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** **

**United StatesSecurities and Exchange Commission**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **x**                                                 | ** ** | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |
|-------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| ** **                                            | ** ** | ** **                                                                                              |
| **For the quarterly period ended June 30, 2008** |
| ** **                                            | ** ** | ** **                                                                                              |
| ** **                                            | ** ** | **Or**                                                                                                  |
| ** **                                            | ** ** | ** **                                                                                              |
| **o**                                                 | ** ** | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |

 

**For the transition period from           to          **

 

**Commission file number 0-21196**

 

**MOTHERS WORK, INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

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

 

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

 

Indicate by check mark whether the Registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer ora smaller reporting company. See definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act.

| Large accelerated filer o                                             |   |                             | Accelerated filer x |
|-----------------------------------------------------------------------|--------|----------------------------------|--------------------------|
|                                                                  |   |                             |                     |
| Non-accelerated filer o(Do not check if a smaller reporting  company) |   | Smaller reporting company o |

 

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

 

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

 

Common Stock, $.01 parvalue 6,071,253 shares outstanding as of July 31, 2008

 

 

 

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**INDEX**

 
| PART I.  FINANCIAL INFORMATION |                                                                                        |
|------------------------------------------|---------------------------------------------------------------------------------------------|
| Item 1.                                  | Financial Statements (unaudited)                                                            |   |
|                                     | Consolidated Balance Sheets                                                                 | 3 |
|                                     | Consolidated Statements of Operations                                                       | 4 |
|                                     | Consolidated Statements of Stockholders’ Equity and  Comprehensive Income              | 5 |
|                                     | Consolidated Statements of Cash Flows                                                       | 6 |
|                                     | Notes to Consolidated Financial Statements                                                  | 7 |
| Item 2.                                  | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 13 |
| Item 3.                                  | Quantitative and Qualitative Disclosures About Market  Risk                                 | 22 |
| Item 4.                                  | Controls and Procedures                                                                     | 23 |
|                                     |                                                                                        |   |
| PART II.   OTHER INFORMATION   |                                                                                        |
| Item  1.                                 | Legal  Proceedings                                                                          | 24 |
| Item 1A.                                 | Risk Factors                                                                                | 24 |
| Item 4.                                  | Submission of Matters to a Vote of Security Holders                                         | 24 |
| Item 6.                                  | Exhibits                                                                                    | 24 |
|                                     |                                                                                        |   |
| Signatures                               | 25                                                                                          |

 

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

(in thousands, except share and per shareamounts)

(unaudited)

 
| ** **                                                                                                                        | ** ** | **June 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| **ASSETS**                                                                                                                        |       |                   |       |                             |       |
| Current assets:                                                                                                                   |       |                   |       |                             |       |
| Cash  and cash equivalents                                                                                                        |       | $                      | 8,522      |                             | $          | 10,130 |   |
| Trade  receivables                                                                                                                |       | 7,645                  |       | 12,094                           |       |
| Inventories                                                                                                                       |       | 95,209                 |       | 100,485                          |       |
| Deferred  income taxes                                                                                                            |       | 7,123                  |       | 7,123                            |       |
| Prepaid  expenses and other current assets                                                                                        |       | 6,046                  |       | 6,603                            |       |
| Total  current assets                                                                                                             |       | 124,545                |       | 136,435                          |       |
| Property,  plant and equipment, net                                                                                               |       | 66,589                 |       | 68,651                           |       |
| Assets  held for sale                                                                                                             |       | 207                    |       | 207                              |       |
| Other assets:                                                                                                                     |       |                   |       |                             |       |
| Goodwill                                                                                                                          |       | 50,389                 |       | 50,389                           |       |
| Deferred  financing costs, net of accumulated amortization of $299 and $133                                                       |       | 989                    |       | 1,251                            |       |
| Other  intangible assets, net of accumulated amortization of $2,098 and $2,478                                                    |       | 471                    |       | 576                              |       |
| Deferred  income taxes                                                                                                            |       | 16,209                 |       | 15,189                           |       |
| Other  non-current assets                                                                                                         |       | 299                    |       | 3,227                            |       |
| Total  other assets                                                                                                               |       | 68,357                 |       | 70,632                           |       |
| Total  assets                                                                                                                     |       | $                      | 259,698    |                             | $          | 275,925 |   |
| ** **                                                                                                                        |       |                   |       |                             |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                    |       |                   |       |                             |       |
| Current liabilities:                                                                                                              |       |                   |       |                             |       |
| Line  of credit borrowings                                                                                                        |       | $                      | —     |                             | $          | — |   |
| Current  portion of long-term debt                                                                                                |       | 1,227                  |       | 1,534                            |       |
| Accounts  payable                                                                                                                 |       | 23,968                 |       | 28,345                           |       |
| Accrued  expenses and other current liabilities                                                                                   |       | 34,238                 |       | 41,633                           |       |
| Total  current liabilities                                                                                                        |       | 59,433                 |       | 71,512                           |       |
| Long-term  debt                                                                                                                   |       | 77,838                 |       | 91,646                           |       |
| Deferred  rent and other non-current liabilities                                                                                  |       | 29,172                 |       | 24,244                           |       |
| Total  liabilities                                                                                                                |       | 166,443                |       | 187,402                          |       |
|                                                                                                                              |       |                   |       |                             |       |
| Commitments  and contingencies (Note 9)                                                                                           |       |                   |       |                             |       |
|                                                                                                                              |       |                   |       |                             |       |
| Stockholders’ equity:                                                                                                        |       |                   |       |                             |       |
| Preferred  stock, 2,000,000 shares authorized                                                                                     |       |                   |       |                             |       |
| Series A  cumulative convertible preferred stock, $.01 par value; 41,000 shares  authorized, none outstanding                |       | —                 |       | —                           |       |
| Series B  junior participating preferred stock, $.01 par value; 300,000 shares  authorized,  none  outstanding               |       | —                 |       | —                           |       |
| Common  stock, $.01 par value; 20,000,000 shares authorized, 6,068,555 and 5,963,434  shares issued and outstanding, respectively |       | 61                     |       | 60                               |       |
| Additional  paid-in capital                                                                                                       |       | 82,773                 |       | 81,047                           |       |
| Retained  earnings                                                                                                                |       | 12,289                 |       | 8,820                            |       |
| Accumulated  other comprehensive loss                                                                                             |       | (1,868                 | )          | (1,404                           | )          |
| Total  stockholders’ equity                                                                                                  |       | 93,255                 |       | 88,523                           |       |
| Total  liabilities and stockholders’ equity                                                                                  |       | $                      | 259,698    |                             | $          | 275,925 |   |

 

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

 

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(in thousands, except per share amounts)

(unaudited)

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2008**                              | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net  sales                                    |       | $                                     | 152,224    |                                 | $          | 153,227 |   | $ | 434,105 |   | $ | 445,568 |   |
| Cost  of goods sold                           |       | 74,022                                |       | 72,105                               |       | 214,255 |   | 211,336 |   |
| Gross  profit                                 |       | 78,202                                |       | 81,122                               |       | 219,850 |   | 234,232 |   |
| Selling,  general and administrative expenses |       | 69,557                                |       | 70,055                               |       | 208,474 |   | 208,668 |   |
| Operating  income                             |       | 8,645                                 |       | 11,067                               |       | 11,376 |   | 25,564 |   |
| Interest  expense, net                        |       | 1,711                                 |       | 2,043                                |       | 5,435 |   | 7,965 |   |
| Loss  on extinguishment of debt               |       | 59                                    |       | 7,330                                |       | 97 |   | 9,423 |   |
| Income  before income taxes                   |       | 6,875                                 |       | 1,694                                |       | 5,844 |   | 8,176 |   |
| Income  tax provision                         |       | 2,738                                 |       | 661                                  |       | 2,449 |   | 3,189 |   |
| Net  income                                   |       | $                                     | 4,137      |                                 | $          | 1,033 |   | $ | 3,395 |   | $ | 4,987 |   |
|                                          |       |                                  |       |                                 |       |   |   |   |   |
| Net  income per share—Basic              |       | $                                     | 0.69       |                                 | $          | 0.18 |   | $ | 0.57 |   | $ | 0.86 |   |
| Average  shares outstanding—Basic        |       | 5,956                                 |       | 5,838                                |       | 5,915 |   | 5,789 |   |
| Net  income per share—Diluted            |       | $                                     | 0.68       |                                 | $          | 0.17 |   | $ | 0.56 |   | $ | 0.81 |   |
| Average  shares outstanding—Diluted      |       | 6,049                                 |       | 6,140                                |       | 6,039 |   | 6,168 |   |

 

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

 

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**MOTHERSWORK, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME**

