** **

**United StatesSecurities and Exchange CommissionWashington, D.C. 20549**

 

**FORM 10-Q**

** **
| **ý**                                                                                                           |   | **Quarterly Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934**  |
|----------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
|                                                                                                                 |   |                                                                                          |
| **For the quarterly  period ended June 30, 2003**                                                                    |
|                                                                                                                 |   |                                                                                          |
| **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)                       |   | (I.R.S.  Employer Identification No.) |
|                                                                                   |   |                                  |
| **456 North 5th Street, Philadelphia,  Pennsylvania**                                  |   | **19123**                             |
| (Address of  principal executive offices)                                              |   | (Zip Code)                            |
|                                                                                   |   |                                  |
| Registrant’s telephone number, including  area code  **(215) 873-2200** |

 

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

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Act). Yes o No ý

 

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

 

Common Stock, $.01 par value — 5,219,774shares outstanding as of August 12, 2003

 

** **

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**MOTHERS WORK, INC. AND SUBSIDIARIESINDEX**

 
| PART I — FINANCIAL INFORMATION | 1                                                                                           |
|-------------------------------------|---------------------------------------------------------------------------------------------|
|                                |                                                                                        |
| Item 1.                             | Financial Statements (unaudited)                                                            | 1 |
|                                | Consolidated Balance Sheets                                                                 | 1 |
|                                | Consolidated Statements of Operations                                                       | 2 |
|                                | Consolidated Statements of Cash Flows                                                       | 3 |
|                                | Notes to Consolidated Financial Statements                                                  | 4 |
| Item 2.                             | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 14 |
| Item 3.                             | Quantitative and Qualitative Disclosures  about Market Risk                                 | 21 |
| Item 4.                             | Controls and Procedures                                                                     | 21 |
|                                |                                                                                        |   |
| PART II — OTHER INFORMATION    | 22                                                                                          |
|                                |                                                                                        |   |
| Item 1.                             | Legal Proceedings                                                                           | 22 |
| Item 6.                             | Exhibits and Reports on Form 8-K                                                            | 23 |
|                                |                                                                                        |   |
| Signatures                          | 24                                                                                          |

 

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**PART I. FINANCIAL INFORMATION**

**Item 1. Financial Statements**

 

**MOTHERS WORK, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**(in thousands, except share and per share amounts)

 
|                                                                                                                                        |   | **June 30,  2003** |       | **September 30, 2002** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|----------------------------------|------------|
|                                                                                                                                        |   | **(unaudited)**    |       |                             |       |
| **ASSETS**                                                                                                                                  |   |               | ** ** |                             | ** ** |
| Current  Assets:                                                                                                                            |   |               |       |                             |       |
| Cash and  cash equivalents                                                                                                                  |   | $                  | 25,142     |                             | $          | 14,759 |   |
| Trade  receivables                                                                                                                          |   | 5,129              |       | 4,839                            |       |
| Inventories                                                                                                                                 |   | 82,208             |       | 76,830                           |       |
| Deferred  income taxes                                                                                                                      |   | 6,581              |       | 8,888                            |       |
| Prepaid  expenses and other current assets                                                                                                  |   | 6,219              |       | 5,126                            |       |
| Total  current assets                                                                                                                       |   | 125,279            |       | 110,442                          |       |
|                                                                                                                                        |   |               |       |                             |       |
| Property,  Plant and Equipment, net                                                                                                         |   | 56,643             |       | 50,460                           |       |
| Assets Held  for Sale                                                                                                                       |   | 1,200              |       | 1,200                            |       |
| Other  Assets:                                                                                                                              |   |               |       |                             |       |
| Goodwill                                                                                                                                    |   | 52,677             |       | 52,677                           |       |
| Deferred  financing costs, net of accumulated amortization of $749 and $465                                                                 |   | 4,183              |       | 4,467                            |       |
| Other  intangible assets, net of accumulated amortization of $2,441 and $2,249                                                              |   | 1,186              |       | 1,199                            |       |
| Deferred  income taxes                                                                                                                      |   | 11,831             |       | 11,831                           |       |
| Other  non-current assets                                                                                                                   |   | 993                |       | 1,009                            |       |
| Total other  assets                                                                                                                         |   | 70,870             |       | 71,183                           |       |
|                                                                                                                                        |   |               |       |                             |       |
|                                                                                                                                        |   | $                  | 253,992    |                             | $          | 233,285 |   |
|                                                                                                                                        |   |               |       |                             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                               |   |               | ** ** |                             | ** ** |
| Current  Liabilities:                                                                                                                       |   |               |       |                             |       |
| Line of  credit borrowings                                                                                                                  |   | $                  | —     |                             | $          | — |   |
| Current  portion of long-term debt                                                                                                          |   | 269                |       | 369                              |       |
| Accounts  payable                                                                                                                           |   | 20,494             |       | 20,110                           |       |
| Accrued  expenses and other current liabilities                                                                                             |   | 40,051             |       | 32,045                           |       |
| Total  current liabilities                                                                                                                  |   | 60,814             |       | 52,524                           |       |
|                                                                                                                                        |   |               |       |                             |       |
| Long-Term  Debt                                                                                                                             |   | 127,901            |       | 127,913                          |       |
| Deferred  Rent and Other Liabilities                                                                                                        |   | 5,954              |       | 5,343                            |       |
| Series C  Cumulative Redeemable Preferred Stock                                                                                             |   | —             |       | —                           |       |
| Total  liabilities                                                                                                                          |   | 194,669            |       | 185,780                          |       |
|                                                                                                                                        |   |               |       |                             |       |
| Commitments  and Contingencies (Note 3)                                                                                                     |   |               |       |                             |       |
|                                                                                                                                        |   |               |       |                             |       |
| Stockholders’  Equity:                                                                                                                 |   |               |       |                             |       |
| Preferred  stock, 2,000,000 shares authorized                                                                                               |   |               |       |                             |       |
|  Series A cumulative convertible preferred  stock, $.01 par value; $280.4878 stated value; 41,000 shares authorized, none  outstanding |   | —             |       | —                           |       |
| Series B  junior participating preferred stock, $.01 par value; 300,000 shares  authorized, none outstanding                                |   | —             |       | —                           |       |
| Common  stock, $.01 par value; 20,000,000 shares authorized, 5,207,124 and 5,179,901  shares issued and outstanding, respectively           |   | 52                 |       | 52                               |       |
| Additional  paid-in capital                                                                                                                 |   | 63,129             |       | 63,623                           |       |
| Accumulated  deficit                                                                                                                        |   | (3,858             | )          | (16,170                          | )          |
| Total  stockholders’ equity                                                                                                            |   | 59,323             |       | 47,505                           |       |
|                                                                                                                                        |   |               |       |                             |       |
|                                                                                                                                        |   | $                  | 253,992    |                             | $          | 233,285 |   |

 

 The accompanying notes are an integral part of these consolidatedfinancial statements.   

 

1

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 **MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands, except per shareamounts)

(unaudited) 

 

 
|                                          |   | **Three  Months Ended  June 30,** |    | **Nine  Months Ended  June 30,** |   |
|-----------------------------------------------|--------|-----------------------------------|---------|----------------------------------|--------|
|                                          |   | **2003**                          |    | **2002**                         |   | **2003** |   | **2002** |   |
| Net sales                                     |   | $                                 | 132,403 |                             | $      | 122,599 |   | $ | 370,047 |   | $ | 341,849 |   |
| Cost of goods sold                            |   | 56,706                            |    | 54,566                           |   | 168,727 |   | 160,201 |   |
| Gross profit                                  |   | 75,697                            |    | 68,033                           |   | 201,320 |   | 181,648 |   |
| Selling, general and administrative  expenses |   | 58,420                            |    | 52,667                           |   | 170,579 |   | 153,918 |   |
| Operating income                              |   | 17,277                            |    | 15,366                           |   | 30,741 |   | 27,730 |   |
| Interest expense, net                         |   | 3,633                             |    | 3,330                            |   | 10,787 |   | 10,350 |   |
| Income before income taxes                    |   | 13,644                            |    | 12,036                           |   | 19,954 |   | 17,380 |   |
| Income tax provision                          |   | 5,275                             |    | 4,476                            |   | 7,642 |   | 6,464 |   |
| Net income                                    |   | 8,369                             |    | 7,560                            |   | 12,312 |   | 10,916 |   |
| Dividends on preferred stock                  |   | —                            |    | 761                              |   | — |   | 2,294 |   |
| Net income available to common stockholders   |   | $                                 | 8,369   |                             | $      | 6,799 |   | $ | 12,312 |   | $ | 8,622 |   |
|                                          |   |                              |    |                             |   |   |   |   |   |
| Income per  share — basic                |   | $                                 | 1.60    |                             | $      | 1.76 |   | $ | 2.35 |   | $ | 2.36 |   |
| Average  shares outstanding — basic      |   | 5,239                             |    | 3,873                            |   | 5,240 |   | 3,654 |   |
|                                          |   |                              |    |                             |   |   |   |   |   |
| Income per  share — diluted              |   | $                                 | 1.50    |                             | $      | 1.45 |   | $ | 2.18 |   | $ | 2.18 |   |
| Average  shares outstanding — diluted    |   | 5,570                             |    | 5,097                            |   | 5,651 |   | 3,982 |   |

 

 The accompanying notes are an integral part of these consolidatedfinancial statements.   

 

