**United StatesSecurities and Exchange Commission**

**Washington, D.C. 20549**

**FORM 10-Q**
| **x**                                             | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|---------------------------------------------------|----------------------------------------------------------------------------------------------------|
| ** **                                        |
| **For the  quarterly period ended June 30, 2006** |
| ** **                                        |
| **Or**                                            |
| ** **                                        |
| **o**                                             | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |

 

**For the transition period from           to           **

**Commission file number 0-21196**

**MOTHERSWORK, INC.**(Exact name of registrant as specified inits charter)

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

 

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

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yesx No o

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

Indicateby check mark whether the Registrant is a shell company (as defined inRule 12b-2 of the Act).  Yes oNo x

Indicate the number of shares outstanding of each of the issuer’s classesof common stock, as of the latest practicable date.

Common Stock, $.01 par value5,453,731 shares outstanding as of August 3, 2006

 

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**MOTHERS WORK, INC. ANDSUBSIDIARIES****INDEX**
| PART I.  FINANCIAL  INFORMATION |                                                                                        |
|--------------------------------------|---------------------------------------------------------------------------------------------|
| Item 1.                              | Financial  Statements (unaudited)                                                           |   |
|                                 | Consolidated  Balance Sheets                                                                | 3 |
|                                 | Consolidated  Statements of Operations                                                      | 4 |
|                                 | Consolidated  Statements of Cash Flows                                                      | 5 |
|                                 | Notes to Consolidated Financial Statements                                                  | 6 |
| Item 2.                              | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 15 |
| Item 3.                              | Quantitative  and Qualitative Disclosures About Market Risk                                 | 22 |
| Item 4.                              | Controls and  Procedures                                                                    | 23 |
|                                 |                                                                                        |
| PART  II.  OTHER INFORMATION    |                                                                                        |
| Item 1.                              | Legal Proceedings                                                                           | 24 |
| Item 6.                              | Exhibits                                                                                    | 24 |
|                                 |                                                                                        |
| Signatures                           | 25                                                                                          |

2

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**PART I.  FINANCIAL INFORMATION**

**Item1.  Financial Statements**

**MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(in thousands, except share and per share amounts)

(unaudited)

 
| ** **                                                                                                                       | ** ** | **June 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| **ASSETS**                                                                                                                       | ** ** | ** **                  | ** ** | ** **                       | ** ** |
| Current  assets:                                                                                                                 |       |                        |       |                             |       |
| Cash and cash equivalents                                                                                                        |       | $                           | 15,641     |                             | $          | 3,037 |   |
| Short-term investments                                                                                                           |       | 25,650                      |       | —                           |       |
| Trade receivables, net                                                                                                           |       | 10,200                      |       | 7,681                            |       |
| Inventories                                                                                                                      |       | 97,076                      |       | 105,911                          |       |
| Deferred income taxes                                                                                                            |       | 6,015                       |       | 6,015                            |       |
| Prepaid expenses and other current assets                                                                                        |       | 3,354                       |       | 4,816                            |       |
| Total current assets                                                                                                             |       | 157,936                     |       | 127,460                          |       |
| Property,  plant and equipment, net                                                                                              |       | 72,673                      |       | 76,173                           |       |
| Assets  held for sale                                                                                                            |       | 700                         |       | 925                              |       |
| Other  assets:                                                                                                                   |       |                        |       |                             |       |
| Goodwill                                                                                                                         |       | 50,389                      |       | 50,389                           |       |
| Deferred financing costs, net of accumulated amortization of $2,331 and  $1,855                                                  |       | 3,224                       |       | 3,697                            |       |
| Other intangible assets, net of accumulated amortization of $2,377 and  $2,481                                                   |       | 694                         |       | 878                              |       |
| Deferred income taxes                                                                                                            |       | 13,897                      |       | 13,261                           |       |
| Other non-current assets                                                                                                         |       | 529                         |       | 534                              |       |
| Total other assets                                                                                                               |       | 68,733                      |       | 68,759                           |       |
| Total assets                                                                                                                     |       | $                           | 300,042    |                             | $          | 273,317 |   |
| ** **                                                                                                                       | ** ** | ** **                  | ** ** | ** **                       | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                    | ** ** | ** **                  | ** ** | ** **                       | ** ** |
| Current  liabilities:                                                                                                            |       |                        |       |                             |       |
| Line of credit borrowings                                                                                                        |       | $                           | —     |                             | $          | — |   |
| Current portion of long-term debt                                                                                                |       | 793                         |       | 769                              |       |
| Accounts payable                                                                                                                 |       | 22,278                      |       | 19,900                           |       |
| Accrued expenses and other current liabilities                                                                                   |       | 48,474                      |       | 35,563                           |       |
| Total current liabilities                                                                                                        |       | 71,545                      |       | 56,232                           |       |
| Long-term  debt                                                                                                                  |       | 127,729                     |       | 128,087                          |       |
| Deferred  rent and other non-current liabilities                                                                                 |       | 24,613                      |       | 25,670                           |       |
| Total liabilities                                                                                                                |       | 223,887                     |       | 209,989                          |       |
|                                                                                                                             |       |                        |       |                             |       |
| Commitments  and contingencies (Note 9)                                                                                          |       |                        |       |                             |       |
|                                                                                                                             |       |                        |       |                             |       |
| Stockholders’  equity:                                                                                                      |       |                        |       |                             |       |
| Preferred stock, 2,000,000 shares authorized                                                                                     |       |                        |       |                             |       |
| Series A  cumulative convertible preferred stock, $.01 par value; 41,000 shares  authorized, none outstanding                    |       | —                      |       | —                           |       |
| Series B junior  participating preferred stock, $.01 par value; 300,000 shares authorized,  none outstanding                     |       | —                      |       | —                           |       |
| Common stock, $.01 par value; 20,000,000 shares authorized, 5,385,921  and 5,268,535 shares issued and outstanding, respectively |       | 54                          |       | 53                               |       |
| Additional paid-in capital                                                                                                       |       | 66,286                      |       | 63,164                           |       |
| Retained earnings                                                                                                                |       | 9,815                       |       | 111                              |       |
| Total stockholders’ equity                                                                                                  |       | 76,155                      |       | 63,328                           |       |
| Total  liabilities and stockholders’ equity                                                                                 |       | $                           | 300,042    |                             | $          | 273,317 |   |

 

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

3

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**MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

(in thousands, except per share amounts)

(unaudited)
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net  sales                                    |       | $                                               | 163,883    |                                           | $          | 152,740 |   | $ | 459,919 |   | $ | 426,390 |   |
| Cost  of goods sold                           |       | 74,023                                          |       | 71,373                                         |       | 217,853 |   | 206,055 |   |
| Gross profit                                  |       | 89,860                                          |       | 81,367                                         |       | 242,066 |   | 220,335 |   |
| Selling,  general and administrative expenses |       | 71,933                                          |       | 68,547                                         |       | 215,035 |   | 200,476 |   |
| Operating income                              |       | 17,927                                          |       | 12,820                                         |       | 27,031 |   | 19,859 |   |
| Interest  expense, net                        |       | 3,541                                           |       | 3,779                                          |       | 11,120 |   | 11,391 |   |
| Income before income taxes                    |       | 14,386                                          |       | 9,041                                          |       | 15,911 |   | 8,468 |   |
| Income  tax provision                         |       | 5,612                                           |       | 3,532                                          |       | 6,207 |   | 3,303 |   |
| Net  income                                   |       | $                                               | 8,774      |                                           | $          | 5,509 |   | $ | 9,704 |   | $ | 5,165 |   |
|                                          |       |                                            |       |                                           |       |   |   |   |   |
| Income  per share—Basic                  |       | $                                               | 1.64       |                                           | $          | 1.05 |   | $ | 1.83 |   | $ | 0.99 |   |
| Average  shares outstanding—Basic        |       | 5,334                                           |       | 5,253                                          |       | 5,298 |   | 5,235 |   |
| Income  per share—Diluted                |       | $                                               | 1.54       |                                           | $          | 1.03 |   | $ | 1.77 |   | $ | 0.96 |   |
| Average shares outstanding—Diluted       |       | 5,684                                           |       | 5,372                                          |       | 5,496 |   | 5,373 |   |

 

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

4

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**MOTHERS WORK, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(in thousands)

