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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| | ---------------------------------------------------------------------------------------

For the quarterly period ended July 31, 2006

OR

| | 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 0-12188

DEB SHOPS, INC.

(Exact name of registrant as specified in its charter)



| | Pennsylvania(State or other jurisdiction ofincorporation or organization) |  | 23-1913593(I.R.S. EmployerIdentification No.) | 
| | ------------------------------------------------------------------------- |  | --------------------------------------------- | 

| |  |  |  | 
| |  |  |  | 

| | 9401
      Blue Grass Road, Philadelphia, Pennsylvania(Address of principal executive offices) |  | 19114(Zip Code) | 
| | ---------------------------------------------------------------------------------------------- |  | --------------- | 

(215)
  676-6000

(Registrants telephone number, including area code)

Not
  Applicable

(Former
  name, former address and former fiscal year, if changed since last report)

Indicate
  by check mark whether the registrant (1) has filed all reports required to be
  filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
  preceding 12 months (or for such shorter period that the registrant was required
  to file such reports), and (2) has been subject to such filing requirements
  for the past 90 days.

Yes
     No

Indicate
  by check mark whether the registrant is a large accelerated filer, an accelerated
  filer, or a non-accelerated filer. See definition of accelerated filer
  and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
  one):

Large
  accelerated filerAccelerated
  filer         Non-accelerated
  filer

Indicate
  by check mark whether the registrant is a shell company (as defined in Rule
  12b-2 of the Exchange Act).

YesNo

Indicate
  the number of shares outstanding of each of the issuers classes of Common
  Stock, as of the latest practicable date.



Common
          Stock, Par Value $.01
      
      14,327,808(Class)
      
      (Outstanding
          at September 5, 2006)





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DEB
  SHOPS, INC. AND SUBSIDIARIES

INDEX



PagePART
          I.
      
      
      
      Financial
          Information:Item
          1.
      
      Financial
          StatementsConsolidated
          Balance Sheets July 31, 2006 (Unaudited) and January 31, 2006
      1Consolidated
          Statements of Operations (Unaudited) Three Months and Six Months Ended
          July 31, 2006 and 2005
      2Consolidated
          Statements of Cash Flows (Unaudited) Six Months Ended July 31, 2006
          and 2005
      3Notes
          to Consolidated Financial Statements July 31, 2006 (Unaudited)
      4-6Item
          2.
      
      Managements
          Discussion and Analysis of Financial Condition and Results of Operations
      7-12Item
          3.
      
      Quantitative
          and Qualitative Disclosures About Market Risk
      12Item
          4.
      
      Controls
          and Procedures
      12PART
          II.
      
      
      
      Other
          Information:Item
          1.
      
      Legal
          Proceedings
      13Item
          1A.
      
      Risk
          Factors
      13Items
          2 - 3.
      
      
      13Item
          4.
      
      Submission
          of Matters to a Vote of Security Holders
      13Item
          5.
      
      
      13Item
          6.
      
      Exhibits
      13Signatures
      
      
      14Exhibit
          Index
      
      
      15




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|PART
          I. Financial Information
|---------------------------------------

Item
          1.Financial Statements


DEB SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



JULY
          31,2006(Unaudited)
      
      JANUARY
          31,2006ASSETSCurrent
          AssetsCash
          and cash equivalents
      
      $
      23,998,950
      
      $
      26,520,757Marketable
          securities
      
      
      92,000,000
      
      
      91,000,000Merchandise
          inventories
      
      
      36,722,679
      
      
      32,902,705Prepaid
          expenses and other
      
      
      3,783,316
      
      
      3,247,389Deferred
          income taxes
      
      
      1,180,154
      
      
      1,180,154Total
          current assets
      
      
      157,685,099
      
      
      154,851,005Property,
          Plant and Equipment - at costLand
      
      
      150,000
      
      
      150,000Buildings
      
      
      2,365,697
      
      
      2,365,697Leasehold
          improvements
      
      
      56,962,163
      
      
      55,615,772Furniture
          and equipment
      
      
      17,570,290
      
      
      16,794,54277,048,150
      
      
      74,926,011Less
          accumulated depreciation and amortization
      
      
      52,729,010
      
      
      51,600,719Net
          property, plant and equipment
      
      
      24,319,140
      
      
      23,325,292Other
          AssetsDeferred
          income taxes
      
      
      7,780,844
      
      
      7,780,844Other
      
      
      1,712,223
      
      
      1,712,223Total
          other assets
      
      
      9,493,067
      
      
      9,493,067Total
          assets
      
      $
      191,497,306
      
      $
      187,669,364LIABILITIES
          AND SHAREHOLDERS EQUITYCurrent
          LiabilitiesTrade
          accounts payable
      