2

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**MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
|                                                                               |   | **Nine  Months Ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                               |   | **2003**                         |   | **2002** |   |
| **Cash Flows from Operating Activities**                                           |   |                             |   |   |   |
| Net income                                                                         |   | $                                | 12,312 |   | $ | 10,916 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                             |   |   |   |
| Depreciation  and amortization                                                     |   | 7,351                            |   | 7,213 |   |
| Loss on  impairment of long-lived assets                                           |   | 89                               |   | — |   |
| Loss on  disposal of assets                                                        |   | 156                              |   | — |   |
| Deferred  income tax provision                                                     |   | 2,307                            |   | 6,532 |   |
| Tax benefit  of stock option exercises                                             |   | 478                              |   | — |   |
| Amortization  of deferred financing costs                                          |   | 284                              |   | 375 |   |
| Accretion of  discount on notes                                                    |   | 100                              |   | 162 |   |
| Provision  for deferred rent                                                       |   | 443                              |   | 353 |   |
| Changes in  assets and liabilities, net of effect of acquisition:                  |   |                             |   |   |   |
| (Increase)  decrease in                                                            |   |                             |   |   |   |
| Trade  receivables                                                                 |   | (290                             | )      | 715 |   |
| Inventories                                                                        |   | (5,378                           | )      | 8,093 |   |
| Prepaid  expenses and other current assets                                         |   | (385                             | )      | 1,054 |   |
| Increase  (decrease) in                                                            |   |                             |   |   |   |
| Accounts  payable, accrued expenses and other liabilities                          |   | 10,687                           |   | (1,989 | ) |
| Net cash  provided by operating activities                                         |   | 28,154                           |   | 33,424 |   |
| **Cash Flows from Investing Activities**                                           |   |                             |   |   |   |
| Acquisition  of iMaternity, net of cash acquired                                   |   | —                           |   | 574 |   |
| Capital  expenditures                                                              |   | (15,979                          | )      | (5,138 | ) |
| Purchase of  intangible assets                                                     |   | (180                             | )      | (128 | ) |
| Net cash  used in investing activities                                             |   | (16,159                          | )      | (4,692 | ) |
| **Cash Flows from Financing Activities**                                           |   |                             |   |   |   |
| Decrease in  line of credit borrowings                                             |   | —                           |   | (30,748 | ) |
| Increase in  cash overdrafts                                                       |   | 1,334                            |   | 939 |   |
| Repayment of  long-term debt                                                       |   | (212                             | )      | (240 | ) |
| Repayment of  debt assumed in acquisition of iMaternity                            |   | —                           |   | (8,892 | ) |
| Repurchase  and retirement of common stock                                         |   | (1,467                           | )      | — |   |
| Payment of  issuance costs of common stock                                         |   | (210                             | )      | — |   |
| Payment of issuance  costs of long-term debt                                       |   | (242                             | )      | — |   |
| Payout on  redemption of Series A Preferred Stock                                  |   | (1,310                           | )      | — |   |
| Proceeds  from exercise of stock options and warrants                              |   | 495                              |   | 2,027 |   |
| Net cash  used in financing activities                                             |   | (1,612                           | )      | (36,914 | ) |
| **Net Increase (Decrease) in Cash and Cash  Equivalents**                          |   | 10,383                           |   | (8,182 | ) |
| **Cash and Cash Equivalents, Beginning of  Period**                                |   | 14,759                           |   | 10,358 |   |
| **Cash and Cash Equivalents, End of Period**                                       |   | $                                | 25,142 |   | $ | 2,176 |   |
|                                                                               |   |                             |   |   |   |
| Supplemental  Disclosures of Cash Flow Information:                                |   |                             |   |   |   |
| Cash paid  for interest                                                            |   | $                                | 6,793  |   | $ | 7,004 |   |
| Cash paid  for income taxes                                                        |   | $                                | 2,529  |   | $ | 2,616 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements. 

 

3

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**MOTHERS WORK, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIALSTATEMENTSJune 30, 2003**(unaudited)

 

**1.****             BASISOF FINANCIAL STATEMENT PRESENTATION**

 

The accompanying unaudited consolidatedfinancial statements have been prepared in accordance with the requirements forForm 10-Q and Article 10 of Regulation S-X and, accordingly,certain information and footnote disclosures have been condensed or omitted.Reference is made to the Annual Report on Form 10-K, as of and for theyear ended September 30, 2002 for Mothers Work, Inc. and Subsidiaries(the “Company” or “Mothers Work”) as filed with the Securities and ExchangeCommission, for additional disclosures including a summary of the Company’saccounting policies.

 

In the opinion of management, theconsolidated financial statements contain all adjustments, consisting of normalrecurring adjustments, necessary to present fairly the consolidated financialposition of the Company for the periods presented. Since the Company’soperations are seasonal, the interim operating results of the Company may notbe indicative of operating results for the full year.

 

**2.****             STOCKOPTIONS AND WARRANTS**

 

During the three and nine months ended June30, 2003, respectively, a total of 28,000 and 238,000 stock options weregranted to certain employees and non-employee directors for the purchase of theCompany’s common stock at prices not less than the fair market value of theCompany’s common stock on the date of grant.

 

In connection with the acquisition ofiMaternity on October 17, 2001 (see Note 8), the Company issued to the sellerswarrants to purchase 350,000 shares of the Company’s common stock at anexercise price of $22.50 per share (the “Warrants”).  The Warrants were immediately vested upon grant and are exercisablefor seven years from the date of grant. During the year ended September 30, 2002, the Company repurchasedWarrants to purchase 125,000 shares of the Company’s common stock for apurchase price of $4.50 per underlying share, or a total of $562,500.  In the first quarter of fiscal 2003, certainholders of the Warrants turned in Warrants to purchase 100,000 shares of theCompany’s common stock and were issued 44,113 shares of the Company’s commonstock pursuant to a cashless exercise net issuance election. As of June 30,2003, Warrants to purchase 125,000 shares remained outstanding.

 

**3.****             COMMITMENTSAND CONTINGENCIES**

 

On July 17, 2002, a purported class action was filed against theCompany in the Superior Court of California for Los Angeles County. Thecomplaint alleged that, under California law, certain former and currentemployees should have received overtime compensation, meal breaks and restbreaks. In March 2003, the Company, without admitting liability, entered into asettlement agreement in connection with this action.  The agreement received preliminary court approval and remainssubject to final court approval.  TheCompany, as previously disclosed, recorded an estimated charge of $800,000related to this settlement during the three months ended March 31, 2003 andreduced its estimate to $700,000 during the three months ended June 30, 2003.

 

The Company was also a party to an action alleging similar claims underWashington law in Spokane County Superior Court. The plaintiffs in theWashington case sought unspecified actual damages, penalties and attorneys’fees. On or about April 23, 2003, one purported subclass of the plaintiffsaccepted a settlement arrangement in the amount of $50,000, plus attorney’sfees and costs incurred through such date. After a trial with the remaining purported subclass, in May 2003, thejury found for the Company on all but one claim, for which it awarded theremaining plaintiffs damages in the amount of $106,000.  The parties are currently contesting costsand expenses being sought by the plaintiffs in the amount of approximately$390,000.  Accordingly, during the threemonths ended June 30, 2003, the Company reserved approximately $545,000 towardsthe estimated legal fees and settlement costs of this case, which have beenincluded in accrued expenses in the accompanying Consolidated Balance Sheet.

 

In addition, from time to time, the Companyis named as a defendant in legal actions arising from its normal businessactivities. Although the amount of any liability that could arise with respectto currently pending actions, including the matters specifically describedabove, cannot be accurately predicted, the Company does not believe that theresolution of any pending action will have a material adverse effect on itsfinancial position.

 

4

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**4.****             EARNINGSPER SHARE (EPS)**

 

The Company follows Statement of FinancialAccounting Standards (“SFAS”) No. 128, “Earnings Per Share.”  Basic earnings (loss) per share (“BasicEPS”) is computed by dividing net income (loss) by the weighted average numberof shares of common stock outstanding. Diluted earnings  (loss) pershare (“Diluted EPS”) is computed by dividing net income  (loss) by the weighted average number ofshares of common stock outstanding, after giving effect to the potentialdilution from the exercise of securities, such as stock options, into shares ofcommon stock as if those securities were exercised.

 

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

 
|                                                                                    |   | **Three Months Ended  June 30, 2003** |   | **Three Months Ended  June 30, 2002** |   |
|-----------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                    |   | **Income**                                 |   | **Shares**                                 |   | **Earnings  Per Share** |   | **Income** |   | **Shares** |   | **Earnings  Per Share** |   |
| Basic EPS                                                                               |   | $                                          | 8,369  |                                       | 5,239  |   | $ | 1.60 |   | $ | 6,799 |   | 3,873 |   | $ | 1.76 |   |
| Incremental  shares from the assumed exercise of outstanding stock options and warrants |   | —                                     |   | 331                                        |   |   |   | — |   | 548 |   |   |   |
| Assumed  conversion of subordinated notes                                               |   | —                                     |   | —                                     |   |   |   | 20 |   | 65 |   |   |   |
| Assumed  conversion of preferred stock                                                  |   | —                                     |   | —                                     |   |   |   | 582 |   | 611 |   |   |   |
| Diluted EPS                                                                             |   | $                                          | 8,369  |                                       | 5,570  |   | $ | 1.50 |   | $ | 7,401 |   | 5,097 |   | $ | 1.45 |   |

 
|                                                                                    |   | **Nine Months Ended  June 30, 2003** |   | **Nine Months Ended  June 30, 2002** |   |
|-----------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                    |   | **Income**                                |   | **Shares**                                |   | **Earnings  Per Share** |   | **Income** |   | **Shares** |   | **Earnings  Per Share** |   |
| Basic EPS                                                                               |   | $                                         | 12,312 |                                      | 5,240  |   | $ | 2.35 |   | $ | 8,622 |   | 3,654 |   | $ | 2.36 |   |
| Incremental  shares from the assumed exercise of outstanding stock options and warrants |   | —                                    |   | 411                                       |   |   |   | — |   | 286 |   |   |   |
| Assumed  conversion of subordinated notes                                               |   | —                                    |   | —                                    |   |   |   | 40 |   | 42 |   |   |   |
| Diluted EPS                                                                             |   | $                                         | 12,312 |                                      | 5,651  |   | $ | 2.18 |   | $ | 8,662 |   | 3,982 |   | $ | 2.18 |   |

 

Options to purchase 264,450 and 10,000 shareswere outstanding as of June 30, 2003 and 2002, respectively, but were notincluded in the computation of Diluted EPS as their effect would have beenantidilutive for the three and nine month periods then ended. These optionscould potentially dilute EPS in the future.

 

During the third quarter of fiscal 2002, certain holders of Series ACumulative Convertible Preferred Stock (the “Series A Preferred Stock”) electedto convert 964 of such shares, with a stated value of $271,000 and at aconversion rate equal to ten shares of common stock for each share of Series APreferred Stock (a total of 9,640 shares of common stock). For the first nine months of fiscal 2002, a totalof 11,496 shares of Series A Preferred Stock with a stated value of $3,224,000were converted into 114,955 shares of common stock.

 

The Company was restrictedunder the terms of its old 12 5/8% senior notes from paying accrued cashdividends to the holders of the Series A Preferred Stock upon conversion.Accordingly, the Company issued subordinated notes totaling $159,000 and$2,214,000 in the third quarter and first nine months of fiscal 2002,respectively.  For the quarter and ninemonths ended June 30, 2002, the conversion feature of the subordinated notesoutstanding, which had an aggregate value of $2,544,000, was determined to makesuch notes dilutive and, therefore, they were included in the Diluted EPScomputation.

 

For the quarter ended June30, 2002, the calculation of Diluted EPS was based on average diluted sharesoutstanding of 5,097,000, which included approximately 611,000 potential sharesthat were required to be included in respect of the conversion features of theCompany’s then outstanding Series A Preferred Stock and Series C CumulativeRedeemable Preferred Stock (the “Series C Preferred Stock”).  These potential shares were included in theDiluted EPS computation for the quarter ended June 30, 2002 because the levelof net income for the quarter had the effect, when factored into thecalculation, of making the potential shares dilutive to earnings.  The 26,913 shares of Series A PreferredStock outstanding at

 

5

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June 30, 2002, which were convertible into 269,128 shares of commonstock, were determined to be antidilutive and therefore excluded from the EPScomputation for the nine months ended June 30, 2002.  All of the shares of Series C Preferred Stock outstanding as ofJune 30, 2002 were excluded from the EPS computations for the nine months thenended as their effect would have been antidilutive.  During the fourth quarter of fiscal 2002, all of the remainingoutstanding Series A Preferred Stock, Series C Preferred Stock and subordinatednotes were redeemed or repurchased using proceeds generated from the Company’sAugust 2002 debt and equity offerings.