(unaudited)
| ** **                                                                         | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                       | ** ** | **2005** | ** ** |
| **Cash  Flows from Operating Activities**                                          |       |                                           |       |   |   |
| Net  income                                                                        |       | $                                              | 9,704      |   | $ | 5,165 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                           |       |   |   |
| Depreciation and amortization                                                      |       | 11,879                                         |       | 11,543 |   |
| Stock-based compensation expense                                                   |       | 1,706                                          |       | — |   |
| Loss on impairment of long-lived assets                                            |       | 2,345                                          |       | 1,773 |   |
| (Gain) loss on disposal of assets                                                  |       | (45                                            | )          | 673 |   |
| Accretion of discount on senior notes                                              |       | 139                                            |       | 123 |   |
| Deferred income tax benefit                                                        |       | (636                                           | )          | (332 | ) |
| Tax benefit of stock option exercises                                              |       | —                                         |       | 100 |   |
| Amortization of deferred financing costs                                           |       | 476                                            |       | 427 |   |
| Changes  in assets and liabilities:                                                |       |                                           |       |   |   |
| Decrease (increase) in —                                                      |       |                                           |       |   |   |
| Trade receivables                                                                  |       | (2,519                                         | )          | (2,089 | ) |
| Inventories                                                                        |       | 8,835                                          |       | (19,015 | ) |
| Prepaid expenses and other assets                                                  |       | 1,467                                          |       | 2,665 |   |
| Increase (decrease) in —                                                      |       |                                           |       |   |   |
| Accounts payable, accrued expenses and other current liabilities                   |       | 13,912                                         |       | 8,224 |   |
| Deferred rent and other non-current liabilities                                    |       | (1,311                                         | )          | (372 | ) |
| Net cash provided by operating activities                                          |       | 45,952                                         |       | 8,885 |   |
|                                                                               |       |                                           |       |   |   |
| **Cash  Flows from Investing Activities**                                          |       |                                           |       |   |   |
| Purchase  of short-term investments                                                |       | (69,655                                        | )          | (7,000 | ) |
| Proceeds  from sale of short-term investments                                      |       | 44,005                                         |       | 13,400 |   |
| Capital  expenditures                                                              |       | (10,811                                        | )          | (15,281 | ) |
| Proceeds  from sale of assets held for sale                                        |       | 225                                            |       | — |   |
| Purchase  of intangible assets                                                     |       | (11                                            | )          | (162 | ) |
| Net cash used in investing activities                                              |       | (36,247                                        | )          | (9,043 | ) |
|                                                                               |       |                                           |       |   |   |
| **Cash  Flows from Financing Activities**                                          |       |                                           |       |   |   |
| Increase  in cash overdraft                                                        |       | 1,167                                          |       | 1,364 |   |
| Repayment  of long-term debt                                                       |       | (473                                           | )          | (383 | ) |
| Payout  of redeemed Series A Preferred Stock                                       |       | —                                         |       | (373 | ) |
| Deferred  financing costs                                                          |       | (3                                             | )          | (621 | ) |
| Proceeds  from exercise of stock options                                           |       | 1,598                                          |       | 412 |   |
| Excess  tax benefit from exercise of stock options                                 |       | 610                                            |       | — |   |
| Net cash provided by financing activities                                          |       | 2,899                                          |       | 399 |   |
| **Net  Increase in Cash and Cash Equivalents**                                     |       | 12,604                                         |       | 241 |   |
| **Cash and  Cash Equivalents, Beginning of Period**                                |       | 3,037                                          |       | 8,467 |   |
| **Cash and  Cash Equivalents, End of Period**                                      |       | $                                              | 15,641     |   | $ | 8,708 |   |
|                                                                               |       |                                           |       |   |   |
| Supplemental  Disclosures of Cash Flow Information:                                |       |                                           |       |   |   |
| Cash paid for interest                                                             |       | $                                              | 7,435      |   | $ | 7,345 |   |
| Cash paid for income taxes                                                         |       | $                                              | 1,110      |   | $ | 1,785 |   |
| Supplemental  Disclosures of Non-Cash Investing and Financing Activities:          |       |                                           |       |   |   |
| Purchase  of equipment under capital lease obligations                             |       | $                                              | —     |   | $ | 1,438 |   |

 

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

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**MOTHERS WORK, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**June 30, 2006**

(unaudited)

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

The accompanying unaudited consolidated financial statements have beenprepared in accordance with the requirements for Form 10-Q andArticle 10 of Regulation S-X and, accordingly, certain informationand footnote disclosures have been condensed or omitted.  Reference is made to the Annual Report onForm 10-K as of and for the year ended September 30, 2005 for MothersWork, Inc. and subsidiaries (the “Company” or “Mothers Work”) as filedwith the Securities and Exchange Commission, for additional disclosuresincluding a summary of the Company’s accounting policies.

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

The Company operates on a fiscal year ending September30 of each year.  All references tofiscal years of the Company refer to fiscal years ended on September 30 inthose years.  For example, the Company’s“fiscal 2006” will end on September 30, 2006. Certain reclassifications have been made to the prior year consolidatedfinancial statements to conform to the current year presentation.

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

Basicearnings per share (“Basic EPS”) is computed by dividing net income by theweighted average number of common shares outstanding.  Diluted earningsper share (“Diluted EPS”) is computed by dividing net income by the weightedaverage number of common shares outstanding, after giving effect to thepotential dilution, if applicable, from the exercise of securities, such asstock options and warrants, into shares of common stock as if those securitieswere exercised.

The followingtable summarizes the Basic EPS and Diluted EPS calculation (in thousands,except per share amounts):
| ** **                                                                              | ** ** | **Three Months Ended  June 30, 2006** | ** ** | **Three Months Ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **Net  Income**                                           | ** ** | **Shares**                                                | ** ** | **EPS** | ** ** | **Net  Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic EPS                                                                               |       | $                                                         | 8,774      |                                                      | 5,334      |   | $ | 1.64 |   | $ | 5,509 |   | 5,253 |   | $ | 1.05 |   |
| Incremental shares from the assumed exercise of outstanding stock  options and warrants |       | —                                                    |       | 350                                                       |       | (0.10 | ) | — |   | 119 |   | (0.02 | ) |
|                                                                                    |       |                                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Diluted  EPS                                                                            |       | $                                                         | 8,774      |                                                      | 5,684      |   | $ | 1.54 |   | $ | 5,509 |   | 5,372 |   | $ | 1.03 |   |

 
| ** **                                                                              | ** ** | **Nine Months Ended  June 30, 2006** | ** ** | **Nine Months Ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **Net  Income**                                          | ** ** | **Shares**                                               | ** ** | **EPS** | ** ** | **Net  Income** | ** ** | **Shares** | ** ** | **EPS** | ** ** |
| Basic EPS                                                                               |       | $                                                        | 9,704      |                                                     | 5,298      |   | $ | 1.83 |   | $ | 5,165 |   | 5,235 |   | $ | 0.99 |   |
| Incremental shares from the assumed exercise of outstanding stock  options and warrants |       | —                                                   |       | 198                                                      |       | (0.06 | ) | — |   | 138 |   | (0.03 | ) |
|                                                                                    |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Diluted  EPS                                                                            |       | $                                                        | 9,704      |                                                     | 5,496      |   | $ | 1.77 |   | $ | 5,165 |   | 5,373 |   | $ | 0.96 |   |

 

For the three monthsended June 30, 2006 and 2005, options and warrants to purchase 149,900 and545,250 shares, respectively, were excluded from the calculation of Diluted EPSas their effect would have been antidilutive. For the nine months ended June 30, 2006 and 2005, options andwarrants to purchase 555,710 and 580,933 shares, respectively, were

6

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excluded from thecalculation of Diluted EPS as their effect would have been antidilutive.  Theseoptions and warrants could potentially dilute EPS in the future.

**3.****              STOCK-BASED COMPENSATION**

EffectiveOctober 1, 2005, the Company adopted Statement of Financial AccountingStandards (“SFAS”) No. 123(R), “Share-Based Payment,” using the modifiedprospective application method.  Prior toadopting SFAS No. 123(R), the Company followed the intrinsic value method ofaccounting for stock-based employee compensation in accordance with AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. On September 27, 2005, the Compensation Committee of the Company’s Boardof Directors approved, and the Board ratified, the acceleration of the vestingof all outstanding stock options having exercise prices of $23.50 or more.Options to purchase 133,500 shares, having exercise prices ranging from $23.62to $37.05 per share, were affected by the vesting acceleration.  The closing price of the Company’s commonstock on September 26, 2005 (the trading day prior to the vesting acceleration)was $11.31 per share.  The primarypurpose of this accelerated vesting program was to eliminate the compensationexpense associated with these stock options that the Company would otherwisehave been required to recognize in future financial statements pursuant to SFASNo. 123(R).  The amount of futurecompensation expense that was avoided in connection with this acceleration wasapproximately $1.3 million, net of tax.

The Company hasthree stock option plans: the Director Stock Option Plan (the “Director Plan”),the Amended and Restated 1987 Stock Option Plan (the “1987 Plan”) and the 2005Equity Incentive Plan (the “2005 Plan”). The Director Plan expired on December 31, 2004 and no furtheroptions may be granted under that plan. Options issued under the Director Plan will remain outstanding untilthey have expired, been exercised or have otherwise terminated.  Under the 1987 Plan, as amended and restated,officers and certain employees, including outside directors, may be grantedoptions to purchase the Company’s common stock with exercise prices asdetermined by the Compensation Committee of the Board of Directors that are nolower than the fair market value of the stock at the date of grant.  In February 2003, the stockholders ofthe Company approved an amendment to increase the number of shares of commonstock available for issuance upon the exercise of options granted under the 1987Plan and the Director Plan by 500,000, up to a total of 2,175,000 options whichmay be issued under the two plans (including up to a total of 200,000 optionswhich were issuable under the Director Plan). In January 2006, the stockholders of the Company approved the adoptionof the 2005 Plan.  Under the 2005 Plan,employees, directors, consultants and other individuals who provide services tothe Company, may be granted awards in the form of options, stock appreciationrights, restricted stock or restricted stock units.  Up to 500,000 shares of the Company’s commonstock may be issued in respect of awards under the 2005 Plan, and awards ofoptions to purchase the Company’s common stock will have exercise prices asdetermined by the Compensation Committee of the Board of Directors that are nolower than the fair market value of the stock at the date of grant.

EffectiveOctober 1, 2004, each outside director is granted 5,000 fully vestedoptions on an annual basis, with an exercise price equal to the fair marketvalue of the stock on the grant date. No options have been granted by theCompany with an exercise price less than the fair market value of the Company’scommon stock on the date of grant for any of the periods presented.  The majority of the options issued under theplans vest ratably over a five-year period, although some options vestimmediately, and options issued under the plans generally expire ten years fromthe date of grant.  The Company issuesnew shares upon exercise of vested options. As of June 30, 2006, there were 562,967 options available for grantunder the plans.

