulfillment ofpurchase orders under our product and license arrangements, adverse weatherconditions, shifts in the timing of certain holidays and promotions, changes ininventory and production levels and the timing of deliveries of inventory, andchanges in our merchandise mix.

 

**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 havehistorically financed these capital requirements from cash flows fromoperations, 

 

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borrowings under our credit facility or available cash balances.

 

Cash and cash equivalents increased by $2.6million during the first quarter of fiscal 2009 compared to an increase of $0.7million for the first quarter of fiscal 2008.  Cash provided by operationsof $17.5 million for the first quarter of fiscal 2009 increased by $13.4million from the $4.1 million cash provided by operations for the first quarterof fiscal 2008.  This increase in cash provided byoperations was primarily the result of working capital changes that providedmore cash in the first quarter of fiscal 2009 compared to the first quarter offiscal 2008.  The working capital changeswere primarily (i) an increase in accounts payable, accrued expenses andother current liabilities in the first quarter of fiscal 2009 compared to adecrease in the first quarter of fiscal 2008, and (ii) a larger decreasein inventories in the first quarter of fiscal 2009 compared to the firstquarter of fiscal 2008, partially offset by a slight decrease in trade accountsreceivable in the first quarter of fiscal 2009 compared to a larger decreasefor the first quarter of fiscal 2008. Our quarterly net income (loss), cash flow adjustments and workingcapital changes may fluctuate significantly and net cash provided by (used in) operating activities for any quarter is notnecessarily indicative of the results that may be achieved for a full fiscalyear.

 

During the first quarter of fiscal 2009, we used cash provided byoperations primarily to fund repayments of long-term debt and to pay forcapital expenditures.  Our repayments of long-term debt in the firstquarter of fiscal 2009 included $10.0 million of prepayments of our TermLoan.  For the first quarter offiscal 2009, we spent $4.1 million on capital expenditures, including$3.1 million for leasehold improvements, fixtures and equipment for newstore facilities, as well as improvements to existing stores, and$1.0 million for our information systems and distribution and corporatefacilities.  The remaining cash provided by operations was used to increase availablecash.  During the first quarter offiscal 2008, we used our cash provided by operations to pay for capitalexpenditures and to fund the grantor trust related to our retirementplans.  For the first quarter of fiscal2008, we spent $3.7 million on capital expenditures, including$2.5 million for leasehold improvements, fixtures and equipment for newstore facilities, as well as improvements to existing stores, and$1.2 million for our information systems 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% 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 our ConsolidatedLeverage Ratio (as defined).  Based uponour applicable quarterly Consolidated Leverage Ratio during the first quarterof fiscal 2009, the applicable margin for LIBOR rate borrowings remained at2.50% for the first quarter of fiscal 2009. We are required to make minimum repayments of the principal amount ofthe Term Loan in quarterly installments of $225,000 each.  We are also required to make an annualprincipal repayment equal to 25% or 50% of Excess Cash Flow (as defined) inexcess of $5,000,000 for each fiscal year, with the 25% or 50% factor dependingon our Consolidated Leverage Ratio.  Theeffect of any non-cash goodwill impairment charge is excluded from thecalculation of Excess Cash Flow under our Term Loan Agreement.  Therequired principal repayment for fiscal 2008, which was calculated based on the50% factor, was $0.6 million and was paid in December 2008.  Additionally, the Term Loan can beprepaid at our option, in part or in whole, at any time without any prepaymentpremium or penalty.  During the firstquarter of fiscal 2009, we prepaid $10.0 million of the outstanding Term Loan,including the $0.6 million prepayment required under the annual excess cashflow provision of the Term Loan.  At December 31,2008, our indebtedness under the Term Loan Agreement was $65.4 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 we have been in compliance with all covenants of our TermLoan 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$90.0 million Term Loan proceeds were received, and expires on April 18,2012.  The interest rate swap agreementeffectively converts a specified amount of the Term Loan (equal to the notionalamount of the interest rate swap) from a floating interest rate of LIBOR plus2.50% (subject to reduction to LIBOR plus 2.25% if we achieve a specifiedleverage ratio), to a fixed interest rate of 7.50% (subject to reduction to7.25% if we achieve a specified leverage ratio).  The notional amount of the interest rate swapwas $75.0 million at the inception of the swap agreement and decreases overtime to a notional amount of $5.0 million at the 

 

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expiration date.  The notionalamount of the swap was $50.0 million as of December 31, 2008 and over thenext eighteen months decreases as follows: to $42.5 million starting April 20,2009; to $35.0 million starting October 19, 2009; and to $27.5 millionstarting April 19, 2010.

