**United StatesSecurities and Exchange Commission**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **ý**                                         | ** ** | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|
| ** **                                         | ** ** | ** **                                                                                         |
| **For the quarterly period  ended March 31, 2006** |
| ** **                                         | ** ** | ** **                                                                                         |
| **Or**                                             |
| ** **                                         | ** ** | ** **                                                                                         |
| **o**                                              | ** ** | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |

 

**For the transition period from           to**

 

**Commission file number 0-21196**

 

**MOTHERS WORK, INC.**

(Exactname of registrant as specified in its charter)

 

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

 

 

Registrant’stelephone number, including area code **(215) 873-2200**

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yesý No o

 

Indicate by check mark whether the Registrantis an accelerated filer (as defined in Rule 12b-2 of the Act). YesýNo o

 

Indicate by check mark whether the Registrantis a shell company (as defined in Rule 12b-2 of the Act). Yes oNo ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 

Common Stock,$.01 par value 5,318,861 shares outstanding as of May 5, 2006

 

 

----

 

**MOTHERS WORK, INC. AND SUBSIDIARIES**

**INDEX**

 
| PART I.  FINANCIAL INFORMATION |                                                                                        |
|-------------------------------------|---------------------------------------------------------------------------------------------|
| Item 1.                             | Financial Statements (unaudited)                                                            |   |
|                                | Consolidated Balance Sheets                                                                 |   |
|                                | Consolidated Statements of Operations                                                       |   |
|                                | Consolidated Statements of Cash Flows                                                       |   |
|                                | Notes to Consolidated Financial Statements                                                  |   |
| Item 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
| Item 3.                             | Quantitative and Qualitative Disclosures  About Market Risk                                 |   |
| Item 4.                             | Controls and Procedures                                                                     |   |
|                                |                                                                                        |   |
| PART II.  OTHER INFORMATION    |                                                                                        |
| Item 1.                             | Legal Proceedings                                                                           |   |
| Item 4.                             | Submission of Matters to a Vote of Security Holders                                         |   |
| Item 5.                             | Other Information                                                                           |   |
| Item  6.                            | Exhibits                                                                                    |   |
|                                |                                                                                        |   |
| Signatures                          |                                                                                        |   |

 

2

----

 

**PART I. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(inthousands, except share and per share amounts)

(unaudited)

 
| ** **                                                                                                                        | ** ** | **March 31, 2006** | ** ** | **September 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **ASSETS**                                                                                                                        |       |                         |       |                             |       |
| Current assets:                                                                                                                   |       |                         |       |                             |       |
| Cash and cash equivalents                                                                                                         |       | $                            | 16,550     |                             | $          | 3,037 |   |
| Short-term investments                                                                                                            |       | 2,550                        |       | —                           |       |
| Trade receivables, net                                                                                                            |       | 10,745                       |       | 7,681                            |       |
| Inventories                                                                                                                       |       | 96,803                       |       | 105,911                          |       |
| Deferred income taxes                                                                                                             |       | 6,015                        |       | 6,015                            |       |
| Prepaid expenses and other  current assets                                                                                        |       | 4,342                        |       | 4,816                            |       |
| Total current assets                                                                                                              |       | 137,005                      |       | 127,460                          |       |
| Property, plant and equipment,  net                                                                                               |       | 74,868                       |       | 76,173                           |       |
| Assets held for sale                                                                                                              |       | 700                          |       | 925                              |       |
| Other assets:                                                                                                                     |       |                         |       |                             |       |
| Goodwill                                                                                                                          |       | 50,389                       |       | 50,389                           |       |
| Deferred financing costs, net  of accumulated amortization of $2,169 and $1,855                                                   |       | 3,386                        |       | 3,697                            |       |
| Other intangible assets, net of  accumulated amortization of $2,356 and $2,481                                                    |       | 745                          |       | 878                              |       |
| Deferred income taxes                                                                                                             |       | 13,563                       |       | 13,261                           |       |
| Other non-current assets                                                                                                          |       | 534                          |       | 534                              |       |
| Total other assets                                                                                                                |       | 68,617                       |       | 68,759                           |       |
| Total assets                                                                                                                      |       | $                            | 281,190    |                             | $          | 273,317 |   |
|                                                                                                                              |       |                         |       |                             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                     |       |                         |       |                             |       |
| Current liabilities:                                                                                                              |       |                         |       |                             |       |
| Line of credit borrowings                                                                                                         |       | $                            | —     |                             | $          | — |   |
| Current portion of long-term  debt                                                                                                |       | 785                          |       | 769                              |       |
| Accounts payable                                                                                                                  |       | 20,787                       |       | 19,900                           |       |
| Accrued expenses and other  current liabilities                                                                                   |       | 40,585                       |       | 35,563                           |       |
| Total current liabilities                                                                                                         |       | 62,157                       |       | 56,232                           |       |
| Long-term debt                                                                                                                    |       | 127,849                      |       | 128,087                          |       |
| Deferred rent and other  non-current liabilities                                                                                  |       | 25,738                       |       | 25,670                           |       |
| Total liabilities                                                                                                                 |       | 215,744                      |       | 209,989                          |       |
|                                                                                                                              |       |                         |       |                             |       |
| Commitments and contingencies  (Note 9)                                                                                           |       |                         |       |                             |       |
|                                                                                                                              |       |                         |       |                             |       |
| Stockholders’ equity:                                                                                                        |       |                         |       |                             |       |
| Preferred stock, 2,000,000  shares authorized                                                                                     |       |                         |       |                             |       |
| Series A cumulative convertible  preferred stock, $.01 par value; 41,000 shares  authorized, none outstanding                |       | —                       |       | —                           |       |
| Series B junior participating preferred stock, $.01 par value;  300,000 shares authorized, none outstanding                       |       | —                       |       | —                           |       |
| Common stock, $.01 par value;  20,000,000 shares authorized, 5,316,121 and 5,268,535 shares issued and  outstanding, respectively |       | 53                           |       | 53                               |       |
| Additional paid-in capital                                                                                                        |       | 64,352                       |       | 63,164                           |       |
| Retained earnings                                                                                                                 |       | 1,041                        |       | 111                              |       |
| Total stockholders’ equity                                                                                                   |       | 65,446                       |       | 63,328                           |       |
| Total liabilities and  stockholders’ equity                                                                                  |       | $                            | 281,190    |                             | $          | 273,317 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

3

----

 

**MOTHERS WORK,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(inthousands, except per share amounts)

(unaudited)

 
| ** **                                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                     |       | $                                                | 144,643    |                                           | $          | 140,031 |   | $ | 296,036 |   | $ | 273,650 |   |
| Cost of goods sold                            |       | 68,620                                           |       | 70,678                                         |       | 143,830 |   | 134,682 |   |
| Gross profit                                  |       | 76,023                                           |       | 69,353                                         |       | 152,206 |   | 138,968 |   |
| Selling, general and  administrative expenses |       | 71,414                                           |       | 65,657                                         |       | 143,102 |   | 131,930 |   |
| Operating income                              |       | 4,609                                            |       | 3,696                                          |       | 9,104 |   | 7,038 |   |
| Interest expense, net                         |       | 3,785                                            |       | 3,857                                          |       | 7,579 |   | 7,612 |   |
| Income (loss) before income  taxes            |       | 824                                              |       | (161                                           | )          | 1,525 |   | (574 | ) |
| Income tax provision (benefit)                |       | 322                                              |       | (64                                            | )          | 595 |   | (229 | ) |
| Net income (loss)                             |       | $                                                | 502        |                                           | $          | (97 | ) | $ | 930 |   | $ | (345 | ) |
|                                          |       |                                             |       |                                           |       |   |   |   |   |
| Income (loss) per share—Basic            |       | $                                                | 0.09       |                                           | $          | (0.02 | ) | $ | 0.18 |   | $ | (0.07 | ) |
| Average shares  outstanding—Basic        |       | 5,291                                            |       | 5,237                                          |       | 5,280 |   | 5,227 |   |
| Income (loss) per share—Diluted          |       | $                                                | 0.09       |                                           | $          | (0.02 | ) | $ | 0.17 |   | $ | (0.07 | ) |
| Average shares  outstanding—Diluted      |       | 5,501                                            |       | 5,237                                          |       | 5,402 |   | 5,227 |   |

 

The accompanying notes are an integral partof these Consolidated Financial Statements.

 

4

----

 

**MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(inthousands)

(unaudited)