      $
      29,810,827
      
      $
      26,917,480Accrued
          expenses and other
      
      
      11,837,450
      
      
      13,173,334Income
          taxes payable
      
      
      1,193,551
      
      
      4,511,782Total
          current liabilities
      
      
      42,841,828
      
      
      44,602,596Deferred
          lease credits
      
      
      11,864,275
      
      
      11,511,430Total
          liabilities
      
      
      54,706,103
      
      
      56,114,026Shareholders
          EquitySeries
          A preferred stock, par value $1.00 per share:Authorized
          - 5,000,000 sharesIssued
          and outstanding  460 shares, liquidation value $460,000
      
      
      460
      
      
      460Common
          stock, par value $.01 per share:Authorized
          - 50,000,000 sharesIssued
          - 15,688,290 shares
      
      
      156,883
      
      
      156,883Additional
          paid in capital
      
      
      14,395,804
      
      
      14,187,841Retained
          earnings
      
      
      130,675,558
      
      
      125,684,867145,228,705
      
      
      140,030,051Less
          common treasury shares, at cost:July
          31, 2006: 1,360,482; January 31, 2006: 1,366,482
      
      
      8,437,502
      
      
      8,474,713Total
          shareholders equity
      
      
      136,791,203
      
      
      131,555,338Total
          liabilities and shareholders equity
      
      $
      191,497,306
      
      $
      187,669,364


See notes to consolidated financial statements.

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DEB SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



Three Months Ended July 31,

        

        Six Months Ended July 31,2006

        

        2005

        

        2006

        

        2005Net sales


      


      $


      75,658,460


      


      $


      75,966,094


      


      $


      157,116,016


      


      $


      153,450,841Cost of sales, including buying and occupancy costs

        

        

        47,162,694

        

        

        46,934,240

        

        

        105,736,083

        

        

        102,617,057Gross profit

        

        

        28,495,766

        

        

        29,031,854

        

        

        51,379,933

        

        

        50,833,784Operating
            expenses:Selling and administrative

        

        

        19,450,105

        

        

        18,526,050

        

        

        37,705,128

        

        

        35,621,310Depreciation and amortization

        

        

        1,310,441

        

        

        1,282,574

        

        

        2,574,589

        

        

        2,649,38120,760,546

        

        

        19,808,624

        

        

        40,279,717

        

        

        38,270,691Operating income

        

        

        7,735,220

        

        

        9,223,230

        

        

        11,100,216

        

        

        12,563,093Other income, principally interest

        

        

        1,166,952

        

        

        1,324,850

        

        

        2,100,026

        

        

        2,373,305Income before income taxes

        

        

        8,902,172

        

        

        10,548,080

        

        

        13,200,242

        

        

        14,936,398Income tax provision

        

        

        3,040,000

        

        

        3,958,000

        

        

        4,600,000

        

        

        5,586,000Net income

        

        $

        5,862,172

        

        $

        6,590,080

        

        $

        8,600,242

        

        $

        9,350,398Net income per common shareBasic

        

        $

        0.41

        

        $

        0.47

        

        $

        0.60

        

        $

        0.67Diluted

        

        $

        0.41

        

        $

        0.46

        

        $

        0.60

        

        $

        0.66Cash dividend declared per common share

        

        $

        0.125

        

        $

        6.125

        

        $

        0.250

        

        $

        6.250Weighted average number of common shares outstandingBasic

        

        

        14,327,808

        

        

        14,080,355

        

        

        14,325,600

        

        

        13,930,967Diluted

        

        

        14,343,532

        

        

        14,160,816

        

        

        14,347,929

        

        

        14,054,870


See notes to consolidated financial statements.

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DEB
  SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED
  STATEMENTS OF CASH FLOWS

(Unaudited)



Six Months Ended July 31,2006

        

        2005Cash flows from operating activities:Net income

        

        $

        8,600,242

        

        $

        9,350,398Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization

        

        

        2,574,589

        

        

        2,649,381Stock compensation expense

        

        

        90,874

        

        

        Loss on retirement of property, plant and equipment

        

        

        55,441

        

        

        34,704Changes in operating assets and liabilities:Increase in merchandise inventories

        

        

        (3,819,974

        )

        

        (4,866,437

        )(Increase) decrease in prepaid expenses and other

        

        

        (300,427

        )

        

        446,101Increase in trade accounts payable

        

        

        2,893,347

        

        

        4,005,287Decrease in accrued expenses and other

        

        

        (1,336,634

        )

        

        (492,675

        )Decrease in income taxes payable

        

        

        (3,318,231

        )

        

        (3,337,245

        )Increase (decrease) in deferred lease credits

        

        

        117,345

        

        

        (436,516

        )Net cash provided by operating activities

        

        

        5,556,572

        

        

        7,352,998Cash flows from investing activities:Purchases of property, plant and equipment

        

        

        (3,623,877

        )

        

        (1,844,430

        )Purchases of investment securities

        

        

        (9,600,000

        )

        

        (71,100,000

        )Sales of investment securities

        

        

        8,600,000

        

        

        147,575,000Net cash (used in) provided by investing activities

        

        

        (4,623,877

        )

        

        74,630,570Cash flows from financing activities:Preferred stock cash dividends paid

        

        

        (27,600

        )

        

        (27,600)Common stock cash dividends paid

        