 

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 quarters of fiscal 2009 and2008, we exceeded the minimum requirements for Excess Availability.

 

As of December 31, 2008,we had no outstanding borrowings under the Credit Facility and $13.5 million inletters of credit, with $35.9 million of availability under our credit linebased on our Borrowing Base limitations. We had average daily direct borrowings of $0.1 million underour Credit Facility for the first quarter of fiscal 2009, compared toaverage daily direct borrowings of $4.3 million during the first quarter offiscal 2008.

 

In March 2007, we entered into the SERP Agreements with the SERPExecutives.  In April 2007, we madean initial required contribution of $2.7 million to the Grantor Trust.  In November 2007, we made an additionalrequired contribution to the Grantor Trust of $1.2 million.  In order to impact positively our ability tocomply with the Consolidated Leverage Ratio covenant of our Term Loan Agreementat March 31, 2008, with the consent of the SERP Executives we withdrew$1.0 million from the Grantor Trust on March 28, 2008.  The withdrawn funds were used to repayindebtedness under our credit facility. On May 20, 2008, we entered into (i) a Letter Agreement withthe SERP Executives and the Trustee, and (ii) an amendment to the GrantorTrust agreement with the Trustee (collectively the “Agreements”).  TheAgreements amended the SERP Agreements and the Grantor Trust agreement toprovide for us to deliver an irrevocable standby letter of credit to theTrustee in an amount equal to our then current funding obligation under theSERP Agreements, which was $3.9 million.  As provided in the Agreements,in the third quarter of fiscal 2008 we received a distribution of the remainingassets held in the Grantor Trust amounting to $2.8 million.  Theamendments affected by the Agreements also allow for the issuance, from time totime, of irrevocable standby letters of credit, or the increase of size of anirrevocable standby letter of credit already held by the Trustee, in lieu ofany deposit to the Grantor Trust otherwise required in the future.  Inaddition, the Agreements permit us, from time to time at our sole discretion,to reduce the size of any irrevocable standby letter of credit issued to theTrustee, so long as we simultaneously fund the Grantor Trust with an amount ofcash equal to the amount of the reduction of the letter of credit.  In October 2008, the Company increasedthe irrevocable standby letter of credit issued to the Trustee to a total of$6.8 million, in lieu of deposits to the Grantor Trust, in connection withadditional vesting of the SERP Executives’ benefits.

 

Our management believes that our current cash and working capitalpositions, expected operating cash flows and available borrowing capacity underour Credit Facility, will be sufficient to fund our working capital, capitalexpenditures and debt repayment requirements and to fund stock and/or debtrepurchases, if any, for at least the next twelve months.

 

###### **Critical Accounting Policies and Estimates**

 

Our consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States. Thesegenerally accepted accounting principles require management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of our consolidatedfinancial statements and the reported amounts of net sales and expenses duringthe reporting period.

 

Our significant accounting policies are described in Note 2 of “Notesto Consolidated Financial Statements” in our Annual Report on Form 10-Kfor the year ended September 30, 2008. We believe that the following discussion addresses our criticalaccounting policies, which are those that are most important to the portrayalof our financial condition and results of operations and require management’smost difficult, subjective and complex judgments, often as a result of the needto make estimates about the effect of matters that are inherentlyuncertain.  If actual results were todiffer significantly from estimates made, future reported results could bematerially affected.  However, we are notcurrently aware of any reasonably likely events or circumstances that wouldresult in materially different results, except for the potential adjustment ofthe goodwill impairment charge further discussed below.  Except as disclosed below and in thefinancial statements and accompanying notes included in Item 1 of 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.

 