7

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For the three months and nine months ended June 30,2006, the Company recognized stock-based employee compensation expense of$895,000 and $1,706,000, less related income tax benefits of $349,000 and$665,000, under the provisions of SFAS No. 123(R).  For the three months and nine months endedJune 30, 2005, no compensation expense was recognized for stock option awardsgranted at fair market value under the provisions of APB Opinion No. 25.  The following table illustrates the pro formaeffect on net income and earnings per share if the Company had accounted forits stock option plans prior to October 1, 2005, using the fair value method ofaccounting under SFAS No. 123, “Accounting for Stock-Based Compensation,” as amendedby SFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure”:

| (in thousands, except per share amounts):                                                                | ** ** | **Three Months  Ended  June 30, 2005** | ** ** | **Nine Months  Ended  June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| Net income, as reported                                                                                                           |       | $                                                     | 5,509      |                                                 | $          | 5,165 |   |
| Deduct: Total stock-based  employee compensation expense determined under the fair value based method  for all grants, net of tax |       | (270                                                  | )          | (1,436                                               | )          |
| Pro forma net income                                                                                                              |       | $                                                     | 5,239      |                                                 | $          | 3,729 |   |
|                                                                                                                              |       |                                                  |       |                                                 |       |
| Basic EPS:                                                                                                                        |       |                                                  |       |                                                 |       |
| As reported                                                                                                                       |       | $                                                     | 1.05       |                                                 | $          | 0.99 |   |
| Pro forma net income                                                                                                              |       | $                                                     | 1.00       |                                                 | $          | 0.71 |   |
|                                                                                                                              |       |                                                  |       |                                                 |       |
| Diluted EPS:                                                                                                                      |       |                                                  |       |                                                 |       |
| As reported                                                                                                                       |       | $                                                     | 1.03       |                                                 | $          | 0.96 |   |
| Pro forma net income                                                                                                              |       | $                                                     | 0.98       |                                                 | $          | 0.69 |   |

 

Stock option activity for all plans was as follows: 

|                                  | ** ** | **Outstanding  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining Life** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------|------------|--------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**  | ** ** | ** **                                 | ** ** | **(years)**                                | ** ** | **(in thousands)**             | ** ** |
| Balance—September  30, 2005 |       | 1,230                    |       | $                                          | 14.50      |                                       |       |                                |       |   |
| Granted                          |       | 273                      |       | 13.71                                      |       |                                       |       |                                |       |
| Exercised                        |       | (117                     | )          | 13.72                                      |       |                                       |       |                                |       |
| Forfeited                        |       | (32                      | )          | 11.11                                      |       |                                       |       |                                |       |
| Expired                          |       | (80                      | )          | 15.37                                      |       |                                       |       |                                |       |
| Balance—June 30,  2006      |       | 1,274                    |       | 14.45                                      |       | 6.9                                        |       | $                                   | 26,323     |   |
| Exercisable—June 30,  2006  |       | 809                      |       | $                                          | 15.06      |                                       | 5.8        |                                | $          | 16,262 |   |

 

As ofJune 30, 2006, $4,654,000 of total unrecognized compensation cost related tonon-vested awards is expected to be recognized over a weighted-average periodof 1.8 years.  During the three monthsended June 30, 2006 and 2005, the total intrinsic value of options exercisedwas $943,000 and $61,000, respectively. The total cash received from these option exercises was $1,168,000 and$151,000, respectively, and the actual tax benefit realized for the taxdeductions from these option exercises was $368,000 and $20,000,respectively.  During the nine monthsended June 30, 2006 and 2005, the total intrinsic value of options exercisedwas $1,564,000 and $322,000, respectively. The total cash received from these option exercises was $1,598,000 and$412,000, respectively, and the actual tax benefit realized for the taxdeductions from these option exercises was $610,000 and $100,000,respectively.  During the nine monthsended June 30, 2005, options to purchase 27,270 shares of common stock with anaggregate exercise price of $307,000 were exercised by the option holderstendering 20,286 shares of the Company’s common stock, which were held by theoption holders.

Theweighted average fair value of the options granted during the three monthsended June 30,****2006 and 2005 was estimated at$15.19 and $8.41 per share, respectively. The weighted average fair value of the options granted during the ninemonths ended June 30,****2006 and 2005was estimated at $8.21 and $8.78 per share, respectively.  The weighted average fair value wascalculated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted average assumptions:

8

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|                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                        | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Dividend yield            |       | None                                            |       | None                                           |       | None |   | None |   |
| Expected price volatility |       | 55.7                                            | %          | 60.9                                           | %          | 57.7 | % | 60.9 | % |
| Risk-free interest rates  |       | 5.0                                             | %          | 3.9                                            | %          | 4.5 | % | 4.0 | % |
| Expected  lives           |       | 6.5 years                                       |       | 8.0 years                                      |       | 6.4 years |   | 8.0 years |   |

 

Expected volatility was determined using a weightedaverage of the historic volatility of the Company’s common stock as of theoption grant date measured over a period equal to the expected life of thegrant.  Risk free interest rates werebased on the U. S. Treasury yield curve in effect at the date of thegrant.  Expected lives were determinedusing the simplified method, which measures the average of the option vestingterm and the option contractual term.

**4.**                 INVENTORIES

Inventories werecomprised of the following (in thousands):

|                  | ** ** | **June 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|------------------|------------|-----------------------------|------------|----------------------------------|------------|
| Finished goods   |       | $                           | 89,099     |                             | $          | 97,056 |   |
| Work-in-progress |       | 3,191                       |       | 3,283                            |       |
| Raw materials    |       | 4,786                       |       | 5,572                            |       |
|             |       | $                           | 97,076     |                             | $          | 105,911 |   |

 

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

Accrued expensesand other current liabilities were comprised of the following (in thousands):

|                                                             | ** ** | **June 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| Salaries, wages and employee benefits                       |       | $                           | 12,073     |                             | $          | 8,846 |   |
| Income taxes payable                                        |       | 5,357                       |       | 1,161                            |       |
| Interest                                                    |       | 5,977                       |       | 2,483                            |       |
| Deferred rent                                               |       | 4,084                       |       | 3,790                            |       |
| Sales taxes                                                 |       | 2,142                       |       | 2,456                            |       |
| Insurance                                                   |       | 2,350                       |       | 2,671                            |       |
| Rent                                                        |       | 285                         |       | 328                              |       |
| Audit and legal                                             |       | 3,270                       |       | 3,400                            |       |
| Reserves recorded in the iMaternity acquisition (Note 6)    |       | 50                          |       | 232                              |       |
| Remaining payout for redemption of Series A Preferred Stock |       | 677                         |       | 677                              |       |
| Accrued store construction costs                            |       | 509                         |       | 152                              |       |
| Gift certificates and store credits                         |       | 3,861                       |       | 3,233                            |       |
| Other                                                       |       | 7,839                       |       | 6,134                            |       |
|                                                        |       | $                           | 48,474     |                             | $          | 35,563 |   |

Interest payments on the Company’s$125,000,000, 111¤4% senior notes (the “SeniorNotes”) are made semiannually on February 1st and August 1st.

**6.****              iMATERNITY ACQUISITION EXIT/RESTRUCTURINGACTIVITY**

The Company acquired eSpecialty Brands, LLC(“iMaternity”) on October 17, 2001.  TheiMaternity manufacturing and warehousing operations in Costa Rica have beenshut down, are being marketed for sale, are not being depreciated and areseparately reflected in the accompanying Consolidated Balance Sheets as “Assetsheld for sale.”  The carrying values ofthe Costa Rica facilities are recorded at their estimated realizable values,which were determined based on purchase offers from interested parties, lessestimated selling costs.  In January2006, the Company sold a portion of the Costa Rica facilities for approximately$225,000, which approximated its estimated realizable value.

During the nine monthsended June 30, 2006 and 2005, the Company made payments of $182,000 and$518,000, respectively, for lease termination fees, severance and other exitcosts in connection with the iMaternity acquisition exit/restructuringactivities.  A summary of the remainingiMaternity acquisition exit/restructuring reserves is as follows (inthousands):

9

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|                      | ** ** | **June 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|----------------------|------------|-----------------------------|------------|----------------------------------|------------|
| Severance            |       | $                           | 50         |                             | $          | 200 |   |
| Exit and other costs |       | —                      |       | 32                               |       |
|                 |       | $                           | 50         |                             | $          | 232 |   |

The balance of theseverance reserve reflects a non-compete and severance arrangement that ispayable ratably on a monthly basis through September 30, 2006.

**7.****              NEW ACCOUNTING PRONOUNCEMENTS**

*SFASNo. 154*

*In May2005, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 154, “Accounting Changes and Error Corrections.”  SFAS No.154 provides guidance on theaccounting for and reporting of accounting changes and error corrections.  This statement is effective for accountingchanges and corrections of errors made in fiscal years beginning afterDecember 15, 2005.  Early adoptionis permitted.  The Company expects to adoptSFAS No. 154 effective as of October 1, 2006.*

*FASBInterpretation No. 48*

*In June2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes.”  FASB InterpretationNo. 48 provides guidance for the recognition and measurement of uncertain taxpositions in an enterprise’s financial statements.  Recognition involves a determination ofwhether it is more likely than not that a tax position will be sustained uponexamination with the presumption that the tax position will be examined by theappropriate taxing authority that would have full knowledge of all relevantinformation.  This interpretation iseffective for fiscal years beginning after December 15, 2006.  Early adoption is permitted if the enterprisehas not issued financial statements, including interim financial statements, inthe period of adoption.  The impact fromadoption of FASB Interpretation No. 48, if any, on the Company’s consolidatedfinancial position or results of operations has not yet been determined.*

*EITFIssue 06-3*

*In June2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “HowTaxes Collected from Customers and Remitted to Governmental Authorities ShouldBe Presented in the Income Statement (That Is, Gross versus Net Presentation).”  EITF Issue 06-3 provides guidancerelated to the presentation in financial statements of any tax assessed by agovernmental authority that is directly imposed on a revenue-producingtransaction between a seller and a customer, including, but not limited to,sales, use, value added, and some excise taxes. The EITF concluded that the presentation of taxes within the scope ofEITF Issue 06-3 on either a gross (included in revenues and costs) or anet (excluded from revenues) basis is an accounting policy decision that shoulddisclosed.  In addition, the aggregateamount of any such taxes that are reported on a gross basis should be disclosedin interim and annual financial statements. The guidance in EITF Issue 06-3 is effective for interim and annualreporting periods beginning after December 15, 2006.  The Company presently reports taxes withinthe scope of EITF Issue 06-3 on a net basis and adoption is notexpected to have an impact on the consolidated financial statements.*

**8.****              GUARANTOR SUBSIDIARIES**

Pursuant to the terms of theindenture relating to the Senior Notes, each of the domestic subsidiaries ofMothers Work, Inc. (the “Guarantor Subsidiaries”) has jointly and severallyprovided an unconditional guarantee of the obligations of Mothers Work with respectto the Senior Notes.  There are norestrictions on any of the assets of the Guarantor Subsidiaries which wouldlimit their ability to transfer funds to Mothers Work in the form of loans,advances or cash dividends, except as provided by applicable law.  None of the Company’s foreign subsidiaries(the “Non-Guarantor Subsidiaries”) have guaranteed the Senior Notes.  The condensed consolidating financialinformation for the parent company, the Guarantor Subsidiaries, and theNon-Guarantor Subsidiaries as of and for the nine months ended June 30, 2006 aspresented below has been prepared from the books and records maintained by theGuarantor Subsidiaries and the Company. The condensed financial information may not necessarily be indicative ofthe results of operations or financial position had the Guarantor Subsidiariesoperated as independent entities. Certain intercompany revenues and expenses included in the subsidiaryrecords are eliminated in consolidation.  As a result of this activity, an amount due to/due from the parentcompany will exist at any time.