**(inthousands)**

**(unaudited)**

** **
| ** **                                                                      | ** ** | **Common Stock** | ** ** | ** ** | ** ** | ** **              | ** ** | **Accumulated** | ** ** | ** **               | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|-------------------------|------------|-----------------|------------|--------------------------|------------|------------|------------|
| ** **                                                                      | ** ** | **Number  of**        | ** ** | ** ** | ** ** | **Additional  Paid-in** | ** ** | **Retained**    | ** ** | **Other  Comprehensive** | ** ** | ** ** | ** ** | **Comprehensive Income** | ** ** |
| ** **                                                                      | ** ** | **Shares**            | ** ** | **Amount** | ** ** | **Capital**             | ** ** | **Earnings**    | ** ** | **Loss**                 | ** ** | **Total**  | ** ** | **Quarter** | ** ** | **Year to Date** | ** ** |
| Balance as of September 30, 2007                                           |       | 5,963                 |       | $          | 60         |                    | $          | 81,047          |       | $                        | 8,820      |       | $          | (1,404 | ) | $ | 88,523 |   |   |   |   |   |
| Net income                                                                      |       | —                |       | —     |       | —                  |       | 3,395           |       | —                   |       | 3,395      |       | $ | 4,137 |   | $ | 3,395 |   |
| Amortization of prior service cost for retirement plans, net of tax             |       | —                |       | —     |       | —                  |       | —          |       | 136                      |       | 136        |       | 55 |   | 136 |   |
| Change in fair value of interest rate swap, net of tax                          |       | —                |       | —     |       | —                  |       | —          |       | (603                     | )          | (603       | )          | 885 |   | (603 | ) |
| Unrealized loss on investments, net of tax                                      |       | —                |       | —     |       | —                  |       | —          |       | 3                        |       | 3          |       | 86 |   | 3 |   |
| Comprehensive income                                                            |       |                  |       |       |       |                    |       |            |       |                     |       |       |       | $ | 5,163 |   | $ | 2,931 |   |
| Cumulative effect of adoption of FIN No. 48 (Note 6)                       |       | —                |       | —     |       | —                  |       | 74              |       | —                   |       | 74         |       |   |   |   |   |
| Stock-based compensation                                                        |       | 40                    |       | —     |       | 1,780                   |       | —          |       | —                   |       | 1,780      |       |   |   |   |   |
| Exercise of stock options                                                       |       | 73                    |       | 1          |       | 684                     |       | —          |       | —                   |       | 685        |       |   |   |   |   |
| Tax benefit shortfall from stock option exercises and restricted  stock vesting |       | —                |       | —     |       | (620                    | )          | —          |       | —                   |       | (620       | )          |   |   |   |   |
| Repurchase and retirement of common shares                                      |       | (7                    | )          | —     |       | (118                    | )          | —          |       | —                   |       | (118       | )          |   |   |   |   |
| Balance as of June 30, 2008                                                |       | 6,069                 |       | $          | 61         |                    | $          | 82,773          |       | $                        | 12,289     |       | $          | (1,868 | ) | $ | 93,255 |   |   |   |   |   |
|                                                                            |       |                  |       |       |       |                    |       |            |       |                     |       |       |       |   |   |   |   |
| Balance as of September 30, 2006                                           |       | 5,624                 |       | $          | 56         |                    | $          | 71,431          |       | $                        | 9,213      |       | $          | — |   | $ | 80,700 |   |   |   |   |   |
| Net income                                                                      |       | —                |       | —     |       | —                  |       | 4,987           |       | —                   |       | 4,987      |       | $ | 1,033 |   | $ | 4,987 |   |
| Initial prior service cost for retirement plans, net of tax                     |       | —                |       | —     |       | —                  |       | —          |       | (1,202                   | )          | (1,202     | )          |   |   |   |   |
| Amortization of prior service cost for retirement plans, net of tax             |       | —                |       | —     |       | —                  |       | —          |       | 71                       |       | 71         |       | 54 |   | 71 |   |
| Change in fair value of interest rate swap, net of tax                          |       | —                |       | —     |       | —                  |       | —          |       | 311                      |       | 311        |       | 311 |   | 311 |   |
| Comprehensive income                                                            |       |                  |       |       |       |                    |       |            |       |                     |       |       |       | $ | 1,398 |   | $ | 5,369 |   |
| Stock-based compensation                                                        |       | 121                   |       | 1          |       | 1,533                   |       | —          |       | —                   |       | 1,534      |       |   |   |   |   |
| Exercise of stock options                                                       |       | 218                   |       | 3          |       | 3,731                   |       | —          |       | —                   |       | 3,734      |       |   |   |   |   |
| Excess tax benefit from stock option exercises                                  |       | —                |       | —     |       | 2,540                   |       | —          |       | —                   |       | 2,540      |       |   |   |   |   |
| Reclassification of equity award from liabilities                               |       | —                |       | —     |       | 1,422                   |       | —          |       | —                   |       | 1,422      |       |   |   |   |   |
| Balance as of June 30, 2007                                                |       | 5,963                 |       | $          | 60         |                    | $          | 80,657          |       | $                        | 14,200     |       | $          | (820 | ) | $ | 94,097 |   |   |   |   |   |

 

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

 

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                         | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                             | ** ** | **2007** | ** ** |
| **Cash  Flows from Operating Activities**                                          |       |                                 |       |   |   |
| Net  income                                                                        |       | $                                    | 3,395      |   | $ | 4,987 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |       |                                 |       |   |   |
| Depreciation  and amortization                                                     |       | 11,879                               |       | 11,868 |   |
| Stock-based  compensation expense                                                  |       | 1,780                                |       | 1,534 |   |
| Loss  on impairment of long-lived assets                                           |       | 1,339                                |       | 949 |   |
| Loss  (gain) on disposal of assets                                                 |       | 695                                  |       | (292 | ) |
| Loss  on extinguishment of debt                                                    |       | 97                                   |       | 9,423 |   |
| Accretion  of discount on senior notes                                             |       | —                               |       | 89 |   |
| Deferred  income tax benefit                                                       |       | (1,136                               | )          | (781 | ) |
| Amortization  of deferred financing costs                                          |       | 187                                  |       | 376 |   |
| Changes in assets and  liabilities:                                                |       |                                 |       |   |   |
| Decrease  (increase) in —                                                     |       |                                 |       |   |   |
| Trade  receivables                                                                 |       | 4,449                                |       | 700 |   |
| Inventories                                                                        |       | 5,276                                |       | (3,739 | ) |
| Prepaid  expenses and other current assets                                         |       | 163                                  |       | 3,817 |   |
| Other  non-current assets                                                          |       | 246                                  |       | (8 | ) |
| Increase  (decrease) in —                                                     |       |                                 |       |   |   |
| Accounts  payable, accrued expenses and other current liabilities                  |       | (12,541                              | )          | (5,726 | ) |
| Deferred  rent and other non-current liabilities                                   |       | 4,119                                |       | (1,544 | ) |
| Net  cash provided by operating activities                                         |       | 19,948                               |       | 21,653 |   |
|                                                                               |       |                                 |       |   |   |
| **Cash  Flows from Investing Activities**                                          |       |                                 |       |   |   |
| Purchase  of short-term investments                                                |       | —                               |       | (19,550 | ) |
| Proceeds  from sale of short-term investments                                      |       | —                               |       | 28,975 |   |
| Contribution  from (to) grantor trust                                              |       | 2,684                                |       | (2,662 | ) |
| Capital  expenditures                                                              |       | (12,368                              | )          | (12,896 | ) |
| Proceeds  from sale of property, plant and equipment                               |       | —                               |       | 85 |   |
| Purchase  of intangible assets                                                     |       | (88                                  | )          | (9 | ) |
| Net  cash used in by investing activities                                          |       | (9,772                               | )          | (6,057 | ) |
|                                                                               |       |                                 |       |   |   |
| **Cash  Flows from Financing Activities**                                          |       |                                 |       |   |   |
| Increase (decrease) in cash overdraft                                              |       | 1,785                                |       | (395 | ) |
| Proceeds  from issuance of long-term debt                                          |       | —                               |       | 90,000 |   |
| Repayment  of long-term debt                                                       |       | (14,115                              | )          | (115,498 | ) |
| Premium  on repurchase of long-term debt                                           |       | —                               |       | (6,469 | ) |
| Deferred  financing costs                                                          |       | (21                                  | )          | (1,019 | ) |
| Repurchase  of common stock                                                        |       | (118                                 | )          | — |   |
| Proceeds  from exercise of stock options                                           |       | 685                                  |       | 3,734 |   |
| Excess  tax benefit from exercise of stock options and restricted stock vesting    |       | —                               |       | 2,540 |   |
| Net  cash used in financing activities                                             |       | (11,784                              | )     | (27,107 | ) |
| **Net  Decrease in Cash and Cash Equivalents**                                     |       | (1,608                               | )     | (11,511 | ) |
| **Cash  and Cash Equivalents, Beginning of Period**                                |       | 10,130                               |       | 18,904 |   |
| **Cash  and Cash Equivalents, End of Period**                                      |       | $                                    | 8,522      |   | $ | 7,393 |   |
|                                                                               |       |                                 |       |   |   |
| Supplemental Disclosures of  Cash Flow Information:                                |       |                                 |       |   |   |
| Cash  paid for interest                                                            |       | $                                    | 5,587      |   | $ | 8,573 |   |
| Cash  paid (received) for income taxes                                             |       | $                                    | 539        |   | $ | (1,006 | ) |

 

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

 

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**MOTHERS WORK, INC. ANDSUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008**

(unaudited)

 

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

 

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

 

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

 

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

 

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

 

Basicearnings per share (“Basic EPS”) is computed by dividing net income by theweighted average number of common shares outstanding, excluding restrictedstock for which the restrictions have not lapsed.  Diluted earnings pershare (“Diluted EPS”) is computed by dividing net income by the weightedaverage number of common shares outstanding, after giving effect to thepotential dilution, if applicable, from the assumed lapse of restrictions onrestricted stock and from the assumed exercise of outstanding stock options.