 

In February 2003, thestockholders of the Company approved an amendment to the Company’s 1987 StockOption Plan, as amended and restated.  This amendment increased the number of shares of common stock availablefor issuance upon the exercise of options granted under this plan by 500,000.

 

InMarch 2003, the Board of Directors approved a share repurchase program underwhich the Company may repurchase up to $10,000,000 of its outstanding commonstock from time to time until March 2005. Pursuant to this program, the Company had repurchased 66,554 shares ofits common stock at a cost of $1,467,000 through June 30, 2003.

 

**5.****            ****STOCK-BASED COMPENSATION**

 

TheCompany follows the intrinsic value method of accounting for stock-basedemployee compensation in accordance with Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. The following tables illustrate the effect on net income(loss) and earnings  (loss) per share if the Company had accounted for its stock option plansusing the fair value method of accounting under SFAS No. 123, “Accounting forStock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure” (in thousands, except pershare amounts):

 
|                                                      |                                                                                                                      | **Three Months Ended June 30,** |   | **Nine Months Ended June 30,** |   |
|-----------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------|---------------------------------|--------|--------------------------------|--------|
|                                                      |                                                                                                                      | **2003**                        |   | **2002**                       |   | **2003** |   | **2002** |   |
| Net  income available to common stockholders, as reported |                                                                                                                      | $                               | 8,369  |                           | $      | 6,799 |   | $ | 12,312 |   | $ | 8,622 |   |
| Deduct:                                                   | Total  stock-based employee compensation expense determined under the fair value  based method for all grants, net of tax |                            | (168   | )                              | (183   | ) | (3,083 | ) | (616 | ) |
| Pro  forma net income                                     |                                                                                                                      | $                               | 8,201  |                           | $      | 6,616 |   | $ | 9,229 |   | $ | 8,006 |   |
| Diluted  EPS:                                             |                                                                                                                      |                            |   |                           |   |   |   |   |   |
| As  reported                                              |                                                                                                                      | $                               | 1.50   |                           | $      | 1.45 |   | $ | 2.18 |   | $ | 2.18 |   |
| Pro  forma                                                |                                                                                                                      | $                               | 1.44   |                           | $      | 1.31 |   | $ | 1.63 |   | $ | 2.02 |   |
|                                                           |                                                                                                                           |                                 |        |                                |        |  |  |  |  |  |  |  |  |  |

 

Pro forma Diluted EPS iscomputed by dividing pro forma net income (loss) by the weighted average number ofshares outstanding after giving effect to the potential dilution from theexercise of securities, such as stock options, into shares of common stock asif those securities were exercised as of the beginning of the period presented.

 

The weighted average fairvalue of the options granted during the three and nine months ended June 30**,**2003is estimated at $23.55 and $35.05 per share, respectively, and at $34.00 and$9.57 per share, respectively, for the three and nine months ended June 30,2002. The weighted average fair value is calculated based on the date of grantusing the Black-Scholes option-pricing model with the following weightedaverage assumptions:

 
|                     |   | **Three Months Ended June 30,** |   | **Nine Months Ended June 30,** |   |
|--------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                     |   | **2003**                        |   | **2002**                       |   | **2003** |   | **2002** |   |
| Volatility               |   | 52.2                            | %      | 80.6                           | %      | 58.0 | % | 67.4 | % |
| Risk  free interest rate |   | 2.5                             | %      | 2.7                            | %      | 4.1 | % | 2.1 | % |
| Expected  life           |   | 10.0 years                      |   | 9.6 years                      |   | 9.2 years |   | 7.9 years |   |

 

6

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**6.****            ****INVENTORIES**

 

Inventorieswere comprised of the following (in thousands):

 
|             |   | **June 30, 2003** |       | **September 30, 2002** |       |
|------------------|--------|-------------------|------------|-----------------------------|------------|
|             |   |              | ** ** |                        | ** ** |
| Finished goods   |   | $                 | 70,073     |                        | $          | 64,889 |   |
| Work-in-progress |   | 3,288             |       | 3,740                       |       |
| Raw materials    |   | 8,847             |       | 8,201                       |       |
|             |   | $                 | 82,208     |                        | $          | 76,830 |   |

 

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

 

Accruedexpenses and other current liabilities were comprised of the following (inthousands):

** **
|                                                          |   | **June 30, 2003** |       | **September 30, 2002** |       |
|---------------------------------------------------------------|--------|------------------------|------------|----------------------------------|------------|
|                                                          |   |                   | ** ** |                             | ** ** |
| Salaries, wages, and employee benefits                        |   | $                      | 10,436     |                             | $          | 7,686 |   |
| Income taxes payable                                          |   | 3,809                  |       | 899                              |       |
| Interest                                                      |   | 5,872                  |       | 2,150                            |       |
| Sales taxes                                                   |   | 2,174                  |       | 1,998                            |       |
| Gift certificates and store credits                           |   | 1,816                  |       | 1,504                            |       |
| Rent                                                          |   | 693                    |       | 1,603                            |       |
| Insurance                                                     |   | 2,214                  |       | 1,862                            |       |
| Audit and legal                                               |   | 2,327                  |       | 1,129                            |       |
| Reserves recorded in the iMaternity  acquisition (see Note 8) |   | 3,451                  |       | 4,330                            |       |
| Remaining payout on redemption of Series A  Preferred Stock   |   | 2,415                  |       | 3,725                            |       |
| Accrued store construction costs                              |   | 1,643                  |       | 3,434                            |       |
| Other                                                         |   | 3,201                  |       | 1,725                            |       |
|                                                          |   | $                      | 40,051     |                             | $          | 32,045 |   |

 

Interestpayments on the senior notes are made semiannually on February 1stand August 1st.

 

**8.****            ****ACQUISITION OF IMATERNITY**

 

TheCompany acquired eSpecialty Brands, LLC (“iMaternity”) on October 17, 2001 (the“Acquisition Date”) for $19,748,000, including transaction costs of$875,000.  The acquisition was accountedfor under the purchase method of accounting, and the results of operations ofiMaternity have been included in the Company’s results of operations from theAcquisition Date. Assets acquired and liabilities assumed were recorded attheir estimated fair values.

 

Basedon the allocation of purchase price, the application of the purchase method ofaccounting resulted in $23,093,000 of excess purchase price over the estimatedfair value of the net tangible assets acquired of $22,145,000 less assumedliabilities of $16,553,000 and costs to exit certain operations and locationsof iMaternity of $8,937,000. The Company recognizes that certain identifiableintangible assets were acquired, primarily trademarks, trade names, andInternet domain names. However, as determined by an independent third partyappraiser, based on the nature of the items and use within the Company’sbusiness and industry, no value was assigned to any of the identifiableintangibles. Accordingly, the excess purchase price was assigned togoodwill.  In addition, in connectionwith the acquisition, the Company assumed certain liabilities with tradecreditors of approximately $2,300,000 that are still in dispute.  With respect to the effect of these tradepayables on the allocation of the purchase price, to the extent that thesepayables are not paid and the associated liability reduced, then goodwill wouldbe reduced.

 

Atthe Acquisition Date, iMaternity operated a total of 166 Dan Howard andMothertime maternity clothing stores, including some under the trade nameiMaternity, and the online iMaternity.com website. The Company developed a planin conjunction with the acquisition to close 92 iMaternity stores and convertthe remaining acquired locations to the Company’s existing store concepts ofMotherhood and Mimi Maternity. Further, the plan included the shutdown ofiMaternity’s corporate headquarters and warehouse operation in Chicago, as wellas its manufacturing and warehousing facilities in Costa

 

7

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Rica.  In connection with theplan, the Company recorded severance costs for involuntarily terminatedemployees of the acquired business of $2,587,000, lease termination fees andrelated legal costs of $4,200,000, and accrued for other costs to be incurredto complete the exit activities of the acquired business totaling $2,150,000.Approximately 850 employees of the acquired business were expected to beterminated as part of the plan, consisting of 528 corporate and 322 storeemployees.

 

Asof June 30, 2003, the Company has closed 93 iMaternity stores, of which 78 wereincluded as part of the 92 planned iMaternity store closures.  During fiscal 2002, the Company closed 88iMaternity stores, of which 75 were included as part of the 92 planned storeclosures.  Also during fiscal 2002, theCompany closed the corporate headquarters and warehouse operation in Chicago,an Internet-related development center in San Diego, California and otherdomestic warehousing facilities. The iMaternity manufacturing and warehousingoperations in Costa Rica have been operationally shut down.  The carrying value of the Costa Ricafacility was reduced to its estimated realizable value as of the AcquisitionDate, which was determined based on a market survey received from anindependent third party, less estimated selling costs, and is classified as“Assets Held for Sale” in the accompanying consolidated balance sheets.  During the first nine months of fiscal 2003,the Company closed an additional five iMaternity stores of which three werepart of the 92 planned store closures. In accordance with its plan, the Company expects to close up to anadditional 14 of the acquired iMaternity stores.  The timing of the store closures is dependent primarily upon theCompany’s ability to negotiate and complete the lease termination settlements.

 

Inconnection with the store closures and the shutdown of the various facilitiesas described above, the Company terminated 820 employees (524 corporate and 296store employees), to whom $1,687,000 in accrued severance was paid out andcharged against the liability as of September 30, 2002.  Included in the severance payouts arequarterly installments made with regard to a non-compete covenant and severancearrangement with a former executive of iMaternity.  The remaining severance accrual of $747,000 as of June 30, 2003principally reflects the balance of the non-compete and severance arrangementthat is payable ratably on a monthly basis through September 2006.