 
| ** **                                                                                          | ** ** | **Six Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                       | ** ** | **2005** | ** ** |
| **Cash Flows from Operating  Activities**                                                           |       |                                           |       |   |   |
| Net income (loss)                                                                                   |       | $                                              | 930        |   | $ | (345 | ) |
| Adjustments to reconcile net  income (loss) to net cash provided by (used in) operating activities: |       |                                           |       |   |   |
| Depreciation and amortization                                                                       |       | 7,937                                          |       | 7,608 |   |
| Stock-based compensation  expense                                                                   |       | 811                                            |       | — |   |
| Loss on impairment of  long-lived assets                                                            |       | 1,851                                          |       | 1,337 |   |
| (Gain) loss on disposal of  assets                                                                  |       | (197                                           | )          | 607 |   |
| Accretion of discount on senior  notes                                                              |       | 91                                             |       | 81 |   |
| Deferred income tax benefit                                                                         |       | (302                                           | )          | (333 | ) |
| Tax benefit of stock option  exercises                                                              |       | —                                         |       | 80 |   |
| Excess tax benefit from  exercise of stock options                                                  |       | (242                                           | )          | — |   |
| Amortization of deferred  financing costs                                                           |       | 314                                            |       | 280 |   |
| Changes in assets and  liabilities:                                                                 |       |                                           |       |   |   |
| Decrease (increase) in —                                                                       |       |                                           |       |   |   |
| Trade receivables                                                                                   |       | (3,064                                         | )          | (3,450 | ) |
| Inventories                                                                                         |       | 9,108                                          |       | (14,772 | ) |
| Prepaid expenses and other  current assets                                                          |       | 474                                            |       | 2,753 |   |
| Increase (decrease) in —                                                                       |       |                                           |       |   |   |
| Accounts payable, accrued  expenses and other current liabilities                                   |       | 4,977                                          |       | 6,643 |   |
| Deferred rent and other  non-current liabilities                                                    |       | 311                                            |       | (864 | ) |
| Net cash provided by (used in)  operating activities                                                |       | 22,999                                         |       | (375 | ) |
|                                                                                                |       |                                           |       |   |   |
| **Cash Flows from Investing Activities**                                                            |       |                                           |       |   |   |
| Purchase of short-term  investments                                                                 |       | (25,525                                        | )          | (4,000 | ) |
| Proceeds from sale of  short-term investments                                                       |       | 22,975                                         |       | 10,400 |   |
| Capital expenditures                                                                                |       | (8,046                                         | )          | (11,923 | ) |
| Proceeds from sale of assets  held for sale                                                         |       | 225                                            |       | — |   |
| Purchase of intangible assets                                                                       |       | (11                                            | )          | (28 | ) |
| Net cash used in investing  activities                                                              |       | (10,382                                        | )          | (5,551 | ) |
|                                                                                                |       |                                           |       |   |   |
| **Cash Flows from Financing  Activities**                                                           |       |                                           |       |   |   |
| Increase in cash overdraft                                                                          |       | 540                                            |       | 1,248 |   |
| Repayment of long-term debt                                                                         |       | (313                                           | )          | (230 | ) |
| Payout of redeemed Series A  Preferred Stock                                                        |       | —                                         |       | (373 | ) |
| Deferred financing costs                                                                            |       | (3                                             | )          | (620 | ) |
| Proceeds from exercise of stock  options                                                            |       | 430                                            |       | 261 |   |
| Excess tax benefit from  exercise of stock options                                                  |       | 242                                            |       | — |   |
| Net cash provided by financing  activities                                                          |       | 896                                            |       | 286 |   |
| **Net Increase (Decrease) in  Cash and Cash Equivalents**                                           |       | 13,513                                         |       | (5,640 | ) |
| **Cash and Cash Equivalents,  Beginning of Period**                                                 |       | 3,037                                          |       | 8,467 |   |
| **Cash and Cash Equivalents,  End of Period**                                                       |       | $                                              | 16,550     |   | $ | 2,827 |   |
|                                                                                                |       |                                           |       |   |   |
| Supplemental Disclosures of  Cash Flow Information:                                                 |       |                                           |       |   |   |
| Cash paid for interest                                                                              |       | $                                              | 7,332      |   | $ | 7,230 |   |
| Cash paid for income taxes                                                                          |       | $                                              | 1,071      |   | $ | 632 |   |
| Supplemental Disclosures of  Non-Cash Investing and Financing Activities:                           |       |                                           |       |   |   |
| Purchase of equipment under  capital lease obligations                                              |       | $                                              | —     |   | $ | 1,438 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

5

----

 

**MOTHERS WORK, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**March 31, 2006**

(unaudited)

 

**1.     BASIS OF FINANCIAL STATEMENTPRESENTATION**

 

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 or omitted. Referenceis made to the Annual Report on Form 10-K as of and for the year endedSeptember 30, 2005 for Mothers Work, Inc. and subsidiaries (the “Company”or “Mothers Work”) as filed with the Securities and Exchange Commission, for additionaldisclosures including a summary of the Company’s accounting policies.

 

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

 

The Companyoperates on a fiscal year ending September 30 of each year. All references tofiscal years of the Company refer to fiscal years ended on September 30 inthose years. For example, the Company’s “fiscal 2006” will end on September 30,2006. Certain reclassifications have been made to the prior yearconsolidated financial statements to conform to the current year presentation.

 

**2.****              EARNINGSPER SHARE (EPS)**

 

Basic earnings per share (“Basic EPS”) iscomputed by dividing net income (loss) by the weighted average number of commonshares outstanding.  Diluted earnings per share (“Diluted EPS”) iscomputed by dividing net income (loss) by the weighted average number of commonshares outstanding, after giving effect to the potential dilution, if applicable,from the exercise of securities, such as stock options and warrants, intoshares of common stock as if those securities were exercised.

 

The following table summarizes the Basic EPS and Diluted EPScalculation (in thousands, except per share amounts):

 
| ** **                                                                              | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **Net  Income**                                            | ** ** | **Shares**                                                 | ** ** | **EPS** | ** ** | **Net  Loss** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic EPS                                                                               |       | $                                                          | 502        |                                                       | 5,291      |   | $ | 0.09 |   | $ | (97 | ) | 5,237 |   | $ | (0.02 | ) |
| Incremental shares from the  assumed exercise of outstanding stock options and warrants |       | —                                                     |       | 210                                                        |       | — |   | — |   | — |   | — |   |
|                                                                                    |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Diluted EPS                                                                             |       | $                                                          | 502        |                                                       | 5,501      |   | $ | 0.09 |   | $ | (97 | ) | 5,237 |   | $ | (0.02 | ) |

 
| ** **                                                                              | ** ** | **Six Months Ended  March 31, 2006** | ** ** | **Six Months Ended  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **Net  Income**                                          | ** ** | **Shares**                                               | ** ** | **EPS** | ** ** | **Net  Loss** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic EPS                                                                               |       | $                                                        | 930        |                                                     | 5,280      |   | $ | 0.18 |   | $ | (345 | ) | 5,227 |   | $ | (0.07 | ) |
| Incremental shares from the  assumed exercise of outstanding stock options and warrants |       | —                                                   |       | 122                                                      |       | (0.01 | ) | — |   | — |   | — |   |
|                                                                                    |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Diluted EPS                                                                             |       | $                                                        | 930        |                                                     | 5,402      |   | $ | 0.17 |   | $ | (345 | ) | 5,227 |   | $ | (0.07 | ) |

 

For the three months and six months endedMarch 31, 2006, options and warrants to purchase 450,760 and 758,615 shares,respectively, were excluded from the computation of Diluted EPS as their effectwould have been antidilutive. For the three months and six monthsended March 31, 2005, since the Company incurred a loss for these periods, all 

 

6

----

 

outstanding stock options andwarrants were excluded from the calculationof Diluted EPS as their effect would have been antidilutive. These options andwarrants could potentially dilute EPS in the future.

 

**3.****              STOCK-BASEDCOMPENSATION**

 

Effective October 1, 2005, the Companyadopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-BasedPayment”, using the modified prospective application method. Prior to adoptingSFAS No. 123(R), the Company followed the intrinsic value method of accountingfor stock-based employee compensation in accordance with Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations. On September 27, 2005, theCompensation Committee of the Company’s Board of Directors approved, and theBoard ratified, the acceleration of the vesting of all outstanding stockoptions having exercise prices of $23.50 or more. Options to purchase 133,500shares, having exercise prices ranging from $23.62 to $37.05 per share, wereaffected by the vesting acceleration. The closing price of the Company’s commonstock on September 26, 2005 (the trading day prior to the vestingacceleration) was $11.31 per share. The primary purpose of this acceleratedvesting program was to eliminate the compensation expense associated with thesestock options that the Company would otherwise have been required to recognizein future financial statements pursuant to SFAS No. 123(R). The amount offuture compensation expense that was avoided in connection with thisacceleration was approximately $1.3 million, net of tax.

 

The Company has three stock option plans: the Director Stock OptionPlan (the “Director Plan”), the Amended and Restated 1987 Stock Option Plan(the “1987 Plan”) and the 2005 Equity Incentive Plan (the “2005 Plan”). TheDirector Plan expired on December 31, 2004 and no further options may begranted under that plan. Options issued under the Director Plan will remainoutstanding until they have expired, been exercised or have otherwiseterminated. Under the 1987 Plan, as amended and restated, officers and certainemployees, including outside directors, may be granted options to purchase theCompany’s common stock at exercise prices as determined by the Compensation Committeeof the Board of Directors that are no lower than the fair market value of thestock at the date of grant. In February 2003, the stockholders of theCompany approved an amendment to increase the number of shares of common stockavailable for issuance upon the exercise of options granted under the 1987 Planand the Director Plan by 500,000, up to a total of 2,175,000 options which maybe issued under the two plans (including up to a total of 200,000 options whichwere issuable under the Director Plan). In January 2006, the stockholders ofthe Company approved the adoption of the 2005 Plan. Under the 2005 Plan, employees,directors, consultants and other individuals who provide services to theCompany, may be granted awards in the form of options, stock appreciationrights, restricted stock or restricted stock units. Up to 500,000 shares of theCompany’s common stock may be issued in respect of awards under the 2005 Plan,and awards of options to purchase the Company’s common stock will be atexercise prices as determined by the Compensation Committee of the Board ofDirectors that are no lower than the fair market value of the stock at the dateof grant.

 

Effective October 1, 2004, each outside director is granted 5,000fully vested options on an annual basis, at an exercise price equal to the fairmarket value of the stock on the grant date. Subsequent to the expiration ofthe Director Plan, options to purchase an aggregate of 25,000 shares of commonstock were issued in both January 2005 (from the 1987 Plan) and January2006 (from the 2005 Plan) to the outside directors (a total of 10,000 optionsto each of the five outside directors). No options have been granted by theCompany with an exercise price less than the fair market value of the Company’scommon stock on the date of grant for any of the periods presented. Themajority of the options issued under the plans vest ratably over a five-yearperiod, although some options vest immediately, and options issued under theplans generally expire ten years from the date of grant. The Company issues newshares upon exercise of vested options. As of March 31, 2006, there were586,987 options available for grant under the plans.