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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 broker fees, aswell as applied product related overhead. A periodic review of inventory quantities on hand is performed in orderto determine if inventory is properly valued at the lower of cost ormarket.  Factors related to currentinventories such as future consumer demand and fashion trends, current aging,current analysis of merchandise based on receipt date, current and anticipatedretail markdowns or wholesale discounts, and class or type of inventory areanalyzed to determine estimated net realizable values.  Criteria utilized by us to quantify agingtrends include factors such as the amount of merchandise received within thepast twelve months, merchandise received more than one year before withquantities on-hand in excess of 12 months of sales, and merchandisecurrently selling below cost.  Aprovision is recorded to reduce the cost of inventories to its estimated netrealizable value, if required. Inventories as of December 31, 2008 and September 30, 2008totaled $77.7 million and $88.1 million, respectively, representing38.8% and 34.4% 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 December 31, 2008 and September 30, 2008totaled $66.5 million and $66.8 million, respectively, representing33.2% and 26.1% 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, that is,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) current fashiontrends are all considered in determining the time frame required for a store toachieve positive financial results, which is assumed to be within two yearsfrom 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 $0.2 millionfor the first quarter of fiscal 2009, and $0.5 million for the first quarter offiscal 2008, 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.  In June 2001, the FASBissued SFAS No. 142, *Goodwill and OtherIntangible Assets*.  SFAS No. 142requires that goodwill no longer be amortized, but instead be tested forimpairment at least annually or as impairment indicators arise.  As of December 31, 2008 and September 30,2008, goodwill totaled $3.4 million and $50.4 million, respectively,representing 1.7% and 19.7% of total assets, respectively.

 

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.  As of September 30, 2008, our book valuewas $14.74 per share of outstanding common stock and the closing trading priceof our common stock was $13.88 per share. The fair value of our singlereporting unit is determined based on a combination of the fair market value ofour outstanding common stock on a control basis, a discounted cash flowanalysis and other generally accepted valuation methodologies and, ifnecessary, with the assistance of an outside independent valuation specialist.  To arrive at the fair market value ofour outstanding common stock we consider our market capitalization as of thevaluation date and comparative market multiples of other companies generallyinfluenced by similar business and economic conditions.  Our discounted cash flow analysis is based onassumptions that are consistent with our estimates of future growth used tomanage the underlying business.  Factorsrequiring significant judgment include assumptions related to future growthrates, discount factors and control premium, among other considerations.  The carrying value of our singlereporting unit, expressed on a per share basis, is represented by the bookvalue per share of our outstanding common stock.  The results of the annual impairment test

 

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performed as of September 30, 2008, indicated the fair value ofthe reporting unit exceeded its carrying value. As part of the Company’s impairment analysis as of September 30,2008, an outside independent valuation was obtained and the fair value of theCompany’s single reporting unit exceeded the carrying value.  If the per share fair value of our singlereporting unit was less than the book value per share on September 30,2008, our goodwill would have been impaired.

 

Our goodwill also needs to be tested for impairment between annualtests if an event occurs or circumstances change that would more likely thannot reduce the fair value of our single reporting unit below its carryingvalue.  As a result of a substantialdecrease in the market price of our common stock subsequent to September 30,2008, reflecting deteriorating overall economic conditions and the verydifficult equity market conditions of recent months, we reassessed the carryingvalue of our goodwill as of December 31, 2008, in accordance with theinterim period requirements of SFAS No. 142 and concluded that ourgoodwill was impaired.  Consequently, werecorded a non-cash goodwill impairment charge of $47.0 million, on both apretax and after tax basis, in the first quarter of fiscal 2009.  The goodwill impairment charge reflects thepreliminary indication from the impairment analysis performed to date, is subjectto finalization of certain fair value estimates being performed with theassistance of an outside independent valuation specialist, and may be adjustedwhen all aspects of the analysis are completed. The goodwill impairment analysis involves calculating the impliedfair value of our goodwill by allocating the fair value of our single reportingunit to all assets and liabilities other than goodwill (including bothrecognized and unrecognized intangible assets) and comparing the residualamount to the carrying value of goodwill. We currently expect to finalize our goodwill impairment analysisduring the second quarter of fiscal 2009. If the final goodwill impairment analysis indicates impairment in excessof our preliminary estimate, we would be required to record additional goodwillimpairment expense of up to $3.4 million, the estimated remaining value of ourgoodwill as of December 31, 2008. Any adjustments to our preliminary estimate of impairment as a result ofcompletion of this evaluation are currently expected to be recorded in our consolidatedfinancial statements for the second quarter of fiscal 2009.

 

***Accounting for Income Taxes.***  Weadopted the provisions of FIN No. 48 effective as of October 1, 2007(see “Notes to Consolidated Financial Statements; Note 9. Income Taxes”).