 

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

 
| ** **                                                                     | ** ** | **Three Months Ended  June 30, 2008** | ** ** | **Three Months Ended  June 30, 2007** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                     | ** ** | **Net  Income**                            | ** ** | **Shares**                                 | ** ** | **EPS** | ** ** | **Net  Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic  EPS                                                                     |       | $                                          | 4,137      |                                       | 5,956      |   | $ | 0.69 |   | $ | 1,033 |   | 5,838 |   | $ | 0.18 |   |
| Incremental  shares from the assumed lapse of restrictions on restricted stock |       | —                                     |       | 23                                         |       | — |   | — |   | 5 |   | — |   |
| Incremental  shares from the assumed exercise of outstanding stock options     |       | —                                     |       | 70                                         |       | (0.01 | )  | — |   | 297 |   | (0.01 | )  |
|                                                                           |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Diluted  EPS                                                                   |       | $                                          | 4,137      |                                       | 6,049      |   | $ | 0.68 |   | $ | 1,033 |   | 6,140 |   | $ | 0.17 |   |

 

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| ** **                                                                     | ** ** | **Nine Months Ended  June 30, 2008** | ** ** | **Nine Months Ended  June 30, 2007** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                     | ** ** | **Net  Income**                           | ** ** | **Shares**                                | ** ** | **EPS** | ** ** | **Net  Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic  EPS                                                                     |       | $                                         | 3,395      |                                      | 5,915      |   | $ | 0.57 |   | $ | 4,987 |   | 5,789 |   | $ | 0.86 |   |
| Incremental  shares from the assumed lapse of restrictions on restricted stock |       | —                                    |       | 16                                        |       | — |   | — |   | 46 |   | (0.01 | ) |
| Incremental  shares from the assumed exercise of outstanding stock options     |       | —                                    |       | 108                                       |       | (0.01 | )  | — |   | 333 |   | (0.04 | ) |
|                                                                           |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Diluted  EPS                                                                   |       | $                                         | 3,395      |                                      | 6,039      |   | $ | 0.56 |   | $ | 4,987 |   | 6,168 |   | $ | 0.81 |   |

 

For the three months ended June 30, 2008and 2007, options for 231,400 and 160,545 shares were excluded from thecalculation of Diluted EPS as their effect would have been antidilutive.  For the nine months ended June 30, 2008and 2007, options for 218,298 and 70,515 shares were excluded from thecalculation of Diluted EPS as their effect would have been antidilutive.

 

**3.**                 INVENTORIES

** **

Inventories were comprised of the following(in thousands):

 

| ** **       | ** ** | **June 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|------------------|------------|------------------------|------------|-----------------------------|------------|
| Finished goods   |       | $                      | 86,910     |                        | $          | 91,860 |   |
| Work-in-progress |       | 2,691                  |       | 2,947                       |       |
| Raw materials    |       | 5,608                  |       | 5,678                       |       |
|             |       | $                      | 95,209     |                        | $          | 100,485 |   |

 

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

 

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

 

| ** **                                                        | ** ** | **June 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| Salaries,  wages and employee benefits                            |       | $                      | 8,981      |                        | $          | 11,106 |   |
| Income  taxes payable                                             |       | 960                    |       | 1,768                       |       |
| Interest                                                          |       | 1,010                  |       | 1,562                       |       |
| Deferred  rent                                                    |       | 4,371                  |       | 4,014                       |       |
| Sales  taxes                                                      |       | 3,211                  |       | 3,561                       |       |
| Insurance                                                         |       | 1,361                  |       | 1,664                       |       |
| Audit  and legal                                                  |       | 1,640                  |       | 4,814                       |       |
| Remaining  payout for redemption of Series A Preferred Stock |       | 679                    |       | 679                         |       |
| Accrued  store construction costs                                 |       | 494                    |       | 442                         |       |
| Gift  certificates and store credits                              |       | 4,951                  |       | 4,591                       |       |
| Other                                                             |       | 6,580                  |       | 7,432                       |       |
|                                                              |       | $                      | 34,238     |                        | $          | 41,633 |   |

 

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

 

OnDecember 8, 2006, the Company repurchased $25,000,000 principal amount ofits 111/4% senior notes(the “Senior Notes”) at 105.625% of the principal amount, plus accrued andunpaid interest.  In connection with the December 2006repurchase, the Company recorded a pre-tax charge totaling $2,093,000,representing the premium paid of $1,406,000 plus the write-off of unamortizeddebt issuance discount and deferred financing costs of $687,000.  On April 18, 2007, the Company completedthe redemption of the remaining outstanding amount of its Senior Notes at105.625% of the $90,000,000 principal amount, plus accrued and unpaidinterest.  In connection with the April 2007redemption, the Company recorded a pre-tax charge totaling $7,330,000,representing the premium paid of $5,063,000 plus the write-off of unamortizeddebt issuance discount and deferred financing costs of $2,267,000.

 

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OnMarch 13, 2007, the Company entered into a Term Loan and SecurityAgreement (the “Term Loan Agreement”) for a $90,000,000 senior secured TermLoan B due March 13, 2013 (the “Term Loan”), the proceeds of which werereceived on April 18, 2007 and were used to redeem the remaining$90,000,000 principal amount of the Senior Notes.  The interest rate on the Term Loan is equalto, at the Company’s election, either (i) the prime rate plus 1.00%, or (ii) theLIBOR rate plus the applicable margin. The applicable margin was initially fixed at 2.50% through and includingthe fiscal quarter ended September 30, 2007.  Thereafter, the applicable margin for LIBORrate borrowings is either 2.25% or 2.50%, depending on the Company’sConsolidated Leverage Ratio (as defined). Based upon the Company’s applicable quarterly Consolidated LeverageRatio during the first nine months of fiscal 2008, the applicable margin forLIBOR rate borrowings remained at 2.50% for the first nine months of fiscal2008.  The Company is required to makeminimum repayments of the principal amount of the Term Loan in quarterlyinstallments of $225,000 each. Additionally, the Term Loan can be prepaid at the Company’s option, inpart or in whole, at any time without any prepayment premium or penalty.  During the first nine months of fiscal 2008,the Company prepaid $13,000,000 of the outstanding Term Loan.  At June 30, 2008, the Company’sindebtedness under the Term Loan Agreement was $75,875,000.

 

TheTerm Loan is secured by a security interestin the Company’s accounts receivable, inventory, real estate interests, letterof credit rights, cash, intangibles and certain other assets. The securityinterest granted to the Term Lenders is, in certain respects, subordinate tothe security interest granted to the Credit Facility Lender.  The Term Loan Agreement imposescertain restrictions on the Company’s ability to, among other things, incuradditional indebtedness, pay dividends, repurchase stock, and enter into othervarious types of transactions.  The TermLoan Agreement also contains quarterly financial covenants that require theCompany to maintain a specified maximum permitted Consolidated Leverage Ratioand a specified minimum permitted Consolidated Interest Coverage Ratio (asdefined).  Since the inception of theTerm Loan Agreement, including the nine month period ended June 30, 2008,the Company was in compliance with the financial covenants of its Term LoanAgreement.

 

Inorder to mitigate the Company’s floating rate interest risk on the variablerate Term Loan, the Company entered into an interest rate swap agreement withthe Agent bank for the Term Loan that commenced on April 18, 2007, thedate the $90,000,000 Term Loan proceeds were received, and expires on April 18,2012.  The interest rate swap agreementenables the Company to effectively convert an amount of the Term Loan equal tothe notional amount of the interest rate swap from a floating interest rate ofLIBOR plus 2.50% (subject to reduction to LIBOR plus 2.25% if the Company achievesa specified leverage ratio), to a fixed interest rate of 7.50% (subject toreduction to 7.25% if the Company achieves a specified leverage ratio) for thesignificant majority of the Term Loan. The notional amount of the interest rate swap was $75,000,000 at theinception of the swap agreement and decreases over time to a notional amount of$5,000,000 at the expiration date.  Thenotional amount of the swap was $57,500,000 as of June 30, 2008 and overthe next eighteen months decreases as follows: to $50,000,000 starting October 20, 2008; to $42,500,000 starting April 20,2009; and to $35,000,000 starting October 19, 2009.

 

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

 

**6.****                ****INCOME TAXES**

 

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

 

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

 

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

 

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

 

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

 

**7.****                ****RETIREMENT PLANS**

 

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

 

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

 

| ** **                          | ** ** | **Three Months Ended,  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **2008**                               | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Service  cost                       |       | $                                      | 243        |                                 | $          | 393 |   | $ | 729 |   | $ | 524 |   |
| Interest  cost                      |       | 45                                     |       | 29                                   |       | 135 |   | 39 |   |
| Amortization  of prior service cost |       | 88                                     |       | 89                                   |       | 264 |   | 118 |   |
| Total  net periodic benefit cost    |       | $                                      | 376        |                                 | $          | 511 |   | $ | 1,128 |   | $ | 681 |   |

 

On April 30, 2007, the Company made an initialrequired contribution of $2,662,000 to a Grantor Trust, which wasestablished for the purpose of accumulating assets in anticipation of theCompany’s payment obligations under the SERP Agreements.  On November 27,2007, the Company made an additional required contribution to the Grantor Trustof $1,160,000.  In order to impact positively the Company’s ability to comply with theConsolidated Leverage Ratio covenant of its Term Loan Agreement at March 31,2008, with the consent of the SERP Executives the Company withdrew $1,000,000from the Grantor Trust on March 28, 2008. The withdrawn funds were used to repay indebtedness under the CreditFacility.

 

On May 20, 2008, theCompany entered into (i) a Letter Agreement with the SERP Executives andthe trustee for the Grantor Trust (the “Trustee”), and (ii) an amendmentto the Grantor Trust agreement with the Trustee (collectively the “Agreements”). The Agreements amended the SERP Agreements and the Grantor Trust agreement toprovide for the Company to deliver an irrevocable standby letter of credit tothe Trustee in an amount equal to the Company’s then current funding obligationunder the SERP Agreements, which was $3,885,000.  As provided in theAgreements, in the third quarter of fiscal 2008 the Company received adistribution of the remaining assets held in the Grantor Trust, amounting to$2,844,000.

 

The amendments affected by theAgreements also allow for, at the Company’s option, the issuance from time totime of irrevocable standby letters of credit, or the increase of size of anirrevocable standby letter of credit already held by the Trustee, in lieu ofany deposit to the Grantor Trust otherwise required in the future.  Inaddition, the Agreements permit the Company, from time to time at its sole discretion,to reduce the size of any irrevocable standby letter of credit issued to theTrustee, so long as the Company simultaneously funds the Grantor Trust with anamount of cash equal to the amount of the reduction of the letter of credit.