 

7

----

 

For the three months and six months endedMarch 31, 2006, the Company recognized stock-based employee compensationexpense of $401,000 and $811,000, less related income tax benefits of $156,000and $316,000, under the provisions of SFAS No. 123(R). For the three months andsix months ended March 31, 2005, no compensation expense wasrecognized for stock option awards granted at fair market value under theprovisions of APB Opinion No. 25. Thefollowing table illustrates the pro forma effect on net loss andearnings per share if the Company had accounted for its stock option plansprior to October 1, 2005, using the fair value method of accounting under SFASNo. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure”:

 
| **(in thousands, except per share amounts):** | ** **                                                                                                                | **Three Months  Ended  March 31, 2005** | ** ** | **Six Months  Ended  March 31, 2005** | ** ** |
|------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|
| Net loss, as reported                                                  |                                                                                                                      | $                                                      | (97        | )                                                    | $          | (345 | ) |
| Deduct:                                                                | Total stock-based employee  compensation expense determined under the fair value based method for all  grants, net of tax |                                                   | (439       | )                                                    | (1,166     | ) |
| Pro forma net loss                                                     |                                                                                                                      | $                                                      | (536       | )                                                    | $          | (1,511 | ) |
|                                                                   |                                                                                                                      |                                                   |       |                                                 |       |
| Basic and Diluted EPS:                                                 |                                                                                                                      |                                                   |       |                                                 |       |
| As reported                                                            |                                                                                                                      | $                                                      | (0.02      | )                                                    | $          | (0.07 | ) |
| Pro forma net loss                                                     |                                                                                                                      | $                                                      | (0.10      | )                                                    | $          | (0.29 | ) |
|                                                                        |                                                                                                                           |                                                        |            |                                                      |            |  |  |  |

 

Stock option activity for all plans was asfollows: 

 
| ** **                            | ** ** | **Outstanding  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining Life** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | **(in thousands)**  | ** ** | ** **                                 | ** ** | ** **                                 | ** ** | **(in thousands)**             | ** ** |
| Balance—September 30,  2005 |       | 1,230                    |       | $                                          | 14.50      |                                       |       |                                |       |   |
| Granted                               |       | 221                      |       | 10.94                                      |       |                                       |       |                                |       |
| Exercised                             |       | (48                      | )          | 9.13                                       |       |                                       |       |                                |       |
| Forfeited                             |       | (5                       | )          | 11.62                                      |       |                                       |       |                                |       |
| Expired                               |       | (78                      | )          | 15.34                                      |       |                                       |       |                                |       |
| Balance—March 31,  2006          |       | 1,320                    |       | 14.07                                      |       | 7.0                                        |       | $                                   | 14,080     |   |
| Exercisable—March  31, 2006      |       | 871                      |       | $                                          | 15.23      |                                       | 6.0        |                                | $          | 8,603 |   |

 

At March 31, 2006, $3,761,000 of totalunrecognized compensation cost related to non-vested awards is expected to berecognized over a weighted-average period of 1.7 years. During the three monthsended March 31, 2006 and 2005, the total intrinsic value of options exercisedwas $618,000 and $97,000, respectively. The total cash received from theseoption exercises was $421,000 and $145,000, respectively, and the actual taxbenefit realized for the tax deductions from these option exercises was$241,000 and $34,000, respectively. During the six months ended March 31, 2006and 2005, the total intrinsic value of options exercised was $621,000 and$261,000, respectively. The total cash received from these option exercises was$430,000 and $261,000, respectively, and the actual tax benefit realized forthe tax deductions from these option exercises was $242,000 and $80,000,respectively. During the sixmonths ended March 31, 2005, options to purchase 27,270 shares of commonstock with an aggregate exercise price of $307,000 were exercised by the optionholders tendering 20,286 shares of the Company’s common stock, which were heldby the option holders.

 

The weightedaverage fair value of the options granted during the three months endedMarch 31,****2006 and 2005 was estimated at$8.64 and $9.56 per share, respectively. The weighted average fair value of theoptions granted during the six months ended March 31,****2006and 2005 was estimated at $6.57 and $8.80 per share, respectively. The weightedaverage fair value was calculated on the date of grant using the Black-Scholesoption-pricing model with the following weighted average assumptions:

 
| ** **                | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Dividend yield            |       | None                                             |       | None                                           |       | None |   | None |   |
| Expected price volatility |       | 54.0                                             | %          | 60.9                                           | %          | 58.2 | % | 60.9 | % |
| Risk-free interest rates  |       | 4.4                                              | %          | 4.1                                            | %          | 4.4 | % | 4.0 | % |
| Expected lives            |       | 5.7 years                                        |       | 8.0 years                                      |       | 6.4 years |   | 8.0 years |   |

 

8

----

 

Expectedvolatility was determined using a weighted average of the historic volatilityof the Company’s common stock as of the option grant date measured over aperiod equal to the expected life of the grant. Risk free interest rates werebased on the U. S. Treasury yield curve in effect at the date of the grant. Expectedlives were determined using the simplified method, which measures the averageof the option vesting term and the option contractual term.

 

**4.**                 INVENTORIES

 

Inventories were comprised of the following (in thousands):

 
| ** **       | ** ** | **March 31, 2006** | ** ** | **September 30, 2005** | ** ** |
|------------------|------------|------------------------------|------------|----------------------------------|------------|
| Finished goods   |       | $                            | 89,558     |                             | $          | 97,056 |   |
| Work-in-progress |       | 2,633                        |       | 3,283                            |       |
| Raw materials    |       | 4,612                        |       | 5,572                            |       |
|             |       | $                            | 96,803     |                             | $          | 105,911 |   |

 

**5.****                 ACCRUEDEXPENSES AND OTHER CURRENT LIABILITIES**

 

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

 
| ** **                                                   | ** ** | **March 31, 2006** | ** ** | **September 30, 2005** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| Salaries, wages and employee  benefits                       |       | $                            | 11,628     |                             | $          | 8,846 |   |
| Income taxes payable                                         |       | 994                          |       | 1,161                            |       |
| Interest                                                     |       | 2,486                        |       | 2,483                            |       |
| Deferred rent                                                |       | 3,953                        |       | 3,790                            |       |
| Sales taxes                                                  |       | 2,778                        |       | 2,456                            |       |
| Insurance                                                    |       | 2,075                        |       | 2,671                            |       |
| Rent                                                         |       | 319                          |       | 328                              |       |
| Audit and legal                                              |       | 3,291                        |       | 3,400                            |       |
| Reserves recorded in the  iMaternity acquisition (Note 6)    |       | 100                          |       | 232                              |       |
| Remaining payout for redemption  of Series A Preferred Stock |       | 677                          |       | 677                              |       |
| Accrued store construction  costs                            |       | 761                          |       | 152                              |       |
| Gift certificates and store  credits                         |       | 4,161                        |       | 3,233                            |       |
| Other                                                        |       | 7,362                        |       | 6,134                            |       |
|                                                         |       | $                            | 40,585     |                             | $          | 35,563 |   |

 

Interest payments on the Company’s $125,000,000,11 1/4% senior notes (the“Senior Notes”) are made semiannually onFebruary 1st and August 1st.

 

**6.****              iMATERNITYACQUISITION EXIT/RESTRUCTURING ACTIVITY**

 

The Company acquired eSpecialty Brands, LLC (“iMaternity”)on October 17, 2001. The iMaternity manufacturing and warehousing operations inCosta Rica have been shut down, are being marketed for sale, arenot being depreciated and are separately reflected in the accompanyingConsolidated Balance Sheets as “Assets held for sale.”  The carrying values of the Costa Rica facilities are recorded attheir estimated realizable values, which were determined based onpurchase offers from interested parties, less estimated selling costs. In January 2006, the Company sold a portion ofthe Costa Rica facilities for approximately $225,000, which approximated itsestimated realizable value.

 

During the six months ended March 31, 2006 and 2005, the Company madepayments of $132,000 and $436,000, respectively, for lease termination fees, severanceand other exit costs in connection with the iMaternity acquisitionexit/restructuring activities. A summary of the remaining iMaternityacquisition exit/restructuring reserves is as follows (in thousands):

 
| ** **           | ** ** | **March 31, 2006** | ** ** | **September 30, 2005** | ** ** |
|----------------------|------------|------------------------------|------------|----------------------------------|------------|
| Severance            |       | $                            | 100        |                             | $          | 200 |   |
| Exit and other costs |       | —                       |       | 32                               |       |
|                 |       | $                            | 100        |                             | $          | 232 |   |

 

The balance of the severance reserve reflectsa non-compete and severance arrangement that is payable ratably on a monthlybasis through September 30, 2006.

 

9

----

 

**7.****              NEWACCOUNTING PRONOUNCEMENTS**

 

*SFAS No. 154*

 

*In May 2005, theFinancial Accounting Standards Board issued SFAS No. 154, “AccountingChanges and Error Corrections.” SFAS No.154 provides guidance on the accounting for and reportingof accounting changes and error corrections. This statement is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. Early adoption is permitted. We expect to adoptSFAS No. 154 effective as of October 1, 2006.*

 

**8.****              GUARANTORSUBSIDIARIES**

 

Pursuant to theterms of the indenture relating to the Senior Notes, each of the domesticsubsidiaries of Mothers Work, Inc. (the “Guarantor Subsidiaries”) has jointlyand severally provided an unconditional guarantee of the obligations of MothersWork with respect to the Senior Notes. There are no restrictions on any of theassets of the Guarantor Subsidiaries which would limit their ability totransfer funds to Mothers Work in the form of loans, advances or cashdividends, except as provided by applicable law. None of the Company’s foreignsubsidiaries (the “Non-Guarantor Subsidiaries”) have guaranteed the SeniorNotes. The condensed consolidating financial information for the parentcompany, the Guarantor Subsidiaries, and the Non–Guarantor Subsidiaries as ofand for the six months ended March 31, 2006 as presented below has beenprepared from the books and records maintained by the Guarantor Subsidiariesand the Company. The condensed financial information may not necessarily beindicative of the results of operations or financial position had the GuarantorSubsidiaries operated as independent entities. Certain intercompany revenuesand expenses included in the subsidiary records are eliminated in consolidation.As a result of this activity, an amount due to/due from parent will exist atany time.