10

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**Mothers Work, Inc.****Condensed Consolidating BalanceSheet****June 30, 2006**(in thousands)(unaudited)
| ** **                                       | ** ** | **Mothers Work  (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Operations)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|--------------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **ASSETS**                                       | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                             | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Current assets:                                  |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Cash and cash equivalents                        |       | $                                        | 14,012     |                        | $          | 53                                                     |       | $                               | 1,576      |                                | $          | — |   | $ | 15,641 |   |
| Short-term investments                           |       | 25,650                                   |       | —                      |       | —                                                 |       | —                          |       | 25,650                              |       |
| Trade receivables, net                           |       | 10,200                                   |       | —                      |       | —                                                 |       | —                          |       | 10,200                              |       |
| Inventories                                      |       | 94,425                                   |       | —                      |       | 2,651                                                  |       | —                          |       | 97,076                              |       |
| Deferred income taxes                            |       | 6,015                                    |       | —                      |       | —                                                 |       | —                          |       | 6,015                               |       |
| Prepaid expenses and other  current assets       |       | 3,246                                    |       | 1                           |       | 107                                                    |       | —                          |       | 3,354                               |       |
| Total current assets                             |       | 153,548                                  |       | 54                          |       | 4,334                                                  |       | —                          |       | 157,936                             |       |
| Property, plant and equipment, net               |       | 70,319                                   |       | —                      |       | 2,354                                                  |       | —                          |       | 72,673                              |       |
| Assets held for sale                             |       | —                                   |       | —                      |       | 700                                                    |       | —                          |       | 700                                 |       |
| Other assets                                     |       | 68,601                                   |       | —                      |       | 132                                                    |       | —                          |       | 68,733                              |       |
| Investments in and advances to (from) affiliates |       | (7,801                                   | )          | 275,443                     |       | (4,057                                                 | )          | (263,585                        | )          | —                              |       |
| Total assets                                     |       | $                                        | 284,667    |                        | $          | 275,497                                                |       | $                               | 3,463      |                                | $          | (263,585 | ) | $ | 300,042 |   |
|                                             |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**    | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                             | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Current liabilities:                             |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Line of credit borrowings                        |       | $                                        | —     |                        | $          | —                                                 |       | $                               | —     |                                | $          | — |   | $ | — |   |
| Current portion of long-term  debt               |       | 793                                      |       | —                      |       | —                                                 |       | —                          |       | 793                                 |       |
| Accounts payable                                 |       | 22,278                                   |       | —                      |       | —                                                 |       | —                          |       | 22,278                              |       |
| Accrued expenses and other  current liabilities  |       | 34,158                                   |       | 13,922                      |       | 394                                                    |       | —                          |       | 48,474                              |       |
| Total current liabilities                        |       | 57,229                                   |       | 13,922                      |       | 394                                                    |       | —                          |       | 71,545                              |       |
| Long-term debt                                   |       | 127,729                                  |       | —                      |       | —                                                 |       | —                          |       | 127,729                             |       |
| Deferred rent and other non-current liabilities  |       | 23,554                                   |       | —                      |       | 1,059                                                  |       | —                          |       | 24,613                              |       |
| Total liabilities                                |       | 208,512                                  |       | 13,922                      |       | 1,453                                                  |       | —                          |       | 223,887                             |       |
|                                             |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Total stockholders’ equity                  |       | 76,155                                   |       | 261,575                     |       | 2,010                                                  |       | (263,585                        | )          | 76,155                              |       |
|                                             |       |                                     |       |                        |       |                                                   |       |                            |       |                                |       |
| Total liabilities and stockholders’ equity  |       | $                                        | 284,667    |                        | $          | 275,497                                                |       | $                               | 3,463      |                                | $          | (263,585 | ) | $ | 300,042 |   |

11

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**Mothers Work, Inc.****Consolidating Statement ofOperations****For the Nine Months Ended June30, 2006**(in thousands)(unaudited)
| ** **                                   | ** ** | **Mothers Work  (Parent Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Companies)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| Net sales                                    |       | $                                            | 446,771    |                        | $          | 23,675                                                |       | $                               | 13,148     |                                | $          | (23,675 | ) | $ | 459,919 |   |
| Cost of goods sold                           |       | 212,245                                      |       | —                      |       | 5,608                                                 |       | —                          |       | 217,853                             |       |
| Gross profit                                 |       | 234,526                                      |       | 23,675                      |       | 7,540                                                 |       | (23,675                         | )          | 242,066                             |       |
| Selling, general and administrative expenses |       | 232,273                                      |       | 288                         |       | 6,149                                                 |       | (23,675                         | )          | 215,035                             |       |
| Operating income                             |       | 2,253                                        |       | 23,387                      |       | 1,391                                                 |       | —                          |       | 27,031                              |       |
| Interest income (expense), net               |       | (26,107                                      | )          | 14,987                      |       | —                                                |       | —                          |       | (11,120                             | )          |
| Equity in earnings of subsidiaries           |       | 39,765                                       |       | —                      |       | —                                                |       | (39,765                         | )          | —                              |       |
| Income before income taxes                   |       | 15,911                                       |       | 38,374                      |       | 1,391                                                 |       | (39,765                         | )          | 15,911                              |       |
| Income tax provision                         |       | 6,207                                        |       | 13,431                      |       | 542                                                   |       | (13,973                         | )          | 6,207                               |       |
| Net  income                                  |       | $                                            | 9,704      |                        | $          | 24,943                                                |       | $                               | 849        |                                | $          | (25,792 | ) | $ | 9,704 |   |

** **

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**Mothers Work, Inc.****Consolidating Cash Flow Statement****For the Nine Months Ended June30, 2006**(in thousands)(unaudited)
| ** **                                                                         | ** ** | **Mothers Work  (Parent  Company)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries  (Foreign  Companies)** | ** ** | **Consolidating  Eliminations** | ** ** | **Mothers Work  Consolidated** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| **Cash Flows from Operating Activities:**                                          | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                            | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Net income                                                                         |       | $                                        | 9,704      |                        | $          | 24,943                                                |       | $                               | 849        |                                | $          | (25,792 | ) | $ | 9,704 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Depreciation and amortization                                                      |       | 11,531                                   |       | —                      |       | 348                                                   |       | —                          |       | 11,879                              |       |
| Stock-based compensation  expense                                                  |       | 1,706                                    |       | —                      |       | —                                                |       | —                          |       | 1,706                               |       |
| Loss on impairment of  long-lived assets                                           |       | 2,271                                    |       | —                      |       | 74                                                    |       | —                          |       | 2,345                               |       |
| Gain on disposal of assets                                                         |       | (50                                      | )          | —                      |       | 5                                                     |       | —                          |       | (45                                 | )          |
| Accretion of discount on  senior notes                                             |       | 139                                      |       | —                      |       | —                                                |       | —                          |       | 139                                 |       |
| Deferred income tax benefit                                                        |       | (636                                     | )          | —                      |       | —                                                |       | —                          |       | (636                                | )          |
| Amortization of deferred  financing costs                                          |       | 476                                      |       | —                      |       | —                                                |       | —                          |       | 476                                 |       |
| Changes in assets and liabilities:                                                 |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Decrease (increase) in—                                                       |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Trade receivables                                                                  |       | (2,596                                   | )          | —                      |       | 77                                                    |       | —                          |       | (2,519                              | )          |
| Inventories                                                                        |       | 8,811                                    |       | —                      |       | 24                                                    |       | —                          |       | 8,835                               |       |
| Prepaid expenses and other  assets                                                 |       | 1,571                                    |       | 3                           |       | (107                                                  | )          | —                          |       | 1,467                               |       |
| Investments in and advances to  (from) affiliates                                  |       | 1,487                                    |       | (27,368                     | )          | 89                                                    |       | 25,792                          |       | —                              |       |
| Increase (decrease) in—                                                       |       |                                     |       |                        |       |                                                  |       |                            |       |                                |       |
| Accounts payable, accrued  expenses and other current liabilities                  |       | 11,378                                   |       | 2,438                       |       | 96                                                    |       | —                          |       | 13,912                              |       |
| Deferred rent and other  non-current liabilities                                   |       | (1,369                                   | )          | —                      |       | 58                                                    |       | —                          |       | (1,311                              | )          |
| Net cash provided by operating  activities                                         |       | 44,423                                   |       | 16                          |       | 1,513                                                 |       | —                          |       | 45,952                              |       |
| **Cash Flows from Investing Activities:**                                          | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                            | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Purchase of short-term investments                                                 |       | (69,655                                  | )          | —                      |       | —                                                |       | —                          |       | (69,655                             | )          |
| Proceeds from sale of short-term investments                                       |       | 44,005                                   |       | —                      |       | —                                                |       | —                          |       | 44,005                              |       |
| Capital expenditures                                                               |       | (10,559                                  | )          | —                      |       | (252                                                  | )          | —                          |       | (10,811                             | )          |
| Proceeds from sale of assets held for sale                                         |       | —                                   |       | —                      |       | 225                                                   |       | —                          |       | 225                                 |       |
| Purchase of intangible assets                                                      |       | (2                                       | )          | —                      |       | (9                                                    | )          | —                          |       | (11                                 | )          |
| Net cash used in investing  activities                                             |       | (36,211                                  | )          | —                      |       | (36                                                   | )          | —                          |       | (36,247                             | )          |
| **Cash Flows from Financing Activities:**                                          | ** ** | ** **                               | ** ** | ** **                  | ** ** | ** **                                            | ** ** | ** **                      | ** ** | ** **                          | ** ** |
| Increase in cash overdraft                                                         |       | 1,167                                    |       | —                      |       | —                                                |       | —                          |       | 1,167                               |       |
| Repayment of long-term debt                                                        |       | (473                                     | )          | —                      |       | —                                                |       | —                          |       | (473                                | )          |
| Deferred financing costs                                                           |       | (3                                       | )          | —                      |       | —                                                |       | —                          |       | (3                                  | )          |
| Proceeds from exercise of stock options                                            |       | 1,598                                    |       | —                      |       | —                                                |       | —                          |       | 1,598                               |       |
| Excess tax benefit of stock option exercises                                       |       | 610                                      |       | —                      |       | —                                                |       | —                          |       | 610                                 |       |
| Net cash provided by financing  activities                                         |       | 2,899                                    |       | —                      |       | —                                                |       | —                          |       | 2,899                               |       |
| **Net Increase in Cash and Cash Equivalents**                                      |       | 11,111                                   |       | 16                          |       | 1,477                                                 |       | —                          |       | 12,604                              |       |
| **Cash and Cash Equivalents, Beginning of Period**                                 |       | 2,901                                    |       | 37                          |       | 99                                                    |       | —                          |       | 3,037                               |       |
| **Cash and  Cash Equivalents, End of Period**                                      |       | $                                        | 14,012     |                        | $          | 53                                                    |       | $                               | 1,576      |                                | $          | — |   | $ | 15,641 |   |