        

        (3,581,202

        )

        

        (3,452,222

        )Proceeds from exercise of stock options

        

        

        142,500

        

        

        9,753,484Tax benefit from stock based compensation

        

        

        11,800

        

        

        520,900Net cash (used in) provided by financing activities

        

        

        (3,454,502

        )

        

        6,794,562(Decrease) increase in cash and cash equivalents

        

        

        (2,521,807

        )

        

        88,778,130Cash and cash equivalents at beginning of period

        

        

        26,520,757

        

        

        30,298,970Cash and cash equivalents at end of period

        

        $

        23,998,950

        

        $

        119,077,100Supplemental disclosures of cash flow information:Cash paid during the period for:Income taxes, net

        

        $

        8,303,000

        

        $

        8,707,000


See notes to consolidated financial statements.

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DEB
  SHOPS, INC. AND SUBSIDIARIES

NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

JULY 31, 2006

- A - Organization / Basis Of Presentation

Deb Shops, Inc. operates 333 womens and mens specialty apparel retail stores in regional malls and strip shopping centers principally located in the East and Midwest regions of the United States. We operate 325 stores under the name DEB which offer moderately priced, fashionable, coordinated womens tops, bottoms, dresses, coats, lingerie, accessories, shoes and novelty items for junior and plus-sizes. DEB merchandise consists of clothing and accessories appealing primarily to fashion-conscious junior and plus-sized female consumers between the ages of 13 and 25. One hundred seventy four of our DEB stores contain plus-size departments. In addition, we operate two outlet stores under the name CSO.  The outlet stores offer the same merchandise as DEB at reduced prices and serve as clearance stores for slow-moving inventory. We also operate
six apparel retail stores under the name Tops N Bottoms.  The Tops N Bottoms stores sell moderately priced mens and womens apparel. Thirteen of the DEB stores contain Tops N Bottoms departments.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the first and third quarters, cost of goods sold and inventories are estimated based on the use of the gross profit method. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended July 31, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2007. For further information, refer to the consolidated financial statements and
footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2006.

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain amounts appearing in the prior period financial statements have been reclassified to conform to current presentation.

- B - Net Income Per Share

The table below sets forth the reconciliation of the numerators and denominators of the basic and diluted net income per common share computations.



Three Months Ended July 31,


      

        Six Months Ended July 31,2006

        

        2005

        

        2006

        

        2005Net income

        

        $

        5,862,172

        

        $

        6,590,080

        

        $

        8,600,242

        

        $

        9,350,398Dividends on preferred stock

        

        

        (13,800

        )

        

        (13,800

        )

        

        (27,600

        )

        

        (27,600

        )Income available to common shareholders

        

        $

        5,848,372

        

        $

        6,576,280

        

        $

        8,572,642

        

        $

        9,322,798Basic weighted average number of common shares outstanding

        

        

        14,327,808

        

        

        14,080,355

        

        

        14,325,600

        

        

        13,930,967Effect of dilutive stock options

        

        

        15,724

        

        

        80,461

        

        

        22,329

        

        

        123,903Diluted weighted average number of common shares outstanding

        

        

        14,343,532

        

        

        14,160,816

        

        

        14,347,929

        

        

        14,054,870


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- B - Net Income Per Share (continued)

For the periods indicated, we issued the following number of common shares as a result of stock option exercises.



Three
          Months Ended July 31,
      
      Six
          Months Ended July 31,2006
      
      2005
      
      2006
      
      2005Common
          shares issued
      
      
      
      463,547
      
      6,000
      
      557,297


For each of the periods indicated, the effect of these exercises is included in the basic and diluted weighted average number of common shares outstanding.

Options to purchase 142,000 shares of common stock, at a weighted average exercise price of $23.91 per share, were outstanding at July 31, 2006. At July 31, 2005, options to purchase 135,500 shares of common stock, at a weighted average exercise price of $23.75 were outstanding. The effect of these options on the diluted weighted average number of common shares outstanding at July 31, 2006 and 2005 is reflected in the above table that reconciles numerators and denominators of the basic and diluted net income per common share computations.

- C - Income Taxes

Our effective tax rate differs from the federal statutory rate due primarily to state income taxes, offset by tax-exempt interest earnings. The rate for the three months ended July 31, 2006 reflects the impact of the reduction of our estimate of our full year tax rate to 34.85% from the 36.3% we had previously estimated. This reduction is due to a forecasted decrease in year over year earnings versus originally projected amounts and that our tax-exempt interest income is expected to represent a greater percentage of our income than was originally anticipated.

In July 2006, the Financial Accounting Standards Board issued Financial Accounting Standards Board Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an enterprises tax return. This interpretation also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition of tax positions. The recognition threshold and measurement attribute is part of a two step tax position evaluation process prescribed in FIN 48. FIN 48 is effective after the
beginning of an entitys first fiscal year that begins after December 15, 2006. We will adopt FIN 48 as of February 1, 2007, and are currently evaluating the impact, if any, to our consolidated financial statements.