 

10

----

 

**Mothers Work, Inc.**

**Condensed Consolidating Balance Sheet**

**March 31, 2006**

(inthousands)

(unaudited)

 
| ** **                                        | ** ** | **Mothers Work  (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Operations)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|---------------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **ASSETS**                                        |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Current assets:                                   |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Cash and cash equivalents                         |       | $                                        | 16,244     |                        | $          | 10                                                     |       | $                               | 296        |                                | $          | — |   | $ | 16,550 |   |
| Short-term investments                            |       | 2,550                                    |       | —                      |       | —                                                 |       | —                          |       | 2,550                               |       |
| Trade receivables, net                            |       | 10,745                                   |       | —                      |       | —                                                 |       | —                          |       | 10,745                              |       |
| Inventories                                       |       | 93,820                                   |       | —                      |       | 2,983                                                  |       | —                          |       | 96,803                              |       |
| Deferred income taxes                             |       | 6,015                                    |       | —                      |       | —                                                 |       | —                          |       | 6,015                               |       |
| Prepaid expenses and other  current assets        |       | 4,308                                    |       | 2                           |       | 32                                                     |       | —                          |       | 4,342                               |       |
| Total current assets                              |       | 133,682                                  |       | 12                          |       | 3,311                                                  |       | —                          |       | 137,005                             |       |
| Property, plant and equipment,  net               |       | 72,471                                   |       | —                      |       | 2,397                                                  |       | —                          |       | 74,868                              |       |
| Assets held for sale                              |       | —                                   |       | —                      |       | 700                                                    |       | —                          |       | 700                                 |       |
| Other assets                                      |       | 68,470                                   |       | —                      |       | 147                                                    |       | —                          |       | 68,617                              |       |
| Investments in and advances to  (from) affiliates |       | (3,940                                   | )          | 261,654                     |       | (3,656                                                 | )          | (254,058                        | )          | —                              |       |
| Total assets                                      |       | $                                        | 270,683    |                        | $          | 261,666                                                |       | $                               | 2,899      |                                | $          | (254,058 | ) | $ | 281,190 |   |
|                                              |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| **LIABILITIES  AND  STOCKHOLDERS’ EQUITY**   |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Current liabilities:                              |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Line of credit borrowings                         |       | $                                        | —     |                        | $          | —                                                 |       | $                               | —     |                                | $          | — |   | $ | — |   |
| Current portion of long-term  debt                |       | 785                                      |       | —                      |       | —                                                 |       | —                          |       | 785                                 |       |
| Accounts payable                                  |       | 20,787                                   |       | —                      |       | —                                                 |       | —                          |       | 20,787                              |       |
| Accrued expenses and other  current liabilities   |       | 31,111                                   |       | 9,061                       |       | 413                                                    |       | —                          |       | 40,585                              |       |
| Total current liabilities                         |       | 52,683                                   |       | 9,061                       |       | 413                                                    |       | —                          |       | 62,157                              |       |
| Long-term debt                                    |       | 127,849                                  |       | —                      |       | —                                                 |       | —                          |       | 127,849                             |       |
| Deferred rent and other  non-current liabilities  |       | 24,705                                   |       | —                      |       | 1,033                                                  |       | —                          |       | 25,738                              |       |
| Total liabilities                                 |       | 205,237                                  |       | 9,061                       |       | 1,446                                                  |       | —                          |       | 215,744                             |       |
|                                              |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Total stockholders’ equity                   |       | 65,446                                   |       | 252,605                     |       | 1,453                                                  |       | (254,058                        | )          | 65,446                              |       |
| Total liabilities and  stockholders’ equity  |       | $                                        | 270,683    |                        | $          | 261,666                                                |       | $                               | 2,899      |                                | $          | (254,058 | ) | $ | 281,190 |   |

 

11

----

 

**Mothers Work, Inc.**

**Consolidating Statement of Operations**

**For The Six Months Ended March 31, 2006**

(inthousands)

(unaudited)

 
| ** **                                    | ** ** | **Mothers Work  (Parent Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Companies)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| Net sales                                     |       | $                                            | 288,478    |                        | $          | 15,270                                                |       | $                               | 7,558      |                                | $          | (15,270 | ) | $ | 296,036 |   |
| Cost of goods sold                            |       | 140,446                                      |       | —                      |       | 3,384                                                 |       | —                          |       | 143,830                             |       |
| Gross profit                                  |       | 148,032                                      |       | 15,270                      |       | 4,174                                                 |       | (15,270                         | )          | 152,206                             |       |
| Selling, general and  administrative expenses |       | 154,523                                      |       | 153                         |       | 3,696                                                 |       | (15,270                         | )          | 143,102                             |       |
| Operating income (loss)                       |       | (6,491                                       | )          | 15,117                      |       | 478                                                   |       | —                          |       | 9,104                               |       |
| Interest income (expense), net                |       | (17,036                                      | )          | 9,457                       |       | —                                                |       | —                          |       | (7,579                              | )          |
| Equity in earnings of  subsidiaries           |       | 25,052                                       |       | —                      |       | —                                                |       | (25,052                         | )          | —                              |       |
| Income before income taxes                    |       | 1,525                                        |       | 24,574                      |       | 478                                                   |       | (25,052                         | )          | 1,525                               |       |
| Income tax provision                          |       | 595                                          |       | 8,601                       |       | 186                                                   |       | (8,787                          | )          | 595                                 |       |
| Net income                                    |       | $                                            | 930        |                        | $          | 15,973                                                |       | $                               | 292        |                                | $          | (16,265 | ) | $ | 930 |   |

 

12

----

 

**Mothers Work, Inc.**

**Consolidating Cash Flow Statement**

**For The Six Months Ended March 31, 2006**

(inthousands)

(unaudited)

 
| ** **                                                                                   | ** ** | **Mothers Work  (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Companies)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **Cash Flows from Operating  Activities:**                                                   | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                            | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Net income                                                                                   |       | $                                        | 930        |                        | $          | 15,973                                                |       | $                               | 292        |                                | $          | (16,265 | ) | $ | 930 |   |
| Adjustments to reconcile net  income to net cash provided by (used in) operating activities: |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Depreciation and amortization                                                                |       | 7,709                                    |       | —                      |       | 228                                                   |       | —                          |       | 7,937                               |       |
| Stock-based compensation  expense                                                            |       | 811                                      |       | —                      |       | —                                                |       | —                          |       | 811                                 |       |
| Loss on impairment of  long-lived assets                                                     |       | 1,851                                    |       | —                      |       | —                                                |       | —                          |       | 1,851                               |       |
| Gain on disposal of assets                                                                   |       | (197                                     | )          | —                      |       | —                                                |       | —                          |       | (197                                | )          |
| Accretion of discount on senior  notes                                                       |       | 91                                       |       | —                      |       | —                                                |       | —                          |       | 91                                  |       |
| Deferred income tax benefit                                                                  |       | (302                                     | )          | —                      |       | —                                                |       | —                          |       | (302                                | )          |
| Excess tax benefit of stock  option  exercises                                          |       | (242                                     | )          | —                      |       | —                                                |       | —                          |       | (242                                | )          |
| Amortization of deferred  financing costs                                                    |       | 314                                      |       | —                      |       | —                                                |       | —                          |       | 314                                 |       |
| Changes in assets and  liabilities:                                                          |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Decrease (increase) in—                                                                 |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Trade receivables                                                                            |       | (3,141                                   | )          | —                      |       | 77                                                    |       | —                          |       | (3,064                              | )          |
| Inventories                                                                                  |       | 9,416                                    |       | —                      |       | (308                                                  | )          | —                          |       | 9,108                               |       |
| Prepaid expenses and other  current assets                                                   |       | 504                                      |       | 2                           |       | (32                                                   | )          |                            |       | 474                                 |       |
| Investments in and advances to  (from) affiliates                                            |       | (2,374                                   | )          | (13,579                     | )          | (312                                                  | )          | 16,265                          |       | —                              |       |
| Increase (decrease) in—                                                                 |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Accounts payable, accrued  expenses and other current liabilities                            |       | 7,291                                    |       | (2,423                      | )          | 109                                                   |       | —                          |       | 4,977                               |       |
| Deferred rent and other  non-current liabilities                                             |       | 279                                      |       | —                      |       | 32                                                    |       | —                          |       | 311                                 |       |
| Net cash provided by (used in)  operating activities                                         |       | 22,940                                   |       | (27                         | )          | 86                                                    |       | —                          |       | 22,999                              |       |
| **Cash Flows from Investing  Activities:**                                                   |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Purchase of short-term  investments                                                          |       | (25,525                                  | )          | —                      |       | —                                                |       | —                          |       | (25,525                             | )          |
| Proceeds from sale of  short-term investments                                                |       | 22,975                                   |       | —                      |       | —                                                |       | —                          |       | 22,975                              |       |
| Capital expenditures                                                                         |       | (7,936                                   | )          | —                      |       | (110                                                  | )          | —                          |       | (8,046                              | )          |
| Proceeds from sale of assets  held for sale                                                  |       | —                                   |       | —                      |       | 225                                                   |       | —                          |       | 225                                 |       |
| Purchase of intangible assets                                                                |       | (7                                       | )          | —                      |       | (4                                                    | )          | —                          |       | (11                                 | )          |
| Net cash (used in) provided by  investing activities                                         |       | (10,493                                  | )          | —                      |       | 111                                                   |       | —                          |       | (10,382                             | )          |
| **Cash Flows from Financing  Activities:**                                                   |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Increase in cash overdraft                                                                   |       | 540                                      |       | —                      |       | —                                                |       | —                          |       | 540                                 |       |
| Repayment of long-term debt                                                                  |       | (313                                     | )          | —                      |       | —                                                |       | —                          |       | (313                                | )          |
| Deferred financing costs                                                                     |       | (3                                       | )          | —                      |       | —                                                |       | —                          |       | (3                                  | )          |
| Proceeds from exercise of stock  options                                                     |       | 430                                      |       | —                      |       | —                                                |       | —                          |       | 430                                 |       |
| Excess tax benefit of stock  option  exercises                                          |       | 242                                      |       | —                      |       | —                                                |       | —                          |       | 242                                 |       |
| Net cash provided by financing  activities                                                   |       | 896                                      |       | —                      |       | —                                                |       | —                          |       | 896                                 |       |
| **Net Increase (Decrease) in  Cash and Cash Equivalents**                                    |       | 13,343                                   |       | (27                         | )          | 197                                                   |       | —                          |       | 13,513                              |       |
| **Cash and Cash Equivalents,  Beginning of Period**                                          |       | 2,901                                    |       | 37                          |       | 99                                                    |       | —                          |       | 3,037                               |       |
| **Cash and Cash Equivalents,  End of  Period**                                          |       | $                                        | 16,244     |                        | $          | 10                                                    |       | $                               | 296        |                                | $          | — |   | $ | 16,550 |   |

 

13

----

 

**9.****              COMMITMENTSAND CONTINGENCIES**

 

OnJanuary 12, 2005, a purported class action was filed against the Companyalleging that, under applicable federal and state law, certain former andcurrent employees should have received overtime compensation. The plaintiffs inthis case sought unspecified actual damages, penalties and attorneys’ fees. TheCompany engaged in efforts to resolve these claims and reached a settlementwith the plaintiffs that received preliminary court approval in February 2006and is currently being administered through a claims process.

 

In addition,from time to time, the Company is named as a defendant in legal actions arisingfrom its normal business activities. Although the amount of any liability thatcould arise with respect to currently pending actions cannot be accuratelypredicted, the Company does not believe that the resolution of any pendingaction will have a material adverse effect on its financial position, resultsof operations or liquidity.