 

As part of the process of preparing our consolidated financialstatements, we are required to estimate our income taxes in each of thejurisdictions in which we operate.  Thisprocess requires us to estimate our actual current tax exposure (includinginterest and penalties) together with assessing temporary differences resultingfrom differing treatment of items, such as depreciation of property andequipment and valuation of inventories, for tax and accounting purposes.  We establish reserves for certain tax positionsthat we believe are supportable, but such tax positions are potentially subjectto successful challenge by the applicable taxing authority.  We determine our provision for income taxesbased on federal and state tax laws and regulations currently in effect, someof which have been recently revised. Legislation changes currently proposed by certain of the states in whichwe operate, if enacted, could increase our transactions or activities subjectto tax.  Any such legislation thatbecomes law could result in an increase in our state income tax expense and ourstate income taxes paid, which could have a material and adverse effect on ournet income or cash flow.

 

The temporary differences between the book and tax treatment of incomeand expenses result in deferred tax assets and liabilities, which are includedwithin our consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will berecovered from future taxable income. Actual results could differ from our assessments if adequate taxableincome is not generated in future periods. Net deferred tax assets as of December 31, 2008 and September 30,2008 totaled $23.7 million and $23.6 million, respectively,representing 11.9% and 9.2% of total assets, respectively.  To the extent we believe that recovery is notmore likely than not, we must establish a valuation allowance.  To the extent we establish a valuationallowance or change the allowance in a future period, income tax expense willbe impacted.

 

***Accounting for Contingencies*.** From time to time, we are named as a defendant in legal actionsarising from our normal business activities. We account for contingencies such as these in accordance with SFAS No. 5,*Accounting for Contingencies*, includingthe provisions of Emerging Issues Task Force Issue D-77, *Accountingfor Legal Costs Expected to Be Incurred in Connection with a Loss Contingency*.  SFAS No. 5 requires us to record anestimated loss contingency when information available prior to issuance of ourfinancial statements indicates that it is probable that an asset has beenimpaired or a liability has been incurred at the date of the financialstatements and the amount of the loss can be reasonably estimated.  An interpretation of SFAS No. 5 furtherstates that when there is a range of loss and no amount within that range is abetter estimate than any other, then the minimum amount of the range shall beaccrued.  Accounting for contingenciesarising from contractual or legal proceedings requires management, after consultationwith outside legal counsel, to use its best judgment when estimating an accrualrelated to such contingencies.  Asadditional information becomes known, our accrual for a loss contingency couldfluctuate, thereby creating variability in our results of operations fromperiod to period.  Likewise, an actualloss arising from a loss contingency which significantly exceeds the amountaccrued for in our financial statements could have a material adverse impact onour operating results for the period in which such actual loss becomes known.

 

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**Recent Accounting Pronouncements**

 

SFAS No. 161

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and Hedging Activities.*  SFAS No. 161 requires companies toprovide qualitative disclosures about the objectives and strategies for usingderivatives, quantitative data about the fair value of and gains and losses onderivative contracts, and details of credit-risk-related contingent features inhedged positions.  SFAS No. 161 iseffective for financial statements issued for fiscal years beginning after November 15,2008, and interim periods within those fiscal years.  The adoption of SFAS No. 161 is notexpected to have a material impact on our consolidated financial position orresults of operations.

 

**Forward-Looking Statements**

 

Some of the information in this report, including the informationincorporated by reference (as well as information included in oral statementsor other written statements made or to be made by us), contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended (the “Exchange Act”).  Theforward-looking statements involve a number of risks and uncertainties.  A number of factors could cause our actualresults, performance, achievements or industry results to be materiallydifferent from any future results, performance or achievements expressed orimplied by these forward-looking statements.  These factors include, but are not limited tothe following: our ability to successfully manage our various businessinitiatives, our ability to successfully manage and retain our leaseddepartment and licensed relationships and marketing partnerships, future salestrends in our existing store base, unusual weather patterns, changes inconsumer preferences and spending patterns, demographics and othermacroeconomic factors that may impact the level of spending for maternityapparel,  overall economic conditions andother factors affecting consumer confidence, the impact of competition,fluctuations in the price, availability and quality of raw materials andcontracted products, availability of suitable store locations, continuedavailability of capital and financing, potential additional impairment charges,ability to hire and develop senior management and sales associates, ability todevelop and source merchandise, ability to receive production from foreignsources on a timely basis, potential stock repurchases, potential debtprepayments, changes in market interest rates, war or acts of terrorism andother factors referenced in our Annual Report on Form 10-K, includingthose set forth under the caption “Risk Factors.”