- D - Stock Related Compensation

We have a stock option plan whereby options may be granted to employees or non-employee directors on the basis of contributions to our operations. Details concerning the plan are described in Note G to the financial statements included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2006.

On February 1, 2006 we adopted Financial Accounting Standards Board (FASB) Statement No. 123(R), Share-Based Payment (FAS 123(R)), requiring that the fair value of stock-based compensation be expensed in our financial statements. FAS 123(R) revised FASB Statement No. 123, Accounting for Stock-Based Compensation (FAS 123) and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). FAS 123(R) is supplemented by Securities Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 107. SAB No. 107 expresses the SEC staffs views regarding the interaction between FAS 123(R) and certain SEC rules and regulations, including the valuation of share-based payment arrangements.

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- D - Stock Related Compensation (continued)

We recognize the cost of all employee stock options on a straight-line attribution basis over the respective vesting periods, net of estimated forfeitures. We have selected the modified prospective method of transition; accordingly, prior periods have not been restated. Prior to adopting FAS 123(R), we applied APB 25 and related interpretations in accounting for our stock-based compensation plans. All stock options were granted at the grant date market price. Accordingly, no compensation cost was recognized for stock option grants. Under the modified prospective method, compensation expense will be recorded for the unvested portion of previously issued awards that were outstanding at February 1, 2006 using the same estimate of the grant date fair value and the same attribution method used to determine the pro forma disclosure under FAS 123.

We
    recognized share-based compensation expense of approximately $43,000 and
    $91,000 for the quarter and six-months ended July 31, 2006, respectively.
    These amounts are included as a component of selling and administrative expenses.
    The effect on net income was less than $0.01 per diluted share in both the
quarter and six-month periods.

Prior to February 1, 2006, we accounted for stock-based awards using the intrinsic value method in accordance with APB 25. The following table illustrates the effect on net income and earnings per share for the quarter and six-month periods ended July 31, 2005 if we had applied the fair value recognition provisions of FAS 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure:



Three MonthsEnded July 31,2005


      

        Six MonthsEnded July 31,2005Net income as reported


      


      $


      6,590,080


      


      $


      9,350,398Stock-based employee compensation cost

        

        

        (45,891

        )

        

        (138,070

        )Pro-forma net income

        

        

        6,544,189

        

        

        9,212,328Dividends on preferred stock

        

        

        (13,800

        )

        

        (27,600

        )Pro forma net income available to common shareholders

        

        $

        6,530,389

        

        $

        9,184,728Basic net income per common share, as reported

        


      $

        0.47

        


      $

        0.67Pro forma basic net income per common share

        


      $

        0.46

        


      $

        0.66Diluted net income per common share, as reported

        


      $

        0.46

        


      $

        0.66Pro forma diluted net income per common share

        


      $

        0.46

        


      $

        0.65


As of July 31, 2006, there was $116,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our stock option plan. Of this amount, $51,000 is expected to be recognized over the remainder of the fiscal year ending January 31, 2007.

- E - Revenue Recognition

We recognize revenue at the time of sale of merchandise to our customers. Sales relating to lay-a-way transactions are recognized at the time the customer remits final payment and takes possession of the merchandise. The value of promotional coupons and other discounts that result in a reduction of the price paid by the customer are recorded as a reduction of sales. Sales returns, which are reserved for based on historical experience, are provided for in the period that the related sales are recorded. Proceeds from the sale of gift cards are recorded as a gift card liability. Revenue is recognized when the gift card is redeemed by the holder.

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Item 2. Managements Discussion and Analysis of Financial Condition and Results Of Operations

Forward-Looking Statements

We have made in this report, and from time to time may otherwise make, forward-looking statements (as that term is defined under federal securities laws) concerning our future operations, performance, profitability, revenues, expenses, earnings and financial condition. This report includes, in particular, forward-looking statements regarding expectations of future performance, store openings and closings and other matters. Such forward-looking statements are subject to various risks and uncertainties. Actual results could differ materially from those currently anticipated due to a number of factors. Such factors may include, but are not limited to, our ability to improve or maintain sales and margins, respond to changes in fashion, find suitable retail locations and our ability to attract and retain key management personnel. Such factors may also include other risks and
uncertainties detailed in our other filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended January 31, 2006 (the 2006 10-K). We assume no obligation to update or revise our forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

Investors should also be aware that while we do communicate with securities analysts from time to time, it is against our policy to disclose to them any material non-public information or other confidential information. Accordingly, investors should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, we have a policy against confirming financial forecasts or projections issued by others. Therefore, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.

Critical Accounting Policies

Our critical accounting policies are discussed in Managements Discussion and Analysis of Financial Condition and Results of Operations and notes accompanying the consolidated financial statements that appear in the 2006 10-K. There were no material changes subsequent to the filing of the 2006 10-K in our critical accounting policies or in the assumptions or estimates used to prepare the financial information appearing in this report.