 

**10.**       SEGMENT ANDENTERPRISE WIDE DISCLOSURES

 

***Operating Segment***. Under SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” a company may be required to report segmented informationabout separately identifiable parts of its business, which both (i) meet thedefinition of an “operating segment” under SFAS No. 131, and (ii) exceedcertain quantitative thresholds established in SFAS No. 131. The Company hasdetermined that its business is comprised of one operating segment: the design,manufacture and sale of maternity apparel and related accessories. While theCompany offers a wide range of products for sale, the substantial portion ofits products are initially distributed through the same distribution facilities,many of the Company’s products are manufactured at common contract manufacturerproduction facilities, the Company’s products are marketed through a commonmarketing department, and these products are sold to a similar customer base,consisting of expectant mothers.

 

***Geographic Information***. Information concerning the Company’s operations by geographic area isas follows (in thousands):

 
| ** **                              | ** ** | **Three Months Ended,  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                          | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net Sales to Unaffiliated Customers** |       |                                              |       |                                           |       |   |   |   |   |
| United States                           |       | $                                                 | 140,943    |                                           | $          | 137,159 |   | $ | 288,478 |   | $ | 267,842 |   |
| Canada                                  |       | $                                                 | 3,700      |                                           | $          | 2,872 |   | $ | 7,558 |   | $ | 5,808 |   |
|                                    |       |                                              |       |                                           |       |   |   |   |   |   |   |   |   |
| ** **                              | ** ** | **March 31,  2006**                          | ** ** | **September 30,  2005**                   | ** ** |   |
| **Long-Lived Assets**                   |       |                                              |       |                                           |       |   |
| United States                           |       | $                                                 | 73,069     |                                           | $          | 74,393 |   |   |
| Canada                                  |       | $                                                 | 2,544      |                                           | $          | 2,658 |   |   |
| Costa Rica                              |       | $                                                 | 700        |                                           | $          | 925 |   |   |

 

***Major Customers*****.**For the periods presented, the Company did not have any one customerwho represented more than 10% of its net sales.

 

**11.**       INTERESTEXPENSE, NET

 

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

 
| ** **            | ** ** | **Three Months Ended,  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|-----------------------|------------|---------------------------------------------------|------------|------------------------------------------------|------------|
| ** **            | ** ** | **2006**                                          | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest expense      |       | $                                                 | 3,902      |                                           | $          | 3,875 |   | $ | 7,739 |   | $ | 7,653 |   |
| Interest income       |       | (117                                              | )          | (18                                            | )          | (160 | ) | (41 | ) |
| Interest expense, net |       | $                                                 | 3,785      |                                           | $          | 3,857 |   | $ | 7,579 |   | $ | 7,612 |   |

 

14

----

 

**Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Results of Operations**

 

The following tables set forth certainoperating data as a percentage of net sales and as a percentage change for thethree and six months ended March 31:

 
| ** **                                        | ** ** | **% of Net Sales (1)**   | ** ** | **% Period to Period  Increase (Decrease)** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                        | ** ** | **Three  Months Ended  March 31,** | ** ** | **Six  Months Ended  March 31,**                      | ** ** | **Three  Months  Ended  March 31,** | ** ** | **Six  Months  Ended  March 31,** | ** ** |
| ** **                                        | ** ** | **2006**                                     | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2006 vs.  2005** | ** ** | **2006 vs.  2005** | ** ** |
| Net sales                                         |       | 100.0                                        | %          | 100.0                                                           | %          | 100.0 | % | 100.0 | % | 3.3 | % | 8.2 | % |
| Cost of goods sold (2)                            |       | 47.4                                         |       | 50.5                                                            |       | 48.6 |   | 49.2 |   | (2.9 | ) | 6.8 |   |
| Gross profit                                      |       | 52.6                                         |       | 49.5                                                            |       | 51.4 |   | 50.8 |   | 9.6 |   | 9.5 |   |
| Selling, general and  administrative expenses (3) |       | 49.4                                         |       | 46.9                                                            |       | 48.3 |   | 48.2 |   | 8.8 |   | 8.5 |   |
| Operating income                                  |       | 3.2                                          |       | 2.6                                                             |       | 3.1 |   | 2.6 |   | 24.7 |   | 29.4 |   |
| Interest expense, net                             |       | 2.6                                          |       | 2.8                                                             |       | 2.6 |   | 2.8 |   | (1.9 | ) | (0.4 | ) |
| Income (loss) before income  taxes                |       | 0.6                                          |       | (0.1                                                            | )          | 0.5 |   | (0.2 | ) | N.M. |   | N.M. |   |
| Income tax provision (benefit)                    |       | 0.2                                          |       | (0.0                                                            | )          | 0.2 |   | (0.1 | ) | N.M. |   | N.M. |   |
| Net income (loss)                                 |       | 0.3                                          | %          | (0.1                                                            | )%         | 0.3 | % | (0.1 | )% | N.M. |   | N.M. |   |

 

----

N.M.   –   NotMeaningful 

 

(1)          Components may not addto total due to rounding.

 

(2)   The “Cost of goods sold”line item includes: merchandise costs (including customs duty expenses),expenses related to inventory shrinkage, product related corporate expenses(including expenses related to our payroll, benefit costs and operating expensesof our buying departments), inventory reserves (including lower of cost ormarket reserves), inbound freight charges, purchasing and receiving costs,inspection costs, warehousing costs, internal transfer costs, and the othercosts of our distribution network.

 

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

 

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

 

| ** **                | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
| **Retail Locations** | ** ** | **Stores**                       | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning of period       |       | 851                              |       | 743 |   | 1,594 |   | 880 |   | 231 |   | 1,111 |   |
| Opened                    |       | 5                                |       | 2 |   | 7 |   | 8 |   | 497 |   | 505 |   |
| Closed                    |       | (25                              | )          | (17 | ) | (42 | ) | (19 | ) | — |   | (19 | ) |
| End of period             |       | 831                              |       | 728 |   | 1,559 |   | 869 |   | 728 |   | 1,597 |   |

 

| ** **                | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **March 31, 2006**   | ** ** | **March 31, 2005** | ** ** |
| **Retail Locations** | ** ** | **Stores**                     | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning of period       |       | 852                            |       | 739 |   | 1,591 |   | 883 |   | 232 |   | 1,115 |   |
| Opened                    |       | 11                             |       | 12 |   | 23 |   | 20 |   | 498 |   | 518 |   |
| Closed                    |       | (32                            | )          | (23 | ) | (55 | ) | (34 | ) | (2 | ) | (36 | ) |
| End of period             |       | 831                            |       | 728 |   | 1,559 |   | 869 |   | 728 |   | 1,597 |   |

 

15

----

 

Our fiscal year ends on September 30. All references in this discussionto our fiscal years refer to the fiscal year ended on September 30 in the yearmentioned. For example, our “fiscal 2006” will end on September 30, 2006.

 

**Three Months EndedMarch 31, 2006 and 2005**

 

***NetSales.***Our netsales for the second quarter of fiscal 2006 increased by 3.3%, or $4.6 million,to $144.6 million from $140.0 million for the second quarter of fiscal2005. Net sales increased primarily due to sales from the expansion ofour proprietary Two HeartsTM Maternity collection to an additional 497 Sears®locations during late March 2005 and, to a lesser extent, increases in ourcomparable store sales and internet sales. These sales increases were partiallyoffset by a reduction in sales for the second quarter of fiscal 2006 from ourlicensed arrangement with Kohl’s® compared to the large initial shipments toKohl’s in the second quarter of fiscal 2005 to provide opening inventory forthe launch of our Oh Baby! by MotherhoodTM licensed arrangement with Kohl’s inFebruary 2005. Comparable store sales increased by 1.4% during the secondquarter of fiscal 2006, based on 998 retail locations, versus a comparablestore sales decrease of 3.0% during the second quarter of fiscal 2005, based on898 retail locations. The comparable store sales increase of 1.4% for thesecond quarter of fiscal 2006 was unfavorably impacted by approximately 0.7percentage points due to January 2006 having one less Saturday than January2005 and the Easter timing shift to April in 2006 from March in 2005.

 

As of March 31, 2006, we operated a total of831 stores and 1,559 total retail locations, compared to 869 stores and 1,597total retail locations as of March 31, 2005. In addition, our Oh Baby! byMotherhood collection is available at Kohl’s stores throughout the UnitedStates. As of March 31, 2006, our store total included 49 multi-brandstores, including 11 Destination MaternityTM superstores, with the remainingmulti-brand stores under the Mimi Maternity® brand. In comparison, as of March31, 2005, we operated 43 multi-brand stores, including eight DestinationMaternity superstores. These multi-brand store figures exclude our A Peain the Pod® stores, which have traditionally carried a full line of both A Peain the Pod and Mimi Maternity branded merchandise. During the second quarter offiscal 2006, we opened five stores (including the opening of three DestinationMaternity superstores and the reopening of one store which had been closedsince late September 2005 due to Hurricane Rita) and closed 25 stores, with 11of these store closings related to multi-brand store openings.

 

***GrossProfit.***Ourgross profit for the second quarter of fiscal 2006 increased by 9.6%, orapproximately $6.6 million, to $76.0 million from $69.4 million for the secondquarter of fiscal 2005, reflecting the increase in net sales and an increase ingross margin.  Gross profit as a percentage of net sales (gross margin)for the second quarter of fiscal 2006 was 52.6% compared to 49.5% for thesecond quarter of fiscal 2005.  The increase in gross margin ofapproximately 3.1 percentage points compared to the prior year resulted from ahigher maintained gross margin in our own stores, and the reduced amount ofsales derived from the lower gross margin Kohl’s licensed arrangement comparedto the sales volume in the second quarter of fiscal 2005 related to the initialKohl’s launch.