 

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**8.****             ****NEW ACCOUNTING PRONOUNCEMENTS**

 

SFAS No. 157

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value, establishesa framework for measuring fair value in U.S. generally accepted accountingprinciples, and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years, for financial assets and liabilitiesthat are measured at fair value on a recurring basis.  The FASB issued a one-year deferral of SFAS No. 157’sfair value measurement requirements for non-financial assets and liabilitiesthat are not required or permitted to be measured at fair value on a recurringbasis.  The impact from adoption ofSFAS No. 157, if any, on the Company’s consolidated financial position orresults of operations has not yet been determined.

 

SFASNo. 159

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities.”  SFAS No. 159provides companies with an option to report selected financial assets andliabilities at fair value and requires entities to display the fair value ofthose assets and liabilities for which the company has chosen to use fair valueon the face of the balance sheet.  SFAS No. 159is effective for financial statements issued for fiscal years beginning after November 15,2007.  The impact from adoption ofSFAS No. 159, if any, on the Company’s consolidated financial position orresults of operations has not yet been determined.

 

**9.****                ****COMMITMENTS AND CONTINGENCIES**

 

From time to time, the Company is named as adefendant in legal actions arising from normal business activities. Litigationis inherently unpredictable and although the amount of any liability that couldarise with respect to currently pending actions cannot be accurately predicted,the Company does not believe that the resolution of any pending action willhave a material adverse effect on its financial position, results of operationsor liquidity.

 

**10.**          SEGMENT AND ENTERPRISE WIDE DISCLOSURES

** **

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

** **

***GeographicInformation***.  Informationconcerning the Company’s operations by geographic area was as follows (inthousands):

** **

| ** **                               | ** ** | **Three Months Ended,  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2008**                               | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Net Sales to Unaffiliated  Customers** |       |                                   |       |                                 |       |   |   |   |   |
| United States                            |       | $                                      | 146,024    |                                 | $          | 147,530 |   | $ | 418,268 |   | $ | 431,826 |   |
| Canada                                   |       | $                                      | 6,200      |                                 | $          | 5,697 |   | $ | 15,837 |   | $ | 13,742 |   |

 

| ** **            | ** ** | **June 30,  2008** | ** ** | **September 30,  2007** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|-------------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| **Long-Lived Assets** |       |                    |       |                         |       |       |       |       |       |
| United States         |       | $                       | 64,824     |                         | $          | 67,125     |       |       |       |   |   |
| Canada                |       | $                       | 2,236      |                         | $          | 2,102      |       |       |       |   |   |
| Costa Rica            |       | $                       | 207        |                         | $          | 207        |       |       |       |   |   |

** **

***Major Customers*****. **Forthe periods presented, the Companydid not have any one customer who represented more than 10% of its net sales.

** **

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** **

**11.**          INTEREST EXPENSE, NET

** **

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

 

| ** **                  | ** ** | **Three Months Ended,  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2008**                               | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest  expense           |       | $                                      | 1,612      |                                 | $          | 2,066 |   | $ | 5,428 |   | $ | 8,283 |   |
| Interest  income            |       | (6                                     | )          | (23                                  | )          | (23 | ) | (318 | ) |
| Other  investment loss, net |       | 105                                    |       | —                               |       | 30 |   | — |   |
| Interest  expense, net      |       | $                                      | 1,711      |                                 | $          | 2,043 |   | $ | 5,435 |   | $ | 7,965 |   |

 

**12.**          SUBSEQUENT EVENT

** **

On July 29, 2008, the Company announcedthat its Board of Directors approved a program to repurchase up to $7 millionof the Company’s outstanding common stock. Under the program, the Company may repurchase shares from time to timethrough solicited or unsolicited transactions in the open market or innegotiated or other transactions.  Theprogram will be in effect until the end of July 2010.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

Ourfiscal year ends on September 30. All references in this discussion to our fiscal years refer to thefiscal year, or periods within the fiscal year, ended on September 30 inthe year mentioned.  For example, our “fiscal2008” will end on September 30, 2008.

 

**Restructuring**

 

OnJuly 1, 2008, the Company announced that it was streamlining itsmerchandise brands and store nameplates and had implemented cost reductions inorder to simplify its business model, reduce overhead costs and improve andtighten its merchandise assortments. Pursuant to the strategic restructuring, the Company will re-brand itsMimi Maternity® merchandise brand under its A Pea in the Pod® brand beginningin November 2008.  The Company alsoplans to streamline its store nameplates by January 2009, by renaming itssingle-brand Mimi Maternity stores as A Pea in the Pod, and by renaming itsmulti-brand Mimi Maternity stores as Destination Maternity®.  The Company expects to incur pre-tax expenseof approximately $0.9 million from its restructuring and cost reductionactions, consisting of approximately $0.5 million for cash severance expenseand severance-related benefits, and approximately $0.4 million of non-cashexpense for accelerated depreciation expense of existing store signs resultingfrom planned store signage changes.   Ofthe $0.9 million expense associated with these actions, the Company expectsapproximately $0.7 million to be recorded in the fourth quarter of fiscal 2008,and approximately $0.2 million to be recorded in the first quarter of fiscal2009. The Company expects to realize approximately $5 million of annualizedpre-tax expense savings from these actions, beginning in the fourth quarter offiscal 2008.

 

**Results of Operations**

 

Thefollowing tables set forth certain operating data as a percentage of net salesand as a percentage change for the three and nine months ended June 30:

 
| ** **                                        | ** ** | **% of Net Sales (1)**                 | ** ** | **% Period to Period  Increase (Decrease)** | ** ** |
|---------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------------|------------|
| ** **                                        | ** ** | **Three  Months Ended  June 30,** | ** ** | **Nine  Months Ended  June 30,**       | ** ** | **Three  Months****Ended  June 30,** | ** ** | **Nine  Months  Ended  June 30,** | ** ** |
| ** **                                        | ** ** | **2008**                               | ** ** | **2007**                                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2008 vs.  2007** | ** ** | **2008 vs.  2007** | ** ** |
| Net  sales                                        |       | 100.0                                  | %          | 100.0                                       | %          | 100.0 | % | 100.0 | % | (0.7 | )% | (2.6 | )% |
| Cost  of goods sold (2)                           |       | 48.6                                   |       | 47.1                                        |       | 49.4 |   | 47.4 |   | 2.7 |   | 1.4 |   |
| Gross  profit                                     |       | 51.4                                   |       | 52.9                                        |       | 50.6 |   | 52.6 |   | (3.6 | )  | (6.1 | )  |
| Selling,  general and administrative expenses (3) |       | 45.7                                   |       | 45.7                                        |       | 48.0 |   | 46.8 |   | (0.7 | )  | (0.1 | )  |
| Operating  income                                 |       | 5.7                                    |       | 7.2                                         |       | 2.6 |   | 5.7 |   | (21.9 | ) | (55.5 | ) |
| Interest  expense, net                            |       | 1.1                                    |       | 1.3                                         |       | 1.3 |   | 1.8 |   | (16.3 | )  | (31.8 | )  |
| Loss  on extinguishment of debt                   |       | 0.0                                    |       | 4.8                                         |       | 0.0 |   | 2.1 |   | (99.2 | ) | (99.0 | ) |
| Income  before income taxes                       |       | 4.5                                    |       | 1.1                                         |       | 1.3 |   | 1.8 |   | N.M. |   | (28.5 | ) |
| Income  tax provision                             |       | 1.8                                    |       | 0.4                                         |       | 0.6 |   | 0.7 |   | N.M. |   | (23.2 | ) |
| Net  income                                       |       | 2.7                                    | %          | 0.7                                         | %          | 0.8 | % | 1.1 | % | N.M. |   | (31.9 | ) |

 

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N.M.—Notmeaningful

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

(2)          The “Cost of goods sold” line item includes merchandise costs (includingcustoms duty expenses), expenses related to inventory shrinkage, productrelated corporate expenses (including expenses related to our payroll, benefitcosts and operating expenses of our buying departments), inventory reserves(including lower of cost or market reserves), inbound freight charges,purchasing and receiving costs, inspection costs, warehousing costs, internaltransfer costs, and the other costs of our distribution network.

(3)          The “Selling, general and administrative expenses” line item includes**advertising and marketing expenses, corporateadministrative expenses, store expenses (including store payroll and storeoccupancy expenses), store opening and store closing expenses, and store assetimpairment charges.