 

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

From time to time,the Company is named as a defendant in legal actions arising from its normalbusiness activities.  Although the amountof any liability that could arise with respect to currently pending actions cannotbe accurately predicted, the Company does not believe that the resolution ofany pending action will have a material adverse effect on its financialposition, results of operations or liquidity.

**10.**          SEGMENT ANDENTERPRISE WIDE DISCLOSURES

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

***Geographic Information***.  Information concerning theCompany’s operations by geographic area is as follows (in thousands):
|                                          | ** ** | **Three Months Ended,  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net  Sales to Unaffiliated Customers** |       |                                             |       |                                           |       |   |   |   |   |
| United States                            |       | $                                                | 158,293    |                                           | $          | 148,341 |   | $ | 446,771 |   | $ | 416,183 |   |
| Canada                                   |       | $                                                | 5,590      |                                           | $          | 4,399 |   | $ | 13,148 |   | $ | 10,207 |   |

 
|                        | ** ** | **June 30,  2006** | ** ** | **September 30,  2005** | ** ** |
|------------------------|------------|-------------------------|------------|------------------------------|------------|
| **Long-Lived  Assets** | ** ** | ** **              | ** ** | ** **                   | ** ** |
| United States          |       | $                       | 70,881     |                         | $          | 74,393 |   |
| Canada                 |       | $                       | 2,486      |                         | $          | 2,658 |   |
| Costa Rica             |       | $                       | 700        |                         | $          | 925 |   |

 

***Major Customers*. **For the periods presented, theCompany did not have any one customer who represented more than 10% ofits net sales.

**11.**          INTERESTEXPENSE, NET

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

|                        | ** ** | **Three Months Ended,  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **             | ** ** | **2006**                                         | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest expense       |       | $                                                | 3,841      |                                           | $          | 3,792 |   | $ | 11,580 |   | $ | 11,445 |   |
| Interest income        |       | (300                                             | )          | (13                                            | )          | (460 | ) | (54 | ) |
| Interest  expense, net |       | $                                                | 3,541      |                                           | $          | 3,779 |   | $ | 11,120 |   | $ | 11,391 |   |

14

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

**Results of Operations**

Thefollowing tables set forth certain operating data as a percentage of net salesand as a percentage change for the three and nine months ended June 30:
| ** **                                       | ** ** | **% of Net Sales (1)**  | ** ** | **% Period to Period  Increase (Decrease)** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three  Months Ended  June 30,** | ** ** | **Nine  Months Ended  June 30,**                      | ** ** | **Three  Months  Ended  June 30,** | ** ** | **Nine  Months  Ended  June 30,** | ** ** |
| ** **                                       | ** ** | **2006**                                    | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2006 vs.  2005** | ** ** | **2006 vs.  2005** | ** ** |
| Net sales                                        |       | 100.0                                       | %          | 100.0                                                           | %          | 100.0 | % | 100.0 | % | 7.3 | % | 7.9 | % |
| Cost of goods sold (2)                           |       | 45.2                                        |       | 46.7                                                            |       | 47.4 |   | 48.3 |   | 3.7 |   | 5.7 |   |
| Gross profit                                     |       | 54.8                                        |       | 53.3                                                            |       | 52.6 |   | 51.7 |   | 10.4 |   | 9.9 |   |
| Selling, general and administrative expenses (3) |       | 43.9                                        |       | 44.9                                                            |       | 46.8 |   | 47.0 |   | 4.9 |   | 7.3 |   |
| Operating income                                 |       | 10.9                                        |       | 8.4                                                             |       | 5.9 |   | 4.7 |   | 39.8 |   | 36.1 |   |
| Interest expense, net                            |       | 2.2                                         |       | 2.5                                                             |       | 2.4 |   | 2.7 |   | (6.3 | ) | (2.4 | ) |
| Income before income taxes                       |       | 8.8                                         |       | 5.9                                                             |       | 3.5 |   | 2.0 |   | 59.1 |   | 87.9 |   |
| Income tax provision                             |       | 3.4                                         |       | 2.3                                                             |       | 1.3 |   | 0.8 |   | 58.9 |   | 87.9 |   |
| Net  income                                      |       | 5.4                                         | %          | 3.6                                                             | %          | 2.1 | % | 1.2 | % | 59.3 |   | 87.9 |   |

 

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

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

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

The following table sets forth certain information concerning the numberof our stores and leased departments for the periods indicated:

|                           | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **June 30, 2006**      | ** ** | **June 30, 2005** | ** ** |
| **Retail Locations** | ** ** | **Stores**                       | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning of period       |       | 831                              |       | 728 |   | 1,559 |   | 869 |   | 728 |   | 1,597 |   |
| Opened                    |       | 1                                |       | 3 |   | 4 |   | 5 |   | 10 |   | 15 |   |
| Closed                    |       | (17                              | )          | (6 | ) | (23 | ) | (17 | ) | (2 | ) | (19 | ) |
| End  of period            |       | 815                              |       | 725 |   | 1,540 |   | 857 |   | 736 |   | 1,593 |   |

 

|                           | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **June 30, 2006**     | ** ** | **June 30, 2005** | ** ** |
| **Retail Locations** | ** ** | **Stores**                      | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** | **Stores** | ** ** | **Leased  Departments** | ** ** | **Total Retail  Locations** | ** ** |
| Beginning of period       |       | 852                             |       | 739 |   | 1,591 |   | 883 |   | 232 |   | 1,115 |   |
| Opened                    |       | 12                              |       | 15 |   | 27 |   | 25 |   | 508 |   | 533 |   |
| Closed                    |       | (49                             | )          | (29 | ) | (78 | ) | (51 | ) | (4 | ) | (55 | ) |
| End  of period            |       | 815                             |       | 725 |   | 1,540 |   | 857 |   | 736 |   | 1,593 |   |

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Ourfiscal year ends on September 30.  Allreferences in this discussion to our fiscal years refer to the fiscal yearended on September 30 in the year mentioned. For example, our “fiscal 2006” will end on September 30, 2006.

**Three Months Ended June 30, 2006 and 2005**

***Net Sales.***  Our netsales for the third quarter of fiscal 2006 increased by 7.3%, or approximately$11.2 million, to $163.9 million from $152.7 million for the third quarterof fiscal 2005. Net sales increased primarily due to our comparablestore sales increase and, to a lesser extent, due to sales increases realizedfrom our internet sales, our licensed arrangement with Kohl’s®, and ourmarketing partnerships.  Comparable storesales increased by 6.4% during the third quarter of fiscal 2006, based on 1,472retail locations, versus a comparable store sales decrease of 1.9% during thethird quarter of fiscal 2005, based on 978 retail locations.

As ofJune 30, 2006, we operated a total of 815 stores and 1,540 total retaillocations, compared to 857 stores and 1,593 total retail locations as of June30, 2005.  In addition, our Oh Baby! byMotherhoodTM collection is available at Kohl’s stores throughout the UnitedStates.  As of June 30, 2006, our storetotal included 49 multi-brand stores, including 11 Destination MaternityTMsuperstores, with the remaining multi-brand stores under the Mimi Maternity® brand.  In comparison, as of June 30, 2005, weoperated 46 multi-brand stores, including eight Destination Maternitysuperstores.  These multi-brand storefigures exclude our A Pea in the Pod® stores, which have traditionallycarried a full line of both A Pea in the Pod and Mimi Maternity brandedmerchandise.  During the third quarter offiscal 2006, we opened one store and closed 17 stores, with one of these storeclosings related to a prior period multi-brand store opening.

***Gross Profit.***  Our grossprofit for the third quarter of fiscal 2006 increased by 10.4%, or $8.5million, to $89.9 million from $81.4 million for the third quarter of fiscal2005, reflecting the increase in net sales and an increase in grossmargin.  Gross profit as a percentage of net sales (gross margin) for thethird quarter of fiscal 2006 was 54.8% compared to 53.3% for the third quarterof fiscal 2005.  The increase in gross margin of approximately 1.5percentage points compared to the prior year resulted primarily from a highermaintained gross margin in our own stores, largely due to lower overallmarkdowns compared to last year.