 

Asummary of the charges incurred and reserves recorded in connection with theiMaternity acquisition exit/restructuring activities during fiscal 2002 and thefirst nine months of fiscal 2003 is as follows (in thousands):

 
|                   |   | **Adjustments and  Reserves Recorded in  Purchase Accounting** |       | **Balance as of  September 30, 2002** |       | **Charges During the  Nine Months Ended  June 30, 2003** |       | **Balance as of  June 30, 2003** |       |
|------------------------|--------|----------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|
|                   |   |                                                           | ** ** |                                  | ** ** |                                                     | ** ** |                             | ** ** |
| Lease termination fees |   | $                                                              | 4,200      |                                  | $          | 2,730                                                    |       | $                                | 563        |   | $ | 2,167 |   |
| Severance              |   | 2,587                                                          |       | 900                                   |       | 153                                                      |       | 747                              |       |
| Exit and other costs   |   | 2,150                                                          |       | 700                                   |       | 163                                                      |       | 537                              |       |
|                   |   | $                                                              | 8,937      |                                  | $          | 4,330                                                    |       | $                                | 879        |   | $ | 3,451 |   |

 

Thefollowing table displays the net non-cash assets (liabilities) that wereacquired as a result of the iMaternity acquisition (in thousands):

 
| Non-cash assets (liabilities):                    |   |    |   |
|---------------------------------------------------|--------|---------|--------|
| Inventory                                         |   | $       | 6,168  |   |
| Property, plant and equipment                     |   | 3,412   |   |
| Deferred income taxes                             |   | 11,450  |   |
| Other current assets                              |   | 541     |   |
| Goodwill                                          |   | 23,093  |   |
| Current liabilities, including transaction  costs |   | (17,473 | )      |
| Debt                                              |   | (8,892  | )      |
| Net non-cash assets acquired                      |   | 18,299  |   |
| Less: Preferred stock issued                      |   | (17,999 | )      |
| Warrants issued                                   |   | (874    | )      |
| Cash acquired from the acquisition of iMaternity  |   | $       | (574   | ) |

 

8

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The following unauditedpro forma summary (in thousands, except per share amounts) combines theconsolidated results of operations of Mothers Work, Inc. and iMaternity as ifthe transaction occurred as of the beginning of the period presented givingeffect to certain adjustments, including recognition of an income tax benefitfor operating losses generated by the acquired business, recognition of accruedand unpaid dividends on the Series C Preferred Stock, discount accretionassociated with the Series C Preferred Stock, and reduction in depreciationexpense as a result of the revaluation of property, plant and equipment. Thispro forma summary is not necessarily indicative of the results of operationsthat would have occurred if the Company and iMaternity had been combined duringsuch period. Moreover, the pro forma summary is not intended to be indicativeof the results of operations that may be attained in the future.

 
|                                         |   | **Nine Months Ended   June 30, 2002** |    |
|----------------------------------------------|--------|--------------------------------------------|---------|
| Net  sales                                   |   | $                                          | 344,046 |   |
| Operating  income                            |   | 26,889                                     |    |
| Net  income                                  |   | 10,268                                     |    |
| Net  income available to common stockholders |   | 7,887                                      |    |
| Income  per share — basic               |   | $                                          | 2.16    |   |
| Income  per share — diluted             |   | $                                          | 1.99    |   |

 

**9.****            ****NEW ACCOUNTING PRONOUNCEMENTS**

# ** **

In June 2001, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 143, “Accounting for AssetRetirement Obligations.” SFAS No. 143 is effective for fiscal yearsbeginning after June 15, 2002, and addresses financial accounting andreporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs. The Company adopted thisstatement effective October 1, 2002. Adoption of SFAS No. 143 did not havea material impact on the Company’s financial position or results of operations.

 

InAugust 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” which established a singleaccounting model, based on the framework established in SFAS No. 121, “Accountingfor the Impairment of Long-Lived Assets and Long-Lived Assets to be DisposedOf,” and resolved significant implementation issues related to SFASNo. 121 and APB Opinion No. 30, “Reporting the Results ofOperations-Reporting the Effects of a Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions.”SFAS No. 144 superceded SFAS No. 121 and portions of APB OpinionNo. 30.  The Company adopted thisstatement effective October 1, 2002. Adoption of SFAS No. 144 did not have a material impact on theCompany’s financial position or results of operations.

 

InApril 2002, the FASB issued SFAS No. 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.”  The provisions of thisstatement related to the rescission of SFAS No. 4 were applied by theCompany effective October 1, 2002. Any gain or loss on extinguishment of debtthat was classified as an extraordinary item in prior periods presented thatdoes not meet the criteria in APB Opinion No. 30 for classification as anextraordinary item will be reclassified. As a result, it will be necessary to reclassify the loss on the earlyextinguishment of debt as additional interest expense for the period endedSeptember 30, 2002.

 

InJuly 2002, the FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities.” SFAS No. 146 supersedesEmerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognitionfor Certain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring),” and is effective fortransactions initiated after December 31, 2002. Under SFAS No. 146, acompany will record a liability for a cost associated with an exit or disposalactivity when that liability is incurred and can be measured at fair value. Aliability is incurred when an event obligates the entity to transfer or useassets. Management does not expect the adoption of this statement will have amaterial impact on the Company’s financial position or results of operations.

 

InNovember 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accountingand Disclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness to Others.” This Interpretation elaborates on the disclosures tobe made by a guarantor in its interim and annual financial statements about itsobligations under guarantees issued. The Interpretation also clarifies that aguarantor is required to recognize, at inception of a guarantee, a liabilityfor the fair value of the obligation undertaken. The initial recognition andmeasurement provisions of the Interpretation are applicable to guaranteesissued or modified after December 31, 2002 and did not have a material impacton the Company’s financial position or results of operations. The disclosurerequirements are effective for financial statements of interim and annualperiods ending after December 31, 2002.

 

9

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In November 2002, the EITFreached a consensus on EITF Issue No. 02-16, “Accounting by a Customer(Including a Reseller) for Certain Consideration Received from a Vendor.” EITFIssue No. 02-16 provides guidance as to how entities should account for cashconsideration received from a vendor. EITF Issue No. 02-16 presumes that cashreceived from a vendor represents a reduction of the prices of the vendor’sproducts or services, unless the cash received represents a payment for assetsor services provided to the vendor or a reimbursement of costs incurred by theentity to sell the vendor’s products. The provisions of EITF Issue No. 02-16will apply to all agreements entered into or modified after December 31, 2002.Management does not expect the provisions of EITF Issue No. 02-16 will have amaterial impact on the Company’s financial position or results of operations.

 

In December 2002, theFASB issued SFAS No. 148.  SFASNo. 148 amends SFAS No. 123 and is effective for fiscal years ending afterDecember 15, 2002.  SFAS No. 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults. The Company has adopted the disclosure requirements for interimfinancial statements.

 

**10.****         ****GUARANTORSUBSIDIARIES**

 

Pursuantto the terms of the indenture relating to the $125,000,000 of 111⁄4% Senior Notesdue 2010 (the “New Senior Notes”), Cave Springs, Inc. and the wholly-owneddomestic subsidiaries of iMaternity (collectively, the “GuarantorSubsidiaries”) have jointly and severally provided an unconditional guaranteeof the obligations of Mothers Work with respect to the New Senior Notes. Thereare no restrictions on any of the assets of the Guarantor Subsidiaries whichwould limit their ability to transfer funds to Mothers Work in the form ofloans, advances or cash dividends, except as provided by applicable law. Noneof the Company’s foreign subsidiaries have guaranteed the New Senior Notes. Thecondensed consolidating financial information for the Company, the GuarantorSubsidiaries, and the Company’s non-guarantor subsidiaries as of and forthe nine months ended June 30, 2003 as presented below has been prepared fromthe books and records maintained by the Guarantor Subsidiaries and the Company.The condensed financial information may not necessarily be indicative of theresults of operations or financial position had the Guarantor Subsidiariesoperated as independent entities. Certain intercompany sales included in thesubsidiary records are eliminated in consolidation. Mothers Work pays allexpenditures on behalf of the Guarantor Subsidiaries. An amount due to/due fromparent will exist at any time as a result of this activity. The condensed financialinformation includes the allocation of material amounts of expenses such ascorporate services, administration and taxes on income. The allocations aregenerally based on proportional amounts of sales or assets, and taxes on incomeare allocated consistent with the asset and liability approach used forconsolidated financial statement purposes. Management believes these allocationmethods are reasonable.

 

10

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**MothersWork, Inc.Condensed Consolidating Balance SheetJune 30, 2003**(unaudited)(in thousands)

** **
|                                              |   | **Mothers Work   (Parent   Company)** |    | **Guarantor  Subsidiaries   (U.S.   Companies)** |   | **Non-Guarantor  Subsidiaries  (Foreign  Companies)** |   | **Consolidating   Eliminations** |   | **Mothers Work   Consolidated** |   |
|---------------------------------------------------|--------|---------------------------------------|---------|--------------------------------------------------|--------|-------------------------------------------------------|--------|----------------------------------|--------|---------------------------------|--------|
| **ASSETS**                                        |   |                                  |    |                                             |   |                                                  |   |                             |   |                            |   |
| Current Assets:                                   |   |                                  |    |                                             |   |                                                  |   |                             |   |                            |   |
| Cash and cash equivalents                         |   | $                                     | 23,939  |                                             | $      | 187                                                   |   | $                                | 1,016  |                            | $      | — |   | $ | 25,142 |   |
| Trade receivables                                 |   | 4,889                                 |    | 240                                              |   | —                                                |   | —                           |   | 5,129                           |   |
| Inventories                                       |   | 80,367                                |    | 1,371                                            |   | 470                                                   |   | —                           |   | 82,208                          |   |
| Deferred income taxes                             |   | 6,581                                 |    | —                                           |   | —                                                |   | —                           |   | 6,581                           |   |
| Prepaid expenses and other current assets         |   | 6,219                                 |    | —                                           |   | —                                                |   | —                           |   | 6,219                           |   |
| Total current assets                              |   | 121,995                               |    | 1,798                                            |   | 1,486                                                 |   | —                           |   | 125,279                         |   |
| Property, Plant and Equipment, net                |   | 53,997                                |    | 1,751                                            |   | 895                                                   |   | —                           |   | 56,643                          |   |
| Assets Held for Sale                              |   | —                                |    | —                                           |   | 1,200                                                 |   | —                           |   | 1,200                           |   |
| Other Assets                                      |   | 37,090                                |    | 354                                              |   | 131                                                   |   | 33,295                           |   | 70,870                          |   |
| Investments in and advances to (from)  affiliates |   | 37,459                                |    | 164,971                                          |   | (3,472                                                | )      | (198,958                         | )      | —                          |   |
| Total assets                                      |   | $                                     | 250,541 |                                             | $      | 168,874                                               |   | $                                | 240    |                            | $      | (165,663 | ) | $ | 253,992 |   |
|                                              |   |                                  |    |                                             |   |                                                  |   |                             |   |                            |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**    |   |                                  |    |                                             |   |                                                  |   |                             |   |                            |   |
| Current Liabilities:                              |   |                                  |    |                                             |   |                                                  |   |                             |   |                            |   |
| Line of credit borrowings                         |   | $                                     | —  |                                             | $      | —                                                |   | $                                | — |                            | $      | — |   | $ | — |   |
| Current portion of long-term debt                 |   | 269                                   |    | —                                           |   | —                                                |   | —                           |   | 269                             |   |
| Accounts payable                                  |   | 20,494                                |    | —                                           |   | —                                                |   | —                           |   | 20,494                          |   |
| Accrued expenses and other current  liabilities   |   | 36,600                                |    | —                                           |   | —                                                |   | 3,451                            |   | 40,051                          |   |
| Total current liabilities                         |   | 57,363                                |    | —                                           |   | —                                                |   | 3,451                            |   | 60,814                          |   |
| Long-Term Debt                                    |   | 127,901                               |    | —                                           |   | —                                                |   | —                           |   | 127,901                         |   |
| Deferred Rent and Other Liabilities               |   | 5,954                                 |    | —                                           |   | —                                                |   | —                           |   | 5,954                           |   |
| Total liabilities                                 |   | 191,218                               |    | —                                           |   | —                                                |   | 3,451                            |   | 194,669                         |   |
| Stockholders’ Equity:                        |   |                                  |    |                                             |   |                                                  |   |                             |   |                            |   |
| Common stockholders’ equity                  |   | 59,323                                |    | 168,874                                          |   | 240                                                   |   | (169,114                         | )      | 59,323                          |   |
| Total liabilities and stockholders’ equity   |   | $                                     | 250,541 |                                             | $      | 168,874                                               |   | $                                | 240    |                            | $      | (165,663 | ) | $ | 253,992 |   |