Overview

This Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and accompanying notes appearing elsewhere in this report. As used in this report, the terms fiscal 2007 and fiscal 2008 refer to our fiscal years that will end on January 31, 2007 and January 31, 2008, respectively. The term fiscal 2006 refers to our fiscal year that ended on January 31, 2006.

We operate 333 womens and mens specialty apparel retail stores in regional malls and strip shopping centers principally located in the East and Midwest regions of the United States. We operate 325 stores under the name DEB which offer moderately priced, fashionable, coordinated womens tops, bottoms, dresses, coats, lingerie, accessories, shoes and novelty items for junior and plus-sizes. DEB merchandise consists of clothing and accessories appealing primarily to fashion-conscious junior and plus-sized female consumers between the ages of 13 and 25. One hundred seventy four of the DEB stores contain plus-size departments. In addition, we operate two outlet stores under the name CSO. The outlet stores offer the same merchandise as DEB at reduced prices and serve as clearance stores for slow-moving inventory. We also operate six apparel retail
stores under the name Tops N Bottoms. The Tops N Bottoms stores sell moderately priced mens and womens apparel. Thirteen of the DEB stores contain Tops N Bottoms departments.

Operating results for the quarter ended July 31, 2006 (the Current Quarter) included a 4.3% decrease in comparable store sales. The comparable store sales decrease was almost fully offset by the sales from new stores. We operated an average of 333 stores during the Current Quarter versus 323 stores during the quarter ended July 31, 2005 (the Comparable Quarter). The decrease in our sales and earnings during the Current Quarter versus the Comparable Quarter was principally due to lower than expected sales throughout our store base during the months of June and July. During the quarter we did experience sales increases in our dresses and, to a lesser extent, shoe categories. However, these increases were more than offset by weakness in our bottoms business in both junior and plus sizes.

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We believe the decrease in our sales and earnings was in part attributable to the challenging economic environment brought on by energy and fuel prices that are near their all-time high and by the effect of rising interest rates. Our target customer is the value conscious female consumer between the ages of 13 to 25. We believe that when there is a reduction in disposable household income for our core demographic, there is typically a temporary, negative impact on purchases of non-essential items such as clothing and accessories.

The following table sets forth certain store information.



Store Data (1)Three Months EndedJuly 31,

        

        Six Months EndedJuly 31,2006

        

        2005

        

        2006

        

        2005Stores open at end of the period


      


      


      333


      


      


      326


      


      


      333


      


      


      326Average number in operation during the period

        

        

        333

        

        

        323

        

        

        331

        

        

        323Average net sales per store (in thousands)

        

        $

        227

        

        $

        235

        

        $

        475

        

        $

        475Average operating income per store (in thousands)

        

        $

        23

        

        $

        29

        

        $

        34

        

        $

        39Comparable store sales(2)- percent change

        

        

        (4.3


      )%

        

        4.5

        %

        

        (0.8


      )%

        

        5.7

        %


The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of net sales:



Three
          Months EndedJuly 31,
      
      Six
          Months EndedJuly 31,2006
      
      2005
      
      2006
      
      2005Net
          sales
      
      100.0
      %
      100.0
      %
      100.0
      %
      100.0
      %Gross
          margin
      
      37.7
      %
      38.2
      %
      32.7
      %
      33.1
      %Operating
          income
      
      10.2
      %
      12.1
      %
      7.1
      %
      8.2
      %Income
          before income taxes
      
      11.8
      %
      13.9
      %
      8.4
      %
      9.7
      %Income
          tax provision
      
      4.0
      %
      5.2
      %
      2.9
      %
      3.6
      %Net
          income
      
      7.8
      %
      8.7
      %
      5.5
      %
      6.1
      %


Results of Operations

Three Months Ended July 31, 2006 Compared to Three Months Ended July 31, 2005

Net sales

Net sales decreased 0.4% during the three months ended July 31, 2006 (the Current Quarter) to $75,658,000 from $75,966,000 in the quarter ended July 31, 2005 (the Comparable Quarter). The $308,000 decrease was the result of a 4.3% or $3,197,000 comparable store sales decrease, offset by the effect of operating an average of 333 stores during the Current Quarter versus 323 stores in the Comparable Quarter. We believe that the comparable store sales decrease is in part attributable to the challenging economic environment brought on by energy and fuel prices that are near their all-time high and by the effect of rising interest rates. The number of transactions during the Current Quarter decreased approximately 2.7% versus the Comparable Quarter.

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|(1) | Includes
        Tops N Bottoms stores.                                                                                                                   
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Comparable
        stores sales include stores open for both periods. A store is added to
        the comparable store base in its 13th month of operation.

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Cost of sales, including buying and occupancy costs

Cost of sales, including buying and occupancy costs, increased $228,000 or 0.5% during the Current Quarter to $47,163,000 from $46,934,000 in the Comparable Quarter. As a percentage of sales, these costs increased to 62.3% from 61.8% in the Comparable Quarter. The dollar increase between periods was due to an increase in buying and occupancy costs as a result of operating an average of 10 additional stores during the Current Quarter versus the Comparable Quarter. As a percentage of sales, these costs increased due to the de-leveraging of buying and occupancy costs as a result of our 4.3% comparable store sales decrease. Partially offsetting the dollar and percentage increases was an improvement in merchandise margins arising from an increase in initial mark-up, net of an increase in markdowns. Buying and occupancy costs were 17.6% and 16.7% of net sales for the Current Quarter and
Comparable Quarter, respectively.