***Selling, General and AdministrativeExpenses.***  Our selling, general and administrativeexpenses for the third quarter of fiscal 2006 increased by 4.9%, or $3.4million, to $71.9 million from $68.5 million for the third quarter offiscal 2005.  This increase in expensefor the quarter resulted primarily from increases in accrued incentivecompensation expense related to improvements in our operating performancecompared to fiscal 2005, and stock-based compensation expense.  As a percentage of net sales, selling,general and administrative expenses decreased to 43.9% for fiscal 2006 comparedto 44.9% for fiscal 2005.  This decreasein the expense percentage for the quarter resulted primarily from the favorableexpense leverage created by our comparable store sales increase, partially offsetby higher variable incentive compensation expense and stock optionexpense.  We incurred charges relating tostore closings of $0.2 million for fiscal 2006 as compared to $0.7 million forfiscal 2005 (primarily lease termination fees). We incurred $0.9 million of non-cash expenses related to stock-basedcompensation expense, including $0.8 million in selling, general andadministrative expense, in the third quarter of fiscal 2006 versus none in thethird quarter of fiscal 2005, since we adopted the provisions of SFAS No.123(R) as of the beginning of fiscal 2006. We also incurred impairment charges for write-downs of store long-livedassets of $0.5 million for fiscal 2006, as compared to $0.4 million for fiscal2005.

***Operating Income.***  Our operating income for the third quarterof fiscal 2006 increased by 39.8%, or $5.1 million, to $17.9 million from$12.8 million for the third quarter of fiscal 2005, due to increased salesvolume and gross profit, which more than offset the impact of higher selling, generaland administrative expenses.  Operatingincome as a percentage of net sales (operating income margin) for the third quarter of fiscal 2006 increased to10.9% from 8.4% for the third quarter of fiscal 2005.  Excluding non-cash stock-based compensationexpense, our operating income for the third quarter of fiscal 2006 was $18.8million, which represents an 11.5% adjusted operating income margin.  We were not required to recognize and,therefore, did not recognize any non-cash stock-based compensation expense infiscal 2005.  The increase in operatingincome margin was due to our increased gross margin and our lower operatingexpense ratio.

***Interest Expense, Net.***  Our netinterest expense for the third quarter of fiscal 2006 decreased by 6.3%, orapproximately $0.3 million, to $3.5 million from $3.8 million for thethird quarter of fiscal 2005, primarily due to our increased balance of cashand short-term investments and the resulting increased interest income.  During the third quarter of fiscal 2006, wehad no direct borrowings under our credit facility.  During the third quarter of fiscal 2005, ouraverage level of direct borrowings under our credit facility was $1.2 million.

***Income Tax Provision.*** Our effective tax rate was a provision of 39.0% for the thirdquarter of fiscal 2006 and 39.1% for the third quarter of fiscal 2005.  We expect our effective tax rate for the full year fiscal 2006 to be approximately

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39%.

***Net Income.***  Netincome for the third quarter of fiscal 2006 was $8.8 million, or $1.54 pershare (diluted), compared to net income of $5.5 million, or $1.03 per share(diluted), for the third quarter of fiscal 2005, representing increases versuslast year of 59.3% in net income and 49.5% in diluted earnings per share.  Excluding non-cash stock-based compensationexpense, net income for the third quarter of fiscal 2006 was $9.3 million, or$1.64 per share (diluted).  We were notrequired to recognize and, therefore, did not recognize any non-cash stock-basedcompensation expense in the third quarter of fiscal 2005.

Ouraverage diluted shares outstanding of 5,684,000 for the third quarter of fiscal2006 was 5.8% higher than the 5,372,000 average diluted shares outstanding forthe third quarter of fiscal 2005.  Theincrease in average diluted shares outstanding reflects the higher dilutiveimpact of outstanding stock options in fiscal 2006 compared to fiscal 2005, aswell as higher shares outstanding in fiscal 2006 compared to fiscal 2005.

**Nine Months Ended June 30, 2006 and 2005**

***Net Sales.***  Our netsales for the first nine months of fiscal 2006 increased by 7.9%, or $33.5million, to $459.9 million from $426.4 million for the first nine monthsof fiscal 2005.  Net salesincreased primarily due to our increased comparable store sales, sales from theexpansion of our Two HeartsTM Maternity collection to additional Sears®locations during late March 2005 and, to a lesser extent, sales increasesrealized from our internet sales, our licensed arrangement with Kohl’s, and ourmarketing partnerships.  Comparable storesales increased by 3.7% during fiscal 2006, based on 959 retail locations,versus a comparable store sales decrease of 3.1% during fiscal 2005, based on846 retail locations.

***Gross Profit.***  Our grossprofit for the first nine months of fiscal 2006 increased by 9.9%, orapproximately $21.8 million, to $242.1 million from $220.3 million for thefirst nine months of fiscal 2005, reflecting the increase in net sales and anincrease in gross margin.  Gross margin for the first nine months of fiscal2006 was 52.6% compared to 51.7% for the first nine months of fiscal2005.  The increase in gross margin of approximately 0.9 percentagepoints compared to the prior year resulted from a higher maintained grossmargin in our own stores, largely due to lower overall markdowns compared to lastyear.

***Selling, General and AdministrativeExpenses.***  Our selling, general and administrativeexpenses for the first nine months of fiscal 2006 increased by 7.3%, orapproximately $14.5 million, to $215.0 million from $200.5 million for thefirst nine months of fiscal 2005.  Thisincrease in expense for the nine month period resulted primarily from increasesin accrued incentive compensation expense related to improvements in ouroperating performance compared to fiscal 2005, rent and related expenses forour retail locations, employee wages and benefits for our retail locations, andstock-based compensation expense.  As apercentage of net sales, selling, general and administrative expenses wasslightly lower at 46.8% for fiscal 2006 compared to 47.0% for fiscal 2005.  This slight decrease in the expensepercentage for the nine-month period resulted primarily from the favorableexpense leverage from our comparable store sales increase, the additional salesfrom our Sears and Kohl’s relationships for the nine-month period, and acontinued sharp focus on expense control. This favorable expense leverage offset increases as a percentage of netsales in accrued incentive compensation expense and stock-based compensationexpense.  We incurred charges relating tostore closings of $1.8 million for fiscal 2006 (primarily lease terminationfees) as compared to $1.4 million for fiscal 2005.  The majority of the store closingcharges for the first nine months of fiscal 2006 and fiscal 2005 were forstores closed in connection with multi-brand store openings.  We incurredimpairment charges for write-downs of store long-lived assets of $2.3million for fiscal 2006, as compared to $1.8 million for fiscal 2005.  We also incurred $1.7 million of non-cashexpenses related to stock-based compensation expense, including $1.5 million inselling, general and administrative expense, in the first nine months of fiscal2006 versus none in the first nine months of fiscal 2005, since we adopted theprovisions of SFAS No. 123(R) as of the beginning of fiscal 2006.

***Operating Income.***  Our operating income for the first ninemonths of fiscal 2006 increased by 36.1%, or approximately $7.1 million, to$27.0 million from $19.9 million for the first nine months of fiscal 2005,due to increased sales volume and gross profit, which more than offset theimpact of higher selling, general and administrative expenses.  Operating income as a percentage of net sales(operating income margin) for thefirst nine months of fiscal 2006 increased to 5.9% from 4.7% for the first ninemonths of fiscal 2005.  Excludingnon-cash stock-based compensation expense, our operating income for the firstnine months of fiscal 2006 was $28.7 million, which represents a 6.2% adjustedoperating income margin.  We were notrequired to recognize and, therefore, did not recognize any non-cashstock-based compensation expense in fiscal 2005.  The increase in operating income margin wasprimarily due to our increased gross margin.

***Interest Expense, Net.***  Our net interest expense for thefirst nine months of fiscal 2006 of $11.1 million was slightly lower than thefirst nine months of fiscal 2005 figure of $11.4 million, due to our increasedbalance of cash and short-term investments and

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the resulting increased interest income. During the first nine months of fiscal 2006, our average level of directborrowings under our credit facility was $0.4 million, but we had no directborrowings under our credit facility as of June 30, 2006.  During the first nine months of fiscal 2005,our average level of direct borrowings under our credit facility was $2.2million.

***Income Tax Provision.*** Our effective tax rate was a provision of39.0% for the first nine months of fiscal 2006 and fiscal 2005.  We expect our effective tax rate for the full year fiscal 2006 to be approximately39%.

***Net Income.***  Netincome for the first nine months of fiscal 2006 was $9.7 million, or $1.77 pershare (diluted), compared to net income of $5.2 million, or $0.96 per share (diluted), for the first nine months offiscal 2005, representing increases versus last year of 87.9% in net income and84.4% in diluted earnings per share. Excluding non-cash stock-based compensation expense, net income for thefirst nine months of fiscal 2006 was $10.7 million, or $1.95 per share(diluted).  We were not required torecognize and, therefore, did not recognize any non-cash stock-basedcompensation expense in the first nine months of fiscal 2005.

Ouraverage diluted shares outstanding of 5,496,000 for the first nine months offiscal 2006 was 2.3% higher than the 5,373,000 average diluted sharesoutstanding for the first nine months of fiscal 2005.  The increase in average diluted sharesoutstanding reflects the higher dilutive impact of outstanding stock options infiscal 2006 compared to fiscal 2005, as well as higher shares outstanding infiscal 2006 compared to fiscal 2005.

**Seasonality**

Ourbusiness, like that of many other retailers, is seasonal.  Our quarterly net sales have historicallybeen highest in our third fiscal quarter, corresponding to the Spring sellingseason, followed by the first fiscal quarter, corresponding to the Fall/holidayselling season.  Given the typicallyhigher gross margin we experience in the third fiscal quarter compared to otherquarters, the relatively fixed nature of most of our operating expenses andinterest expense, and the historically higher sales level in the third quarter,we have typically generated a very significant percentage of our full yearoperating income and net income during the third quarter.  Results for any quarter are not necessarilyindicative of the results that may be achieved for a full fiscal year.  Quarterly results may fluctuate materiallydepending upon, among other things, the timing of new store openings and newleased department openings, net sales and profitability contributed by newstores and leased departments, increases or decreases in comparable storesales, the timing of the fulfillment of purchase orders under our product andlicense arrangements, adverse weather conditions, shifts in the timing ofcertain holidays and promotions, changes in inventory and production levels andthe timing of deliveries of inventory, and changes in our merchandise mix.