 

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The following tablesets forth certain information concerning the number of our stores and leaseddepartments for the periods indicated:

 

| ** **           | ** ** | **Three Months Ended** | ** ** |
|----------------------|------------|------------------------|------------|
| ** **           | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
| **Retail Locations** | ** ** | **Stores**             | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning  of period |       | 766                    |       | 771 |   | 1,537 |   | 795 |   | 821 |   | 1,616 |   |
| Opened               |       | 7                      |       | — |   | 7 |   | 5 |   | 2 |   | 7 |   |
| Closed               |       | (12                    | )          | (477 | ) | (489 | ) | (13 | ) | (11 | ) | (24 | ) |
| End  of period       |       | 761                    |       | 294 |   | 1,055 |   | 787 |   | 812 |   | 1,599 |   |

 

| ** **           | ** ** | **Nine Months Ended**  | ** ** |
|----------------------|------------|------------------------|------------|
| ** **           | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
| **Retail Locations** | ** ** | **Stores**             | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning  of period |       | 781                    |       | 795 |   | 1,576 |   | 810 |   | 731 |   | 1,541 |   |
| Opened               |       | 24                     |       | 4 |   | 28 |   | 16 |   | 121 |   | 137 |   |
| Closed               |       | (44                    | )          | (505 | ) | (549 | ) | (39 | ) | (40 | ) | (79 | ) |
| End  of period       |       | 761                    |       | 294 |   | 1,055 |   | 787 |   | 812 |   | 1,599 |   |

 

**Three Months Ended June 30, 2008 and 2007**

 

***Net Sales.***  Our net sales for the thirdquarter of fiscal 2008 decreased by 0.7%, or $1.0 million, to $152.2 millionfrom $153.2 million for the third quarter of fiscal 2007.  The decrease in net sales versus last yearresulted primarily from a decrease in sales from our leased department andlicensed relationships, largely due to a decrease in Sears® leaseddepartment sales, as well as reduced salesvolume from the ongoing closure of certain underperforming stores,substantially offset by an increase in comparable store sales and increasedinternet sales. Comparable store sales increased by 2.4% for the third quarterof fiscal 2008, based on 989 retail locations, versus a comparable store salesdecrease of 8.2% for the third quarter of fiscal 2007, based on 1,393retail locations.  We attribute the increase in comparable storesales of 2.4% for the third quarter of fiscal 2008, to comparatively weakersales results from a year ago and the positive impact from refinement of ourmerchandise assortments and our in-store merchandise presentation, despite thecontinued weak overall economic and retail environment.

 

Asof June 30, 2008, we operated a total of 761 stores and 1,055 total retaillocations, compared to 787 stores and 1,599 total retail locations as of June 30,2007.  In addition, our Oh Baby byMotherhoodTM collection is available at Kohl’s® stores throughout the UnitedStates.  During the third quarter offiscal 2008, we opened seven stores, including three multi-brand storeopenings, and closed 12 stores, with seven of the store closings related tomulti-brand store openings.  In addition,during the third quarter of fiscal 2008, the Company closed 477 leaseddepartment locations within Sears® stores. As we disclosed in September 2007, pursuant to mutual agreement ourrelationship with Sears ended in June 2008.

 

***Gross Profit.***  Our gross profit for the thirdquarter of fiscal 2008 decreased by 3.6%, or $2.9 million, to $78.2 millionfrom $81.1 million for the third quarter of fiscal 2007, primarily reflectingthe effect of our lower gross margin and lower sales volume compared to lastyear.  Gross profit as a percentage ofnet sales (gross margin) for the third quarter of fiscal 2008 was 51.4%compared to 52.9% for the third quarter of fiscal 2007.  The decrease ingross margin of 1.5 percentage points compared to the prior year resultedprimarily from more price promotional activity compared to last year, increasedproduct costs and the effect of spreading fixed product overhead costs over alower sales volume.

 

***Selling, General andAdministrative Expenses.***  Our selling, general and administrativeexpenses for the third quarter of fiscal 2008 decreased by 0.7%, or $0.5million, to $69.6 million from $70.1 million for the third quarter offiscal 2007.  This decrease in expensefor the quarter resulted primarily from a decrease in legal expenses partiallyoffset by increased store closing costs. As a percentage of net sales, selling, general and administrativeexpenses remained consistent at 45.7% for the third quarters of fiscal 2008 andfiscal 2007.  We incurred impairmentcharges for write-downs of store long-lived assets of $0.4 million for thethird quarter of fiscal 2008, as compared to $0.6 million for the third quarterof fiscal 2007.  We recorded charges of$0.4 million related to store closings for the third quarter of fiscal 2008, ascompared to third quarter fiscal 2007 store closing charges of $15,000.

 

***Operating Income.***  Our operating income for the third quarter of fiscal 2008decreased by 21.9%, or approximately $2.5 million, to $8.6 million from$11.1 million for the third quarter of fiscal 2007, due to the lower grossmargin, lower sales volume and associated gross profit reduction, partiallyoffset by lower selling, general and administrative expenses.  Operating income as

 

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a percentage of net sales (operating income margin) for the third quarter of fiscal 2008 decreased to5.7% from 7.2% for the third quarter of fiscal 2007.  The decrease in operating income margin wasdue to our lower gross margin compared to the third quarter of fiscal 2007.

 

***Interest Expense, Net.***  Our net interest expense for thethird quarter of fiscal 2008 decreased by 16.3%, or $0.3 million, to $1.7million from $2.0 million for the third quarter of fiscal 2007.  This decrease was primarily due to the lowerinterest rate on our new $90.0 million Term Loan compared to the interest rateon our Senior Notes and, to a much lesser extent, our lower debt level,primarily as a result of the $5 million Term Loan prepayment in March 2008 andthe $8 million Term Loan prepayment in June 2008, partially offset by higheraverage borrowings under our credit facility. During the third quarter of fiscal 2008, our average daily level ofdirect borrowings under our credit facility was $3.4 million compared to $1.1million for the third quarter of fiscal 2007. We did not have any direct borrowings under our credit facility as of June 30,2008.

 

***Loss on Extinguishment of Debt*****. **In June 2008, we prepaid $8.0 million principal amount of ouroutstanding Term Loan.  The $8.0 millionTerm Loan prepayment resulted in a third quarter fiscal 2008 pre-tax charge of$59,000, representing the write-off of unamortized deferred financingcosts.  In April 2007, we repurchased the remaining $90.0 million principalamount of our outstanding Senior Notes with the proceeds from a new TermLoan.  The $90.0 million Senior Noterepurchase resulted in a third quarter fiscal 2007 pre-tax charge of $7.3million, representing the premium paid plus the write-off of unamortizeddebt issuance discount and deferred financing costs.

 

***Income Tax Provision.***  Our effective tax rate was39.8% for the third quarter of fiscal 2008 and 39.0% for the third quarter offiscal 2007.  We expect our effective taxrate for the full year fiscal 2008 to be approximately 46%.  Our third quarter and full year fiscal 2008income tax rates reflect the effect of additional income tax expense (includinginterest and penalties) being recognized in connection with the implementationand ongoing accounting requirements of FIN No. 48.

 

***Net Income.***  Net income for the third quarterof fiscal 2008 was $4.1 million, or $0.68 per share (diluted), compared to netincome of $1.0 million, or $0.17 per share (diluted), for the third quarter offiscal 2007.

 

Our average diluted shares outstanding of 6,049,000 forthe third quarter of fiscal 2008 was 1.5% lower than the 6,140,000 averagediluted shares outstanding for the third quarter of fiscal 2007.  The decrease inaverage diluted shares outstanding reflects the lower dilutive impact ofoutstanding stock options in the third quarter of fiscal 2008 compared to thethird quarter of fiscal 2007, as a result of the lower average market price forthe Company’s common stock, partially offset by higher shares outstanding inthe third quarter of fiscal 2008 compared to the third quarter of fiscal 2007,as a result of stock option exercises and vesting of restricted stock awards.

 

**Nine Months Ended June 30, 2008 and 2007**

 

***Net Sales.***  Our net sales for the first ninemonths of fiscal 2008 decreased by 2.6%, or $11.5 million, to $434.1 millionfrom $445.6 million for the first nine months of fiscal 2007.  The decrease in sales versus last yearresulted primarily from a decrease in sales from our leased department andlicensed relationships, largely due to a decrease in Sears leased departmentsales, as well as reduced sales volume from the ongoing closure of certainunderperforming stores and a decrease in comparable store sales, partiallyoffset by increased internet sales. Comparable store sales decreased by 0.6% for the first nine months of fiscal2008, based on 842 retail locations, versus a comparable store sales decreaseof 4.1% for the first nine months of fiscal 2007, based on 1,365retail locations.

 

Duringthe first nine months of fiscal 2008, we opened 24 stores, including fivemulti-brand store openings, and closed 44 stores, with 16 of the store closingsrelated to multi-brand store openings. In addition, during the first nine months of fiscal 2008, the Companyclosed 501 leased department locations within Sears stores, pursuant to mutualagreement with Sears and, as we disclosed in September 2007, ourrelationship with Sears ended in June 2008.

 

***Gross Profit.***  Our gross profit for the firstnine months of fiscal 2008 decreased by 6.1%, or approximately $14.3 million,to $219.9 million from $234.2 million for the first nine months of fiscal 2007,primarily reflecting the effect of our lower gross margin and lower salesvolume compared to last year.  Grossprofit as a percentage of net sales (gross margin) for the first nine months offiscal 2008 was 50.6%, compared to 52.6% for the first nine months of fiscal2007.  The decrease in gross margin of 2.0 percentage pointscompared to the prior year resulted primarily from more price promotionalactivity compared to last year, increased product costs and the effect ofspreading fixed product overhead costs over a lower sales volume.

 

***Selling, General andAdministrative Expenses.***  Our selling, general and administrativeexpenses for the first nine months of fiscal 2008 decreased by 0.1%, or $0.2million, to $208.5 million from $208.7 million for the first nine monthsof

 

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fiscal 2007.  Thisslight decrease in expense for the nine-month period resulted primarily fromdecreased legal expenses offset by increases in store closing costs andimpairment charges for write-downs of store long-lived assets.  As a percentage of net sales, selling,general and administrative expenses for the first nine months of fiscal 2008were 48.0% compared to 46.8% for the first nine months of fiscal 2007.  This increase in the expense percentage forthe nine-month period resulted primarily from negative expense leverage from thedecrease in sales, partially offset by the $0.2 million decrease in selling,general and administrative expenses.  Weincurred impairment charges for write-downs of store long-lived assets of $1.3million for the first nine months of fiscal 2008, as compared to $0.9 millionfor the first nine months of fiscal 2007. We recorded charges of $0.9 million related to store closings for thefirst nine months of fiscal 2008, as compared to a gain of $0.1 million fromstore closings in the first nine months of fiscal 2007.