 

***Selling,General and Administrative Expenses.***Our selling, general and administrative expensesfor the second quarter of fiscal 2006 increased by 8.8%, or approximately $5.7million, to $71.4 million from $65.7 million for the second quarter offiscal 2005. This increase in expense for the quarter resulted primarily fromincreases in store-closing costs, rent and related expenses for our retaillocations, employee wages and benefits for our retail locations, and accrued incentivecompensation expense related to improvements in our operating performancecompared to fiscal 2005. As a percentage of net sales, selling, general andadministrative expenses increased to 49.4% for fiscal 2006 compared to 46.9%for fiscal 2005. This increase in the expense percentage for the quarterresulted primarily from the unfavorable expense leverage from the lower Kohl’slicensed sales compared to the large initial shipments in the secondquarter of fiscal 2005, as well as increasesas a percentage of net sales in store-closing costs and accrued incentivecompensation expense. We incurred charges relating to store closings of $1.4million for fiscal 2006 (primarily lease termination fees) as compared to $0.2million for fiscal 2005. The majority of the store-closing costs related tothree of the stores closed in conjunction with the opening of our DestinationMaternity superstore in New York City. We incurred $0.4 million of non-cashexpenses related to stock-based compensation expense, including $0.3 million inselling, general and administrative expense, in the second quarter of fiscal2006 versus none in the second quarter of fiscal 2005, since we adopted the provisionsof SFAS No. 123(R) as of the beginning of fiscal 2006. We also incurredimpairment charges for write-downs of store long-lived assets of $0.3 millionfor fiscal 2006, as compared to $0.8 million for fiscal 2005.

 

16

----

 

***OperatingIncome.*** Our operating income for the second quarter of fiscal 2006 increased by 24.7%,or $0.9 million, to $4.6 million from $3.7 million for the second quarterof fiscal 2005, due to increased sales volume and gross profit, which more thanoffset the impact of higher selling, general and administrative expenses. Operatingincome as a percentage of net sales (operating income margin) for the second quarter of fiscal 2006 increasedto 3.2% from 2.6% for the second quarter of fiscal 2005. Excluding non-cashstock-based compensation expense, our operating income for the second quarterof fiscal 2006 was $5.0 million, which represents a 3.5% adjusted operatingincome margin. We were not required to recognize and, therefore, did not recognizeany non-cash stock-based compensation expense in fiscal 2005. The increase inoperating income margin was due to our increased gross margin, partially offsetby our higher operating expense ratio.

 

***InterestExpense, Net.***Ournet interest expense for the second quarter of fiscal 2006 of $3.8 million wasslightly lower than the second quarter of fiscal 2005 due to somewhat higherinterest income compared to the prior year. During the second quarter of fiscal2006, we had no direct borrowings under our credit facility. During the secondquarter of fiscal 2005, our average level of direct borrowings under our creditfacility was $5.3 million.

 

***IncomeTax Provision.*** Our effective tax rate was a provision of approximately 39.0% for thesecond quarter of fiscal 2006 and a benefit of 40.0% for the second quarter offiscal 2005. We expect our effective taxrate for the full year fiscal 2006 to be approximately 39%.

 

***NetIncome (Loss).***Netincome for the second quarter of fiscal 2006 was $0.5 million, or $0.09 pershare (diluted), compared to a net loss of $0.1 million, or $(0.02) per share(diluted), for the second quarter of fiscal 2005. Excluding non-cashstock-based compensation expense, net income for the second quarter of fiscal2006 was $0.7 million, or $0.14 per share (diluted). We were not required torecognize and, therefore, did not recognize any non-cash stock-basedcompensation expense in the second quarter of fiscal 2005.

 

Our averagediluted shares outstanding of 5,501,000 for the second quarter of fiscal 2006was 5.0% higher than the 5,237,000 average diluted shares outstanding for thesecond quarter of fiscal 2005.  The increase in averagediluted shares outstanding reflects the dilutive impact of outstanding stockoptions in fiscal 2006, as well as higher shares outstanding in fiscal 2006compared to fiscal 2005. No dilutive impact of stock options was included infiscal 2005, due to the net loss for the second quarter.

 

**Six Months Ended March 31, 2006 and 2005**

 

***NetSales.***Our netsales for the first six months of fiscal 2006 increased by 8.2%, orapproximately $22.3 million, to $296.0 million from $273.7 million for thefirst six months of fiscal 2005. Net sales increased primarily due tosales from the expansion of our proprietary Two Hearts. Maternity collection toan additional 497 Sears locations during late March 2005 and, to a lesserextent, our comparable store sales increase and increased sales from ourlicensed arrangement with Kohl’s, which began during the second quarter offiscal 2005. Comparable store sales increased by 2.4% during fiscal 2006, basedon 982 retail locations, versus a comparable store sales decrease of 3.7%during fiscal 2005, based on 866 retail locations.

 

***GrossProfit.***Ourgross profit for the first six months of fiscal 2006 increased by 9.5%, orapproximately $13.2 million, to $152.2 million from $139.0 million for thefirst six months of fiscal 2005, reflecting the increase in net sales and anincrease in gross margin.  Gross margin for the first six months of fiscal2006 was 51.4% compared to 50.8% for the first six months of fiscal 2005. The increase in gross margin of 0.6 percentage points compared to theprior year resulted from a higher maintained gross margin in our own stores,largely due to lower overall markdowns in the first six months of fiscal 2006as compared to the same period in fiscal 2005.

 

***Selling,General and Administrative Expenses.***Our selling, general and administrative expensesfor the first six months of fiscal 2006 increased by 8.5%, or $11.2 million, to$143.1 million from $131.9 million for the first six months of fiscal 2005.This increase in expense for the quarter resulted primarily from increases inrent and related expenses for our retail locations, employee wages and benefitsfor our retail locations, accrued incentive compensation expense, store-closingcosts, legal expense and stock-based compensation expense. As a percentage ofnet sales, selling, general and administrative expenses was slightly higher at48.3% for fiscal 2006 compared to 48.2% for fiscal 2005. This slight increasein the expense percentage for the six month period resulted primarily fromincreases as a percentage of net sales in accrued incentive compensationexpense, store-closing costs, legal expense, and stock-based compensationexpense.

 

17

----

 

Thesecategories of expense percentage net increase were mostly offset by thefavorable expense leverage from the additional sales from our Sears and Kohl’srelationships, our comparable store sales increase of 2.4% and a continuedsharp focus on expense control. We incurred charges relating to store closingsof $1.6 million for fiscal 2006 (primarily lease termination fees) as comparedto $0.8 million for fiscal 2005. The majority of the storeclosing charges for the first six months of fiscal 2006 and fiscal 2005 werefor stores closed in connection with multi-brand store openings. We incurred impairment charges for write-downsof store long-lived assets of $1.9 million for fiscal 2006, as compared to $1.3million for fiscal 2005. We also incurred $0.8 million of non-cash expensesrelated to stock-based compensation expense, including $0.7 million in selling,general and administrative expense, in the first six months of fiscal 2006versus none in the first six months of fiscal 2005, since we adopted theprovisions of SFAS No. 123(R) as of the beginning of fiscal 2006.

 

***OperatingIncome.*** Our operating income for the first six months of fiscal 2006 increased by29.4%, or $2.1 million, to $9.1 million from $7.0 million for the firstsix months of fiscal 2005, due to increased sales volume and gross profit,which more than offset the impact of higher selling, general and administrativeexpenses. Operating income as a percentage of net sales (operatingincome margin) for the first six months offiscal 2006 increased to 3.1% from 2.6% for the first six months of fiscal 2005.Excluding non-cash stock-based compensation expense, our operating income forthe first six months of fiscal 2006 was $9.9 million, which represents a 3.3%adjusted operating income margin. We were not required to recognize and,therefore, did not recognize any non-cash stock-based compensation expense infiscal 2005. The increase in operating income margin was due to our increasedgross margin.

 

***InterestExpense, Net.***Ournet interest expense for the first six months of fiscal 2006 of $7.6 millionwas slightly lower than the first six months of fiscal 2005 due to somewhathigher interest income compared to the prior year. During the first six monthsof fiscal 2006, our average level of direct borrowings under our creditfacility was $0.7 million, but we had no direct borrowings under our creditfacility as of March 31, 2006. During the first six months of fiscal 2005, ouraverage level of direct borrowings under our credit facility was $2.6 million.

 

***IncomeTax Provision.*** Our effective tax rate was a provision of approximately 39.0% for thefirst six months of fiscal 2006 and a benefit of 40.0% for the first six monthsof fiscal 2005. We expect our effective taxrate for the full year fiscal 2006 to be approximately 39%.

 

***NetIncome (Loss).***Netincome for the first six months of fiscal 2006 was $0.9 million, or $0.17 pershare (diluted), compared to a net loss of $0.3 million, or $(0.07) per share(diluted), for the first six months of fiscal 2005. Excluding non-cashstock-based compensation expense, net income for the first six months of fiscal2006 was $1.4 million, or $0.26 per share (diluted). We were not required to recognizeand, therefore, did not recognize any non-cash stock-based compensation expensein the first six months of fiscal 2005.

 

Our averagediluted shares outstanding of 5,402,000 for the first six months of fiscal 2006was 3.3% higher than the 5,227,000 average diluted shares outstanding for thefirst six months of fiscal 2005.  The increase in averagediluted shares outstanding reflects the dilutive impact of outstanding stockoptions in fiscal 2006, as well as higher shares outstanding in fiscal 2006 comparedto fiscal 2005. No dilutive impact of stock options was included in fiscal2005, due to the net loss for the first six months.

 

**Seasonality**

 

Our business,like that of many other retailers, is seasonal. Our quarterly netsales have historically been highest in our third fiscal quarter, correspondingto the Spring selling season, followed by the first fiscal quarter,corresponding to the Fall/holiday selling season. Given the typically highergross margin we experience in the third fiscal quarter compared to otherquarters, the relatively fixed nature of most of our operating expenses andinterest expense, and the historically higher sales level in the third quarter,we have typically generated a very significant percentage of our full yearoperating income and net income during the third quarter. Results for any quarter are not necessarily indicative of the resultsthat may be achieved for a full fiscal year.  Quarterly results mayfluctuate materially depending upon, among other things, the timing of newstore openings and new leased department openings, net sales and profitabilitycontributed by new stores and leased departments, increases or decreases incomparable store sales, the timing of the fulfillment of purchase orders underour product and license arrangements, adverse weather conditions, shifts in thetiming of certain holidays and promotions, changes in inventory and productionlevels and the timing of deliveries of inventory, and changes in ourmerchandise mix.