**Liquidity and Capital Resources**

Our cash needs have primarily been for: (i) debtservice, (ii) capital expenditures, including leasehold improvements,fixtures and equipment for new stores, store relocations and expansions of ourexisting stores, as well as improvements and new equipment for our distributionand corporate facilities and information systems, and (iii) working capital,including inventory to support our new business initiatives and our new andexisting stores.  We have historicallyfinanced these capital requirements from cash flows from operations, borrowingsunder our credit facility or available cash balances.

Cash and cash equivalents increased by $12.6 millionduring the first nine months of fiscal 2006 compared to an increase of $0.2million for the first nine months of fiscal 2005.  Cash provided by operations of $46.0 millionfor the first nine months of fiscal 2006 increased by $37.1 million from $8.9million provided for the first nine months of fiscal 2005.  This increase in cash provided by operationswas primarily the result of cash generated by reducing inventories in the firstnine months of fiscal 2006 compared to an increase in inventories during thefirst nine months of fiscal 2005.  Totalinventories as of June 30, 2006 were $97.1 million, a decrease of $8.8 millionor 8.3% below the $105.9 million inventories balance as of September 30, 2005,and a decrease of $14.7 million or 13.1% below the $111.8 million inventoriesbalance at June 30, 2005.  During thefirst nine months of fiscal 2006, we used our cash provided by operationsprimarily to increase our short-term investments, increase our cash and cashequivalents, and pay for capital expenditures. During the first nine months of fiscal 2005, we paid for our capitalexpenditures through cash provided from operations and the utilization ofproceeds from sales of short-term investments.

On August 3, 2006, we announced that our Board ofDirectors has authorized the repurchase at this time of up to $10 millionprincipal amount of our 111¤4% Senior Notes.  The timing and extent to which we repurchaseour Senior Notes will depend upon market conditions and other corporate considerations, and will be at our solediscretion.

For the first nine monthsof fiscal 2006, we spent $10.8 million on capital expenditures, including$9.0 million for leasehold improvements, fixtures and equipment principallyfor new store facilities, as well as improvements to existing stores, and$1.8 million for our distribution and corporate facilities and informationsystems.  This compares to$15.3 million in capital expenditures for the first nine months of fiscal2005, of which $11.7 million was spent for new store facilities andimprovements to existing stores and retail locations, and $3.5 million forour distribution and corporate facilities and information systems.  Thedecrease in capital expenditures was primarily due to decreased expendituresfor new stores and

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decreased expenditures for distribution facilities and informationsystems compared to last year.

OnOctober 15, 2004, we entered into a new five-year $60.0 million seniorsecured revolving credit facility (the “Credit Facility”).  The Credit Facility will mature onOctober 15, 2009.  There are no financial covenant requirementsunder the Credit Facility unlesseither (i) Excess Availability (as defined in the agreement) falls below$10 million, or (ii) average Financial Covenant Adjusted Availability (asdefined in the agreement) for any calendar month is less than $15 million.  If either of the events in items (i) or(ii) above occurs, we would be required to meet a certain minimum fixedcharge coverage ratio (which increases from 1.00x during the first two years ofthe Credit Facility to 1.10x during the fifth year of the CreditFacility). During the first nine months of fiscal 2006 and the first nine months offiscal 2005, we exceeded the requirements for Excess Availability and averageFinancial Covenant Adjusted Availability.

As ofJune 30, 2006, outstanding borrowings under the Credit Facility consisted of nodirect borrowings and $9.0 million in letters of credit, with $51.0 million ofavailability under our credit line.  Ouraverage level of direct borrowings under our credit facility was $0.4 millionfor the first nine months of fiscal 2006, compared to average direct borrowingsof $2.2 million during the first nine months of fiscal 2005.

Our managementbelieves that our current cash and working capital positions, expectedoperating cash flows and available borrowing capacity under our CreditFacility, will be sufficient to fund our working capital, capital expendituresand debt repayment requirements and to fund stock and/or debt repurchases, ifany, for at least the next twelve months.

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

Our consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States. These generally acceptedaccounting principles require management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of our consolidated financialstatements and the reported amounts of net sales and expenses during thereporting period.

Our significantaccounting policies are described in Note 2 of “Notes to ConsolidatedFinancial Statements” in our Annual Report on Form 10-K for the year endedSeptember 30, 2005.  We believe that thefollowing discussion addresses our critical accounting policies, which arethose that are most important to the portrayal of our financial condition andresults of operations and require management’s most difficult, subjective andcomplex judgments, often as a result of the need to make estimates about theeffect of matters that are inherently uncertain.  If actual results were to differsignificantly from estimates made, future reported results could be materiallyaffected.  However, we are not currentlyaware of any reasonably likely events or circumstances that would result inmaterially different results.

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

***Inventories.***  Wevalue our inventories, which consist primarily of maternity apparel, at thelower of cost or market. Cost is determined on the first-in, first-out method(FIFO) and includes the cost of merchandise, freight, duty and broker fees. Aperiodic review of inventory quantities on hand is performed in order todetermine if inventory is properly valued at the lower of cost or market.Factors related to current inventories such as future consumer demand andfashion trends, current aging, current analysis of merchandise based on receiptdate, current and anticipated retail markdowns or wholesale discounts, and classor type of inventory are analyzed to determine estimated net realizablevalues.  Criteria utilized by us toquantify aging trends include factors such as the amount of merchandisereceived within the past twelve months, merchandise received more than one yearbefore with quantities on-hand in excess of 12 months of sales, andmerchandise currently selling below cost. A provision is recorded to reduce the cost of inventories to itsestimated net realizable value, if required. Inventories as of June 30, 2006 and September 30, 2005 totaled$97.1 million and $105.9 million, respectively, representingapproximately 32.4% and 38.7% of total assets, respectively.  Given the significance of inventories to our consolidatedfinancial statements, the determination of net realizable values is consideredto be a critical accounting estimate. Any significant unanticipated changes inthe factors noted above could have a significant impact on the value of ourinventories and our reported operating results.

***Long-Lived Assets.***  Our long-lived assetsconsist principally of store leasehold improvements (included in the “Property,plant and equipment, net” line item in our consolidated balance sheets) and, toa much lesser extent, lease

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acquisition costs(included in the “Other intangible assets, net” line item in our consolidatedbalance sheets).  These long-lived assetsare recorded at cost and are amortized using the straight-line method over theshorter of the lease term or their useful life. Net long-lived assets as of June 30, 2006 and September 30, 2005totaled $73.4 million and $77.1 million, respectively, representingapproximately 24.5% and 28.2% of total assets, respectively.

Inassessing potential impairment of these assets, we periodically evaluate thehistorical and forecasted operating results and cash flows on a store-by-storebasis. Newly opened stores may take time to generate positive operating andcash flow results.  Factors such as(i) store type, that is, company store or leased department,(ii) store concept, that is, Motherhood Maternity®, Mimi Maternity, A Peain the Pod or Destination Maternity, (iii) store location, for example,urban area versus suburb, (iv) current marketplace awareness of ourbrands, (v) local customer demographic data, (vi) anchor storeswithin the mall in which our store is located and (vii) current fashiontrends are all considered in determining the time frame required for a store toachieve positive financial results, which is assumed to be within two yearsfrom the date a store location is opened. If economic conditions are substantially different from ourexpectations, the carrying value of certain of our long-lived assets may becomeimpaired.  As a result of ourimpairment assessment, we recorded write-downs of long-lived assets of $2.3million for the first nine months of fiscal 2006, and $1.8 million for thefirst nine months of fiscal 2005.

***Goodwill*.** The purchase method of accounting for business combinations requires theuse of estimates and judgments to allocate the purchase price paid foracquisitions to the net tangible and identifiable intangible assets.  Goodwill represents the excess of theaggregate purchase price over the fair value of net assets acquired in businesscombinations and is separately disclosed in our consolidated balancesheets.  As of both June 30, 2006 andSeptember 30, 2005, goodwill totaled $50.4 million, representing16.8% and 18.4% of total assets, respectively. In June 2001, the FASB issued SFAS No. 142, “Goodwill andOther Intangible Assets.”  SFAS No. 142requires that goodwill be tested for impairment at least annually or asimpairment indicators arise.

Theimpairment test requires us to compare the fair value of business reportingunits to their carrying value, including assigned goodwill.  In assessing potential impairment ofgoodwill, we have determined that we have one reporting unit for purposes ofapplying SFAS No. 142 based on our reporting structure.  The fair value of our single reporting unitis determined based on the fair market value of our outstanding common stock ona control basis and, if necessary, an outside independent valuation is obtainedto determine the fair value.  Thecarrying value of our single reporting unit, expressed on a per share basis, isrepresented by our book value per share of outstanding common stock.  The results of the annual impairment testperformed as of September 30, 2005 indicated the fair value of thereporting unit exceeded its carrying value. As of September 30, 2005, our book value was $12.02 per share ofoutstanding common stock and the closing trading price of our common stock was$10.00 per share.  As part of the Company’simpairment analysis as of September 30, 2005, an outside independentvaluation was obtained that indicated that the fair value of the Company’ssingle reporting unit exceeded the carrying value.  If the per share fair value of our singlereporting unit had been less than the book value per share onSeptember 30, 2005, our goodwill would likely have become impaired.  As of June 30, 2006, our book value was$14.14 per share of outstanding common stock and the closing trading price ofour common stock was $35.05 per share.

***Accounting for Income Taxes.***  Aspart of the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate.  This process requires us toestimate our actual current tax exposure together with assessing temporarydifferences resulting from differing treatment of items, such as depreciationof property and equipment and valuation of inventories, for tax and accountingpurposes.  We determine our provision forincome taxes based on federal and state tax laws and regulations currently ineffect, some of which have been recently revised.  Legislation changes currently proposed bycertain of the states in which we operate, if enacted, could increase ourtransactions or activities subject to tax. Any such legislation that becomes law could result in an increase in ourstate income tax expense and our state income taxes paid, which could have amaterial and adverse effect on our net income.