Selling and administrative expenses

Selling and administrative expenses increased $924,000 or 5.0% during the Current Quarter to $19,450,000 from $18,526,000 in the Comparable Quarter. As a percentage of net sales, these costs increased to 25.7% from 24.4% in the Comparable Quarter. The increase was due to increases in store, store supervisory and corporate office payroll expenses and buyer and store supervisory related travel expenses.

Depreciation and amortization

Depreciation expense increased $28,000 or 2.2% to $1,310,000 in the Current Quarter from $1,283,000 in the Comparable Quarter. As a percentage of net sales, these expenses remained consistent at 1.7%.

Other income, principally interest

Other
    income, principally interest, decreased $158,000 or 11.9% to $1,167,000 in
    the Current Quarter from $1,325,000 in the Comparable Quarter. The decrease
    was the result of a $63,900,000 decrease in the average amount invested.
    The decrease in the amount invested was the result of the $6 per share special
    dividend paid on August 16, 2005, partially offset by cash generated from
    our operations. Further offsetting the decrease in other income was an increase
    in the average interest rates during the Current Quarter versus the Comparable
    Quarter.

Income tax provision

The income tax provision for the Current Quarter was $3,040,000, resulting in a 34.1% effective tax rate, as compared to $3,958,000 and a 37.5% effective tax rate for the Comparable Quarter. The effective tax rate for the Current Quarter resulted from decreasing the anticipated tax rate for fiscal 2007 to 34.85%. The rate reduction resulted from a forecasted decrease in year over year earnings and the fact that our tax-exempt interest income is expected to represent a greater percentage of our income than was originally anticipated. The effective tax rate for the Comparable Quarter represents the rate that, at that time, was anticipated for fiscal 2006. The actual rate for fiscal 2006 was 36.6%.

Six Months Ended July 31, 2006 Compared to Six Months Ended July 31, 2005

Net sales

Net sales increased 2.4% during the six months ended July 31, 2006 (the Current Year-to-Date Period) to $157,116,000 from $153,451,000 in the six months ended July 31, 2005 (the Comparable Year-to-Date Period). The $3,665,000 increase was the result of operating an average of 331 stores during the Current Year-to-Date Period versus 323 stores in the Comparable Year-to-Date Period, offset by a 0.8%, or $1,194,000 decrease in comparable store sales. The decrease in comparable store sales began in late May and continued through July. We believe that the comparable store sales decrease is in part attributable to the challenging economic environment brought on by energy and fuel prices that are near their all-time high and by the effect of rising interest rates. The number of transactions during the Current Year-to-Date Period decreased approximately 2.7% versus
the Comparable Year-to-Date Period.

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Cost of sales, including buying and occupancy costs

Cost of sales, including buying and occupancy costs, increased $3,119,000 or 3.0% during the Current Year-to-Date Period to $105,736,000 from $102,617,000 in the Comparable Year-to-Date Period. As a percentage of sales, these costs increased to 67.3% from 66.9% in the Comparable Year-to-Date Period. The dollar increase was due to the aforementioned $3,665,000 increase in sales and from the fact that we operated an average of 331 stores during the Current Year-to-Date Period versus 323 stores in the Comparable Year-to-Date Period. The additional stores result in higher overall occupancy costs. The increase as a percentage of sales was due to the de-leveraging of buying and occupancy costs as a result of our 0.8% comparable store sales decrease. Buying and occupancy costs were 16.7% and 16.3% of net sales for the Current Year-to-Date Period and Comparable Year-to-Date Period, respectively.

Selling and administrative expenses

Selling and administrative expenses increased $2,084,000 or 5.9% during the Current Year-to-Date Period to $37,705,000 from $35,621,000 in the Comparable Year-to-Date Period. As a percentage of net sales, these costs increased to 24.0% from 23.2% in the Comparable Year-to-Date Period. The increase was due to a $1,500,000 increase in store, store supervisory and corporate office payroll expenses, $237,000 in buyer and store supervisory related travel expenses, a $95,000 increase in merchant fees related to credit card charges, and $91,000 in stock compensation expense arising from the adoption of FAS 123(R).

Depreciation and amortization

Depreciation expense decreased $75,000 or 2.8% to $2,575,000 in the Current Year-to-Date Period from $2,649,000 in the Comparable Year-to-Date Period. As a percentage of net sales, these expenses decreased to 1.6% from 1.7% in the Comparable Year-to-Date Period. The decrease was due to the fact that in the Comparable Year-to-Date Period, we recorded an additional depreciation expense charge relating to a store that was closing prior to its scheduled lease termination. Partially offsetting this decrease is depreciation expense related to assets placed in service for new and remodeled stores during the past 12 months. During the period from August 1, 2005 through July 31, 2006, we opened 14 new stores and remodeled 11 locations.