 

***Operating Income.***  Our operating income for the first nine months of fiscal 2008decreased by 55.5%, or $14.2 million, to $11.4 million from $25.6 millionfor the first nine months of fiscal 2007, primarily due to the lower grossmargin, lower sales volume and associated gross profit reduction.  Operating income as a percentage of net sales(operating income margin) for thefirst nine months of fiscal 2008 decreased to 2.6% from 5.7% for the first ninemonths of fiscal 2007.  The decrease inoperating income margin was due to our lower gross margin and our higheroperating expense ratio compared to the first nine months of fiscal 2007.

 

***Interest Expense, Net.***  Our net interest expense for thefirst nine months of fiscal 2008 decreased by 31.8%, or approximately $2.6million, to $5.4 million from $8.0 million for the first nine months offiscal 2007.  This decrease was primarilydue to the lower interest rate on our new $90.0 million Term Loan, which wasused to redeem the remaining outstanding balance of our Senior Notes and, to alesser extent, our lower debt level, as a result of the repurchase of $25.0million of our Senior Notes in December 2006, the $5 million Term Loanprepayment in March 2008 and the $8 million Term Loan prepayment in June 2008,partially offset by higher average borrowings under our credit facility.  During the first nine months of fiscal 2008,our average daily level of direct borrowings under our credit facility was $5.3million compared to $0.7 million for the first nine months of fiscal 2007.  We did not have any direct borrowings underour credit facility as of June 30, 2008.

 

***Loss on Extinguishment of Debt*****. **During the first nine months of fiscal 2008, we prepaid $13.0 millionprincipal amount of our outstanding Term Loan. The $13.0 million Term Loan prepayments resulted in pre-tax chargestotaling $0.1 million.  During thefirst nine months of fiscal 2007, werepurchased $25.0 million principal amount of Senior Notes in December 2006and, with the proceeds of a new Term Loan, we redeemed the remaining $90.0 millionprincipal amount of Senior Notes in April 2007.  The $115.0 million of Senior Note repurchasesresulted in pre-tax charges totaling $9.4 million, representing thepremium paid plus the write-off of unamortized debt issuance discount anddeferred financing costs.

 

***Income Tax Provision.***  Our effective tax rate was41.9% for the first nine months of fiscal 2008 and 39.0% for the first ninemonths of fiscal 2007.  Our income taxrate for the first nine months of fiscal 2008 reflects the effect of additionalincome tax expense (including interest and penalties) being recognized inconnection with the implementation and ongoing accounting requirements of FIN No. 48.

 

***Net Income.***  Net income for the first ninemonths of fiscal 2008 was $3.4 million, or $0.56 per share (diluted), comparedto net income of $5.0 million, or $0.81 per share (diluted), for the first ninemonths of fiscal 2007.  Net income forthe first nine months of fiscal 2008 includes an after-tax debt extinguishmentcharge of $59,000, or $0.01 per share (diluted).  Net income for the first nine months offiscal 2007 includes an after-tax debt extinguishment charge of $5.7 million,or $0.93 per share (diluted).

 

Our average diluted shares outstanding of 6,039,000 forthe first nine months of fiscal 2008 was 2.1% lower than the 6,168,000 averagediluted shares outstanding for the first nine months of fiscal 2007.  The decrease inaverage diluted shares outstanding reflects the lower dilutive impact ofoutstanding stock options and restricted stock in the first nine months offiscal 2008 compared to the first nine months of fiscal 2007, as a result ofthe lower average market price for the Company’s common stock, partially offsetby higher shares outstanding in the first nine months of fiscal 2008 comparedto the first nine months of fiscal 2007, as a result of stock option exercisesand vesting of restricted stock awards.

 

**Seasonality**

 

Our business, like that of many other retailers, isseasonal.  Our quarterly net sales havehistorically been highest in our third fiscal quarter, corresponding to theSpring selling season, followed by the first fiscal quarter, corresponding tothe Fall/holiday selling season.  Giventhe typically higher gross margin we experience in the third fiscal quartercompared to other quarters, the relatively fixed nature of most of ouroperating expenses and interest expense, and the historically higher saleslevel in the third quarter, we have typically generated a very significantpercentage of our full year operating income

 

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andnet income during the third quarter.  Results for any quarter are not necessarilyindicative of the results that may be achieved for a full fiscal year. Quarterly results may fluctuate materially depending upon, among other things,the timing of new store openings and new leased department openings, net salesand profitability contributed by new stores and leased departments, increasesor decreases in comparable store sales, the timing of the fulfillment ofpurchase orders under our product and license arrangements, adverse weatherconditions, shifts in the timing of certain holidays and promotions, changes ininventory and production levels and the timing of deliveries of inventory, andchanges in our merchandise mix.

 

**Liquidity and Capital Resources**

 

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

 

Cash and cash equivalents decreased by $1.6 millionduring the first nine months of fiscal 2008 compared to a decrease of $11.5million for the first nine months of fiscal 2007.  Cash provided byoperations of $19.9 million for the first nine months of fiscal 2008 decreasedby approximately $1.8 million from the $21.7 million cash provided byoperations for the first nine months of fiscal 2007.  This decreasein cash provided by operations was primarily the result of lower net income inthe first nine months of fiscal 2008 compared to the first nine months offiscal 2007, substantially offset by other working capital changes thatprovided cash in the first nine months of fiscal 2008 compared to a use of cashin the first nine months of fiscal 2007. During the first nine months of fiscal 2008, we used the majority of ourcash provided by operations to pay for capital expenditures.  We fundedrepayments of long-term debt in the first nine months of fiscal 2008, including$13.0 million of prepayments of our Term Loan, with the remaining cash providedby operations, the cash received from the Grantor Trust, cash generated fromcash overdraft timing, and the drawdown of a portion of our cash balance.  During the first nine months of fiscal2007, we used the majority of our cash provided by operations to pay forcapital expenditures.  We funded the $25.0 million repurchase of ourSenior Notes by utilizing available cash, cash generated by net proceeds fromthe sales (net of purchases) of short-term investments, cash generatedfrom stock option exercises, as well as the remaining cash provided byoperations.

 

Forthe first nine months of fiscal 2008, we spent $12.4 million on capitalexpenditures, including $9.3 million for leasehold improvements, fixturesand equipment principally for new store facilities, as well as improvements toexisting stores, and $3.1 million for our information systems anddistribution and corporate facilities. This compares to $12.9 million in capital expenditures for thefirst nine months of fiscal 2007, of which $8.9 million was spent for newstore facilities and improvements to existing stores and retail locations, and$4.0 million for our information systems and distribution and corporatefacilities.

 

OnDecember 8, 2006, we completed the repurchase of $25.0 million principalamount of our Senior Notes at 105.625% of the principal amount, plus accruedand unpaid interest.  On April 18,2007, we completed the redemption of the remaining $90.0 million principalamount of our outstanding Senior Notes through a new Term Loan financing.  The new Term Loan extended the maturity for$90.0 million principal amount of our debt from August 1, 2010 (thematurity date of the redeemed Senior Notes) to March 13, 2013 (thematurity date of the new Term Loan), with quarterly required principal paymentsof $225,000.  The December 2006 and April 2007redemptions of the Senior Notes, which were both at a price of 105.625% ofprincipal amount, plus accrued interest, resulted in “Loss on extinguishment ofdebt” of $9.4 million on a pre-tax basis, consisting of the $6.5 million cashredemption premium and $2.9 million of non-cash expense from the write-off ofunamortized deferred financing costs and debt issuance costs.

 

In March 2007, we entered into SupplementalExecutive Retirement Agreements (the “SERP Agreements”) with our Chairman ofthe Board and Chief Executive Officer and our President and Chief CreativeOfficer (the “SERP Executives”).  In April 2007,we made an initial required contribution of $2.7 million to a Grantor Trust,which was established for the purpose of accumulating assets in anticipation ofour payment obligations under the SERP Agreements.  In November 2007, we made an additionalrequired contribution to the Grantor Trust of $1.2 million.  In order to impact positively our ability tocomply with the Consolidated Leverage Ratio covenant of our Term Loan Agreementat March 31, 2008, with the consent of the SERP Executives we withdrew$1.0 million from the Grantor Trust on March 28, 2008.  The withdrawn funds were used to repayindebtedness under our credit facility. On May 20, 2008, we entered into (i) a Letter Agreement withthe SERP Executives and the trustee for the Grantor Trust (the “Trustee”), and (ii) anamendment to the Grantor Trust agreement with the Trustee (collectively the “Agreements”). The Agreements amended the SERP Agreements and the Grantor Trust

 

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agreementto provide for us to deliver an irrevocable standby letter of credit to theTrustee in an amount equal to our then current funding obligation under theSERP Agreements, which was $3.9 million.  As provided in the Agreements,in the third quarter of fiscal 2008 we received a distribution of the remainingassets held in the Grantor Trust amounting to $2.8 million.  Theamendments affected by the Agreements also allow for the issuance, from time totime, of irrevocable standby letters of credit, or the increase of size of anirrevocable standby letter of credit already held by the Trustee, in lieu ofany deposit to the Grantor Trust otherwise required in the future.  Inaddition, the Agreements permit us, from time to time at our sole discretion,to reduce the size of any irrevocable standby letter of credit issued to theTrustee, so long as we simultaneously fund the Grantor Trust with an amount ofcash equal to the amount of the reduction of the letter of credit.