Thetemporary differences between the book and tax treatment of income and expensesresult in deferred tax assets and liabilities, which are included within ourconsolidated balance sheets.  We mustthen assess the likelihood that our deferred tax assets will be recovered fromfuture taxable income.  As ofSeptember 30, 2005, we determined that the deferred tax assets shouldreflect the state tax benefits for several of the states in which we areoperating.  This determination was madein accordance with the provisions of SFAS No. 109, “Accounting for IncomeTaxes.”  Actual results could differ fromour assessments if adequate taxable income is not generated in futureperiods.  Net deferred tax assets as ofJune 30, 2006 and September 30, 2005 totaled $19.9 million and$19.3 million, respectively, representing approximately 6.6% and 7.1% oftotal assets, respectively.  To theextent we believe that recovery is not more likely than not, we must establisha valuation allowance.  To the extent weestablish a valuation allowance or change the allowance in a future period,income tax expense will be impacted.

***Accounting for Contingencies*.**  From timeto time, we are named as a defendant in legal actions arising from our

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normal businessactivities.  We account for contingenciessuch as these in accordance with SFAS No. 5, “Accounting forContingencies.”  SFAS No. 5 requiresus to record an estimated loss contingency when information available prior tothe issuance of our financial statements indicates that it is probable that anasset has been impaired or a liability has been incurred at the date of thefinancial statements and the amount of the loss can be reasonablyestimated.  An interpretation of SFASNo. 5 further states 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, after consultation with outside legal counsel,to use its best judgment when estimating an accrual related to suchcontingencies.  As additional informationbecomes known, our accrual for a loss contingency could fluctuate, therebycreating variability in our results of operations from period to period.  Likewise, an actual loss arising from a losscontingency which significantly exceeds the amount accrued for in our financialstatements could have a material adverse impact on our operating results forthe period in which such actual loss becomes known.

**Recent Accounting Pronouncements**

*SFAS No. 154*

In May 2005, theFinancial Accounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards  No. 154 (“SFAS No. 154”), “Accounting Changes and ErrorCorrections.”  SFAS No.154 providesguidance on the accounting for and reporting of accounting changes and errorcorrections.  This statement is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.  Earlyadoption is permitted.  We expect toadopt SFAS No. 154 effective as of October 1, 2006*.*

*FASBInterpretation No. 48*

In June 2006, the FASB issued FASB Interpretation No.48, “Accounting for Uncertainty in Income Taxes.” FASB Interpretation No. 48provides guidance for the recognition and measurement of uncertain taxpositions in an enterprise’s financial statements.  Recognition involves a determination ofwhether it is more likely than not that a tax position will be sustained uponexamination with the presumption that the tax position will be examined by theappropriate taxing authority that would have full knowledge of all relevantinformation.  This interpretation is effectivefor fiscal years beginning after December 15, 2006.  Early adoption is permitted if the enterprisehas not issued financial statements, including interim financial statements, inthe period of adoption.  The impact fromadoption of FASB Interpretation No. 48, if any, on our consolidated financialposition or results of operations has not yet been determined.

*EITFIssue 06-3*

*In June2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “HowTaxes Collected from Customers and Remitted to Governmental Authorities ShouldBe Presented in the Income Statement (That Is, Gross versus Net Presentation).”  EITF Issue 06-3 provides guidance related tothe presentation in financial statements of any tax assessed by a governmentalauthority that is directly imposed on a revenue-producing transaction between aseller and a customer, including, but not limited to, sales, use, value added,and some excise taxes.  The EITFconcluded that the presentation of taxes within the scope of EITF Issue 06-3 oneither a gross (included in revenues and costs) or a net (excluded fromrevenues) basis is an accounting policy decision that should disclosed.  In addition, the aggregate amount of any suchtaxes that are reported on a gross basis should be disclosed in interim andannual financial statements.  Theguidance in EITF Issue 06-3 is effective for interim and annual reportingperiods beginning after December 15, 2006. We presently report taxes within the scope of EITF Issue 06-3 on a netbasis and adoption is not expected to have an impact on our consolidatedfinancial statements.*

**Forward-Looking Statements**

Some of the informationin this report, including information incorporated by reference, if applicable,(as well as information included in oral statements or other written statementsmade or to be made by us), contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  The forward-lookingstatements involve a number of risks and uncertainties.  A number of factors could cause our actualresults, performance, achievements or industry results to be materiallydifferent from any future results, performance or achievements expressed orimplied by these forward-looking statements.  These factors include, but are not limitedto: the success of our new business initiatives, future sales trends in ourexisting store base, changes in consumer spending patterns, raw material priceincreases, consumer preferences and overall

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economicconditions, the impact of competition and pricing, availability of suitablestore locations, continued availability of capital and financing, ability tohire and develop senior management and sales associates, ability to develop andsource merchandise, ability to receive production from foreign sources on atimely basis, potential stock repurchases, potential debt repurchases, war oracts of terrorism and other factors referenced in our Annual Report on Form10-K, including those set forth under the caption “Risk Factors.”

Inaddition, these forward-looking statements necessarily depend uponassumptions, estimates and dates that may be incorrect or imprecise and involveknown and unknown risks, uncertainties and other factors.  Accordingly, any forward-lookingstatements included in this report do not purport to be predictions of futureevents or circumstances and may not be realized. Forward-lookingstatements can be identified by, among other things, the use of forward-lookingterms such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “proforma,” “anticipates,” “intends,” “continues,” “could,” “estimates,” “plans,” “potential,”“predicts,” “goal,” “objective,” or the negative of any of these terms, orcomparable terminology, or by discussions of our outlook, plans, goals,strategy or intentions.  Forward-lookingstatements speak only as of the date made. We assume no obligation to update any of these forward-lookingstatements to reflect actual results, changes in assumptions or changes inother factors affecting these forward-looking statements.

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

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

As ofJune 30, 2006, we had cash, cash equivalents and short-term investments of$41.3 million, which include money market accounts and auction rate securitiesthat bear interest at variable rates.  A change in market interest rates earned on the cash,cash equivalents and short-term investmentsimpacts the interest income and cash flows, but does not impact the fair marketvalue of the financial instruments.  Dueto the average maturity and conservative nature of our investment portfolio, webelieve a sudden change in interest rates would not have a material effect onthe value of our investment portfolio.

As of June 30, 2006, the principal components of ourdebt portfolio were the $125.0 million of Senior Notes and the$60.0 million Credit Facility, both of which are denominated in U.S.dollars.  The fair value of the debt portfolio is referred to as the “debtvalue.”  The Senior Notes bear interest at a fixed rated of 111⁄4%. Although a change in market interest rates would not affect the interestincurred or cash flow related to this fixed rate portion of the debt portfolio,the debt value would be affected.

Our Credit Facility carries a variable interest ratethat is tied to market indices.  As of June 30, 2006, we had no directborrowings and $9.0 million of letters of credit outstanding under our CreditFacility.  Borrowings under the Credit Facility would have borne interestat a rate between approximately 6.6% and 8.3% per annum as of June 30,2006.  Any future borrowings under the Credit Facility would, to theextent of outstanding borrowings, be affected by changes in market interestrates.  A change in market interest rateson the variable portion of the debt portfolio impacts the interest incurred andcash flows, but does not impact the debt value of the financial instrument.

The sensitivity analysis as it relates to the fixed rateportion of our debt portfolio assumes an instantaneous 100 basis point move ininterest rates from their levels as of June 30, 2006, with all other variablesheld constant.  A 100 basis point increase in market interest rates wouldresult in a decrease in the value of the debt by approximately $4.0 million asof June 30, 2006.  A 100 basis point decline in market interest rateswould cause the debt value to increase by approximately $4.1 million as of June30, 2006.

Basedon the variable rate debt included in our debt portfolio as of June 30, 2006, a100 basis point increase in interest rates would result in additional interestincurred for the year of less than $0.1 million.  A 100 basis point decrease in interest rateswould correspondingly lower our interest expense for the year by less than $0.1million.

Otherthan as described above, we do not believe that the market risk exposure onother financial instruments is material.

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**Item 4.  Controls and Procedures**

***DisclosureControls and Procedures***

Our disclosurecontrols and procedures are designed to ensure that information required to bedisclosed by us in the reports that are filed or submitted under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules andforms.  These disclosure controls andprocedures include controls and procedures designed to ensure that informationrequired to be disclosed under the Exchange Act is accumulated and communicatedto our management on a timely basis to allow decisions regarding requireddisclosure.  We evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures as of June 30, 2006. Based on this evaluation, the Company’s ChiefExecutive Officer and Chief Financial Officer have concluded that as of June30, 2006, these controls and procedures were effective.

***InternalControl over Financial Reporting***

There have been nochanges in internal control over financial reporting identified in connectionwith the foregoing evaluation that occurred during the fiscal quarter endedJune 30, 2006, that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

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**PART II. OTHER INFORMATION**

**Item1.  Legal Proceedings**

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

**Item 6.  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 Executive Vice President-Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
| 32.1         |       | Certification of the Chief Executive Officer  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                          |
| 32.2         |       | Certification of the Executive Vice President-Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                      |     | MOTHERS WORK, INC.                                         |       |
|----------------------|----------|------------------------------------------------------------|------------|
|                 |     |                                                       |       |
| Date: August 9, 2006 | By:      | **/s/ DAN W. MATTHIAS**                                    | ** ** |
|                 |     | Dan W. Matthias                                            |       |
|                 | * * | *Chairman of the Board and  Chief Executive Officer*       | * *   |
|                 |     |                                                       |       |
|                 |     |                                                       |       |
| Date: August 9, 2006 | By:      | **/s/ EDWARD M. KRELL**                                    | ** ** |
|                 |     | Edward M. Krell                                            |       |
|                 | * * | *Executive  Vice President—  Chief Financial Officer* | * *   |

 

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**INDEX OFEXHIBITS FILED WITHFORM 10-Q OF MOTHERS WORK, INC.FOR THE QUARTER ENDED JUNE 30, 2006**
| 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 Executive Vice President-Cheif Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                |
| 32.1        |       | Certification of  the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted  Pursuant to section 906 of the Sarbanes-Oxley Act of 2002.                           |
| 32.2        |       | Certification of  the Executive Vice President-Chief Financial Officer Pursuant to 18 U.S.C.  Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

 

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