Other income, principally interest

Other
    income, principally interest, decreased $273,000 or 11.6% to $2,100,000 in
    the Current Year-to-Date Period from $2,373,000 in the Comparable Year-to-Date
    Period. The decrease was the result of a $61,000,000 decrease in the average
    amount invested. The decrease in the amount invested was the result of the
    $6 per share special dividend paid on August 16, 2005, partially offset by
    cash generated from our operations. Further offsetting the decrease in other
    income was an increase in the average interest rates during the Current Year-to-Date
    Period versus the Comparable Year-to-Date Period.

Income tax provision

The income tax provision for the Current Year-to-Date Period was $4,600,000, resulting in a 34.85% effective tax rate, as compared to $5,586,000 and a 37.4% effective tax rate for the Comparable Year-to-Date Period. The effective tax rate for the Current Year-to-Date Period is the rate anticipated for fiscal 2007. The actual effective tax rate for fiscal 2006 was 36.6%. The effective tax rate for the Current Year-to-Date Period is lower than the actual rate for fiscal 2006 because our tax-exempt interest income is expected to represent a greater percentage of our income in fiscal 2007 than in fiscal 2006.

Liquidity and Capital Resources

As of July 31, 2006, we had cash and cash equivalents of $23,999,000 and marketable securities of $92,000,000 compared to cash and cash equivalents of $119,077,000 and marketable securities of $69,625,000 as of July 31, 2005. The decrease in our total cash and cash equivalents and marketable securities compared to last year is primarily the result of the August 16, 2005 payment of a $6 per share special dividend. The total amount of this dividend payment was $85,916,000.

The cash and cash equivalents are invested principally in money market mutual funds while the marketable securities are invested principally in auction market securities, which trade on a par-in, par-out basis and provide interest-rate reset options on a revolving 35-day basis. Because we regularly liquidate our investments in these securities for reasons including, among others, changes in market interest rates and changes in the availability of and the yield on alternative investments, we have classified these securities as available for sale. We do not invest for trading purposes and therefore do not believe we have significant exposure to market risk with respect to our investments.

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During the Current Year-to-Date and Comparable Year-to-Date Periods, we funded all of our operating needs internally, including capital expenditures for the opening of new stores and the remodeling of existing stores. For the Current Year-to-Date Period, cash provided by operations was $5,557,000, resulting primarily from net income, increased by the non-cash charge for depreciation and amortization. Offsetting the cash generated from earnings were payments made for income taxes and a reduction in accrued and other expenses. Cash was also used for the seasonal build-up in merchandise inventory. A portion of this build-up is reflected in the increase in accounts payable.

During the Comparable Year-to-Date period, cash provided by operations was $7,353,000, resulting primarily from net income and the non-cash charge for depreciation and amortization and by the increase in trade accounts payable, offset by the related increase in merchandise inventories. Tax payments also offset operating cash flows.

Using cost of sales (excluding buying and occupancy expenses) divided by average inventory at cost for the applicable periods, the inventory turnover rates were approximately 2.5 times for the Current Year-to-Date Period and 2.6 times for the Comparable Year-to-Date Period.

During the Current Year-to-Date Period, net cash used in investing activities was $4,624,000. We used $3,624,000 for capital acquisitions related to opening of 10 new stores and for the remodeling of five existing locations. We also purchased $9,600,000 in marketable securities, offset by sales of $8,600,000 of similar investments.

During the Comparable Year-to-Date Period, net cash provided by investing activities was $74,631,000. These funds were generated from the net sales of marketable securities, primarily to fund the special $6.00 per common share dividend we paid on August 16, 2005. We also used $1,844,000 for capital additions relating to the opening of four new stores and the remodeling of 11 existing stores.

During the Current Year-to-Date Period, net cash used in financing activities was $3,455,000. These funds were used for the payment of dividends on common and preferred stock, partially offset by proceeds from employee stock option exercises.

During the Comparable Year-to-Date Period, net cash provided by financing activities was $6,795,000. These funds were provided by employee stock option exercises and the related tax benefits, partially offset by the payment of dividends on common and preferred stock.

During
    fiscal 2008, we expect to begin the roll-out of new point-of-sale hardware
    and software. We anticipate the cost of this implementation will not exceed
    $4,000,000 and expect completion during fiscal 2008. We have an unsecured
    line of credit in the amount of $20,000,000 as of July 31, 2006. Of this
    amount, $295,000 was outstanding as letters of credit for the purchase of
    inventory. We believe that our existing cash and marketable securities and
    internally generated funds will be sufficient to meet our anticipated capital
    expenditures and current operating needs. Initial lease terms for our retail
    apparel stores, warehouse and office building range from 10 to 20 years.
    Following is a summary of our contractual obligations for minimum rental
    payments on
    our non-cancelable operating leases and minimum payments on other commitments
    as of July 31, 2006.