 

OnMarch 13, 2007, we entered into a Term Loan Agreement for a $90.0 millionsenior secured Term Loan B due March 13, 2013, the proceeds of which werereceived on April 18, 2007 and were used to redeem the remaining $90.0million principal amount of our Senior Notes. The interest rate on the Term Loan is equal to, at our election, either (i) theprime rate plus 1.00%, or (ii) the LIBOR rate plus the applicablemargin.  The applicable margin wasinitially fixed at 2.50% through and including the fiscal quarter ended September 30,2007.  Thereafter, the applicable marginfor LIBOR rate borrowings is either 2.25% or 2.50%, depending on ourConsolidated Leverage Ratio (as defined). Based upon our applicable quarterly Consolidated Leverage Ratio duringthe first nine months of fiscal 2008, the applicable margin for LIBOR rateborrowings remained at 2.50% for the first nine months of fiscal 2008.  We are required to make minimum repayments ofthe principal amount of the Term Loan in quarterly installments of $225,000each.  Additionally, the Term Loan can beprepaid at our option, in part or in whole, at any time without any prepaymentpremium or penalty.  On March 19,2008, we prepaid $5.0 million of the outstanding Term Loan and on June 19,2008 we prepaid $8.0 million of the outstanding Term Loan.  At June 30, 2008, our indebtedness underthe Term Loan Agreement was $75.9 million.

 

The Term Loan issecured by a security interest in our accounts receivable, inventory, realestate interests, letter of credit rights, cash, intangibles and certain otherassets. The security interest granted to the Term Lenders is, in certainrespects, subordinate to the security interest granted to the Credit FacilityLender.  The Term Loan Agreementimposes certain restrictions on our ability to, among other things, incuradditional indebtedness, pay dividends, repurchase stock, and enter into othervarious types of transactions.  The TermLoan Agreement also contains quarterly financial covenants that require us tomaintain a specified maximum permitted Consolidated Leverage Ratio and aspecified minimum permitted Consolidated Interest Coverage Ratio (asdefined).  Since the inception of theTerm Loan Agreement, including all of the nine month period ended June 30,2008, we were in compliance with all covenants of our Term Loan Agreement.

 

Inorder to mitigate our floating rate interest risk on the variable rate TermLoan, we entered into an interest rate swap agreement with the Agent bank forthe Term Loan that commenced on April 18, 2007, the date the $90.0 millionTerm Loan proceeds were received, and expires on April 18, 2012.  The interest rate swap agreement enables usto effectively convert an amount of the Term Loan equal to the notional amountof the interest rate swap from a floating interest rate of LIBOR plus 2.50%(subject to reduction to LIBOR plus 2.25% if we achieve a specified leverageratio), to a fixed interest rate of 7.50% (subject to reduction to 7.25% if weachieve a specified leverage ratio) for the significant majority of the TermLoan.  The notional amount of theinterest rate swap was $75.0 million at the inception of the swap agreement anddecreases over time to a notional amount of $5.0 million at the expirationdate.  The notional amount of the swapwas $57.5 million as of June 30, 2008 and over the next eighteen monthsdecreases as follows:  to $50.0 millionstarting October 20, 2008; to $42.5 million starting April 20, 2009;and to $35.0 million starting October 19, 2009.

 

Inconnection with the Term Loan transaction, we amended our existing $60.0million Credit Facility in order to permit the new Term Loan financing.  This amendment of the Credit Facility alsoextended its maturity from October 15, 2009 to March 13, 2012,increased its size to $65.0 million, and reduced the LIBOR-based interest rateoption under the facility by 0.25%.  Thereare no financial covenant requirements under the Credit Facility provided thatExcess Availability (as defined) does not fall below 10% of the Borrowing Base(as defined).  If Excess Availabilitywere to fall below 10% of the Borrowing Base, we would be required to meet aspecified minimum Fixed Charge Coverage Ratio (as defined).  During the first nine months of fiscal 2008and 2007, we exceeded the minimum requirements for Excess Availability.

 

As of June 30, 2008, we had no outstandingborrowings under the Credit Facility and $10.7 million in letters of credit,with $48.9 million of availability under our credit line based on our BorrowingBase limitations.  We had average daily direct borrowings of $5.3 million under our Credit Facilityfor the first nine months of fiscal 2008, compared to average daily directborrowings of $0.7 million during the first nine months of fiscal 2007.

 

Our management believes that our current cashand working capital positions, expected operating cash flows and available borrowingcapacity under our Credit Facility, will be sufficient to fund our workingcapital, capital expenditures and debt repayment requirements and to fund stockand/or debt repurchases, if any, for at least the next twelve months.

 

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###### **CriticalAccounting Policies and Estimates**

###### ** **

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

 

Our significant accounting policies aredescribed in Note 2 of “Notes to Consolidated Financial Statements” in ourAnnual Report on Form 10-K for the year ended September 30,2007.  We believe that the followingdiscussion addresses our critical accounting policies, which are those that aremost important to the portrayal of our financial condition and results ofoperations and require management’s most difficult, subjective and complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. If actual results were to differ significantly from estimates made,future reported results could be materially affected.  However, we are not currently aware of anyreasonably likely events or circumstances that would result in materiallydifferent results.  Except as disclosedbelow and in the financial statements and accompanying notes included in Item 1of this report, there were no material changes in, or additions to, ourcritical accounting policies or in the assumptions or estimates we used toprepare the financial information appearing in this report.

 

Oursenior management has reviewed these critical accounting policies and estimatesand the related Management’s Discussion and Analysis of Financial Condition andResults of Operations with the Audit Committee of our Board of Directors.

 

***Inventories.***  We value our inventories,which consist primarily of maternity apparel, at the lower of cost or market.Cost is determined on the first-in, first-out method (FIFO) and includes thecost of merchandise, freight, duty and broker fees.  A periodic review of inventory quantities onhand is performed in order to determine if inventory is properly valued at thelower of cost or market.  Factors relatedto current inventories such as future consumer demand and fashion trends,current aging, current analysis of merchandise based on receipt date, currentand anticipated retail markdowns or wholesale discounts, and class or type ofinventory are analyzed to determine estimated net realizable values.  Criteria utilized by us to quantify agingtrends include factors such as the amount of merchandise received within thepast twelve months, merchandise received more than one year before withquantities on-hand in excess of 12 months of sales, and merchandisecurrently selling below cost.  Aprovision is recorded to reduce the cost of inventories to its estimated net realizablevalue, if required.  Inventories as of June 30,2008 and September 30, 2007 totaled $95.2 million and$100.5 million, respectively, representing 36.7% and 36.4% of totalassets, respectively.  Given thesignificance of inventories to our consolidated financial statements, thedetermination of net realizable values is considered to be a criticalaccounting estimate.  Any significantunanticipated changes in the factors noted above could have a significant impacton the value of our inventories and our reported operating results.

 

***Long-Lived Assets.***  Our long-lived assetsconsist principally of store leasehold improvements (included in the “Property,plant and equipment, net” line item in our consolidated balance sheets) and, toa much lesser extent, lease acquisition costs (included in the “Otherintangible assets, net” line item in our consolidated balance sheets).  These long-lived assets are recorded at costand are amortized using the straight-line method over the shorter of the leaseterm or their useful life.  Netlong-lived assets as of June 30, 2008 and September 30, 2007 totaled$67.1 million and $69.2 million, respectively, representing 25.8% and25.1% of total assets, respectively.

 

Inassessing potential impairment of these assets, we periodically evaluate thehistorical and forecasted operating results and cash flows on a store-by-storebasis.  Newly opened stores may take timeto generate positive operating and cash flow results.  Factors such as: (i) store type, thatis, company store or leased department, (ii) store concept, that is,Motherhood Maternity®, Mimi Maternity®, A Pea in the Pod® or DestinationMaternity®, (iii) store location, for example, urban area versus suburb, (iv) currentmarketplace awareness of our brands, (v) local customer demographic data, (vi) anchorstores within the mall in which our store is located and (vii) currentfashion trends are all considered in determining the time frame required for astore to achieve positive financial results, which is assumed to be within twoyears from the date a store location is opened. If economic conditions are substantially different from ourexpectations, the carrying value of certain of our long-lived assets may becomeimpaired.  As a result of our impairmentassessment, we recorded write-downs of long-lived assets of $1.3 million forthe first nine months of fiscal 2008, and $0.9 million for the first ninemonths of fiscal 2007, respectively.

 

***Goodwill*****.**  The purchasemethod of accounting for business combinations requires the use of estimatesand judgments to allocate the purchase price paid for acquisitions to the fairvalue of the net tangible and identifiable intangible 

 

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assets.  Goodwill represents the excess of theaggregate purchase price over the fair value of net assets acquired in businesscombinations and is separately disclosed in our consolidated balance sheets.  As of both June 30, 2008 and September 30,2007, goodwill totaled $50.4 million, representing 19.4% and 18.3% oftotal assets, respectively.  In June 2001,the FASB issued SFAS 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.

 

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

 

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

 

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

 

Thetemporary differences between the book and tax treatment of income and expensesresult in deferred tax assets and liabilities, which are included within ourconsolidated balance sheets.  We mustthen assess the likelihood that our deferred tax assets will be recovered fromfuture taxable income.  Actual resultscould differ from our assessments if adequate taxable income is not generatedin future periods.  Net deferred taxassets as of June 30, 2008 and September 30, 2007 totaled$23.3 million and $22.3 million, respectively, representing 9.0% and8.1% of total assets, respectively.  Tothe extent we believe that recovery is not more likely than not, we mustestablish a valuation allowance.  To theextent we establish a valuation allowance or change the allowance in a futureperiod, income tax expense will be impacted.

 

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

 

**Recent Accounting Pronouncements**

 

SFAS No. 157

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value, establishesa framework for measuring fair value in U.S. generally accepted accountingprinciples, and expands disclosures 

 

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about fair valuemeasurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years, for financial assets andliabilities that are measured at fair value on a recurring basis.  The FASB issued a one-year deferral of SFAS No. 157’sfair value measurement requirements for non-financial assets and liabilitiesthat are not required or permitted to be measured at fair value on a recurringbasis.  The impact from adoption ofSFAS No. 157, if any, on our consolidated financial position or results ofoperations has not yet been determined.