 

In addition, these forward-looking statements necessarily dependupon assumptions, estimates and dates that may be incorrect or imprecise andinvolve known and unknown risks, uncertainties and other factors.  Accordingly, any forward-lookingstatements included in this report do not purport to be predictions of futureevents or circumstances and may not be realized. Forward-lookingstatements can be identified by, among other things, the use of forward-lookingterms such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “proforma,” “anticipates,” “intends,” “continues,” “could,” “estimates,” “plans,” “potential,”“predicts,” “goal,” “objective,” or the negative of any of these terms, orcomparable terminology, or by discussions of our outlook, plans, goals,strategy or intentions.  Forward-lookingstatements speak only as of the date made.  Except as required by applicable law,including the securities laws of the United States and the rules andregulations of the Securities and Exchange Commission, we assume no obligationto update any of these forward-looking statements to reflect actualresults, changes in assumptions or changes in other factors affecting theseforward-looking statements.

 

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

 

Destination Maternity is exposed to marketrisk from changes in interest rates.  We have not entered into any marketsensitive instruments for trading purposes.  The analysis below presentsthe sensitivity of the market value of our financial instruments to selectedchanges in market interest rates.  The range of changes presented reflectsour view of changes that are reasonably possible over a one-year period.

 

As of December 31, 2008, we had cash and cash equivalents of $14.7million.  Our cash equivalents consist ofmoney market accounts that bear interest at variable rates.  A changein market interest rates earned on our investments  impacts the interest income and cash flows, butdoes not materially impact the fair market value of the financialinstruments.  Due to the average maturityand conservative nature of our investment portfolio, we believe a sudden changein interest rates would not have a material effect on the value of ourinvestment portfolio.

 

As of December 31, 2008, the principalcomponents of our debt portfolio were the $65.4 million Term Loan and the$65.0 million Credit Facility, both of which are denominated in U.S. dollars.

 

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Our Credit Facility carries a variableinterest rate that is tied to market indices.  As of December 31, 2008,we had no direct borrowings and $13.5 million of letters of credit outstandingunder our Credit Facility.  Borrowings under the Credit Facility wouldhave resulted in interest at a rate between approximately 1.44% and 3.25% perannum as of December 31, 2008.  Interest on any future borrowingsunder the Credit Facility would, to the extent of outstanding borrowings, beaffected by changes in market interest rates. A change in market interest rates on the variable rate portion of thedebt portfolio impacts the interest expense incurred and cash flows.

 

The Term Loan carries a variable interestrate that is tied to market indices.  Thesensitivity analysis as it relates to this portion of our debt portfolioassumes an instantaneous 100 basis point move in interest rates from theirlevels as of December 31, 2008, with all other variables heldconstant.  The principal amount of the Term Loan was $65.4million as of December 31, 2008.  A 100 basis point increase in market interestrates would result in additional annual interest expense on the TermLoan of approximately $0.6 million.  A100 basis point decline in market interest rates would correspondinglylower our annual interest expense on the Term Loan by approximately $0.6million.

 

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 interest rate swap agreement effectivelyconverts a specified amount of the Term Loan (equal to the notional amount ofthe interest rate swap) from a floating interest rate (LIBOR plus 2.50%), to afixed 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 atthe expiration date.  The notional amountof the swap was $50.0 million as of December 31, 2008 and over the nexttwelve months decreases as follows:  to$42.5 million starting April 20, 2009; and to $35.0 million starting October 19,2009.  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 of approximately$0.4 million.  A 100 basis pointdecline in market interest rates would correspondingly increase ourinterest expense for the year by approximately $0.4 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 $0.2 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 $0.2 million on theTerm Loan and swap agreement combined.

 

Based on the limited other variable rate debt included in our debtportfolio as of December 31, 2008, a 100 basis point increase in interestrates would result in additional interest expense incurred for the year of lessthan $0.1 million.  A 100 basis pointdecrease in interest rates would correspondingly lower our interest expense forthe year by less than $0.1 million.

 

Other than as described above, we do notbelieve that the market risk exposure on other financial instruments ismaterial.

 

**Item 4.  Controls and Procedures**

 

***Disclosure Controls and Procedures***

 

Our disclosure controls and procedures are designed to ensure thatinformation required to be disclosed by us in the reports that are filed orsubmitted under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  Thesedisclosure controls and procedures include controls and procedures designed toensure that information required to be disclosed under the Exchange Act isaccumulated and communicated to our management on a timely basis to allowdecisions regarding required disclosure. We evaluated the effectiveness of the design and operation of ourdisclosure controls and procedures as of December 31, 2008.  Based on this evaluation, the Company’s ChiefExecutive Officer and Chief Financial Officer have concluded that as of December 31,2008, these controls and procedures were effective.