 

11

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**MothersWork, Inc.Condensed Consolidating Statement of OperationsFor The Nine Months Ended June 30, 2003**(unaudited)(in thousands)

 
|                                          |   | **Mothers Work   (Parent  Company)** |       | **Guarantor   Subsidiaries   (U.S.   Companies)** |       | **Non-  Guarantor   Subsidiaries   (Foreign   Companies)** |       | **Consolidating   Eliminations** |       | **Mothers Work   Consolidated** |       |
|-----------------------------------------------|--------|--------------------------------------|------------|---------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                                          |   |                                 | ** ** |                                              | ** ** |                                                       | ** ** |                             | ** ** |                            | ** ** |
| Net sales                                     |   | $                                    | 348,168    |                                              | $          | 31,032                                                     |       | $                                | 3,508      |                            | $          | (12,661 | ) | $ | 370,047 |   |
| Cost of goods sold                            |   | 160,198                              |       | 7,347                                             |       | 1,182                                                      |       | —                           |       | 168,727                         |       |
| Gross profit                                  |   | 187,970                              |       | 23,685                                            |       | 2,326                                                      |       | (12,661                          | )          | 201,320                         |       |
| Selling, general and administrative  expenses |   | 172,846                              |       | 8,598                                             |       | 1,796                                                      |       | (12,661                          | )          | 170,579                         |       |
| Operating income                              |   | 15,124                               |       | 15,087                                            |       | 530                                                        |       | —                           |       | 30,741                          |       |
| Interest income (expense), net                |   | (16,900                              | )          | 6,113                                             |       | —                                                     |       | —                           |       | (10,787                         | )          |
| Equity in earnings of subsidiaries            |   | 14,034                               |       | —                                            |       | —                                                     |       | (14,034                          | )          | —                          |       |
| Income (loss) before income taxes             |   | 12,258                               |       | 21,200                                            |       | 530                                                        |       | (14,034                          | )          | 19,954                          |       |
| Income tax provision (benefit)                |   | (54                                  | )          | 7,494                                             |       | 202                                                        |       | —                           |       | 7,642                           |       |
|                                          |   |                                 |       |                                              |       |                                                       |       |                             |       |                            |       |
| Net income (loss)                             |   | $                                    | 12,312     |                                              | $          | 13,706                                                     |       | $                                | 328        |                            | $          | (14,034 | ) | $ | 12,312 |   |

 

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**MothersWork, Inc.Condensed Consolidating Cash Flow StatementFor The Nine Months Ended June 30, 2003**(unaudited)(in thousands)

 
|                                                                                      |   | **Mothers   Work   (Parent   Company)** |   | **Guarantor   Subsidiaries   (U.S.   Companies)** |   | **Non-  Guarantor   Subsidiaries   (Foreign   Companies)** |   | **Consolidating   Eliminations** |   | **Mothers   Work   Consolidated** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------------------|--------|------------------------------------------------------------|--------|----------------------------------|--------|-----------------------------------|--------|
| **Cash  Flows from Operating Activities:**                                                |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Net income (loss)                                                                         |   | $                                       | 12,312 |                                              | $      | 13,706                                                     |   | $                                | 328    |                              | $      | (14,034 | ) | $ | 12,312 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Depreciation and amortization                                                             |   | 7,130                                   |   | 171                                               |   | 50                                                         |   | —                           |   | 7,351                             |   |
| Loss on impairment of long-lived assets                                                   |   | 89                                      |   | —                                            |   | —                                                     |   | —                           |   | 89                                |   |
| Loss on disposal of assets                                                                |   | 156                                     |   | —                                            |   | —                                                     |   | —                           |   | 156                               |   |
| Deferred income tax provision                                                             |   | 2,307                                   |   | —                                            |   | —                                                     |   | —                           |   | 2,307                             |   |
| Tax benefit of stock option exercises                                                     |   | 478                                     |   | —                                            |   | —                                                     |   | —                           |   | 478                               |   |
| Amortization of deferred financing costs                                                  |   | 284                                     |   | —                                            |   | —                                                     |   | —                           |   | 284                               |   |
| Accretion of discount on notes                                                            |   | 100                                     |   | —                                            |   | —                                                     |   | —                           |   | 100                               |   |
| Provision for deferred rent                                                               |   | 443                                     |   | —                                            |   | —                                                     |   | —                           |   | 443                               |   |
| Changes in assets and liabilities:                                                        |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Decrease (increase) in—                                                              |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Trade receivables                                                                         |   | (129                                    | )      | (161                                              | )      | —                                                     |   | —                           |   | (290                              | )      |
| Inventories                                                                               |   | (5,744                                  | )      | 649                                               |   | (283                                                       | )      | —                           |   | (5,378                            | )      |
| Prepaid expenses and other current assets                                                 |   | (273                                    | )      | 19                                                |   | (131                                                       | )      | —                           |   | (385                              | )      |
| Intercompany balance                                                                      |   | (2,263                                  | )      | (13,514                                           | )      | 1,743                                                      |   | 14,034                           |   | —                            |   |
| Increase (decrease) in—                                                              |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Accounts payable, accrued expenses and  other liabilities                                 |   | 11,406                                  |   | (630                                              | )      | (89                                                        | )      | —                           |   | 10,687                            |   |
| Net cash provided by operating activities                                                 |   | 26,296                                  |   | 240                                               |   | 1,618                                                      |   | —                           |   | 28,154                            |   |
| **Cash  Flows from Investing Activities:**                                                |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Capital expenditures                                                                      |   | (15,084                                 | )      | (99                                               | )      | (796                                                       | )      | —                           |   | (15,979                           | )      |
| Purchase of intangible assets                                                             |   | (180                                    | )      | —                                            |   | —                                                     |   | —                           |   | (180                              | )      |
| Net cash used in investing activities                                                     |   | (15,264                                 | )      | (99                                               | )      | (796                                                       | )      | —                           |   | (16,159                           | )      |
| **Cash  Flows from Financing Activities:**                                                |   |                                    |   |                                              |   |                                                       |   |                             |   |                              |   |
| Increase in cash overdrafts                                                               |   | 1,334                                   |   | —                                            |   | —                                                     |   | —                           |   | 1,334                             |   |
| Repayment of long-term debt                                                               |   | (212                                    | )      | —                                            |   | —                                                     |   | —                           |   | (212                              | )      |
| Repurchase of common stock                                                                |   | (1,467                                  | )      | —                                            |   | —                                                     |   | —                           |   | (1,467                            | )      |
| Payment of issuance costs of common stock                                                 |   | (210                                    | )      | —                                            |   | —                                                     |   | —                           |   | (210                              | )      |
| Payment of issuance costs of long-term debt                                               |   | (242                                    | )      | —                                            |   | —                                                     |   | —                           |   | (242                              | )      |
| Payout on redemption of Series A Preferred  Stock                                         |   | (1,310                                  | )      | —                                            |   | —                                                     |   | —                           |   | (1,310                            | )      |
| Proceeds from exercise of stock options and  warrants                                     |   | 495                                     |   | —                                            |   | —                                                     |   | —                           |   | 495                               |   |
| Net cash used in financing activities                                                     |   | (1,612                                  | )      | —                                            |   | —                                                     |   | —                           |   | (1,612                            | )      |
| **Net  Increase in Cash and Cash Equivalents**                                            |   | 9,420                                   |   | 141                                               |   | 822                                                        |   | —                           |   | 10,383                            |   |
| **Cash  and Cash Equivalents, Beginning of Period**                                       |   | 14,519                                  |   | 46                                                |   | 194                                                        |   | —                           |   | 14,759                            |   |
| **Cash  and Cash Equivalents, End of Period**                                             |   | $                                       | 23,939 |                                              | $      | 187                                                        |   | $                                | 1,016  |                              | $      | — |   | $ | 25,142 |   |

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**Results of Operations**

 

The following tables setforth certain operating data as a percentage of net sales and as a percentagechange for the periods indicated:

** **
|                                          |   | **Percentage of Net Sales**        |   | **% Period to Period  Increase**  |   |
|-----------------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|
|                                          |   | **Three   Months Ended  June 30,** |   | **Nine   Months Ended  June 30,** |   | **Three Months  Ended  June 30,** |   | **Nine Months   Ended  June 30,** |   |
|                                          |   | **2003**                           |   | **2002**                          |   | **2003** |   | **2002** |   | **2003 vs. 2002** |   | **2003 vs. 2002** |   |
| Net  sales                                    |   | 100.0                              | %      | 100.0                             | %      | 100.0 | % | 100.0 | % | 8.0 | % | 8.2 | % |
| Cost  of goods sold                           |   | 42.8                               |   | 44.5                              |   | 45.6 |   | 46.9 |   | 3.9 |   | 5.3 |   |
| Gross  profit                                 |   | 57.2                               |   | 55.5                              |   | 54.4 |   | 53.1 |   | 11.3 |   | 10.8 |   |
| Selling,  general and administrative expenses |   | 44.2                               |   | 43.0                              |   | 46.1 |   | 45.0 |   | 10.9 |   | 10.8 |   |
| Operating  income                             |   | 13.0                               |   | 12.5                              |   | 8.3 |   | 8.1 |   | 12.4 |   | 10.9 |   |
| Interest  expense, net                        |   | 2.7                                |   | 2.7                               |   | 2.9 |   | 3.0 |   | 9.1 |   | 4.2 |   |
| Income  before income taxes                   |   | 10.3                               |   | 9.8                               |   | 5.4 |   | 5.1 |   | 13.4 |   | 14.8 |   |
| Income  tax provision                         |   | 4.0                                |   | 3.6                               |   | 2.1 |   | 1.9 |   | 17.9 |   | 18.2 |   |
| Net  income                                   |   | 6.3                                |   | 6.2                               |   | 3.3 |   | 3.2 |   | 10.7 |   | 12.8 |   |
| Dividends  on preferred stock                 |   | —                             |   | 0.6                               |   | — |   | 0.7 |   | NM |   | NM |   |
| Net  income available to common stockholders  |   | 6.3                                | %      | 5.6                               | %      | 3.3 | % | 2.5 | % | 23.1 |   | 42.8 |   |

 