 

SFASNo. 159

 

*In February 2007, the FASB issued SFAS No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 provides companies with anoption to report selected financial assets and liabilities at fair value andrequires entities to display the fair value of those assets and liabilities forwhich the company has chosen to use fair value on the face of the balancesheet.  SFAS No. 159 is effectivefor financial statements issued for fiscal years beginning after November 15,2007.  The impact from adoption of SFAS No. 159,if any, on our consolidated financial position or results of operations has notyet been determined.*

* *

**Forward-Looking Statements**

 

Some of the information in this report,including the information incorporated by reference (as well as informationincluded in oral statements or other written statements made or to be made byus), contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”).  The forward-looking statements involve anumber of risks and uncertainties. A number of factors could cause our actualresults, performance, achievements or industry results to be materiallydifferent from any future results, performance or achievements expressed orimplied by these forward-looking statements. These factors include, but are not limited to the following: our abilityto successfully manage our various business initiatives, our ability tosuccessfully manage and retain our leased department and licensed relationshipsand marketing partnerships, future sales trends in our existing store base,unusual weather patterns, changes in consumer preferences and spendingpatterns, demographics and other macroeconomic factors that may impact thelevel of spending for maternity apparel, overall economic conditions and other factors affecting consumerconfidence, the impact of competition and fluctuations in the price,availability and quality of raw materials and contracted products, availabilityof suitable store locations, continued availability of capital and financing,ability to hire and develop senior management and sales associates, ability todevelop and source merchandise, ability to receive production from foreignsources on a timely basis, potential stock repurchases, potential debtprepayments, changes in market interest rates, war or acts of terrorism andother factors referenced in our Annual Report on Form 10-K, includingthose set forth under the caption “Risk Factors.”

 

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

 

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

 

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

 

Asof June 30, 2008, we had cash and cash equivalents of $8.5 million.  Our cash equivalents consist of money marketaccounts that bear interest at variable rates. A change in market interest ratesearned on our investments  impactsthe interest income and cash flows, but does not materially impact the fairmarket value of the financial instruments. Due to the average maturity and conservative nature of our investmentportfolio, we believe a sudden change in interest rates would not have amaterial effect on the value of our investment portfolio.

 

As of June 30, 2008, the principal components ofour debt portfolio were the $75.9 million Term Loan and the$65.0 million Credit Facility, both of which are denominated in U.S.dollars.

 

Our Credit Facility carries a variable interest ratethat is tied to market indices.  As of June 30, 2008, we had nodirect borrowings and $10.7 million of letters of credit outstanding under ourCredit Facility.  Borrowings under the Credit Facility would have resultedin interest at a rate between approximately 3.5% and 5.0% per annum as of June 30,2008.  Interest on any future borrowings under the Credit Facility would,to the extent of outstanding borrowings, be affected by changes in marketinterest rates.  A change in marketinterest rates on the variable rate portion of the debt portfolio impacts theinterest expense incurred and cash flows.

 

The Term Loan carries a variable interest rate that istied to market indices.  The sensitivityanalysis as it relates to this portion of our debt portfolio assumes aninstantaneous 100 basis point move in interest rates from their levels as of June 30,2008, with all other variables held constant.  The principal amount of theTerm Loan was $75.9 million as of June 30, 2008.  A 100basis point increase in market interest rates would result in additionalannual interest expense on the Term Loan of approximately $0.8 million.  A 100 basis point decline in marketinterest rates would correspondingly lower our annual interest expenseon the Term Loan by approximately $0.8 million.

 

Inorder to mitigate our floating rate interest risk on the variable rate TermLoan, we entered into an interest rate swap agreement with the Agent bank forthe Term Loan that commenced on April 18, 2007.  The interest rate swap agreement enables usto effectively convert an amount of the Term Loan equal to the notional amountof the interest rate swap from a floating interest rate (LIBOR plus 2.50%), toa fixed interest rate (7.50%).  Thenotional amount of the interest rate swap was $75.0 million at inception of theswap agreement and decreases over time to a notional amount of $5.0 million atthe expiration date.  The notional amountof the swap was $57,500,000 as of June 30, 2008 and over the next twelvemonths decreases as follows:  to$50,000,000 starting October 20, 2008; and to $42,500,000 starting April 20,2009.  Based on the scheduled swapnotional amount during the next 12 months of the swap agreement, a 100 basis point increase in market interestrates would result in interest expense savings for the year ofapproximately $0.5 million.  A 100basis point decline in market interest rates would correspondinglyincrease our interest expense for the year by approximately $0.5 million.  Thus, a100 basis point increase in market interest rates during the next 12 months ofthe swap agreement would result in additional interest expense for theyear of approximately $0.3 million on the Term Loan and swap agreement combined.  A 100 basis point decline in marketinterest rates during the next 12 months of the swap agreement would correspondinglylower our interest expense for the year by approximately $0.3 million on theTerm Loan and swap agreement combined.

 

Basedon the limited other variable rate debt included in our debt portfolio as of June 30,2008, a 100 basis point increase in interest rates would result in additionalinterest expense incurred for the year of less than $0.1 million.  A 100 basis point decrease in interest rateswould correspondingly lower our interest expense for the year by less than $0.1million.

 

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

 

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**Item 4.  Controls and Procedures**

 

***Disclosure Controls and Procedures***

*** ***

Our disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that are filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.  These disclosure controls and proceduresinclude controls and procedures designed to ensure that information required tobe disclosed under the Exchange Act is accumulated and communicated to ourmanagement on a timely basis to allow decisions regarding requireddisclosure.  We evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures as of June 30, 2008. Based on this evaluation, the Company’s Chief Executive Officer andChief Financial Officer have concluded that as of June 30, 2008, thesecontrols and procedures were effective.

 

***Internal Control over Financial Reporting***

*** ***

There have been no changes in internalcontrol over financial reporting identified in connection with the foregoingevaluation that occurred during the fiscal quarter ended June 30, 2008,that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

**Item 1A.  Risk Factors**

 

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

 

**Item 4. ****Submission of Matters to a Voteof Security Holders**

 

At the Company’s Annual Meeting of Stockholders held on January 22,2008, the stockholders of the Company elected three directors of the Company,approved the amendment and restatement of the Company’s Management IncentiveProgram, and ratified the Audit Committee’s appointment of KPMG LLP as theCompany’s independent registered public accounting firm for the fiscalyear ending September 30, 2008.

 

Mrs. Rebecca C. Matthias, Mr. Joseph A. Goldblum,and Mr. David Schlessinger were elected to serve as directors at themeeting.  The voting results were5,009,245 shares for and 38,823 shares withheld for Mrs. Matthias,5,004,349 shares for and 43,719 shares withheld for Mr. Goldblum, and5,010,645 shares for and 37,423 shares withheld for Mr. Schlessinger. Dan W. Matthias, Elam M. Hitchner, III, Anne T. Kavanagh and William A.Schwartz, Jr. continue to serve their terms as directors.

 

The shareholders voted3,904,298 shares for, 43,113 shares against, 2,576 shares abstained, and therewere 1,098,080 broker non-votes with respect to the amendment and restatementof the Company’s Management Incentive Program. The shareholders voted 5,027,025 shares for, 17,511 shares against, and3,531 shares abstained from the ratification of the appointment of KPMG LLP.

 

**Item 6.  Exhibits**

 
| **Exhibit   No.** | ** ** | **Description**                                                                                                                                                                                                      |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |       |                                                                                                                                                                                                                 |
| 10.1*             |       | Letter Agreement dated  May 20, 2008, among Dan W. Matthias, Rebecca C. Matthias, Wachovia Bank,  National Association and Mothers Work, Inc. (Exhibit 10.1 to the  May 20, 2008 Form 8-K). |
| 10.2*             |       | Employment Agreement  with Judd P. Tirnauer dated July 23, 2008 (Exhibit 10.1 to the  July 21, 2008 Form 8-K).                                                                                   |
| 10.3*             |       | Restrictive Covenant  Agreement with Judd P. Tirnauer dated July 23, 2008 (Exhibit 10.2  to the July 21, 2008 Form   8-K).                                                                       |
| 10.4*             |       | Restricted Stock Award  Agreement with Judd P. Tirnauer dated July 23, 2008 (Exhibit 10.3  to the July 21, 2008 Form 8-K).                                                                       |
| 31.1              |       | Certification  of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                       |
| 31.2              |       | Certification  of the Senior Vice President & Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                      |
| 32.1              |       | Certification  of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                   |
| 32.2              |       | Certification  of the Senior Vice President & Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                 |

 

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*                          Incorporated byreference.

 

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**Signatures**

 

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

 
|                      |     | MOTHERS  WORK, INC.                                           |
|---------------------------|----------|---------------------------------------------------------------|
|                      |     |                                                          |
| Date: August 8, 2008 | By:      | **/s/  DAN W. MATTHIAS**                                      |
|                      |     | Dan  W. Matthias                                              |
| * *                  | * * | *Chairman  of the Board and  Chief Executive Officer*         |
| * *                  | * * | * *                                                      |
| * *                  | * * | * *                                                      |
| Date: August 8, 2008 | By:      | **/s/  EDWARD M. KRELL**                                      |
|                      |     | Edward  M. Krell                                              |
| * *                  | * * | *Chief  Operating Officer*                                    |
| * *                  | * * | * *                                                      |
|                      |     |                                                          |
| Date: August 8, 2008 | By:      | **/s/  JUDD P. TIRNAUER**                                     |
|                      |     | Judd P. Tirnauer                                              |
| * *                  | * * | *Senior  Vice President &   Chief Financial Officer* |

 

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**INDEX OF EXHIBITS FILED WITH**

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

**FOR THE QUARTER ENDED JUNE 30, 2008**

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

 

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