Payments Due by PeriodContractual obligations

        

        Total

        

        Less than 1year

        

        1 - 3years

        

        3 - 5years

        

        More than 5yearsOperating leases


      


      $


      157,414,000


      


      $


      25,310,000


      


      $


      44,981,000


      


      $


      34,649,000


      


      $


      52,474,000Letters of credit

        

        

        295,000

        

        

        295,000

        

        

        

        

        

        

        

        

        Total

        

        $

        157,709,000

        

        $

        25,605,000

        

        $

        44,981,000

        

        $

        34,649,000

        

        $

        52,474,000


The above table excludes $1,805,000 in common and preferred stock dividends, which were accrued at July 31, 2006 and were paid in August 2006.

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Other Matters

Seasonality and Quarterly Results

Our operating results are subject to seasonal fluctuations. Highest sales levels have historically occurred during the five-month period from August 1 to December 31 of each year (the back-to-school and holiday periods). Sales generated during these periods have traditionally had a significant impact on our results of operations. Any decreases in sales for these periods or in the availability of working capital needed in the months preceding these periods could have a material adverse effect on our results of operations. Results of operations in any one fiscal quarter are not necessarily indicative of the results of operations that can be expected for any other fiscal quarter or for the full fiscal year.

Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of expenses incurred in connection with, and sales contributed by, new stores, store remodels and the integration of new stores into our operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of July 31, 2006, we had cash and cash equivalents of $23,999,000 and marketable securities of $92,000,000 compared to cash and cash equivalents of $119,077,000 and marketable securities of $69,625,000 as of July 31, 2005. The decrease in our total cash and cash equivalents and marketable securities compared to last year is primarily the result of the August 16, 2005 payment of a $6 per share special dividend. The total amount of this dividend payment was $85,916,000.

The cash and cash equivalents are invested principally in money market mutual funds while the marketable securities are invested principally in auction market securities, which trade on a par-in, par-out basis and provide interest-rate reset options on a revolving 35-day basis. Because we regularly liquidate our investments in these securities for reasons including, among others, changes in market interest rates and changes in the availability of and the yield on alternative investments, we have classified these securities as available for sale. We do not invest for trading purposes and therefore do not believe we have significant exposure to market risk with respect to our investments.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our chief executive officer and chief financial officer, with the participation of other members of management, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report (the Evaluation Date) and, based on that evaluation, concluded that, as of the Evaluation Date, the disclosure controls and procedures were effective for recording, processing, summarizing and reporting information that is required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, within the time periods specified in the SECs rules and forms.

(b) Changes in Internal Control over Financial Reporting

There has not been any change in our internal control over financial reporting during the quarter ended July 31, 2006 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

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PART II. Other Information

Item 1.Legal Proceedings

Not Applicable.

Item 1A.Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part 1, Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended January 31, 2006, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K for the fiscal year ended January 31, 2006 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and / or operating results.

Items 2 and 3.

Not Applicable

Item 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our annual meeting was held on Wednesday, May 17, 2006. Total votes present either in person or by proxy were 13,918,852.

Votes were cast as follows for the election of directors:



FOR
      
      WITHHELDMarvin
          Rounick
      
      13,815,003
      
      103,849Warren
          Weiner
      
      13,815,003
      
      103,849Jack
          A. Rounick
      
      13,815,003
      
      103,849Barry
          H. Feinberg
      
      13,682,671
      
      236,181Barry
          H. Frank
      
      13,634,649
      
      284,203Ivan
          Inerfeld
      
      13,684,571
      
      234,281Ned
          J. Kaplin
      
      13,900,703
      
      18,149


There were no other matters voted on at the meeting.

Item 5.

Not Applicable

Item 6.Exhibits



Exhibit
          31.1
      Section
          302 Certification by President and Chief Executive Officer, pursuant
          to Rule 13a-14(a) under the Securities Exchange Act of 1934Exhibit
          31.2
      Section
          302 Certification by Chief Financial Officer, pursuant to Rule 13a-14(a)
          under the Securities Exchange Act of 1934Exhibit
          32.1
      Certification
          of Periodic Report by President and Chief Executive Officer, pursuant
          to 18 U.S.C. Section 1350Exhibit
          32.2
      Certification
          of Periodic Report by Chief Financial Officer, pursuant to 18 U.S.C.
          Section 1350


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SIGNATURES

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



DEB SHOPS, INC.DATE: September 8, 2006

        

        By:

        /s/ Marvin RounickMarvin RounickPresident and Chief Executive OfficerDATE:  September 8, 2006

        

        By:

        /s/ Barry J. Susson, CPABarry J. Susson, CPAChief Financial Officer and Assistant Secretary


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Exhibit Index



Exhibit
          31.1
      Section
          302 Certification by President and Chief Executive OfficerExhibit
          31.2
      Section
          302 Certification by Chief Financial OfficerExhibit
          32.1
      Certification
          of Periodic Report by President and Chief Executive OfficerExhibit
          32.2
      Certification
          of Periodic Report by Chief Financial Officer


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