Thefollowing tables set forth certain information concerning the number of Companystores and leased departments for the periods indicated:

 
|                                                    |   | **Three Months Ended** |   |
|---------------------------------------------------------|--------|------------------------|--------|
|                                                    |   | **June 30, 2003**      |   | **June 30, 2002** |   |
|                                                    |   | **Stores**             |   | **Leased  Departments** |   | **Total** |   | **Stores** |   | **Leased  Departments** |   | **Total** |   |
|                                                    |   |                   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                     |   | 801                    |   | 148 |   | 949 |   | 761 |   | 132 |   | 893 |   |
| iMaternity acquired locations, net of  related closures |   | (1                     | )      | — |   | (1 | ) | (20 | ) | — |   | (20 | ) |
| Opened                                                  |   | 25                     |   | 5 |   | 30 |   | 13 |   | 13 |   | 26 |   |
| Closed                                                  |   | (4                     | )      | (2 | ) | (6 | ) | (1 | ) | — |   | (1 | ) |
| End of period                                           |   | 821                    |   | 151 |   | 972 |   | 753 |   | 145 |   | 898 |   |

 
|                                                    |   | **Nine Months Ended** |   |
|---------------------------------------------------------|--------|-----------------------|--------|
|                                                    |   | **June 30, 2003**     |   | **June 30, 2002** |   |
|                                                    |   | **Stores**            |   | **Leased  Departments** |   | **Total** |   | **Stores** |   | **Leased  Departments** |   | **Total** |   |
|                                                    |   |                  |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                     |   | 763                   |   | 146 |   | 909 |   | 639 |   | 132 |   | 771 |   |
| iMaternity acquired locations, net of  related closures |   | (5                    | )      | — |   | (5 | ) | 83 |   | — |   | 83 |   |
| Opened                                                  |   | 73                    |   | 9 |   | 82 |   | 38 |   | 14 |   | 52 |   |
| Closed                                                  |   | (10                   | )      | (4 | ) | (14 | ) | (7 | ) | (1 | ) | (8 | ) |
| End of period                                           |   | 821                   |   | 151 |   | 972 |   | 753 |   | 145 |   | 898 |   |

 

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**Three Months Ended June 30, 2003 and 2002**

 

*Net Sales.* Our net sales for the third quarter of fiscal 2003 increased 8.0%, a$9.8 million increase, to $132.4 million from $122.6 million forthe third quarter of fiscal 2002.  Netsales for the third quarter increased primarily from the addition of newstores, with the total number of our locations increasing to 972 at June 30,2003 compared to 898 at June 30, 2002. For the quarter ended June 30, 2003, weopened 30 new locations and closed seven locations, including one iMaternitystore closed in connection with the consolidation of that acquired store chain.Since acquiring 166 iMaternity stores in October 2001, we have closed a totalof 93 stores where we believed we could transfer a sufficient portion of thesales to our existing stores within the same area while eliminating acquiredstore expenses and improving inventory utilization. Comparable store sales forthe third quarter of fiscal 2003 decreased by 0.4%, based on 821 locations,versus a comparable store sales increase of 4.1% during the third quarter offiscal 2002, based on 718 locations. The comparable store sales results for thequarter were adversely affected by the continued difficult retail environmentand the lack of consistent Spring-like weather conditions conducive to sellingSpring apparel during most of the quarter in much of the United States.

 

*Gross Profit.* Our gross profit for the third quarter of fiscal 2003 increased by11.3%, a $7.7 million increase, to $75.7 million from $68.0 million for thethird quarter of fiscal 2002.  Thisincrease was attributable primarily to our increased sales compared to lastyear, and, to a lesser extent, our improved gross margin.  Gross profit as a percentage of net salesfor the third quarter of fiscal 2003 improved by 168 basis points (1.68percentage points of net sales) to 57.2% from 55.5% for the third quarter offiscal 2002.  The increase in grossmargin versus last year primarily reflects the reduction of our product costsas a result of the continued expansion and refinement of our global sourcinginitiatives, as well as delays in the timing of certain product selling pricereductions to the fourth quarter due to the delay in the onset of Springweather in much of the United States compared to last year.

 

*Selling, General and Administrative Expenses.* Our selling, general and administrative (“SG&A”) expenses for thethird quarter of fiscal 2003 increased by 10.9%, a $5.8 million increase,to $58.4 million from $52.7 million for the third quarter of fiscal2002. Compared to the third quarter of fiscal 2002, store wages and relatedbenefit costs increased by $2.2 million and store rent and relatedexpenses increased by $1.9 million, primarily resulting from our new storeopenings during the past twelve months and increased medical benefitsexpenses.  In addition, our SG&Aexpenses for the third quarter of fiscal 2003 included a pre-tax legal expensecharge of approximately $0.4 million (0.3% of net sales) for the estimatedcosts related to the previously disclosed employment-related litigation inWashington.  As a percentage of netsales, SG&A expenses increased to 44.2% for the third quarter of fiscal2003 compared to 43.0% for the third quarter of fiscal 2002, primarilyreflecting increased store payroll, benefits and rent expenses as a percentageof net sales, and the impact of the $0.4 million pre-tax legal expensecharge.  The increase in store expensesas a percentage of net sales primarily reflects the relatively low comparablestore sales increase for the quarter as well as the higher store expense ratiosof our newer stores.

 

*Operating Income.* Our operating income for the third quarter of fiscal 2003 increased by12.4%, a $1.9 million increase, to $17.3 million from$15.4 million for the third quarter of fiscal 2002.  Operating income as a percentage of netsales for the third quarter of fiscal 2003 increased to 13.0% from 12.5% forthe third quarter of fiscal 2002, due to the increase in our gross margin,partially offset by an increased operating expense ratio.

 

*Interest Expense, Net.* Our net interest expense for the third quarter of fiscal 2003 increasedby 9.1%, a $0.3 million increase, to $3.6 million from $3.3 million for thethird quarter of fiscal 2002.  Theincrease in interest expense for the current period reflects the higher overalldebt balance compared to last year, due to the net impact of our August 2002debt and equity offerings.

 

*Income Taxes.* Our effective income tax rate wasa provision of 38.7% for the third quarter of fiscal 2003 compared to aprovision of 37.2% for the third quarter of fiscal 2002.   Theeffective income tax rate of 38.7% for the third quarter of fiscal2003 was computed based on an estimated annual effective tax rate of 38.3%for fiscal 2003.  The increase in ourestimated annual effective tax rate for fiscal 2003 primarily reflects anincrease in our estimated effective state income tax rate.

 

*Dividends on Preferred Stock. *Preferred dividends were zero forthe third quarter of fiscal 2003 compared to $0.8 million for the third quarterof fiscal 2002, reflecting the redemption of our Series A Preferred Stock andrepurchase of our Series C Preferred Stock in the fourth quarter of fiscal2002. Consequently, we will no longer report any dividends with respect tothese two series of preferred stock.  Asof June 30, 2003,  $2.4 million has notyet been paid for the redeemed Series A Preferred Stock and will be paid outupon submission of proper documentation from the remaining holders of thoseshares.

 

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*Net Income Available to CommonStockholders. *Net income available to commonstockholders for the third quarter of fiscal 2003 was $8.4 million, or $1.50per common share (diluted), compared to $6.8 million, or $1.45 per common share(diluted), for the third quarter of fiscal 2002, representing a 23.1% increasein net income and a 3.4% increase in diluted earnings per share.  The average diluted shares outstanding of 5,570,000for the third quarter of fiscal 2003 were 9.3% higher than the 5,097,000 sharesfor the third quarter of fiscal 2002. As of June 30, 2003, we had 5,207,124 outstanding common shares, whichreflects the retirement of 60,554 shares we repurchased during the thirdquarter of fiscal 2003 pursuant to our share repurchase program.

 

**Nine Months Ended June 30, 2003 and 2002**

 

*Net Sales.* Our net sales for the first nine months of fiscal 2003 increased 8.2%, a$28.2 million increase, to $370.0 million from $341.8 millionfor the first nine months of fiscal 2002. Net sales for the first nine months increased primarily due to theaddition of new stores.  Comparablestore sales for the first nine months of fiscal 2003 increased by 1.1%, basedon 722 locations, versus a comparable store sales increase of 1.0% during thefirst nine months of fiscal 2002, based on 665 locations.  The comparable store sales results for thefirst nine months of fiscal 2003 were adversely affected by the continueddifficult retail environment.  For thenine months ended June 30, 2003, we opened 82 new locations and closed 19locations, including five iMaternity stores closed in connection with theconsolidation of the acquired store chain.

 

*Gross Profit*.    Our gross profit for the first nine months of fiscal 2003increased 10.8%, a $19.7 million increase, to $201.3 million**,**compared to $181.6 million for the first nine months of fiscal 2002, due toincreased sales and, to a lesser extent, improved gross margin compared to lastyear. Gross profit as a percentage of net sales for the first nine months offiscal 2003 increased by 127 basis points to 54.4% from 53.1% in the comparableperiod of fiscal 2002. The improvement in gross margin versus last yearprimarily reflects our continued success at reducing product costs through ourglobal sourcing initiatives.

 

*Selling, General and Administrative Expenses*.    Our SG&A expenses for the first nine months of fiscal 2003increased by 10.8%, a $16.7 million increase, to $170.6 million from $153.9million for the first nine months of fiscal 2002. Compared to the first ninemonths of fiscal 2002, store wages and related benefit costs increased by $6.6million and store rent and related expenses increased by $5.1 million,primarily resulting from our new store openings during the past twelve monthsand increased medical benefits expenses.  In addition, our SG&A expenses for the first nine months of fiscal2003 included pre-tax legal expense charges of approximately $1.2 millionrelated to the estimated settlement costs, judgment costs and related expensesof previously disclosed separate employment-related litigation in Californiaand Washington.  As a percentage of netsales, SG&A expenses increased to 46.1% for the first nine months of fiscal2003 compared to 45.0% for the first nine months of fiscal 2002, primarilyreflecting increased store payroll, benefits and rent expenses as a percentageof net sales, and the impact of the $1.2 million pre-tax legal expensecharges.  The increase in store expensesas a percentage of net sales primarily reflects the relatively low comparablestore sales increase for the first nine months as well as the higher storeexpense ratios of our newer stores.

 

*OperatingIncome*.    Our operating income for the first ninemonths of fiscal 2003 increased by 10.9%, a $3.0 million increase, to $30.7million compared to $27.7 million for the first nine months of fiscal 2002, dueto the higher sales volume and improved gross margin, partially offset byhigher SG&A expenses. Operating income as a percentage of net sales for thefirst nine months of fiscal 2003 increased to 8.3% from 8.1% in the comparableperiod of fiscal 2002 due to the increase in our gross margin, largely offsetby an increased operating expense ratio.

 

*InterestExpense, Net*.    Our net interest expense for the firstnine months of fiscal 2003 increased by 4.2%, or $0.4 million, to$10.8 million, compared to $10.4 million for the first nine months offiscal 2002. The increase reflects the somewhat higher overall debt balancecompared to last year due to the net impact of our August 2002 debt and equityofferings, partially offset by a $0.3 million non-recurring interest expensecredit in fiscal 2003 related to our credit facility.

 

*IncomeTaxes*.    Our effective income tax rate was aprovision of 38.3% for the first nine months of fiscal 2003 compared to 37.2%for the first nine months of fiscal 2002. The increase in the effective incometax rate primarily reflects an increase in our estimated effective state incometax rate.

 

*Dividendson Preferred Stock. *Preferred dividends were zero forthe first nine months of fiscal 2003 compared to $2.3 million for the firstnine months of fiscal 2002, reflecting the redemption of our Series A PreferredStock and repurchase of our Series C Preferred Stock in the fourth quarter offiscal 2002.