 

***Internal Control over Financial Reporting***

 

There have been no changes in internal control over financial reportingidentified in connection with the foregoing evaluation that occurred during thefiscal quarter ended December 31, 2008, that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II. OTHER INFORMATION**

** **

**Item 1.  Legal Proceedings**

 

From time to time, we are named as a defendant in legal actions arisingfrom our normal business activities. Although the amount of any liability that could arise with respect tocurrently pending actions cannot be accurately predicted, we do not believethat the resolution of any pending action will have a material adverse effecton our financial position or liquidity.

 

**Item 1A.  Risk Factors**

 

In addition to the other information set forth inthis Form 10-Q, you should carefully consider the factors discussed in Part I,Item 1A “Risk Factors” of our Form 10-K for the yearended September 30, 2008.  The risks described in our Form 10-Kare not the only risks that we face. Additional risks not presently known to us or that we donot currently 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 followingtable provides information about purchases by us during the quarter ended December 31,2008 of equity securities that are registered by us pursuant to Section 12of the Securities 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)** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1 to  October 31, 2008   |       | —                                                |       | —                                           |       | —                                                                                                                           |       | $                                                                                                                                                    | 7,000,000  |   |
| November 1 to  November 30, 2008 |       | 252                                                   |       | $                                                | 6.73       |                                                                                                                             | —     |                                                                                                                                                 | $          | 7,000,000 |   |
| December 1 to  December 31, 2008 |       | 287                                                   |       | $                                                | 7.64       |                                                                                                                             | —     |                                                                                                                                                 | $          | 7,000,000 |   |
| Total                                      |       | 539                                                   |       | $                                                | 7.21       |                                                                                                                             | —     |                                                                                                                                                 | $          | 7,000,000 |   |

 

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(1) Representsshares repurchased directly from certain employees to satisfy income taxwithholding obligations for such employees in connection with restricted stockawards that vested during the period and, to a much lesser extent, fractionalshares repurchased in connection with the Company’s Employee Stock PurchasePlan.

(2) On July 29,2008, our Board of Directors approved a program to repurchase up to $7.0million of our outstanding common stock. Under the program, we may repurchase shares from time to time throughsolicited or unsolicited transactions in the open market or in negotiated orother transactions.  The program will bein effect until the end of July 2010. There were no repurchases of common stock under theprogram during the first quarter of fiscal 2009.

 

**Item 6.  Exhibits**

 
| **Exhibit   No.** | ** **  | **Description** |
|-------------------|-------------|-----------------|
|              |        |            |
|              | 10.1†  |            | Amendment  to Second Amended and Restated Employment Agreement dated as  of December 18, 2008 between the Company and Rebecca C. Matthias. |
|              | 10.2*† |            | Amended and Restated 2005 Equity Incentive Plan (Exhibit 10.1 to  the Company’s Current Report on Form 8-K dated January 23, 2009). |
|              | 31.1        |            | Certification of the Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|              | 31.2        |            | Certification of the Senior Vice President & 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 Senior Vice President & 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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*                          Incorporated by reference.

 

†                           Management contract orcompensatory plan or arrangement.

 

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**Signatures**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                        |     |   DESTINATION MATERNITY   |
|-----------------------------|----------|-------------------------------------|
|                        |     |   CORPORATION             |   |
|                        |     |                                |
| Date: February 9, 2009 | By:      | **/s/ EDWARD M. KRELL**             |
|                        |     | Edward M. Krell                     |   |
|                        |     | *Chief Executive Officer*           |   |
| * *                    | * * | * *                            |
|                        |     |                                |
| Date: February 9, 2009 | By:      | **/s/ JUDD P. TIRNAUER**            |
|                        |     | Judd P. Tirnauer                    |   |
|                        |     | *Senior Vice  President &* |   |
|                        |     | *Chief Financial Officer*           |   |

 

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**INDEX OF EXHIBITS FILED WITH**

**FORM 10-Q OF DESTINATION MATERNITYCORPORATION**

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

 
| **Exhibit   No.** | ** ** | **Description** |
|-------------------|------------|-----------------|
|              |       |            |
|              | 10.1† |            | Amendment  to Second Amended and Restated Employment Agreement dated as  of December 18, 2008 between the Company and Rebecca C. Matthias. |
|              | 31.1       |            | Certification of the Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|              | 31.2       |            | Certification of the Senior Vice President & 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 Senior Vice President & 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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†                           Management contract orcompensatory plan or arrangement.

 

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