 

18

----

 

**Liquidity and Capital Resources**

 

Our cash needshave primarily been for: (i) debt service, (ii) capital expenditures,including leasehold improvements, fixtures and equipment for new stores, storerelocations and expansions of our existing stores, as well as improvements andnew equipment for our distribution and corporate facilities and informationsystems, and (iii) working capital, including inventory to support our newbusiness initiatives and our new and existing stores. We have historicallyfinanced these capital requirements from cash flows from operations, borrowingsunder our credit facility or available cash balances.

 

Cash and cashequivalents increased by $13.5 million during the first six months of fiscal2006 compared to a decrease of $5.6 million for the first six months of fiscal2005.  Cash provided by operations of $23.0 million for the first sixmonths of fiscal 2006 increased by $23.4 million from $0.4 million used for thefirst six months of fiscal 2005.  This increase in cashprovided by operations was primarily the result of cash generated by reducinginventories in the first six months of fiscal 2006 compared to an increase ininventories during the first six months of fiscal 2005. Total inventories atMarch 31, 2006 were $96.8 million, a decrease of $9.1 million or 8.6% below the$105.9 million inventories balance at September 30, 2005, and a decrease of$10.7 million or 10.0% below the $107.5 million inventories balance at March31, 2005. During the first six months of fiscal 2006, we used our cash providedby operations primarily to pay for capital expenditures, and, to a lesserextent, to increase our short-terminvestments. During the first sixmonths of fiscal 2005, we paid for our capital expenditures through theutilization of proceeds from sales of short-term investments, as well asutilizing a portion of our cash and cash equivalents.

 

For the first six months of fiscal 2006, wespent $8.0 million on capital expenditures, including $7.0 millionfor leasehold improvements, fixtures and equipment principally for new storefacilities, as well as improvements to existing stores, and $1.1 millionfor our distribution and corporate facilities and information systems. Thiscompares to $11.9 million in capital expenditures for the first six monthsof fiscal 2005, of which $9.3 million was spent for new store facilitiesand improvements to existing stores and retail locations, and $2.6 millionfor our distribution and corporate facilities and information systems. The decrease in capital expenditures wasprimarily due to decreased expenditures for new stores and decreasedexpenditures for distribution facilities and information systems compared tolast year.

 

On October 15, 2004, we entered into anew five-year $60.0 million senior secured revolving credit facility (the “CreditFacility”). The Credit Facility will mature on October 15, 2009. There are no financial covenant requirementsunder the Credit Facility unlesseither (i) Excess Availability (as defined in the agreement) falls below$10 million, or (ii) average Financial Covenant Adjusted Availability (asdefined in the agreement) for any calendar month is less than $15 million. Ifeither of the events in items (i) or (ii) above occurs, we would berequired to meet a certain minimum fixed charge coverage ratio (which increasesfrom 1.00x during the first two years of the Credit Facility to 1.10x duringthe fifth year of the Credit Facility).During the first six months of fiscal 2006 and the first six months of fiscal2005, we exceeded the requirements for Excess Availability and averageFinancial Covenant Adjusted Availability.

 

Asof March 31, 2006, outstanding borrowings under the Credit Facility consistedof no direct borrowings and $9.2 million in letters of credit, with availableborrowings of $50.8 million. Our average level of direct borrowings under ourcredit facility was $0.7 million for the first six months of fiscal 2006,compared to average direct borrowings of $2.6 million during the first sixmonths of fiscal 2005. We may have borrowings under our Credit Facility duringcertain periods in the future, reflecting seasonal and other timing variations in cash flow.

 

Our management believes that our current cashand working capital positions, expected operating cash flows and availableborrowing capacity under our Credit Facility, will be sufficient to fund ourworking capital, capital expenditures and debt repayment requirements and tofund stock and/or debt repurchases, if any, for at least the next twelvemonths.

 

**Critical Accounting Policiesand Estimates**

 

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

 

Oursignificant accounting policies are described in Note 2 of “Notes toConsolidated Financial Statements” in our Annual Report on Form 10-K for theyear ended September 30, 2005. We believe that the following discussionaddresses our critical accounting policies, which are those that are mostimportant to the portrayal of our financial

 

19

----

 

condition and results ofoperations and require management’s most difficult, subjective and complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. If actual results were to differsignificantly from estimates made, future reported results could be materiallyaffected. However, we are not currently aware of any reasonably likely eventsor circumstances that would result in materially different results.

 

Our seniormanagement has reviewed these critical accounting policies and estimates andthe related Management’s Discussion and Analysis of Financial Condition andResults of Operations with the Audit Committee of our Board of Directors.

 

***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. Aperiodic review of inventory quantities on hand is performed in order todetermine if inventory is properly valued at the lower of cost or market. Factorsrelated to current inventories such as future consumer demand and fashiontrends, current aging, current analysis of merchandise based on receipt date,current and anticipated retail markdowns or wholesale discounts, and class ortype of inventory are analyzed to determine estimated net realizable values. Criteriautilized by us to quantify aging trends include factors such as the amount ofmerchandise received within the past twelve months, merchandise received morethan one year before with quantities on-hand in excess of 12 months ofsales, and merchandise currently selling below cost. A provision is recorded toreduce the cost of inventories to its estimated net realizable value, ifrequired. Inventories as of March 31, 2006 and September 30, 2005 totaled$96.8 million and $105.9 million, respectively, representingapproximately 34.4% and 38.7% of total assets, respectively. Given thesignificance of inventories to our consolidated financial statements, thedetermination of net realizable values is considered to be a criticalaccounting estimate. Any significant unanticipated changes in the factors notedabove could have a significant impact on the value of our inventories and ourreported operating results.

 

***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 are recorded at cost and are amortized usingthe straight-line method over the shorter of the lease term or their usefullife. Net long-lived assets as of March 31, 2006 and September 30, 2005totaled $75.6 million and $77.1 million, respectively, representingapproximately 26.9% and 28.2% of total assets, respectively.

 

In assessingpotential impairment of these assets, we periodically evaluate the historicaland forecasted operating results and cash flows on a store-by-store basis.Newly opened stores may take time to generate positive operating and cash flowresults. Factors such as (i) store type, that is, company store or leaseddepartment, (ii) store concept, that is, Motherhood Maternity®, MimiMaternity, A Pea in the Pod or Destination Maternity, (iii) storelocation, for example, urban area versus suburb, (iv) current marketplaceawareness of our brands, (v) local customer demographic data,(vi) anchor stores within the mall in which our store is located and(vii) current fashion trends are all considered in determining the timeframe required for a store to achieve positive financial results, which isassumed to be within two years from the date a store location is opened. Ifeconomic conditions are substantially different from our expectations, thecarrying value of certain of our long-lived assets may become impaired.  As a result of our impairment assessment,we recorded write-downs of long-lived assets of $1.9 million for the first sixmonths of fiscal 2006, and $1.3 million for the first six months of fiscal2005.

 

***Goodwill*.** The purchase method of accounting for business combinations requires theuse of estimates and judgments to allocate the purchase price paid foracquisitions to the net tangible and identifiable intangible assets. Goodwillrepresents the excess of the aggregate purchase price over the fair value ofnet assets acquired in business combinations and is separately disclosed in ourconsolidated balance sheets. As of both March 31, 2006 and September 30,2005, goodwill totaled $50.4 million, representing 17.9% and 18.4% oftotal assets, respectively. In June 2001, the FASB issuedSFAS No. 142, “Goodwill and Other Intangible Assets.”  SFAS No. 142 requires that goodwillno longer be amortized, but instead be tested for impairment at least annuallyor as impairment indicators arise. Prior to our adoption ofSFAS No. 142 on October 1, 2001, goodwill was amortized usingthe straight-line method over a period of 20 years.

 

The impairmenttest requires us to compare the fair value of business reporting units to theircarrying value, including assigned goodwill. In assessing potential impairmentof goodwill, we have determined that we have one reporting unit for purposes ofapplying SFAS No. 142 based on our reporting structure. The fairvalue of our single reporting unit is determined based on the fair market valueof our outstanding common stock on a control basis and, if necessary, anoutside independent valuation is obtained to determine the fair value. Thecarrying value of our single reporting unit, expressed on a per share basis, isrepresented by our book value per share of outstanding common stock. Theresults of the annual impairment test performed as of September 30, 2005indicated the fair value of the reporting unit exceeded its carrying value.

 

20

----

 

As of September 30, 2005,our book value was $12.02 per share of outstanding common stock and the closingtrading price of our common stock was $10.00 per share. As part of the Company’simpairment analysis as of September 30, 2005, an outside independentvaluation was obtained that indicated that the fair value of the Company’ssingle reporting unit exceeded the carrying value. If the per share fair valueof our single reporting unit had been less than the book value per share onSeptember 30, 2005, our goodwill would likely have become impaired. As ofMarch 31, 2006, our book value was $12.31 per share of outstanding commonstock and the closing trading price of our common stock was $24.02 per share.

 

***Accounting for Income Taxes.***Aspart of the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. This process requires us to estimate our actual current tax exposuretogether with assessing temporary differences resulting from differingtreatment of items, such as depreciation of property and equipment andvaluation of inventories, for tax and accounting purposes. We determine ourprovision for income taxes based on federal and state tax laws and regulationscurrently in effect, some of which have been recently revised. Legislationchanges currently proposed by certain of the states in which we operate, ifenacted, could increase our transactions or activities subject to tax. Any suchlegislation that becomes law could result in an increase in our state incometax expense and our state income taxes paid, which could have a material andadverse effect on our net income.

 

The temporarydifferences between the book and tax treatment of income and expenses result indeferred tax assets and liabilities, which are included within our consolidatedbalance sheets. We must then assess the likelihood that our deferred tax assetswill be recovered from future taxable income. As of September 30, 2005, wedetermined that the deferred tax assets should reflect the state tax benefitsfor several of the states in which we are operating. This determination wasmade in accordance with the provisions of SFAS No. 109, “Accounting forIncome Taxes.”  Actual results coulddiffer from our assessments if adequate taxable income is not generated infuture periods. Net deferred tax assets as of March 31, 2006 andSeptember 30, 2005 totaled $19.6 million and $19.3 million,respectively, representing approximately 7.0% and 7.1% of total assets,respectively. To the extent we believe that recovery is not more likely thannot, we must establish a valuation allowance. To the extent we establish avaluation allowance or change the allowance in a future period, income taxexpense will be 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 suchas these in accordance with SFAS No. 5, “Accounting for Contingencies.”  SFAS No. 5 requires us to record anestimated loss contingency when information available prior to the issuance ofour financial 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. Aninterpretation of SFAS No. 5 further states that when there is a range ofloss and no amount within that range is a better estimate than any other, thenthe minimum amount of the range shall be accrued. Accounting for contingenciesarising from contractual or legal proceedings requires management, afterconsultation with outside legal counsel, to use its best judgment whenestimating an accrual related to such contingencies. As additional informationbecomes known, our accrual for a loss contingency could fluctuate, therebycreating variability in our results of operations from period to period. Likewise,an actual loss arising from a loss contingency which significantly exceeds theamount accrued for in our financial statements could have a material adverseimpact on our operating results for the period in which such actual lossbecomes known.