 

*NetIncome Available to Common Stockholders. *Netincome available to common stockholders for the first nine months of fiscal2003 was $12.3 million, or $2.18 per common share (diluted), compared to $8.6million, or $2.18 per common share (diluted), for the first nine months offiscal 2002, representing a 42.8% increase in net income.  The average

 

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diluted shares outstanding of 5,651,000 for the first nine months offiscal 2003 were 41.9% higher than the 3,982,000 shares for the first ninemonths of fiscal 2002, due to the shares issued in our August 2002 common stockoffering as well as the impact of stock options and warrants exercised duringthe past 12 months and the increased dilutive effect of outstanding stockoptions and warrants compared to last year.

 

**Seasonality**

 

Our business, like that of certain otherretailers, is seasonal. A significant portion of our net sales and profits aretypically realized during the first and third fiscal quarters, corresponding tothe holiday and Spring selling seasons. Results for any quarter are notnecessarily indicative of the results that may be achieved for a full fiscalyear.  Quarterly results may fluctuatematerially depending upon, among other things, the timing of new storeopenings, net sales and profitability contributed by new stores, increases ordecreases in comparable store sales, adverse weather conditions, shifts in thetiming of certain holidays and promotions, changes in inventory and productionlevels and the timing of deliveries of inventory, and changes in ourmerchandise mix.

 

# **Liquidity and Capital Resources**

 

Our cash needs have primarily been for(i) debt service on our senior notes and our credit facility,(ii) capital expenditures, including leasehold improvements, fixtures andequipment for new stores, store relocations and expansions, and existing stores, aswell as for our distribution and corporate facilities and information systems,and (iii) working capital, including inventory to support our new stores aswell as existing stores. We have historically financed these capitalrequirements from cash flows from operations and borrowings under our creditfacility.

 

InAugust 2002, we completed debt and equity offerings whereby we issued $125.0million of 11 1/4% senior notes due 2010 (the “New Senior Notes”) and 1,165,000new shares of common stock (including the full exercise of the over-allotmentoption by the underwriters of our common stock offering), and used the netproceeds (i) to repay the $92.0 million of 12 5/8% senior notes (the “OldSenior Notes”) plus accrued and unpaid interest; (ii) to repay subordinatednotes issued to former holders of shares of our Series A Preferred Stock inlieu of accrued and unpaid dividends; (iii) to redeem all of the outstandingshares of our Series A Preferred Stock and to purchase, through an offer topurchase, all of the outstanding shares of our Series C Preferred Stock, ineach case, for a price which included all accrued and unpaid dividends; (iv) torepay the outstanding borrowings under our credit facility and (v) for generalcorporate purposes.  We received netproceeds from these debt and equity offerings of approximately $147.9 million,after deducting fees and expenses of the offerings.  We used approximately $92.6 million of the net proceeds of theofferings for the repurchase of our Old Senior Notes, including accrued andunpaid interest and related fees and expenses. We used approximately $2.6 million for the repayment of subordinatednotes that had been issued in lieu of cash dividends on shares of Series APreferred Stock previously converted into common stock. We used approximately$13.4 million to redeem all of the outstanding Series A Preferred Stock, includingaccrued and unpaid dividends, of which $11.0 million has been paid as of June30, 2003, and $2.4 million will be paid out upon submission of properdocumentation from the remaining holders of the Series A Preferred Stock.  The $2.4 million amount is reflected in ourconsolidated balance sheet as of June 30, 2003 in accrued expenses and othercurrent liabilities.  We usedapproximately $20.9 million of the net proceeds from the offerings for therepurchase of all of the outstanding Series C Preferred Stock issued to thesellers of iMaternity in October 2001, including accrued and unpaid dividends.The remaining $18.4 million of net proceeds from the offerings were used torepay all of the outstanding borrowings under the credit facility, with thebalance invested in short-term investments and available for general corporatepurposes.  The net proceeds ofapproximately $147.9 million from the debt and equity offerings includesapproximately $0.6 million of cash proceeds from the exercise of stock optionsby certain selling stockholders in conjunction with the equity offering.

 

TheNew Senior Notes were issued at 98.719% of their face amount, resulting in anannual effective interest rate of 11.50%. Interest on the New Senior Notes is payable semi-annually in cash onFebruary 1st and August 1st, and commenced on February 1,2003.  The New Senior Notes were issuedby Mothers Work, are senior unsecured obligations of Mothers Work, and areunconditionally guaranteed on a senior basis by all of our domestic subsidiaries.  See Note 10 of “Notes to ConsolidatedFinancial Statements.”  The New SeniorNotes are redeemable at our option, in whole or in part, at any time on orafter August 1, 2006 at 105.625% of their face amount, plus accrued and unpaidinterest, declining ratably to 100% of their face amount, plus accrued andunpaid interest, on and after August 1, 2009. Additionally, before August 1, 2005, we may redeem, at our option, up to35% of the aggregate principal amount of the New Senior Notes with the proceedsfrom equity offerings at 111.25% of their principal amount, plus accrued andunpaid interest.  The New Senior Notesimpose certain restrictions on our ability to, among other things, incuradditional indebtedness, pay dividends, repurchase stock, and enter into othervarious types of transactions.

 

Cashand cash equivalents increased by $10.4 million during the first nine months offiscal 2003 compared to a

 

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decrease of $8.2 million for the first nine months of fiscal 2002.  Cash provided by operations was$28.2 million for the first nine months of fiscal 2003, a decrease of $5.3million from the $33.4 million for the first nine months of fiscal 2002.  During the first nine months of fiscal 2003,we used cash provided by operations primarily to pay for $16.0 million ofcapital expenditures and to increase our cash and cash equivalents.  During the first nine months of fiscal 2002,we used our cash provided by operations, along with excess cash balances, primarilyto reduce borrowings under our credit facility by $30.7 million and torepay outstanding iMaternity debt of $8.9 million assumed upon ouracquisition of iMaternity in October 2001.

 

For the first nine months of fiscal 2003, wespent $16.0 million on capital expenditures, including $11.1 million onfurniture, fixtures and leasehold improvements principally for new storefacilities, as well as improvements to existing stores, and $4.9 million forour distribution and corporate facilities and information systems.  In comparison, we spent a total of $5.1million on capital expenditures in the first nine months of fiscal 2002, ofwhich $4.4 million was spent for new store facilities and improvements toexisting stores, and $0.7 million on distribution and corporate facilities andinformation systems.  The increase incapital expenditures primarily reflects the increased number of our new storeopenings compared to a year ago, as well as expenditures to expand the capacityand throughput of our distribution center and increased investment in ourmanagement information systems, including the continued rollout of our newproprietary point-of-sale system.

 

In March 2003, our Board of Directorsapproved a share repurchase program under which we may repurchase up to $10.0million of the Company’s outstanding common stock from time to time until March2005.  Pursuant to this program, we hadrepurchased 66,554 shares of the Company’s common stock at a cost of $1,467,000through June 30, 2003.

 

Wehave a $60 million credit facility that includes a $56.0 millionborrowing base revolving line of credit and approximately $4 million tosupport a special purpose letter of credit facility. This $60 millioncredit facility matures on September 15, 2004.  In October 2001, the credit facility was amended andrestated primarily to increase the collateral base to include the assetsacquired in our purchase of iMaternity. On August 5, 2002, we further amended the credit facility to, amongother things, permit the consummation of the debt and equity offerings and theuse of proceeds thereof, and modify the covenants in order to increase theannual capital expenditures limit to $30.0 million and permit acquisitions,capital stock repurchases and early redemptions of senior notes withinspecified limits. The amendment also added an unused facility fee of 10 basispoints per annum.  Interest on directborrowings under the credit facility is currently based on the lender’s primerate or, at our election, an alternative rate of LIBOR plus 200 basis pointsfor all or part of the direct borrowings outstanding. At June 30, 2003, therewere no direct borrowings under the credit facility.  Borrowings under the credit facility would have borne interest atthe rate of between approximately 3.1% and 4.0% per annum as of June 30,2003.  Amounts available for directborrowings, net of letters of credit outstanding, are limited to the lesser of(a) the unused portion of the credit facility or (b) the AggregateAdjusted Availability (“AAA”) as defined in the agreement based on a percentageof eligible inventory, receivables and cash. The credit facility is secured bya security interest in our accounts receivable, inventory, equipment, fixtures,cash and other assets. There are no financial covenant requirements in theagreement unless the AAA falls below $10.0 million. In such event, wewould have to achieve minimum cash flow, as defined in the agreement, of notless than zero. During the first nine months of fiscal 2003 and all of fiscal2002, we have exceeded the AAA minimum. As of June 30, 2003, outstanding borrowings under the credit facilityconsisted of no direct borrowings and $3.5 million in letters of credit,with AAA and available borrowings of $52.5 million.  By comparison, as of June 30, 2002,outstanding borrowings under the credit facility consisted of $1.5 million ofdirect borrowings and $3.1 million in letters of credit, with AAA andavailable borrowings of $46.3 million. In addition, pursuant to thespecial purpose letter of credit facility, as of June 30, 2003 we have anoutstanding $3.4 million standby letter of credit to collateralize anoutstanding industrial revenue bond and a $1.0 million letter of credit tocollateralize a government mortgage note.

 

Management of the Company believes that ourcurrent cash and working capital positions, expected operating cash flows andavailable borrowing capacity under the credit facility will be sufficient tofund our working capital, capital expenditures and debt repayment requirementsand to fund stock repurchases, if any, for the foreseeable future.

 

**Critical Accounting Policies and Estimates**

 

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

 

Our significant accounting policies weredescribed in Note 2 of “Notes to Consolidated Financial Statements”contained in the Annual Report on Form 10-K as filed for the fiscal year endedSeptember 30, 2002.  We believethat the following discussion addresses our critical accounting policies, whichare those that are most important to the portrayal of our

 

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financial condition and results of operations and require management’smost difficult, subjective and complex judgments, often as a result of the needto make estimates about the effect of matters that are inherentlyuncertain.  If actual results were todiffer significantly from estimates made, the reported results could bematerially affected.  However, theCompany is not currently aware of any reasonably likely events or circumstancesthat would result in materially different results.

 

The Company’s senior management has reviewedthese critical accounting policies and estimates and Management’s Discussionand Analysis regarding them with its audit committee.

 

*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-outmethod (FIFO) and includes the cost of merchandise and freight. A periodicreview of inventory quantities on hand is performed in order to determine ifinventory is properly positioned at the lower of cost or market. Factors relatedto current inventories such as future consumer demand and fashion trends,current analysis of merchandise based on receipt date, current and anticipatedretail markdowns or discounts, and class or type of inventory are analyzed todetermine estimated net realizable values. Criteria utilized by the Company to quantify aging trends includefactors such as amount of merchandise received within the past twelve months,merchandise received more than one year before with quantities on-hand inexcess of 12 months of sales, and merchandise currently selling belowcost.  A provision is recorded to reducethe cost of inventories to the estimated net realizable values, if required.Inventories as of June 30, 2003 and September 30, 2002 totaled $82.2 million and$76.8 million, respectively, representing approximately 32.4% and 32.9% oftotal assets, respectively. Given the significance of inventories to theCompany’s consolidated financial statements, the determination of netrealizable values is considered to be a critical accounting estimate. Anysignificant unanticipated changes in the factors noted above could have asignificant impact on the value of our inventories and our reported operatingresults.