 

**Recent AccountingPronouncements**

 

*SFAS No. 154*

 

In May 2005,the Financial Accounting Standards Board issued SFAS No. 154, “AccountingChanges and Error Corrections.” SFAS No.154 provides guidance on the accounting for and reportingof accounting changes and error corrections. This statement is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. Early adoption is permitted. We expect to adoptSFAS No. 154 effective as of October 1, 2006*.*

 

**Forward-Looking Statements**

 

Some of theinformation in this report, including information incorporated by reference, ifapplicable, (as well as information included in oral statements or otherwritten 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”). The forward-looking statements involve a numberof risks and uncertainties. A number of factors could cause our actual results,performance, achievements or industry results to be materially different fromany future results, performance or achievements expressed or implied by theseforward-looking statements. These factors include, but are not limited to: thesuccess of our new business initiatives, future sales trends in our

 

21

----

 

existing store base, changes inconsumer spending patterns, raw material price increases, consumer preferencesand overall economic conditions, the impact of competition and pricing,availability of suitable store locations, continued availability of capital andfinancing, ability to hire and develop senior management and sales associates,ability to develop and source merchandise, ability to receive production fromforeign sources on a timely basis, potential stock repurchases, potential debtrepurchases, war or acts of terrorism and other factors referenced in ourAnnual Report on Form 10-K, including those set forth under the caption “RiskFactors.”

 

In addition, these forward-looking statementsnecessarily depend upon assumptions, estimates and dates that may be incorrector imprecise and involve known and unknown risks, uncertainties and otherfactors. Accordingly, any forward-looking statements included in this report donot purport to be predictions of future events or circumstances and may not berealized. Forward-looking statements can be identified by, among other things,the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “should,”“seeks,” “pro forma,” “anticipates,” “intends,” “continues,” “could,” “estimates,”“plans,” “potential,” “predicts,” “goal,” “objective,” or the negative of any ofthese terms, or comparable terminology, or by discussions of our outlook,plans, goals, strategy or intentions. Forward-looking statements speak only asof the date made. We assume no obligation to update any of these forward-lookingstatements to reflect actual results, changes in assumptions or changes inother factors affecting these forward-looking statements.

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

Mothers Work isexposed to market risk from changes in interest rates.  We have notentered into any market sensitive instruments for trading purposes.  Theanalysis below presents the sensitivity of the market value of our financialinstruments to selected changes in market interest rates.  The range ofchanges presented reflects our view of changes that are reasonably possibleover a one-year period.

 

As ofMarch 31, 2006, the principal components of our debt portfolio were the$125.0 million of Senior Notes and the $60.0 million Credit Facility,both of which are denominated in U.S. dollars.  The fair value of the debtportfolio is referred to as the “debt value.”  The Senior Notes bearinterest at a fixed rated of 111⁄4%.  Although a change in market interestrates would not affect the interest incurred or cash flow related to this fixedrate portion of the debt portfolio, the debt value would be affected.

 

Our CreditFacility carries a variable interest rate that is tied to market indices. As of March 31, 2006, we had no direct borrowings and $9.2 million ofletters of credit outstanding under our Credit Facility.  Borrowings underthe Credit Facility would have borne interest at a rate between approximately6.1% and 7.8% per annum as of March 31, 2006.  Any future borrowings underthe Credit Facility would, to the extent of outstanding borrowings, be affectedby changes in market interest rates. A change in market interest rates on thevariable portion of the debt portfolio impacts the interest incurred and cashflows, but does not impact the debt value of the financial instrument.

 

The sensitivityanalysis as it relates to the fixed rate portion of our debt portfolio assumesan instantaneous 100 basis point move in interest rates from their levels as ofMarch 31, 2006, with all other variables held constant.  A 100 basis pointincrease in market interest rates would result in a decrease in the value ofthe debt by approximately $4.2 million as of March 31, 2006.  A 100basis point decline in market interest rates would cause the debt value toincrease by approximately $4.3 million as of March 31, 2006.

 

Based on the variable rate debt included inour debt portfolio as of March 31, 2006, a 100 basis point increase ininterest rates would result in additional interest incurred for the year ofless than $0.1 million. A 100 basis point decrease in interest rates wouldcorrespondingly lower our interest expense for the year by less than $0.1million.

 

Other than asdescribed above, we do not believe that the market risk exposure on otherfinancial instruments is material.

 

22

----

 

**Item 4. Controls and Procedures**

 

***Disclosure Controls and Procedures***

 

Our disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that are filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms. These disclosurecontrols and procedures include controls and procedures designed to ensure thatinformation required to be disclosed under the Exchange Act is accumulated andcommunicated to our management on a timely basis to allow decisions regardingrequired disclosure. We evaluated the effectiveness of the design and operationof our disclosure controls and procedures as of March 31, 2006. Based onthis evaluation, the Company’s Chief Executive Officer and Chief FinancialOfficer have concluded that as of March 31, 2006, these controls andprocedures 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 March 31, 2006, that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

23

----

 

**PART II. OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

OnJanuary 12, 2005, a purported class action was filed against the Companyalleging that, under applicable federal and state law, certain former andcurrent employees should have received overtime compensation. The plaintiffs inthis case sought unspecified actual damages, penalties and attorneys’ fees. TheCompany engaged in efforts to resolve these claims and reached a settlementwith the plaintiffs that received preliminary court approval in February 2006and is currently being administered through a claims process.

 

In addition,from time to time, the Company is named as a defendant in legal actions arisingfrom its normal business activities. Although the amount of any liability thatcould arise with respect to currently pending actions cannot be accuratelypredicted, the Company does not believe that the resolution of any pendingaction will have a material adverse effect on its financial position, resultsof operations or liquidity.

 

## **Item 4. Submission of Matters to a Vote of SecurityHolders**

## ** **

At the Company’s Annual Meeting of Stockholders held on January 20,2006, the stockholders of the Company elected two directors of the Company,approved the adoption of the Company’s 2005 Equity Incentive Plan, and ratifiedthe Audit Committee’s appointment of KPMG LLP as the Company’sindependent registered public accounting firm for the fiscal year endingSeptember 30, 2006.

 

Mr. William A. Schwartz, Jr. and Mr. Stanley C.Tuttleman were elected to serve as directors at the meeting. The votingresults were 3,397,032 shares for and 640,800 shares withheld for Mr. Schwartzand 3,458,590 shares for and 579,242 shares withheld forMr. Tuttleman.  Dan W. Matthias, Rebecca C. Matthias, ElamM. Hitchner, III, Joseph A. Goldblum and David Schlessinger continue to servetheir terms as directors.

 

The shareholders voted 2,154,444 shares for, 871,290 shares against,1,363 shares abstained, and there were 1,010,735 broker non-votes for theadoption of the Company’s 2005 Equity Incentive Plan. The shareholders voted4,008,492 shares for, 29,307 shares against, and 33 shares abstained for theratification of the appointment of KPMG LLP.

 

**Item 5. Other Information**

 

(a)  Not applicable.

 

(b)  On December 13, 2005, the Board of Directors of Mothers Work,Inc. adopted the 2005 Equity Incentive Plan, subject to stockholder approval. ThePlan was submitted to stockholders and was approved at the Company’s AnnualMeeting of Stockholders held on January 20, 2006, and the Plan is being filedwith this Form 10-Q as Exhibit 10.1.

 

On May 8,2006, the Company and each of Dan and Rebecca Matthias entered into amendments to the Matthiases’ employment agreements. Pursuant to these amendments,the Matthiases agreed that any stockoptions that they receive under the terms of their employment agreements inrespect of fiscal 2006 corporate and/or individual performance will not vestimmediately. Instead, such options will vest one year after the date of grant(or earlier upon certain specified types of employment termination), providedthat the optionee remains in continuous service with the Company through the vestingdate.

 

**Item 6. Exhibits**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                 |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                                                                      |
|   10.1      |       | 2005 Equity  Incentive Plan                                                                                                                                                                                                                                                     |
| *10.2            |       | Amendment to  Amended and Restated Employment Agreement dated as of December 29, 2005,  between Mothers Work, Inc. and Dan W. Matthias (Exhibit 10.19 to the  Company’s Current Report on Form 8-K dated December 29, 2005 (the “December  29, 2005 Form 8-K”)). |
| *10.3            |       | Amendment to  Amended and Restated Employment Agreement dated as of December 29, 2005,  between Mothers Work, Inc. and Rebecca C. Matthias (Exhibit 10.20 to the  December 29, 2005 Form 8-K).                                                                                  |
|   10.4      |       | Second  Amendment to Amended and Restated Employment Agreement dated as of May 8,  2006, between Mothers Work, Inc. and Dan W. Matthias.                                                                                                                                        |
|   10.5      |       | Second  Amendment to Amended and Restated Employment Agreement dated as of May 8,  2006, between Mothers Work, Inc. 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 Executive 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 Executive 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.                                                                                    |

 

----

*  Incorporated by reference.

 

24

----

 

**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.

 
|               |     | MOTHERS WORK, INC.                                        |                    |
|--------------------|----------|-----------------------------------------------------------|-------------------------|
|               |     |                                                      |                    |
| Date: May 10, 2006 | By:      | ** **                                                | **/s/ DAN W. MATTHIAS** | ** ** |
|               |     | Dan W. Matthias                                           | * *                |
| * *           | * * | *Chairman of the Board and  Chief Executive Officer*      |                    |
| * *           | * * | * *                                                  | * *                |
|               |     |                                                      |                    |
| Date: May 10, 2006 | By:      | ** **                                                | **/s/ EDWARD M. KRELL** | ** ** |
|               |     | Edward M. Krell                                           |                    |
| * *           | * * | *Executive Vice President—  Chief Financial Officer* |                    |

 

25

----