 

*Long-LivedAssets.*  Our long-lived assets consist principally ofstore leasehold improvements and are included in the “Property, Plant andEquipment, net” line item in our consolidated balance sheets. These long-livedassets are recorded at cost and are amortized using the straight-line method,which deducts equal amounts of costs from earnings every year over the lesserof the applicable store lease term or the estimated useful life of theleasehold improvements. The typical initial lease term for our stores is tenyears.  Net property, plant andequipment as of June 30, 2003 and September 30, 2002 totaled $56.6 million and$50.5 million, respectively, representing approximately 22.3% and 21.6% oftotal assets, respectively.

 

In assessing potential impairment of theseassets, we periodically evaluate the historical and forecasted operatingresults and cash flows on a store-by-store basis. Newly opened stores may taketime to generate positive operating and cash flow results. Factors such as (i)store type, that is, company store or leased department, (ii) store concept,that is, Motherhood, Mimi Maternity, or A Pea in the Pod, (iii) store location,for example, urban area versus suburb, (iv) current marketplace awareness ofour brands, (v) local customer demographic data and (vi) current fashion trendsare all considered in determining the time frame required for a store toachieve positive financial results, which is assumed to be within two yearsfrom the date a store location is opened. If economic conditions aresubstantially different from our expectations, the carrying value of certain ofour long-lived assets may become impaired. In the third quarter and nine months ended June 30, 2003, we recordedzero and $89,000, respectively, in write-downs of long-lived assets.

 

*Goodwill*. The purchase method of accounting for business combinations requires theCompany to make use of estimates and judgments to allocate the purchase pricepaid for acquisitions to the fair value of the net tangible and identifiableintangible assets.  Goodwill representsthe excess of the aggregate purchase price over the fair value of net assets ofan acquired entity.  As of both June 30,2003 and September 30, 2002, goodwill totaled $52.7 million, representingapproximately 20.7% and 22.6% of total assets, respectively.  In June 2001, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards (“SFAS”) No.142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires thatgoodwill no longer be amortized, but instead be tested for impairment at leastannually or as impairment indicators arise. Prior to our adoption of SFAS No.142 on October 1, 2001, goodwill was amortized using the straight-line methodover a period of 20 years.

 

The impairment test requires the Company tocompare the fair value of business reporting units to their carrying value,including assigned goodwill.  SFAS No.142 required an initial impairment test within nine months after adoption bythe Company and annually thereafter.  Inaddition, goodwill is tested more frequently if changes in circumstances or theoccurrence of events indicate impairment exists.  In assessing potential impairment of goodwill, we have determinedthat we have one reporting unit for purposes of applying SFAS No. 142 based onour reporting structure. The fair value of our single reporting unit isdetermined based on the fair market value of our outstanding common stock on acontrol basis. The Company performed the initial adoption impairment test inearly fiscal 2002.  The results of theinitial impairment test and the annual impairment test performed as ofSeptember 30, 2002 indicated fair value amounts exceeded carrying amounts by asubstantial margin.  If any significantunanticipated change in the fair value of our outstanding common stock on acontrol basis occurs, our goodwill may become impaired.

 

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*Accounting for Income Taxes.* As part of the process of preparing our consolidated financialstatements, we are required to estimate our income taxes in each of thejurisdictions in which we operate. This process requires us to estimate ouractual current tax expense together with assessing temporary differencesresulting from differing treatment of items, such as depreciation of propertyand equipment and valuation of inventories, for tax and accountingpurposes.  We determine our provisionfor income taxes based on federal and state tax laws and regulations ascurrently in effect, some of which have been recently revised.  Legislation changes currently proposed bycertain states in which we operate, if enacted, could increase the transactionsor activities subject to tax. Any such legislation that becomes law couldresult in an increase in our income tax expense and our income taxes paid.

 

The temporary differences result in deferredtax assets and liabilities, which are included within our consolidated balancesheets. We must then assess the likelihood that our deferred tax assets will berecovered from future taxable income. Actual results could differ from thisassessment if adequate taxable income is not generated in future periods.Deferred tax assets as of June 30, 2003 and September 30, 2002 totaled $18.4million and $20.7 million, respectively, representing approximately 7.2% and8.9% of total assets, respectively. To the extent we believe that recovery ofthe deferred tax assets is not more likely than not, we must establish avaluation allowance. To the extent we establish a valuation allowance orincrease the allowance in a period, we must include an expense within the taxprovision in the statement of operations.

 

*Accountingfor Contingencies*.  From time to time, weare named as a defendant in legal actions arising from our normal businessactivities.  We account forcontingencies such as these in accordance with SFAS No. 5, “Accounting forContingencies.”  SFAS No. 5 requires usto record an estimated loss contingency when information available prior toissuance of our financial statements indicates that it is probable that anasset has been impaired or a liability has been incurred at the date of thefinancial statements and the amount of the loss can be reasonablyestimated.  SFAS No. 5 and itsinterpretation further state that when there is a range of loss and no amountwithin that range is a better estimate than any other, then the minimum amountof the range shall be accrued. Accounting for contingencies arising from contractual or legalproceedings requires management to use its best judgment when estimating anaccrual related to such contingencies, which includes consultation with theCompany’s legal counsel.  As of June 30,2003, accruals for loss contingencies include charges totaling $1.2 million inconnection with our previously disclosed separate employment-related litigationin California and Washington.  Asadditional information becomes known, our accrual for a loss contingency couldfluctuate, thereby creating variability in our results of operations fromperiod to period. Likewise, an actual loss arising from a loss contingencywhich significantly exceeds the amount accrued for in our financial statementscould have a material adverse impact on our operating results for the period inwhich such actual loss becomes known.

 

**Forward-Looking Statements**

 

Some of the information in this report, includingthe information incorporated by reference (as well as information included inoral statements or other written statements made or to be made by us), containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. 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 notlimited to: changes in consumer spending patterns, raw material priceincreases, consumer preferences and overall economic conditions, the impact ofcompetition and pricing, availability of suitable store locations, continuedavailability of capital and financing, ability to hire and develop seniormanagement and sales associates, ability to develop and source merchandise andability to receive production from foreign sources on a timely basis, potentialstock repurchases and other factors referenced in our Annual Report on Form10-K, including those set forth under the caption “Risk Factors.”

 

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

 

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**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

 

Mothers Work is exposed to market risk fromchanges in interest rates.  We have notentered into any market sensitive instruments for trading purposes.  The analysis below presents the sensitivityof the market value of our financial instruments to selected changes in marketinterest rates.  The range of changespresented reflects our view of changes that are reasonably possible over aone-year period.

 

At June 30, 2003, the principal components ofour debt portfolio were the $125.0 million of New Senior Notes due 2010and the $60 million credit facility, both of which are denominated in U.S.dollars.  The fair value of the debtportfolio is referred to as the “debt value.” The New Senior Notes bear interest at a fixed rate of 111⁄4%.  While a change in market interest rates wouldnot affect the interest incurred or cash flow related to this fixed rate portionof the debt portfolio, the debt value would be affected.

 

Our revolving credit facility carries avariable interest rate that is tied to market indices.  At June 30, 2003, we had no directborrowings and $3.5 million of letters of credit outstanding under our creditfacility (plus an additional $4.4 million of letters of credit outstandingunder a special purpose letter of credit facility).  Direct borrowings under the credit facility would have borneinterest at a rate between approximately 3.1% and 4.0% per annum as of June 30,2003.  Any future borrowings under thecredit facility would, to the extent of outstanding borrowings, be affected bychanges in market interest rates. A change in market interest rates on thevariable portion of the debt portfolio impacts the interest incurred and cashflows, but does not impact the value of the financial instrument.

 

The sensitivity analysis as it relates to thefixed portion of our debt portfolio assumes an instantaneous 100 basis pointchange in interest rates from their levels at June 30, 2003 with all othervariables held constant.  A 100 basispoint increase in market interest rates would result in a decrease in the debtvalue of the New Senior Notes by $5.8 million at June 30, 2003.  Conversely, a 100 basis point decline inmarket interest rates would cause the debt value to increase by $6.2 million atJune 30, 2003.

 

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

 

**Item 4.Controls and Procedures**

 

We carried out an evaluation under thesupervision and with the participation of our internal review committee and ourmanagement, including our Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-14(c) and 15d-14(c) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) asof the end of the period covered by this Quarterly Report on Form 10-Q. Based onthat evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective to ensurethat information required to be disclosed by us in our Exchange Act reports wasrecorded, processed, summarized and reported within the applicable timeperiods.

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**PART II.OTHER INFORMATION**

**Item 1.Legal Proceedings**

 

On July 17, 2002, apurported class action was filed against the Company in the Superior Court ofCalifornia for Los Angeles County. The complaint alleged that, under Californialaw, certain former and current employees should have received overtimecompensation, meal breaks and rest breaks. In March 2003, the Company, without admitting liability, entered into asettlement agreement in connection with this action.  The agreement received preliminary court approval and remainssubject to final court approval.  TheCompany, as previously disclosed, recorded an estimated charge of $800,000related to this settlement during the three months ended March 31, 2003 andreduced its estimate to $700,000 during the three months ended June 30, 2003.

 

The Companywas also a party to an action alleging similar claims under Washington law inSpokane County Superior Court. The plaintiffs in the Washington case soughtunspecified actual damages, penalties and attorneys’ fees. On or about April23, 2003, one purported subclass of the plaintiffs accepted a settlementarrangement in the amount of $50,000, plus attorney’s fees and costs incurredthrough such date.  After a trial withthe remaining purported subclass, in May 2003, the jury found for the Companyon all but one claim, for which it awarded the remaining plaintiffs damages inthe amount of $106,000.  The parties arecurrently contesting costs and expenses being sought by the plaintiffs in theamount of approximately $390,000. Accordingly, during the three months ended June 30, 2003, the Companyreserved approximately $545,000 towards the estimated legal fees and settlementcosts of this case, which have been included in accrued expenses in theaccompanying Consolidated Balance Sheet.

 

In addition, from time to time, the Companyis named as a defendant in legal actions arising from its normal businessactivities. Although the amount of any liability that could arise with respectto currently pending actions, including the matters specifically describedabove, cannot be accurately predicted, the Company does not believe that theresolution of any pending action will have a material adverse effect on itsfinancial position.

 

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**Item 6. Exhibits and Reports on Form 8-K**

### ** **

(a)          Exhibits.

** **
| **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 |

 

(b)         Reports on Form 8-K.

 

None.

 

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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 14, 2003 | By:                | /s/ DAN W. MATTHIAS |
|                  |               | Dan W. Matthias |
|                  |               | *Chairman  of the Board and  Chief Executive Officer* |
|                  |               |   |
|                  |               |   |
| Date: August 14, 2003 | By:                | /s/ EDWARD M. KRELL |
|                  |               | Edward M. Krell |
|                  |               | *Senior  Vice President—  Chief Financial Officer* |

 

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